[Senate Hearing 112-594]
[From the U.S. Government Publishing Office]
S. Hrg. 112-594
INTERNATIONAL HARMONIZATION OF WALL STREET REFORM: ORDERLY LIQUIDATION,
DERIVATIVES, AND THE VOLCKER RULE
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HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
ON
EXAMINING ORDERLY LIQUIDATION, DERIVATIVES, AND THE VOLCKER RULE
__________
MARCH 22, 2012
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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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
Charles Yi, Chief Counsel
Laura Swanson, Policy Director
Glen Sears, Senior Policy Advisor
Jeff Siegel, Senior Counsel
Jeannette Quick, OCC Detailee
Jana Steenholdt, Legislative Assistant
Andrew Olmem, Republican Chief Counsel
Michelle Adams, Republican Counsel
Mike Piwowar, Republican Senior Economist
Dawn Ratliff, Chief Clerk
Riker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, MARCH 22, 2012
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
WITNESSES
Lael Brainard, Under Secretary for International Affairs,
Department of the Treasury..................................... 4
Prepared statement........................................... 37
Responses to written questions of:
Senator Hagan............................................ 70
Senator Toomey........................................... 70
Daniel K. Tarullo, Member, Board of Governors of the Federal
Reserve
System......................................................... 6
Prepared statement........................................... 40
Responses to written questions of:
Senator Toomey........................................... 72
Elisse B. Walter, Member, Securities and Exchange Commission..... 7
Prepared statement........................................... 43
Responses to written questions of:
Senator Hagan............................................ 75
Senator Toomey........................................... 77
Martin J. Gruenberg, Acting Chairman, Federal Deposit Insurance
Corporation.................................................... 9
Prepared statement........................................... 52
John G. Walsh, Acting Comptroller, Office of the Comptroller of
the Currency................................................... 10
Prepared statement........................................... 58
Jacqueline H. Mesa, Director of the Office of International
Affairs, Commodity Futures Trading Commission.................. 12
Prepared statement........................................... 66
Additional Material Supplied for the Record
Letter submitted by Senator Merkley from Thierry Philiponnat,
Secretary General, Finance Watch............................... 79
(iii)
INTERNATIONAL HARMONIZATION OF WALL STREET REFORM: ORDERLY LIQUIDATION,
DERIVATIVES, AND THE VOLCKER RULE
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THURSDAY, MARCH 22, 2012
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:48 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 call this hearing to order.
I thank our witnesses for joining us.
Today, this Committee continues its oversight of the
implementation of the Wall Street Reform Act. Since our last
Wall Street Reform hearing in December, there have been
significant developments on implementation, including new
proposed and final rules in areas critical to strengthening
market oversight and stability.
Among the many lessons apparent from the recent financial
crisis is that the financial system is truly global and that
risks and regulations in one country can have significant
effects on institutions and markets worldwide. Last month, we
held a hearing to examine the European debt crisis and any
potential spillover effects in the U.S. Today's hearing will
focus on the possible effects of our new financial rules on
international markets and on international competitiveness for
U.S. institutions.
Some of the most complex and critical rulemakings of the
Wall Street Reform Act are the ones with international
implications that we will focus on today. The FDIC's new
orderly liquidation authority, as well as the creation of
living wills and the SIFI designation, will together help
ensure that large, multinational, interconnected financial
institutions may be quickly wound down in times of stress
without exposing taxpayers to losses or threatening the
financial system.
In order to fully implement these important rules, our
agencies must work closely with their international partners to
make cross-border resolutions orderly and coordinated so that
global firms will no longer be too big to fail. I look forward
to the agencies providing an update on efforts to harmonize
regulations.
The Volcker Rule also raises a number of complicated issues
with potential international effects. It is important to
carefully implement the rule's prohibitions on prop trading and
fund investments in a manner that does not impair market
making, underwriting, client services, hedging, and other
permitted activities so important to our economy. Market
participants need greater clarity about the conformance period
and what will be required of them starting this July. I look
forward to hearing the witnesses' comments on these issues as
well as their views on the rule's potential impact on capital
markets, Governments, and institutions around the world.
Additionally, international coordination is key to bringing
greater stability and transparency to the $700 trillion global
derivatives market. Ideally, the rules the CFTC, SEC, and
prudential regulators are working to finalize should have no
substantive degree of variance and only differ for kinds of
firms and transactions the rules are being applied to. In
addition, global harmonization and rules relating to margin,
capital, and clearing will be essential to promoting financial
stability, effective oversight, and competitiveness of U.S.
companies doing business abroad.
I welcome the regulators' updates on these developments and
on the next steps for strengthening the global financial
system.
While our economy is starting to show signs of recovery
from the financial crisis, we must remain vigilant in ensuring
that Wall Street Reform is implemented thoughtfully and with
full consideration of international implications. The Wall
Street Reform law gave our regulators the tools to address
global threats to financial stability as well as oversight over
new, uncharted areas of the international financial markets. We
have already seen good progress in the recently announced
stress tests, showing U.S. banks in a much stronger position
than they were before the crisis. But until the new rules are
fully implemented, our financial system remains vulnerable to
threats both from within the U.S. and from abroad.
I believe our Committee's robust oversight of Wall Street
Reform has reaffirmed the need for, and improved the
implementation of, this important legislation. As I have said
before, I am open to the idea of improving Wall Street Reform
by making technical corrections and fixing unintended
consequences, but in today's political environment, there will
need to be broad bipartisan support to get anything approved.
Senator Shelby, your opening statement.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you. Thank you, Mr. Chairman.
Welcome, everyone.
Today, our financial regulators will update us on their
efforts to harmonize the requirements of the Dodd-Frank Act
with the financial regulations of other countries. I think this
is an important issue due to the global nature of modern
financial markets.
Today, nearly all major U.S. financial institutions have
operations overseas, and most major foreign financial
institutions have operations, of course, in the U.S. The
globalization of finance has generally been a positive
development. It helps firms raise capital at lower rates and
more effectively manage their risk. This, in turn, helps
financial institutions lend more cheaply to businesses and to
consumers.
Yet the globalization of finance means that regulators need
to be mindful of how their regulations interact with the
regulations of other countries. Poorly conceived loans or
ineffective coordination by regulators can easily undermine the
efficiency of the international economic system. And although
such regulatory failures often go largely unnoticed, the
consequences can be significant.
The impacts show up in the form of higher interest rates
and fees for consumers and higher operating costs for
businesses. Ultimately, higher prices reduce economic growth
and job creation.
We only need to recall how poor international economic
coordination in the 1930s stemming from the Smoot-Hawley Act
and other laws worsened the Great Depression. Accordingly, I
believe it is critical that Congress and our financial
regulators make sure that Dodd-Frank does not worsen an already
troubled economy by unnecessarily impeding the international
financial system.
I think it is worth noting that 2 years ago, when Dodd-
Frank was passed, the thought that Dodd-Frank would create any
international coordination problems was not on the minds of the
Act's supporters. Rather, we were told here that the rest of
the world would follow our lead and adopt legislation similar
to Dodd-Frank. Of course, this has not happened.
To the contrary, foreign regulators and Governments have
publicly expressed serious concerns about Dodd-Frank. Canada,
Germany, Japan, the United Kingdom, as well as European Union
have all identified profound problems with the implementation
of Dodd-Frank. These problems include reducing the liquidity of
their Government bond markets and the discriminatory treatment
of foreign firms.
In addition, many market participants have expressed
concerns about the extraterritorial reach of Dodd-Frank. They
justifiably fear that they will find themselves caught in a
regulatory trap, as many Dodd-Frank rules may conflict with
theirs. These concerns have been worsened by the fact that our
financial regulators have already missed 70 percent of the
Dodd-Frank rulemaking deadlines. And as a consequence, 2 years
after the passage of Dodd-Frank, market participants are still
unclear if and how Dodd-Frank rules will apply to their
international banking operations.
The risk of having to comply with Dodd-Frank's costly
regulations is causing many firms to reconsider doing business
in the U.S. The U.S. should be the market of choice because it
is the most sophisticated and modern. It should not be the
market firms desperately seek to avoid due to its costly and
heavy-handed regulatory approach.
But looking forward, it is my hope that our regulators will
take the time to ensure that the Dodd-Frank rulemakings have as
few unintended consequences as possible. I hope to hear today
how our financial regulators are working with their foreign
counterparts to address legitimate concerns about Dodd-Frank.
In particular, I hope to hear how our regulators are working to
address the major discrepancies that exist between the U.S. and
international derivatives rules, especially with respect to
margin and capital requirements.
I also hope to learn today what specific steps regulators
have taken to ensure that the FDIC's new orderly liquidation
authority can effectively wind down a large international firm.
As we saw with the failure of Lehman and, more recently, MF
Global, the collapse of an international financial firm can
leave customer assets frozen in several countries, making
resolution of a firm substantially more difficult. Hopefully,
the next time a major international financial institution
fails, regulators will have a far more efficient and effective
response than the CFTC's response to MF Global.
Unfortunately, in the nearly 2 years since the passage of
Dodd-Frank, regulators have done little to instill confidence
that Dodd-Frank will do anything other than increase the cost
of doing business in America.
Thank you, Mr. Chairman.
Chairman Johnson. Thank you, Senator Shelby.
Are there any other Members who wish to make a brief
opening statement?
[No response.]
Chairman Johnson. Thank you all. I want to remind my
colleagues that the record will be open for the next 7 days for
opening statements and any other material you would like to
submit.
Now, I will briefly introduce our witnesses. Lael Brainard
is the Under Secretary for International Affairs at the U.S.
Department of the Treasury.
Dan Tarullo is currently serving as a Member of the Board
of Governors of the Federal Reserve System.
Elisse Walter is currently serving as a Commissioner on the
U.S. Securities and Exchange Commission.
Marty Gruenberg is the Acting Chairman of the Federal
Deposit Insurance Corporation.
John Walsh is the Acting Comptroller of the Office of the
Comptroller of the Currency.
Jacqueline Mesa is Director of International Affairs at the
U.S. Commodities Futures Trading Commission.
I thank you all again for being here today. I would like to
ask the witnesses to please keep your remarks to 5 minutes.
Your full written statements will be included in the hearing
record.
Under Secretary Brainard, you may begin your testimony.
STATEMENT OF LAEL BRAINARD, UNDER SECRETARY FOR INTERNATIONAL
AFFAIRS, DEPARTMENT OF THE TREASURY
Ms. Brainard. Thank you, Chairman Johnson, Ranking Member
Shelby, and distinguished Members of the Committee.
There is an important debate over the merits of moving slow
or fast, of moving first or last. As you know, partly due to
the efforts of this Committee, we moved both fast and first to
reform our financial system and this strategy is already
demonstrating its effectiveness, both in terms of the strength
of our institutions and their ability to weather shocks and in
bringing the world to our standards.
From 2009 through the end of 2011, Tier I common equity of
large bank holding companies increased by more than $400
billion. Short-term wholesale funding at the four largest bank
holding companies decreased from 36 percent to 20 percent. And
core deposits as a share of total liabilities at FDIC-insured
institutions increased from a low of 44 percent to 64 percent.
Far from disadvantaging U.S. institutions and harming credit,
these early actions put U.S. banks in a stronger position as we
entered the financial volatility at the end of last year and,
indeed, supported credit growth of 11 to 12 percent annual
rates in the third and fourth quarters.
By contrast, as you know, Europe opted to move more slowly.
As a result, many Euro area banks were less resilient in the
face of shocks last year, contributing to financial stress and
a negative spiral.
By moving first, we led from a position of strength in
setting the international reform agenda and elevating the
world's standards to our own. The alternatives, either
following the reform standards set by other countries or
subjecting our firms to a divergent set of standards across the
board, would have been unacceptable. It is also worth noting
that not only the established financial centers in advanced
economies but also up-and-coming emerging market financial
centers are signing up for the same set of standards.
As you know, going into the crisis, too many financial
institutions had too much leverage and too little liquidity. We
have now gotten across the international system new global
capital liquidity and leverage standards. We have identified
globally systemic important banks and agreed globally to
subject them to enhanced prudential measures, including a
capital surcharge. We are, of course, remaining vigilant as
these rules are implemented, and we are pressing to ensure
banks across the world measure risk-weighted assets similarly.
Going into the crisis, few understood the magnitude of
aggregate derivatives exposures in the system. Now, we have
secured agreement on international standards for the OTC
derivatives markets for the first time, requiring consistent
reporting, moving trading onto exchanges, and requiring central
clearing. Of course, as these rules are implemented, we have to
guard against fragmentation or weaknesses in the global
payments infrastructure and avoid geographic mandates for
clearing. We are also pressing for accelerated time tables. We
are also pressing, with success, to finalize a global standard
for posting margin on uncleared derivatives transactions to
reinforce the incentives for central clearing.
And finally, going into the crisis, countries lacked tools
to resolve systemically important financial institutions,
effectively rendering them too big to fail. Going forward, all
major financial jurisdictions have agreed to put in place the
tools to resolve large cross-border firms. Implementation is
already underway. The UK, Germany, and Canada have already
passed resolution legislation and the European Commission is
developing a draft for the second quarter of this year. The FSB
is working actively to ensure regulators and the major global
banks developed cross-border living wills by the end of 2012,
criteria to improve the resolvability of these institutions,
and institution-specific resolution cooperation arrangements.
New laws and rules aimed at the home market of any major
financial center will inevitably, as you recognized in writing
the law, have cross-border implications. Regulators now have to
sort out whose rules apply, how, and where. Aligning the
substance the timing of reforms across jurisdictions is perhaps
the first best insurance we have in that process. The greater
the convergence around high-quality standards, the greater the
scope for deferring to jurisdictions that have similar
regulatory regimes.
There are only one or two notable exceptions. As you know,
the United States has moved ahead of others on the Volcker
Rule, but it is important to recognize that other jurisdictions
are grappling with the same issues pertaining to the structure
of risk taking. In the UK, the Vickers Commission proposed
rules to ring fence core financial intermediation activities,
and in the EU, Commissioner Barnier has set up a commission to
look at this issue with particular interest in studying the
implementation of the Volcker Rule.
We cannot lose sight of the costs of the last crisis, nor
can we lose sight of the causes. That is why we think it is
critical to complete the work we have begun. Thank you.
Chairman Johnson. Thank you.
Governor Tarullo, please proceed.
STATEMENT OF DANIEL K. TARULLO, MEMBER, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Tarullo. Thank you, Mr. Chairman, Senator Shelby, other
Members of the Committee.
Let me run down briefly for you my perspective on the
significant international activities that are either quite
directly or more generally related to the Dodd-Frank Act.
The Members of this Committee will not be surprised that I
put capital at the top of the list of regulatory imperatives,
both here in the United States and internationally. Basel 2.5,
which deals with market risk, and Basel III, which deals with
both the amount and quality of required capital, were already
done or nearly done when Dodd-Frank was passed, but Dodd-Frank
did add a new requirement that we have enhanced capital
standards for large banking organizations. We supported what
turned out to be a successful international effort to agree on
capital surcharges for banking organizations of global systemic
importance, and the Federal Reserve intends to implement the
Dodd-Frank requirement in a manner consistent with that
international agreement.
We have had a lot of progress on capital internationally,
and I would say that in this area the principal task in the
near term will be to ensure that these various agreements are
being implemented rigorously, both at national levels and
within individual banking organizations. I am pleased that the
Basel Committee has now launched what is far and away its most
significant effort ever to monitor implementation at both the
national and firm level.
On liquidity standards, here too we would like to make the
Basel agreement consistent with our implementation of the Dodd-
Frank requirements of enhanced liquidity standards for large
institutions. Unlike the capital standards, though, the
liquidity standards are in need of further study and revision,
which is currently in progress internationally.
On resolution mechanisms, Title II of the Dodd-Frank Act is
fully consistent with the international standards that have
been adopted, and other jurisdictions are gradually putting in
place their own generally comparable mechanisms. However, even
if all major financial centers follow suit, not all cross-
border resolution problems will be solved. So we will continue
the work that we have begun, along with the FDIC, in addressing
these continuing problems in both multilateral and bilateral
fora.
On OTC derivatives, implementation of the G20 commitments
for reform is proceeding internationally, but I would
characterize it at a somewhat uneven pace from jurisdiction to
jurisdiction. Here, I think our top international priority
should be agreement on margin requirements for uncleared
derivatives.
And finally, I have noted in my prepared testimony a number
of specific issues implicating international interests in parts
of the Dodd-Frank Act where there is less likely to be an
international initiative. In these instances, we do not have
the realistic option of trying to conform an international
agreement to domestic practice, or vice-versa, for that matter.
So here we are going to have to be considering carefully all
these concerns in our own rulemaking as we move forward.
Thank you, Mr. Chairman.
Chairman Johnson. Thank you.
Commissioner Walter, please proceed.
STATEMENT OF ELISSE B. WALTER, MEMBER, SECURITIES AND EXCHANGE
COMMISSION
Ms. Walter. Thank you, Chairman Johnson, Ranking Member
Shelby, and Members of the Committee, for the opportunity to
testify on behalf of the Securities and Exchange Commission
about international cooperation in the realm of financial
regulation.
The impact of regulation across borders has become ever
more important as business has become increasingly global. And
thus, as part of our rulemaking efforts to implement the Dodd-
Frank Act, the SEC has been actively engaged with our
counterparts abroad to coordinate our regulatory reforms. Our
international efforts include both informal and formal
bilateral discussions and arrangements and working through
multilateral organizations. Due to the extensive international
coordination efforts undertaken by the SEC and our colleagues
at other U.S. financial regulatory agencies within
international bodies, the recommendations and international
standards being developed by these groups are broadly
consistent with the Dodd-Frank Act and the G20 objectives.
As the SEC's representative to the Financial Stability
Board and the International Organization of Securities
Commissions, I have detailed our international efforts in my
written testimony, but I would like to highlight just a few
areas this morning.
First, international coordination is particularly important
in reform of the global over-the-counter derivatives markets.
Following the 2008 financial crisis, Congress recognized the
need to bring transparency to these markets and the G20 leaders
shared this concern. SEC and CFTC staff have been working with
our international counterparts to coordinate the technical
issues relating to regulation of derivatives transactions. In
December, global leaders and senior representatives of
authorities responsible for regulation of OTC derivatives
markets met to discuss significant cross-border issues related
to the implementation of new legislation and rules.
Given the global nature of the market, the SEC intends to
address the international implications of its Dodd-Frank
derivatives rules in a single proposal in order to give
interested parties, including investors, market participants,
and foreign regulators, an opportunity to consider as an
integrated whole our approach to cross-border security-based
swap transactions.
The second area that requires robust international
coordination and cooperation is the identification and
mitigation of cross-border risks. The SEC has worked to enhance
its capability to spot and address proactively emerging issues
before they have the potential to cause serious harm to U.S.
markets and the global financial system. We have opened lines
of communication and shared data with our international
counterparts to discuss emerging risks and to react promptly to
new developments.
A third area where international cooperation is important
is the implementation of the Volcker Rule. In the proposal, we
requested and received comment on several international issues.
For example, the proposal, which closely tracks the statute,
includes an exemption for proprietary trading in certain U.S.
and municipal Government obligations, but not for foreign
Government obligations. Many commenters, including some foreign
Governments, have requested that such an exemption be adopted
and have expressed concerns about the proposed rule's potential
impact on liquidity in foreign sovereign debt markets. However,
some commenters have indicated that such an exemption would not
be necessary or would not meet the statutory requirement that
it promote and protect safety and soundness.
The Volcker Rule's general prohibition on covered fund
activities includes certain non-U.S. funds in an effort to
prevent circumvention by simply relocating activities offshore.
Some commenters have stated that this definition may be too
broad, sweeping in foreign retail mutual funds or other types
of regulated pooled investment vehicles. Our Commission staff
is reviewing and considering the comments we have received,
including those on the cross-border implications of Volcker.
A fourth area where we and our foreign counterparts have a
common interest is market efficiency and integrity in light of
the rapid development of new trading technologies and trading
platforms.
Another key priority is assuring meaningful oversight of
registrant firms wherever they are located. In an
interconnected world, increased international supervisory
cooperation is critical. Unfortunately, there currently are
limitations on the ability of some U.S. regulators to achieve
meaningful inspections in some foreign jurisdictions.
Finally, I would like to mention our longstanding bilateral
and multilateral efforts in the enforcement arena.
In conclusion, our ability to further shared objectives and
strengthen cooperative relationships with our counterparts is
an increasingly critical part of our mission. We simply must
work together.
Thank you again for this opportunity to testify.
Chairman Johnson. Thank you.
Chairman Gruenberg, please proceed.
STATEMENT OF MARTIN J. GRUENBERG, ACTING CHAIRMAN, FEDERAL
DEPOSIT INSURANCE CORPORATION
Mr. Gruenberg. Thank you, Mr. Chairman. Chairman Johnson,
Ranking Member Shelby, and Members of the Committee, thank you
for the opportunity to testify on international harmonization
issues related to implementation of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
While there are several issues addressed in my written
testimony, I thought I would focus my oral remarks on progress
we have made on cross-border cooperation on the resolution of
systemically important financial institutions, the so-called
SIFIs.
Section 210 of the Dodd-Frank Act requires the FDIC ``to
coordinate to the maximum extent possible'' with appropriate
foreign regulatory authorities in the event of a resolution of
a SIFI with cross-border operations. The FDIC has been working
on both a multilateral and a bilateral basis with our foreign
counterparts in supervision and resolution to address these
important cross-border issues.
In October of last year, the Financial Stability Board of
the G20 countries released the Key Attributes of effective
resolution regimes for financial institutions. These Key
Attributes set out the features of a legal and regulatory
regime that would allow authorities to resolve financial
institutions in an orderly manner without taxpayer exposure.
They address such critical issues as the scope and independence
of the resolution authority and how jurisdictions can
facilitate cross-border cooperation in resolutions of
significant financial institutions. The FDIC was deeply
involved in the development of the Key Attributes and many of
them parallel the provisions of the U.S. resolution regime
under Title II of the Dodd-Frank Act.
In November of last year, the G20 endorsed these Key
Attributes, and as a result, financial regulators from the G20
member Nations are required to move toward a resolution
framework to resolve SIFIs in an orderly manner that protects
global financial stability.
Now, in addition to the Key Attributes, the FDIC and its
U.S. and foreign financial regulatory counterparts have formed
what have been called Crisis Management Groups under the
auspices of the Financial Stability Board for each of the
internationally active SIFIs. These are the so-called G-SIFIs,
or Global SIFIs, identified by the G20 at the November meeting
last year. These Crisis Management Groups, consisting of both
home and host country authorities, are intended to enhance
institution-specific planning for possible future resolution.
The FDIC has participated in Crisis Management Group
meetings hosted by authorities in various foreign
jurisdictions. In addition, the FDIC has hosted Crisis
Management Group meetings for the five largest U.S. G-SIFIs and
met with specific foreign regulators to discuss the progress
these firms have made on their recovery and resolution plans as
well as other related cross-border issues. These meetings
assist the FDIC in developing and refining its own resolution
strategies for these institutions and helps regulators in
identifying and overcoming impediments to cross-border
resolution.
Finally, the FDIC is also actively reaching out on a
bilateral basis to the foreign supervisors and resolution
authorities with jurisdiction over the foreign operations of
key U.S. firms. The goal is to be prepared to address issues
regarding cross-border regulatory requirements and to gain an
in-depth understanding of the cross-border resolution regimes
and the concerns that face our international counterparts.
It is worth noting that although U.S. SIFIs have foreign
operations in dozens of countries around the world, these
operations tend to be concentrated in a relatively small number
of key foreign jurisdictions, particularly the United Kingdom.
While the challenges to cross-border resolution are formidable,
they may be more amenable than is commonly thought to effective
management through bilateral cooperation.
Our initial work with foreign authorities has been
encouraging. In particular, the U.S. financial regulatory
agencies have made substantial progress with authorities in the
UK in understanding how our respective resolution regimes and
resolution strategies would work. To facilitate bilateral
discussions and cooperation, the FDIC is negotiating Memoranda
of Understanding pertaining to resolutions with regulators in
various countries.
In conclusion, through multilateral and bilateral
engagement, we believe we have made significant progress in
developing a foundation for effective cross-border cooperation
in the event of a future failure of an internationally active
systemically important financial institution. Thank you.
Chairman Johnson. Thank you.
Comptroller Walsh, please proceed.
STATEMENT OF JOHN G. WALSH, ACTING COMPTROLLER, OFFICER OF THE
COMPTROLLER OF THE CURRENCY
Mr. Walsh. Thank you. Chairman Johnson, Ranking Member
Shelby, and Members of the Committee, I appreciate this
opportunity to provide my perspective on the international
implications of the Dodd-Frank Act and on efforts currently
underway to harmonize U.S. regulatory requirements with
international standards.
My written testimony provides greater detail on the
intersection of Dodd-Frank and international efforts in five
key areas: Capital standards, liquidity requirements, orderly
resolution of large complex firms, derivatives activities, and
the Volcker Rule.
Since the financial crisis of 2008, much has been
accomplished to improve the safety and soundness of financial
systems and institutions. Internationally, the G20 Governments,
the Financial Stability Board, the Basel Committee on Banking
Supervision, and other international bodies have developed and
are introducing standards to increase capital and liquidity,
create better mechanisms for resolving large financial
institutions, centralize derivatives clearing, and strengthen
supervision in a number of other areas. Implementation of this
reform agenda is underway in all the G20 countries.
Within the United States, the Dodd-Frank Act encompasses
many important parts of the international reform agenda. It
enhances the resiliency of the U.S. financial system, requires
higher capital and liquidity standards for large financial
institutions, and imposes steps to preclude future taxpayer
bailouts. The Act also seeks to strengthen operations and
safeguards pertaining to derivatives activities by enhancing
transparency and reducing counterparty credit risks.
Most of these efforts are still works in progress and I
believe paths are available for international harmonization in
many of these areas. However, even where there is broad
international consensus, there will be areas where policy
makers in individual countries have chosen to tailor standards
to their countries' specific circumstances rather than adopt
the totality of the international approach.
In the U.S., for example, the Dodd-Frank Act has added two
requirements that will cause our implementation of
international capital standards to differ from those of other
countries. For example, the Collins Amendment requires the same
generally applicable minimum capital requirements to be applied
to bank holding companies as to banks, and places a floor under
the capital requirement for large banks, applying Basel's
advanced approaches capital framework. This goal is to ensure
that capital requirements for large banks do not decline below
generally applicable minimum capital requirements, but it also
means that U.S. banks pursuing safer loans or lower-risk
securities would not obtain a capital benefit for doing so.
Section 939(a) of Dodd-Frank requires all Federal agencies
to remove references to and reliance on credit ratings from
their regulations and replace them with appropriate
alternatives for evaluating creditworthiness. Basel III, in
contrast, continues to rely on credit ratings in many areas, so
implementation of those provisions of Basel III will differ
from international standards and generally be more stringent in
that U.S. credit ratings are referenced in various places,
including in noncapital regulations. While we fully agree that
blind reliance on credit ratings should be stopped, the
cumulative impact of precluding any reference to credit
ratings, even in conjunction with other factors, will be
challenging, particularly for community banks.
The Dodd-Frank Act also contains certain provisions that
have no foreign equivalent, and unlike capital and liquidity
requirements, currently are not the subject of international
harmonization efforts, most notably the Volcker Rule. This
provision generally prohibits a bank from engaging in
proprietary trading and from making investments in and having
certain relationships with a hedge fund or private equity fund.
This is a policy aimed at the organization of activities within
the U.S. banking system, not part presently of a broader
international policy consensus, and as such the legislation
reflects a determination that these policy objectives need to
predominate over competitive considerations.
The OCC is committed to consistent implementation of the
Dodd-Frank Act and international financial regulatory
agreements, and as we move forward with implementing Dodd-
Frank, we must be mindful of the need to strike an appropriate
balance between enhanced regulations, better supervision, and
market restrictions. Achieving a level playing field for
internationally active institutions is an important objective,
but it is never fully achieved and sometimes national policy
choices place other important national objectives above
competitive equity.
Thank you for the opportunity to discuss the international
obligations of Dodd-Frank and to update the Committee on
efforts underway to harmonize U.S. regulatory requirements with
international standards and frameworks. I am happy to answer
your questions.
Chairman Johnson. Thank you.
Ms. Mesa, please proceed.
STATEMENT OF JACQUELINE H. MESA, DIRECTOR OF THE OFFICE OF
INTERNATIONAL AFFAIRS, COMMODITY FUTURES TRADING COMMISSION
Ms. Mesa. Good morning, Chairman Johnson, Ranking Member
Shelby, and Members of the Committee. Thank you for the
opportunity to testify today regarding international aspects of
the Dodd-Frank Act.
The financial crisis has generated international consensus
on the need to strengthen financial regulation by improving
transparency, mitigating systemic risk, and protecting against
market abuse. In September 2009, the G20 leaders agreed that
OTC derivatives contracts should be reported to trade
repositories, standardized contracts should be cleared and
traded on exchanges or platforms, and noncleared contracts
should be subject to higher capital requirements.
In 2010, less than 1 year following that G20 commitment,
Congress broadened the CFTC's and SEC's jurisdiction to include
oversight of the previously unregulated swaps and security-
based swaps market. The CFTC is developing regulations to
implement the Dodd-Frank Act and to establish a regulatory
framework for swaps.
As CFTC rulemakings have progressed, one issue that has
arisen is how Dodd-Frank requirements might apply to swap
activities occurring on a cross-border basis. The CFTC
recognizes that the swaps business flows across national
borders with agreements negotiated and executed between
counterparties in different jurisdictions and individual
transactions often booked and risk managed in other
jurisdictions.
In addressing cross-border issues, the CFTC is charged with
implementing Section 722(d) of the Dodd-Frank Act, which
provides that Title VII provisions shall not apply to swaps
activities outside the United States unless those activities
have a direct and significant U.S. connection or contravene
anti-evasion regulations. The CFTC plans to provide guidance on
the application of Title VII and the Commission's regulations
to non-U.S. entities and to swaps activities occurring on a
cross-border basis and we will seek public input on that
guidance.
In line with the G20 commitments, efforts to regulate OTC
derivatives are underway not only in the United States, but
also abroad. Japan has already passed reform legislation and
the EU is finalizing legislation that provides for mandatory
clearing, reporting, and risk mitigation for OTC derivatives.
Other countries, such as Canada, Hong Kong, and Singapore, have
published consultation documents on the regulation of OTC
derivatives. The global and interconnected nature of the swaps
market makes it imperative that the United States consult and
coordinate with foreign regulators.
The fact that all major market jurisdictions are developing
their OTC requirements pursuant to the G20 directive provides
an opportunity to create a harmonized framework. Congress
directed the CFTC and other U.S. regulators to consult and
coordinate with foreign regulatory authorities on the
establishment of consistent international standards. The CFTC
is fulfilling this statutory mandate through comprehensive and
ongoing bilateral consultation and global coordination. The
CFTC has considered international standards and principles in
developing regulations, and staff has shared our rulemaking
drafts with international counterparts throughout this process.
The CFTC Chairman and Commissioners have met with foreign
regulators to discuss financial reform, and Chairman Gensler
and I have traveled to Brussels several times to discuss
implementation of Title VII. Chairmen Gensler and Schapiro have
met with Canadian, European, and Asian regulators last December
to discuss cross-border issues related to OTC derivatives, and
an even broader group of regulators will meet again in May.
At a staff level, the CFTC and SEC are holding an
unprecedented number of meetings to coordinate regulatory
approaches, specifically with counterparts in Canada, the EU,
Hong Kong, Japan, and Singapore. These discussions will
continue as other jurisdictions develop their own regulatory
requirements for OTC derivatives. In addition, CFTC staff is
participating in the several standard-setting initiatives and
cochairs the IOSCO task force on OTC derivatives.
Throughout implementation of the Dodd-Frank Act, the CFTC
is working with foreign regulators in an effective way to
coordinate regulatory approaches and requirements to the
greatest extent possible.
Thank you, and I would be happy to answer any questions.
Chairman Johnson. Thank you for your testimony.
As we begin questions, I will ask the Clerk to put 5
minutes on the clock for each Member.
Secretary Brainard, I believe the U.S. has led the way with
the comprehensive package of Wall Street reforms as to the
financial crisis. Do you agree, and going forward, how will the
U.S. continue to lead while working toward a level playing
field internationally?
Ms. Brainard. Mr. Chairman, I have participated in multiple
international negotiations, both at the G20 and the FSB, where
our goal has been to bring the world to convergence around the
very strong protections put in place under Dodd-Frank in order
to guard against a competitive disadvantage and also to protect
the safety and soundness of our system.
I would say that, having participated in a lot of
international negotiations over the years in a whole number of
subject areas, we have achieved remarkable success across the
whole host of areas where convergence is seen to be critically
important. OTC derivatives in the area where there really is no
international regulation at all, we now have commitments across
the Financial Stability Board members to put in place
protections that are really modeled in many respects on the
protections under the Dodd-Frank Act.
As Governor Tarullo mentioned, we have a very strong
agreement on capital liquidity and leverage across
internationally active banks, and, for the first time,
agreement that the largest, most complex institutions should be
subjected to additional prudential standards as well as a
capital surcharge that will be equivalent across countries.
Chairman Johnson. Chairman----
Ms. Brainard. I am sorry.
Chairman Johnson. Chairman Gruenberg, can you give us your
assessment of the progress made with foreign regulators on how
to address cross-border resolution issues.
Mr. Gruenberg. Thank you, Mr. Chairman. I think it is fair
to say we have made significant progress in what is admittedly
a very challenging area. I outlined in my testimony the
international set of standards that have been agreed to, the
so-called ``Key Attributes,'' which sets sort of a baseline for
Governments across the world to use in establishing resolution
regimes, and that simply has not existed before. So, the
international acknowledgement of the importance of the issue of
having cross-border cooperation and a capacity to place large
systemically significant institutions into an effective
resolution process, I would suggest, is really an important
step forward.
And, there has been tremendous attention to the systemic
institutions of particular importance. The Crisis Management
Groups--organized under the auspices of the Financial Stability
Board--bringing together the multiple regulators of these
globally significant financial institutions has been really a
valuable tool in getting mutual understanding among us about
the operations of these companies.
And I will tell you, we do put particular importance on
developing bilateral relationships. When you are dealing with a
systemic company that gets into difficulty, you have got to be
able to work as an operational matter with your counterpart,
the supervisor of the country where the foreign operations are.
At the end of the day, that really comes down to the
relationship of our regulators here with the individuals in the
other country. And if you do not have that personal
relationship established, an understanding of the respective
legal requirements that apply, and some common understanding of
the strategies we are considering for resolving these
companies, it becomes very difficult to carry out the
authorities of the Act.
I think what is encouraging is that we have the authorities
here in the United States. We are developing the capability.
And I think we are making progress in terms of establishing the
relationships with our key counterparts to enable us to manage
an orderly resolution of one of these companies.
Chairman Johnson. Governor Tarullo, on the Volcker Rule,
will the agencies provide any formal guidance detailing what
current or prospective activities banks need to unwind or stop
in July, and what will happen during the 2-year conformance
period? Also, since the Volcker Rule amends the Bank Holding
Company Act, will the Fed lead the ongoing supervision,
interpretation, and enforcement of the final rule?
Mr. Tarullo. Mr. Chairman, with respect to the
implementation and what happens with enforcement in any
intervening period, I think there are a couple of things to
say.
First, the Dodd-Frank Act required the Federal Reserve to
promulgate a conformance period regulation within 6 months of
passage, which we did. But, of course, that was promulgated
before we knew what the substantive proposed rule was going to
look like and so it was a bit in the dark as to what activities
the firms were actually going to have to conform.
And I would say that some of the issues that have been
raised by a number of you, a number of your colleagues on the
House side, and by some of the institutions themselves have led
a lot of people to think we probably need to provide some
clarification in light of the proposed rule itself. We do not
have Board action, so I cannot speak to what that would be
specifically, but I can tell you people are aware of the issue.
With respect to the July 21 issue, that would presumably
arise if, first, we do not get a final rule out by then, and
second, regardless of whether we do, whether there is a
question about something being immediately effective and,
therefore, enforceable as opposed to falling under the
conformance period. There is obviously a real possibility that
we do not meet the July 21 date, although I personally think we
should keep trying to do so. However, if we are not going to, I
think it is incumbent on all the regulators to provide some
guidance for firms to let them know exactly what the
expectations will be and not let this hang out there as an
unknown, and I think we should be able to do that, if needed.
You also asked about Volcker Rule implementation. The
Volcker Rule is a joint enterprise. It is actually going to be
two different rules--one, the three prudential regulators, the
other, the two market regulators--so we are obviously trying to
coordinate the terms of the rule and I hope that we would
coordinate our data gathering and enforcement efforts
thereafter.
But I would not say that we would be in the lead,
particularly because in terms of the actual activity to be
regulated, the Federal Reserve would be supervising a
relatively small group of the activities in question. Since the
broker-dealers are primarily regulated by the SEC, the national
banks by the OCC, the Federal Reserve has the nonbank, non-
broker-dealer affiliates of holding companies which do engage
in trading activities, but not in the amounts that those other
two groups do.
Chairman Johnson. One more question. Commissioner Walter
and Director Mesa, I am concerned that the SEC and the CFTC may
not take a unified approach to the potential application of
U.S. swap rules abroad. How will the CFTC and the SEC harmonize
efforts in this area, and would not a unified approach improve
compliance? When will your agencies release these plans?
Ms. Walter. Mr. Chairman, the efforts are ongoing between
our two agencies to reach a harmonized solution. Although we
have taken different procedural approaches, we have been
actively engaged in discussions about what we are going to
suggest, and there will be public comment on which people will
be able to react to both the SEC proposal and the CFTC
proposal. Those discussions are not only concerning broad
principles, but also digging down into the details, and our
efforts so far both in that area and in other areas of
cooperation and coordination under Dodd-Frank are going forward
quite smoothly.
Chairman Johnson. Director Mesa.
Ms. Mesa. I would just add to that to say, as a point of
fact, we even had a meeting between high-level staff at the SEC
and CFTC this week to coordinate our approaches, and I think as
conversations are ongoing, we are going to get closer and
closer on our approaches.
Chairman Johnson. When will your agencies release these
plans?
Ms. Walter. For our part, our international release raising
the cross-border issues, which will cover all of Title VII, is
being drafted as we speak and should be out in the public
domain in a relatively short period of time, although I cannot
give you a precise date.
Chairman Johnson. Ms. Mesa.
Ms. Mesa. Staff is working very hard to complete something
to provide to our Commission. We think that in the coming
weeks, we will actually be able to provide something for our
Commission to then provide staff feedback and eventually
release to the public.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Governor Tarullo, as I mentioned in my opening statement,
as I understand it, Dodd-Frank fails to exempt foreign
Government securities from the prohibition on proprietary
trading by banks. A lot of Governments, such as Japan and
Canada, have filed comments stating that this provision of
Dodd-Frank could--could--adversely affect the liquidity and
pricing of foreign Government bonds. Do you believe there is
any merit to these concerns, and have you performed any
analysis at the Fed of the proposed rule's potential impact on
Government bond markets, and if not, why not?
Mr. Tarullo. Mr. Chairman, I certainly understand the
foreign Governments' observation of the asymmetric treatment
and, as you noted, there have been a lot of comments filed with
the agencies in response to the proposed rule.
We have, in fact, tried to start collecting information,
which goes to several points. First--actually, we also tried to
provide some information, because there is some misconception
among at least some of the foreign observers--not all, but some
who, for example, were not aware of the fact there is a market
making exception and were not aware of the fact that if a
foreign sovereign debt obligation is held for investment and
not a matter of short-term trading, then that is not covered,
either.
So we have tried to provide that information and then, in
turn, ask for information about the holdings by U.S. entities,
or the holdings by U.S. affiliates of foreign parents of the
sovereigns in question. That is, we are trying to figure out
how much is market making, how much is held for longer-term
investment, and what proportion of those bonds were arguably
part of a proprietary trading operation. To date, at least, I
think there has not been as much information breaking things
down in that way as would be useful, but I am hopeful we will
get more of that and, thus, be able to make a better judgment
as to what kind of impact this may have.
The other thing I would add, of course, is there are other
firms that are not subject to the Volcker Rule who are out
there who may take up any slack that does exist.
Senator Shelby. In a recent speech, Secretary Geithner
defended Dodd-Frank claiming that there is, and I will quote
him, ``no credible evidence to support the argument that these
reforms are having a material negative effect on the economy,''
end quote. Secretary Brainard, do you believe that Dodd-Frank's
imposition of price controls on debit interchange rates has had
a positive impact on the economy?
Ms. Brainard. Well, I think, generally speaking, many of
these reforms are being implemented. It is a little early to
speak to them. I do not think--we have looked across a variety
of areas and have not seen a negative impact. As I said
earlier, arguably, the inclination to move early, we have
already seen a test of why it put our firms in a better
position to withstand financial stresses and actually supported
the recovery at a time when in Europe we saw a retreat of
credit.
So I think we, obviously, have to be very careful as we are
moving forward to be looking carefully at the potential impact
on the economy and to be vigilant to ensure there are not
unintended consequences. But the flip side of that, as I said
earlier, is that by moving forward with this framework, we
really set the terms for the international debate and were able
to move other countries to our framework at a time when if we
had not, we would have been on the defensive and been reacting
to their proposals.
Senator Shelby. Has there been any quantitative evidence
that you know about that Dodd-Frank actually has had a material
positive effect on the economy? If you have, would you furnish
that to the Committee.
Ms. Brainard. I do not think there have been, as I said
systematic empirical studies either on the negative or on the
positive side. It is still very early days in terms of the
implementation. There have been attempts to look, for instance,
in the international context at the potential long-term
implications of the new capital standards, where a negative
effect was not found. But again, these are not backward-
looking. There has not yet been enough time to have a
systematic empirical analysis of rules that are really only now
being implemented in many cases.
Senator Shelby. Commissioner Walter, the SEC's Inspector
General recently conducted a review of cost-benefit analyses in
Dodd-Frank rulemaking. Among the many troubling findings, the
report by the Inspector General found that the SEC did not
consider that its proposed rules for securities-based swaps
might cause market participants to move swaps trading from the
U.S. to foreign jurisdictions. In light of the Inspector
General's findings, the Inspector General of the SEC, what
specific actions has the SEC taken or plan to take to ensure
that swap trading does not move out of this country to other
jurisdictions?
Ms. Walter. I can assure you, Senator, that both in that
context and in other contexts, we do consider issues of
competitiveness and what happens to the marketplace. Perhaps we
did not reflect that as well as we might have liked in the
documents that the--our Inspector General issued. But in light
of his report as well as other external input on cost-benefit
analysis from the D.C. Circuit, from the GAO, we have
undertaken a fairly continual review process of how to enhance
our efforts to adequately consider those issues.
Senator Shelby. I would like to direct this question back
to you, Commissioner Walter, and also Secretary Brainard.
Section 763 of the Dodd-Frank law includes a provision that
requires swap data repositories and clearinghouses to obtain an
indemnification from regulators before sharing critical data
with them. This indemnification requirement makes it difficult
for foreign regulators to obtain information on swap
transactions. Should Congress repeal the indemnification
requirement in 763?
Ms. Walter. Yes, we do support that. It is problematic for
data that takes place in a global business to be available only
easily to certain regulators.
Senator Shelby. In other words, I know a SEC staffer
testified yesterday that the SEC recommends that Congress
consider repealing the indemnification requirement. Is that
what your testimony is?
Ms. Walter. Yes. We do agree that that should be done.
Senator Shelby. OK. Secretary Brainard, do you agree?
Ms. Brainard. Well, I certainly share the observation that
our market regulators are trying to work through this issue
with foreign market regulators and it is challenging. I think
more broadly, we believe that we are still in early stages of
the implementation of the Dodd-Frank Act. There are a few areas
of technical challenge, but that we think, generally speaking,
that we should push ahead on implementation of the Dodd-Frank
Act, try to work through some of these changes----
Senator Shelby. I was not asking----
Ms. Brainard. ----and give ourselves a little more time----
Senator Shelby. I was not asking you----
Ms. Brainard. ----before we contemplate any changes to
the----
Senator Shelby. ----a general question. Do you disagree
with the Commissioner?
Ms. Brainard. We generally share the observation that this
presents challenges to the market regulators, but we are not
recommending a legislative fix to any of the provisions that--
in Dodd-Frank at the moment.
Senator Shelby. So you disagree with the SEC.
Governor Tarullo, one more question. In a recent speech,
Secretary Geithner said, to provide a fair and level playing
field for U.S. firms, we need a more level playing field
globally. This is particularly important in the reforms, that
is, in the global derivatives markets. These are the
Secretary's words. Is there any class of OTC derivatives on
which you do not expect European and other foreign regulators
to impose margin requirements comparable to those required by
Dodd-Frank, and is there any aspect of derivatives or bank
regulations where you believe that foreign regulators have
adopted a better approach than the approach set forth in Dodd-
Frank?
Mr. Tarullo. Senator, I think the discussions are at too
early a stage to make a judgment as to whether any of the
eventualities that you hypothesize may come to pass. As I said
in both my written and oral testimony, I think for us as a
country, the highest priority internationally with respect to
derivatives ought to be the harmonization of margin rules, and
at least as of this moment, I have not detected any important
divergence in the potential views of countries as to how they
would apply those rules.
On the second part of your question, I think this is a case
in which the United States has been leading, and as I said in
my statement, I think that other countries are implementing the
best practices and the kind of commitments that have been made.
At this juncture, though, the pace of implementation does vary
some. The Europeans are probably closest to us, but they, too,
are somewhat behind. So I think on this one, we will have to
come back next year for you to ask the same question. I suspect
we will have a better sense then.
Senator Shelby. I will not get the same answer, will I?
Mr. Tarullo. Well, I hope not. I hope by then either
something will have been agreed to or we will be able to say,
yes, here are a few areas in which agreement looks hard to
achieve.
Chairman Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman, and thank you for
holding this hearing. I want to just underscore an observation
you made a minute ago, that as we think about this
international harmonization, it also is, I think, the interest
of many people on this Committee that our agencies reach
harmonization domestically, as well. So anything we can do to
move ourselves forward in that direction, I would support.
I also want to pick up just where the Ranking Member left
off, Governor Tarullo. As you know, financial institutions
under the Wall Street Reform bill who use the Fed's discount
window or deposit insurance must create separate entities to
engage in certain types of swap dealing. This was typically
referred to as the push-out rule. And in your written
testimony, you noted that it was unlikely that this was going
to be followed in other places. I wonder whether you could talk
a little bit about the consequences of that potential gap.
Mr. Tarullo. Certainly, Senator. On that one, I think there
are consequences probably on both sides, both for U.S. firms
and for foreign firms. For the U.S. firms, I think the
potential consequences are fairly self-evident, meaning that
they will not be able to have all their derivatives trading
concentrated in the insured depository institution, usually a
large national bank. And that means they would have to have
separate risk management capabilities and separate
capitalization for the different derivatives activities. It
also means that the counterparty with whom they deal would not
obviously be able to net their trading with the two different
parts of the same bank holding company.
The other side of it, the impact on the foreign firms----
Senator Bennet. Is that--just on that side, does that
present something unworkable, or is it just----
Mr. Tarullo. The amount of derivatives from many
institutions that would have to be pushed out is relatively
small, meaning it is not like 50 or 60 or 70 percent. But what
I said a moment ago is that it would presumably increase the
costs of that kind of trading because you would have to
duplicate some of your risk management and you would not have
the counterparty netting arrangements that you do when it is a
single counterparty.
On the other side, the push-out requirement does provide
that insured depository institutions in the United States get
an exemption for activities which are basically bank compliant
or for derivatives activities which involve instruments that
the Federal banking laws allow banks to engage in. But because
it applies only to insured depository institutions by the terms
of the statute, it seems not to apply to the branches of
foreign commercial banks here in the United States. And as a
result, seemingly, those branches will be subject to the rule
but without the exemption that applies to U.S.-insured
depository institutions, and I say ``seemingly'' because there
is at least one interpretation that that would not be the case,
but that, I think, is the concern that has been expressed.
Senator Bennet. And what are the implications of that?
Mr. Tarullo. The implications of that would be that the
branch of a foreign commercial bank here in the United States
would not be able to engage in the kinds of derivatives
activities in which a U.S. commercial bank located here in the
United States, one of Comptroller Walsh's supervised
institutions, would be able to engage.
Senator Bennet. Director Mesa, as you know, the derivatives
title of the bill was generally limited to transactions within
the United States, and the law, as you said in your testimony,
can be applied on an extraterritorial basis when the
international activities of U.S. firms have a direct and
significant effect on U.S. commerce. You mentioned that you are
working on this, that you are going to be seeking public
comment on it. I wonder if you could talk just a little bit for
the Committee about how the CFTC is going to implement this
provision and what are we likely to hear in the public comment.
Ms. Mesa. I can speak about what staff may recommend to the
Commission, but ultimately, the Commission will make the final
decision. At a staff level, we clearly need to give guidance on
what is a direct and significant effect to the U.S. commerce or
activities in the U.S., and so an example of that would be if
there is a foreign-based entity that has a significant amount
of transactions with a counterparty in the U.S. How many
transactions make that significant and direct, and that is the
kind of guidance that we seek to put forward. But once there is
a direct and significant connection with the U.S., then what
regulations and rules will apply to that entity?
Also, the CFTC has had a long history of reliance on
comparable regulation abroad if there is comparable regulation
to the U.S. regulation. I think we are also considering some
aspects of that in this release.
Senator Bennet. Thank you, Mr. Chairman.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman.
I want to return to the question that the Chairman raised
earlier with regard to the implementation of the Volcker Rule
and the problem that we see with the July 21 deadline. Federal
Reserve Chairman Ben Bernanke recently stated before the Senate
Banking Committee and the House Financial Services Committee
that the interagency Volcker Rule will likely not be ready by
the July date, and I think you confirmed that is a likelihood
today, Mr. Tarullo, although you say you would like to keep
working toward that objective.
He also said that we certainly do not expect people to obey
a rule that does not exist and that the agencies will certainly
make sure that firms have all the time they need to respond.
And again, Mr. Tarullo, you said today that you think that
somehow the agencies have got to address this issue in the
process.
But it is not that simple. The problem is that this section
of the Dodd-Frank Act is self-executing and has an effective
date of July 21, irrespective of whether the final rules are in
place. And market participants are understandably concerned
about what they should do on the July 21 deadline if the
agencies have not been able to coordinate effectively and
promulgate a final rule. I know that there has been a 2-year
conformance period raised and some have suggested that that
should allay all concerns.
But many commenters have raised the discrepancy between the
2-year conformance period and the statute and the pending
proposed rule, which states that the agencies expect full
compliance as soon as practicable after the effective July 21
date. A lot of folks are raising concerns about the fact that
legal experts are advising their clients now that if the July
21 date arrives and we do not have a final promulgated rule,
that the banks, in order to be safe, are going to have to start
shutting down significant securitization activities that are
expected to be authorized in the rule and we could have
significant disruption in the market in the United States.
As a result of that concern, earlier today, Senators
Warner, Corker, Toomey, Hagan, and Carper and I have introduced
legislation, bipartisan legislation, that corrects this aspect
of the statute and simply links the effective date of the
Volcker Rule to 12 months after the issuance of a final rule.
It just changes two words in the statute so that instead of
saying the earlier of, it says the later of the dates, which
would provide the kind of clarity to the marketplace, and I
would think provide the kind of support to the agencies as they
try to move forward with these deadlines looming to enable us
to calm the waters and proceed more effectively with the
rulemaking process.
Mr. Tarullo, I would like to ask you first whether you see
any concern or problem with this kind of legislation and
whether it would be helpful or not.
Mr. Tarullo. Senator, we should be able to address the
concerns through two means. One is, as I mentioned earlier,
guidance provided by the agencies, and this, by the way, is not
unprecedented. There have been occasions in the past where a
statutory provision by its terms takes effect and the
implementing regulation has not yet been enacted. So there is
some precedent for the way this could be dealt with, and that
would deal with any gap between the promulgation of the rule
and July 21.
With respect to the applicability, scope of the conformance
period, what it covers and what it does not cover, again, I
think that we, the Federal Reserve Board, have the authority to
change that conformance period regulation in order to clarify
the questions which have arisen, as I say, because I think that
when we promulgated the conformance period regulation, we did
not know what the substantive regulation was going to look
like.
So that is a long way of saying I think we can deal with
both issues here without legislation and we will try to go
ahead and do so regardless of what legislative path is
followed.
Senator Crapo. Is there any reason why legislation would
not assist in that process, though? I understand that you think
you can clarify everything, but the statute is self-executing.
Why would it not be helpful for us to have that clarification
made?
Mr. Tarullo. I think you alluded to this. The statute says
it becomes effective, but then in the next subsection it says,
the activities need to be conformed within the conformance
period that is provided for in the statute. So I think that the
coverage can be achieved through that mechanism, but there may
be other readings of the statute. That is the one I think that
we are proceeding under.
Senator Crapo. Mr. Walsh, could you comment on the same
issue.
Mr. Walsh. Certainly, Senator. As to the logic of what is
being proposed, the suggestion is to do in this area what the
statute does in other areas, which is link the application to a
time period after issuance of a regulation. But it is certainly
true that there are a variety of places in the Dodd-Frank Act
where we will have to deal among the agencies and
administratively with problems of this kind and I do not
disagree with Governor Tarullo that we will make the effort to
make sure that the banks both understand--those affected
understand what our expectations are and the conformance period
does provide a period of breathing room, if you will, during
which banks are expected to comply.
Senator Crapo. Would the clarification of the statute's
impact of the nature that I just described have any negative
impact on the rulemaking process and the conformance period
that the agencies are working on?
Mr. Walsh. There is always the pressure of deadlines to
keep people focused, and the suggestion that we continue to
work toward this deadline even though it is approaching and
seems increasingly challenging to meet. But the pressure of
deadlines is a meaningful pressure.
Senator Crapo. But a deadline that is executing a rule that
has not been created yet may be a difficult deadline that
creates legal difficulties in the marketplace. It seems to me
that we would not be changing the deadline of the
implementation of the rule, which it has already been
acknowledged is going to be passed without meeting that
deadline. The question remains, as I see it, why would we not
want to try to fix the problem and make it clear legally that
there is not going to be the kind of disruption of our markets
that could happen if the statute self-executes. Mr. Walsh.
Mr. Walsh. Well, Senator, Congress has set the deadlines.
If Congress changes the deadline, we will adapt to the change.
But in the meantime, we will continue to try to work toward
both meeting the deadline and providing guidance so that during
this period of what will be hopefully a brief period of
potential uncertainty, that those affected will understand how
to respond.
Senator Crapo. Thank you.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair, and thank
you all for your testimony and for helping us wrestle with how
the work we are doing here interacts with the international
environment.
I want to start by noting a letter from Finance Watch that
was received by Committee Members and ask if it can be entered
into the record.
Chairman Johnson. Without objection.
Senator Merkley. Thank you. Finance Watch is a European
group set up by European parliamentarians to help wrestle with
some of these same issues and they note in this letter, let me
assure you, European financial regulators are committed to
adopting critical elements of the financial reform agenda set
out under your leadership in the Dodd-Frank Wall Street Reform
and Consumer Protection Act. These include higher capital
requirements across the banking system, and toward clearing,
transparency--transparent trading, margin and capital for
derivatives regulation of hedge funds and private pools of
capital, orderly restriction for failing--resolution for
failing firms, reform of credit rating agencies and shadow
banking, retail investment products, and so forth, many of the
things that this Committee has been working on for quite some
time.
I found it interesting in the third page of the letter.
They turned to the failure of MF Global. The recent failure of
MF Global helped remind us of the grave dangers that highly
leveraged bets can pose to a firm. Fortunately, because MF
Global was a small nonbank of little significance to the
broader financial system, the consequences of its mistakes did
not ripple far. If, however, the U.S. were to not press forward
with implementation of the Volcker Rule, these very same
activities would continue eating away at the integrity of the
global banking system, endangering not only your large firms
and threatening much more consequences for the broader economy,
but also putting intense pressure on European regulators not to
address the issue of structural reform of the European Union
banking sector.
Indeed, I think in some ways, MF Global sums up the
situation of why you have tried to put a firewall between hedge
fund style activities and deposit taking, loan making, banking
essential to providing liquidity for families and businesses
across America. So I just wanted to remind folks that, somehow,
we lose track of what the Volcker Rule is all about. That is
the hedge fund firewall issue that it was addressing.
And some of these conversations about, well, why not trade
in foreign currencies as a liquidity provision in between
making loans, well, that puts exactly, basically--that has
opened the door exactly to what MF Global was doing, and if you
want that problem inside our banking system, we have been
there. It was destructive and let us not do it again.
Turning to some of the recent news, I want to understand
your all's perspective on Goldman's announcement that they
are--let me see if I can capture this--they have announced that
they are looking to become a monoline bond insurer, that is, a
group that writes insurance on bonds and presumably executes
trades with revenues from the premiums, not unlike CDS. What do
you make of that? Let me see. Yes, here is the title, ``Goldman
Eyes Monoline Move''. Is this an effort to open the door to
proprietary trading? Any thoughts or insights on what is going
on with that?
Mr. Tarullo. For reasons you will understand, Senator, I am
not going to address any comments to a particular institution
that the Federal Reserve supervises, but maybe I can make a
couple of general comments, one about the Fed and one about
financial institutions.
So the one about the financial institutions is, I think, as
everybody recognizes, firms are still in the process of
adjusting to what the nature of financial services is going to
be in the postcrisis, postrecovery, postadaptation period. So I
think you see a number of firms, banks, nonbank financial
institutions--regulated and unregulated--trying to determine
where there are opportunities which will provide them with
profit opportunities, on the one hand, while on the other hand
fitting within the new regulatory framework that will exist.
And I think we have seen any number of instances of that, some
of which the institutions follow through on, some of which they
appear not to follow through on.
From the Federal Reserve's point, with respect to any
regulated financial institution that is proposing to or does
get into any new line of business, we do apply close
supervisory scrutiny with respect to the capacity of the firm
prudently to engage in the business in question, to the
relative degree of risk that will be associated with that
business, and obviously, to the capital and liquidity levels of
the firm. So while, again, I am not commenting on anything
specifically, I can assure you that as firms, for the first
reason I mentioned, begin to think about different activities,
we will be applying the same kind of prudential supervisory
scrutiny that should always be applied in such instances.
Senator Merkley. Thank you. Let me ask another quick
question on recent news, and that is today's news in the
Financial Times that the Deutsche Bank is dropping its U.S.
bank holding company in order to minimize capital that must be
held under U.S. rules, which leaves only its highly leveraged
investment bank inside the U.S. Sheila Bair is quoted as saying
she is concerned, because when a bank fails, it is principally
the capital that is located within the country that is
available for resolution. Does this undermine or change our
U.S. resolution authority or capability?
Mr. Tarullo. As Chairman Gruenberg said a few moments ago,
there are a lot of multilateral, and now some bilateral efforts
to get a better understanding between countries of how
resolution would proceed in the event that a firm fails--that
is, what host countries would do with respect to operations of
their firms in other countries. Having said that, as I think
about the appropriate modes of regulation and supervision of
foreign banking organizations in the United States, the
development to which you just alluded has certainly affected my
thinking about how we do structure regulation of foreign bank
organizations, and I think we will need to respond to that.
Senator Merkley. Thank you.
Chairman Johnson. Senator Corker.
Senator Corker. Thank you, Mr. Chairman, and I thank all of
you as witnesses. I think this has been a very good hearing,
and I know in your opening comments, Mr. Chairman, you talked
about a technical corrections bill. I do think that this
hearing and many others have pointed out the need for that and
I just want you to know that should you and the Ranking Member
decide that you are going to go forward with one, I would look
forward to working with you in a way that really is just a
technical corrections bill and not some political statement. So
if you decide to do that, please let me know, OK.
Speaking of that, I know, Mr. Tarullo, you talked a little
bit about the swap desk issue and as it relates--the impact it
is having on foreign banks here, which, by the way, provide
about 18 percent of the commercial industrial loans here in the
United States. We have an amendment to try to correct that, and
should the Chairman and Ranking Member decide to go forward
with a technical corrections bill, I hope you would support
that.
But I want you to, if you will, comment on the MSR issue,
the mortgage servicing rights issue. I know that when you all
meet with international folks, there is a spirit of
collegiality, if you will, and you try not to create exemptions
that are different for the U.S., and I understand that. But we
have a very unique situation in our country where, because of
the GSEs, when the large institutions originate loans, they
have to hold 25 basis points as mortgage servicing rights and
it ends up affecting capital. I know you all talked about
limiting the amount of capital that that can go forward, and I
know we have had numbers of institutions coming in and talking
to us about how it is going to handicap them over time. I am
just wondering if you might comment on that and the exception
we might create in that regard.
Mr. Tarullo. Senator, that was one of many quality of
capital related issues that were discussed during Basel III
negotiations and they are incorporated in the Basel III
agreement. So the flip side of that, if you will, is the
limitation that Basel III places upon the capital treatment of
minority interests held in other financial firms, which is
something that particularly affects a lot of European
institutions.
On the mortgage servicing rights issue, the limitation on
the amount of MSRs that can be treated as capital derives from
the basic premise that common equity really does need to be the
true buffer against losses that can be suffered from any
activity of any sort, seen and unforseen, and events that are
seen and unforseen. The issue of MSRs, of course, arises
because, by and large, a firm cannot treat a receivable as if
it is part of capital. You have a contractual obligation that
says, I am going to be paid in the future such and so much
money. Therefore, I can include it as capital. When you get the
money, then it can be treated as capital.
MSRs were traditionally treated differently, presumably on
the rationale that they were readily marketable and, thus, like
a security, there would be funding available in the event that
the firm needed it.
Senator Corker. Let me--so I do not----
Mr. Tarullo. I am sorry. If I can just finish. But the
rationale for the limitation is that it is not at all clear
that a firm could readily market MSRs, a huge amount of MSRs,
and thus there should be a limit on the degree to which they
can count as capital, not completely eliminating them.
Senator Corker. So I think we ought to at least look at
maybe should it be 25 basis points, and I know that is
something we need--it is a whole another subject----
Mr. Tarullo. Right. It is.
Senator Corker. But maybe it is 12-and-a-half basis points,
maybe it is something else, but that is something we should
wrestle with here.
You know, the Volcker Rule, we talked about a great deal. I
know Senator Crapo offered a semi-solution. We know it is
creating lots of issues and we have talked about it a great
deal. You alluded to some market making exemptions. I know you
were in our office recently. And obviously, I think, now that
Volcker is part of the mantra here, I think most of us just
want to make sure that market making is not excluded. We
understand about prop trading.
You mentioned an exemption. So are you feeling like you
have--there is going to be really no issue as it relates to
institutions here in the United States of America being able to
deal with central market making activities? Is that your
present stance? It is, I think, a little different than when
you were in our office a few weeks ago.
Mr. Tarullo. No, I would not say that, Senator. I think my
perspective on it is the following. Volcker explicitly excludes
market making from the definition of prop trading. Then the
regulatory exercise is to distinguish between proprietary
trading and market making, and to take the extreme example, if
someone just took their prop trading desk and then said, oh,
this is market making----
Senator Corker. Yes----
Mr. Tarullo. ----we presumably would not allow that. Now,
there are going to be----
Senator Corker. But let me just--I want to have a two-way
conversation here. The market making piece, then, you think
that there is going to be no issue with ultimately having rules
that allow market making, real market making within banking
institutions, is that what you are saying?
Mr. Tarullo. No, I would not say there will be no issues. I
think that just in the structure of the interagency rules, you
can see that issue of distinguishing between market making and
proprietary trading is not a straightforward one and it is one
that varies from instrument to instrument because of the
different liquidity characteristics, like----
Senator Corker. You mentioned other firms would take up the
slack. Would not those mostly be other firms that were
unregulated taking up the slack if much of this moved out of
the regulated----
Mr. Tarullo. For pure prop trading, yes.
Senator Corker. Let me ask you, would we not come up with a
much better rule, would the regulators not be engaged together
a little bit more if we did not exclude Treasuries and
mortgage-backed securities, that all debt instruments were
treated equally? Would that not be a much better place for us
to be in creating these rules? Why have we decided to
differentiated between Treasuries, which you can lose your
shirt on, or mortgage-backed securities, which you certainly
can lose your shirt on? Why have we left them out of this
particular area, do you think?
Mr. Tarullo. That was not our decision. That was a
Congressional decision to do that----
Senator Corker. Would you be open to that coming back in so
we came up with a real fair--we would not have countries like
Japan and Canada and others worried about it? Would you be OK
with that?
Mr. Tarullo. I think one does have to bear in mind the role
that Treasuries and their equivalents in other countries play--
both the relationship of financial institutions to the
Government--the finance ministry, the central bank, or both--
and to the use of those instruments in a lot of the regulatory
apparatus of the firms. I suspect that was the motivation for
excluding Treasuries and that what we are hearing from other
countries is, yes, there is a good rationale there. Why do you
not exclude our sovereign bonds, as well, for the same reason.
Senator Corker. Mr. Chairman, I have a number of questions,
but I know Senator Johanns is here and I would like to have a
second round, so thank you.
Chairman Johnson. Senator Johanns.
Senator Johanns. Thank you, Mr. Chairman. To all of you,
thank you for being here today.
Let me follow up on a question or observation offered by
Senator Merkley, and it is a good one and it gets to the heart
of what I think the problem is here with Dodd-Frank. And I am
going to quote from a Wall Street Journal article that just
popped up within the last hour or so. It points out that
Deutsche Bank changed the legal structure of its huge U.S.
subsidiary to show that from new regulations that would have
required the German bank to pump new capital into the U.S. arm,
it points out that the bank on February 1 reorganized its
subsidiaries so that it is no longer classified as a bank
holding company, according to disclosures by the bank. It goes
on to point out that they are not the first. As you know,
Deutsche Bank is at least the second large European bank to
make such a change following in the footstep's of UK's
Barclays.
It is something we talked about a lot and I warned about,
and that is the more aggressively you regulate, because you
have been directed to do so by Dodd-Frank, the more tempting it
is for somebody to say, see you around. We do not have to be in
the United States. And they do not.
So let me just ask a specific question. Can anybody on the
panel name three countries that have passed into law, signed by
their leader, Dodd-Frank-type regulations? Oh, that is not so
good.
Mr. Tarullo. Secretary Brainard may want to address this.
Certainly, I do not think anybody has had something that looks
like Dodd-Frank. Several people have already alluded to the
UK's set of initiatives, which includes the Vickers Commission
proposals that would work a substantial change in the structure
of the UK financial services----
Senator Johanns. But they have not been passed into law.
Mr. Tarullo. No, they have not, and again, Secretary
Brainard should comment on this because it is in the realm of
political spheres of their Government--but my understanding is
there is support for that, and, I should add, under its
existing regulatory authority, the Financial Services Authority
has already promulgated some constraints upon relationships
among different parts of their firms which do not apply in the
United States, are not included in Dodd-Frank. They just did
not need legislation to do it.
Senator Johanns. You know, I cannot even begin to describe
how meaningless that last statement is to me, and here is why.
Our institutions are being regulated under a whole new set of
rules and principles that you folks cannot even agree on, that
you debate. How will you ever administer these things in a
sensible way so people know what they can and they cannot do,
irrespective of the issue that folks are just going to say, why
bother with the United States any more? And that is exactly
what is happening here.
Now, let me just say, Mr. Gruenberg, I heard your comments
about the importance of bilateral relations. Not to be
disrespectful, but to me, that is just happy talk, and here is
why I believe that. I will tell you, as Secretary of
Agriculture, I think I had great bilateral relations with
countries like Japan. I could call their Secretary of
Agriculture on the phone and address them by first name and on
and on. It did not stop them 1 minute from doing the things
that they wanted to do. They would close their country to our
beef. And I could go country after country and describe that.
So I am glad you get along with your colleagues well, but
it still does not solve the problem we have here, and that is I
am now seeing evidence that folks are just deciding not to do
business in the United States because of what is happening with
Dodd-Frank. Do you agree with that?
Mr. Gruenberg. Well, Senator, just to respond specifically
to the point you made, you know, in my comments, I was
referring to the relationships we are developing with respect
to the resolution authorities in the United States and other
countries in regard to systemically important financial
institutions.
I guess the reference I was making was particular to the
United Kingdom, where there is a significant concentration of
the foreign operations of our major institutions. Among the
countries of the world in regard to the specific area of
resolution authority, I think it is fair to say that the U.S.
and the UK have actually adopted statutory provisions that
provide powers that did not exist before and there seems to be
a commitment on both sides by the policy makers to make
effective use of those authorities.
I could not agree with you more that just because people
are polite or friendly to each other, it does not necessarily
mean you are going to get the outcome at the end of the day,
particularly if problems develop. So I do not mean to----
Senator Johanns. But would you agree with me that no
country--you know, I think I asked for three--but no country
has passed anything anywhere near what Dodd-Frank has required?
Mr. Gruenberg. Yes. I think it is fair to say I am not
aware of an individual country that has passed the sort of
comprehensive legislation that we have undertaken here, so----
Senator Johanns. So if you are--let us say you are an
insurance company and in the effort here to regulate them, and
you reach the conclusion that they present a systemic risk to
the U.S. economy, all of these additional burdens are placed on
them, why would they not just leave? Why would they not locate
someplace else where the regulatory atmosphere is better for
them? And what would stop them?
Mr. Gruenberg. Well, if you are talking about the foreign
operations of a U.S.--of a company here in the United States
that is based in some country that is overseas, there is the
balancing issue raised in terms of the obligations we impose
here and how it might impact foreign companies and their
willingness to operate here.
I do believe that the core issues that the Dodd-Frank
legislation tries to address in terms of a set of prudential
standards on our biggest systemically important financial
institutions, particularly in the area of capital, and the
expanded authorities relating to resolution so that we can hold
these, effectively, too big to fail companies accountable to a
certain market discipline, I think those are the core
authorities and I think those were important authorities to
enact in the aftermath of what we have been through.
Senator Johanns. Let me just wrap up with this, because
this is very important. Not only is it the competitive
disadvantage we have placed the United States in at a time
where our economy is struggling, but second, as a former
Secretary, as a former cabinet member, there is a point at
which these regulations become so impossible to interpret that
you cannot train your employees to the result you are trying to
get, and that is what your employees are telling me and, I will
bet, other Members of this Committee, is how do we ever train
to get to this result, because nobody understands it, whether
it is the Volcker Rule or whatever. And even if we could get
that far, how are we ever going to get the people up to speed
to get the job done?
That is what they are saying. They are saying, how do we
train our people to get there? And I think that is a very
serious problem. That is not even addressing the fact that we
do not even have agreement with our own agencies and
departments about what Dodd-Frank says and does not say. I
think it is a serious problem.
Ms. Brainard. Can I just jump in to answer his first
question?
Chairman Johnson. Yes, you may.
Ms. Brainard. Thanks. So on resolution, Canada, the UK,
Germany have already passed legislation to put in place
resolution authorities that they did not have before.
Jurisdictions have moved actually quicker than we have in many
cases to promulgate rules to put in place Basel III new capital
requirements. In the case of Switzerland, they are imposing an
additional surcharge, very substantial, on capital.
So I think, generally, the pattern is that jurisdictions
are moving at different paces on the core reforms, but what,
again, is quite remarkable is that we have heads of State of
all the jurisdictions that are significant in the international
financial system committed to a set of rules that converge to
our own and that all of the jurisdictions, including in Japan,
for instance, where they have also moved forward with
legislation, for instance, on derivatives very quickly, that
all of those jurisdictions are actually moving forward on all
the core elements in a way that we have never seen before.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman, and I want to thank
all of our witnesses here for testifying today and for all that
you do.
I just wanted to ask a question on gas prices, because
everybody is--we are all so concerned about the increase and
the rise of gas. And as you know, American companies use
derivatives to hedge the risk inherent in their daily
operations. For example, airlines are using the derivatives
contracts to hedge their cost for fuel. And currently, banking
entities are the primary source of commodities hedging
liquidity for our large corporations.
Have you thought about what impact the Volcker Rule will
have on the price of fuel prices for U.S. airlines and U.S.
consumers at the gas pumps? Ms. Mesa, if you could start, and
anybody else who would like to address this issue.
Ms. Mesa. Well, the CFTC is not a price-setting agency, but
we do ensure that the markets are open, transparent,
competitive, and free from fraud and manipulation. Given what
is going on currently in the prices, it is no different from
normal practice that we have heightened surveillance in these
markets to make sure that those things--free from fraud and
manipulation--our regular surveillance is going on.
I might not talk about the Volcker Rule and might let Dan
Tarullo do that if he wants to take that one on, but tell you
that on an international scale, on a global scale, we are
making sure that regulation is consistent because oil markets
are global. They trade on not only U.S. exchanges, but other
exchanges around the world. Last year, there was a global
consensus on managing positions in the markets, on having daily
large trader reports like the CFTC does so that we can surveil
who is in the market on a daily basis, and I am making sure all
authorities--that the regulators have all necessary
authorities, including attempted manipulation, to attempted
manipulation, and I think that is an important one, because
prior to 2012, European Union Nations did not have attempted
manipulation authority and I think that is an important matter
to know.
Mr. Tarullo. Senator, on the overall issue of the impact of
both Volcker and, I would say, probably the derivatives push-
out rule----
Senator Hagan. Right.
Mr. Tarullo. ----is where you are probably going to see the
effect here. On the derivatives push-out, I had mentioned
earlier that there was a relatively small proportion of
derivatives that would need to be pushed out of most national
banks, but commodities is one of those areas. And so if we are
going to see an effect----
Senator Hagan. Is one of those areas that needs----
Mr. Tarullo. That would have to be pushed out, that is
right. The commodities derivatives would have to be pushed out.
So there, if there is an effect, I think that is probably where
you are going to see it.
Senator Hagan. And when you say pushed out----
Mr. Tarullo. The derivative cannot be written within the
national bank. And the reason why that has an effect is that
you are going to need to set up a separate operation for your
derivatives in your nonbank affiliate. The relative amount of
cost associated with that is presumably going to vary from
organization to organization because there may be a holding
company that does a lot of derivatives work already in a
nonbank affiliate, and thus for them the cost would be fairly
incremental. But one can imagine, at least, that there would be
an institution which would have to set up a separate apparatus
and thus the cost would be higher.
Senator Hagan. How much do you think that jobs would be
lost overseas in this scenario?
Mr. Tarullo. I do not think we have the kind of precise
data that would allow us to project that. I think probably from
our perspective the concern is, are you making what are
otherwise safe and sound transactions more costly than they
otherwise would be. And even if you cannot trace that through
to a particular job number, that is not a circumstance you
usually want to have, when you are just increasing costs where
it is not necessary to achieve safety and soundness.
Senator Hagan. Well, obviously, we are concerned about
safety and soundness, but I, too, am concerned about jobs in
the U.S. on a daily basis.
Legislation has been proposed that would exempt certain
interim affiliate transactions of swap dealers from meeting
margin and clearing requirements, and if these contracts are
classified as separate transactions, there is a concern that it
will increase cost for the customers of these products to
appropriately manage the business risk. Has the CFTC acted to
provide this exemption for interaffiliate transactions, and if
not, if you have not acted in this area, can you provide an
explanation about when you expect the CFTC to act.
Ms. Mesa. We have not provided such an exemption in this
area, but it is something that the industry has heavily
commented to the agency about and it is something we are
considering at a staff level and the Commission is fully aware
that staff is developing something in this area.
Senator Hagan. Well, it is my understanding that the SEC
may treat interaffiliate transactions differently than the
CFTC, and does it make sense for market participants to have to
comply with two different sets of rules for similar products.
Ms. Mesa. As mandated under Dodd-Frank, we are, of course,
coordinating, consulting with the SEC, and we will work with
them as we think through this issue.
Senator Hagan. I think there are a lot of issues that are
arising because of the two different entities regulating the
same transactions.
And then I understand that certain aspects of Basel III
with respect to regulatory capital intersect with changing
accounting standards in the U.S. and internationally, and it
has been brought to my attention that if such changes are
adopted in the U.S., as proposed, it may produce several
unintended consequences, such as a narrowing of the investor
base for longer-term debt, public debt instruments, including
our U.S. Treasuries, mortgage-backed securities, and municipal
bonds. Prior to U.S. implementation, do Treasury, FDIC, and/or
the OCC intend to study the issue or to propose alternatives in
light of the above-mentioned concerns? Governor Tarullo, do you
want to start that one.
Mr. Tarullo. There has been a series of accounting issues
that have an impact on capital. I think our aim--at least the
Federal Reserve's aim, I will let the other prudential
regulators speak for themselves--has been to maintain
substantial if not overwhelming congruence between the
accounting standards that FASB applies for purposes of investor
protection and transparency, on the one hand, and regulatory
capital on the other, the reason for that being that otherwise
you have got different sets of books, in essence, that
investors have to look at.
Having said that, there have been some areas in which I
think the accounting standards do not--have not--or at least
some of the proposals have not well reflected the reality of
certain assets. The proposal that was floating around for a
while to insist on fair value treatment for loans written by a
community bank and held to maturity, I think, was sort of a
stunning example of that.
So my own sense is that our effort as regulators ought to
be to try to take our observations on what are sensible
accounting standards for all investors and to urge those in
appropriate channels on the FASB, and I think FASB is listening
to those kinds of arguments. Our chief accountants from the
three agencies frequently get together to talk about these
kinds of issues and then try to make representations, as
appropriate.
Chairman Johnson. Neither Senator Shelby nor I have any
further questions, but does Senator Corker have a concluding
question?
Senator Corker. I do. I have several concluding questions.
Thank you.
[Laughter.]
Senator Corker. And I took a lot less time than most of our
questioners, so thank you for the time now.
Mr. Tarullo, I thought your answer on MSRs was actually a
very good one and I think that we should deal with how much--
what the basis point set-aside should be. That is something
that has nothing to do with you, but I thought that was very
good. Sometimes I think they are wrong answers, but it was a
very good one.
But let us move to the Treasuries. You were talking about
them playing a very unique role, Treasuries and mortgage-backed
securities, and, therefore, we should treat them differently
than other types of debt instruments, and Volcker does that, of
course. Should we really have a bias in our private banking
system toward Government debt, or should all debt not be
treated the same? I mean, is this bias something that is
healthy for us in this free enterprise economy that we have?
Mr. Tarullo. Senator, the special treatment of U.S.
Treasuries, for example, is grounded in substantial part on the
risk-free character of those Treasuries and, thus, they serve
as both a capital and liquidity backstop for firms----
Senator Corker. But they are not risk-free as it relates to
interest rate changes.
Mr. Tarullo. No. No.
Senator Corker. OK.
Mr. Tarullo. You are absolutely right, and that is why we
have interest rate risk supervision. But I would say, I do not
think--so the argument for a preference, for an identification,
I think, is very strong. But it is not all encompassing.
And so, for example, on liquidity regulation, which
basically looks to make sure that a firm could sustain a major
market shock and keep operating long enough to allow order to
be restored--I do not think we want to rely solely on U.S.
Government securities or, indeed, any Government securities.
There, I think we do want to look to the actual experience. We
now have, unfortunately, a real world experiment, which is to
say 2008, 2009, where we can see how different instruments--the
liquidity value of different instruments was realized over that
period of time. And in the revision of the liquidity coverage
ratio internationally, that is the position we have urged, is
to look and see how instruments actually performed and give
credit where nongovernments are, in fact, liquid, even in times
of stress.
Senator Corker. Thank you very much.
Mr. Gruenberg, we yesterday spent a good deal of time with
Sheila Bair just talking a little bit about orderly
liquidation. I was on a panel a few weeks ago and there are
portions of Title II that I am really proud of because I was
highly involved in, and other portions, not so much.
But there has been a lot of discussion about the SIFI piece
which precludes that, I think maybe in Title I, and people are
concerned as they look at orderly liquidation. And if you are a
SIFI--we have had numbers of people who deal with financial
institutions--their thinking is that if orderly liquidation
occurred with a significantly important financial institution,
then they would be treated differently than if they were
creditors to a smaller institution, and their fears are that if
an institution starts going bad and it is not a significantly
important institution, that it is going to be like a run of
people away from that institution.
I am not seeing that myself, but we certainly had an hour
yesterday with Sheila talking about that. I am wondering if you
have bumped into that or have any comments in that regard.
Mr. Gruenberg. Well, you know, it is an important issue,
Senator. I would note that the premise of the legislation is
that the orderly liquidation authority would be invoked only
if, for some reason, there was a judgment that the bankruptcy
courts could not handle the failure without some systemic
consequences----
Senator Corker. And on that note, would you urge some
changes in the Bankruptcy Code to make the Bankruptcy Code work
even better for institutions?
Mr. Gruenberg. Well, I do not know that I have changes to
suggest. I think we are certainly open, and we have talked
about this in the past, to engaging with you on that issue.
But just to the point of the treatment of creditors, I
think in the first instance, the effort will be to utilize the
bankruptcy process as it would normally be used. If you had an
extraordinary circumstance where the failure of a company, it
would appear, could not be handled by the bankruptcy process
without some larger systemic consequence, then we have these
admittedly extraordinary authorities under Title II. But even
then, the directive in Title II in terms of the treatment of
creditors is to try to follow, as a general practice, the
practices under the bankruptcy process.
So I think the goal would be to be as consistent with that
as we possibly can and that is certainly the premise of all the
planning we have done in terms of our resolution authority.
Senator Corker. One of the nuances that I just recently--
and I am embarrassed to say this--have picked up, but orderly
liquidation really would only be used in a case where the bulk
of the assets were of a banking nature. And if that were not
the case, then if the assets were generally not of a normal
depository institution, you would probably lean toward
bankruptcy in those cases instead of orderly liquidation. Is
that the way you understand----
Mr. Gruenberg. I am not sure that is--I think the proviso
of the statute is really a judgment, and it is a joint judgment
of the Federal Reserve and the FDIC making determinations and
recommendations to the Treasury Department, which would then
have to make a judgment in consultation with the President, and
that authority could apply to any financial company, and the
key there is whether the failure of the company would cause
significant disruption to the financial system. So that
authority, while, I think, in the most likely case would apply
to a bank holding company, given the nature of the large and
systemically important institutions in our country, it could be
applied to a nonbank financial company, as well.
Senator Corker. I know the Chairman----
Mr. Tarullo. Is that the question you were asking, Senator?
I thought you were asking about whether the authority was
likely to be applied only to bank holding companies where most
of the assets were traditional commercial----
Senator Corker. That is what I was asking.
Mr. Tarullo. Yes. So that is not your intention, right?
Mr. Gruenberg. Where most of the assets are not in
traditional--whether they were in the bank or not----
Mr. Tarullo. No, I think the Senator was asking whether
Title II is likely to apply only to bank holding companies
where traditional commercial banking assets are the
preponderance----
Senator Corker. Are the majority of the assets, yes.
Mr. Gruenberg. I do not think that is necessarily the case.
Senator Corker. It would still be, in each case, solely--we
have had differing responses to this, but in your mind as the
chief liquidator----
[Laughter.]
Senator Corker. ----our Nation's ``chief liquidator''--that
is quite a title--it would be a judgment call made relative to
whether this institution would create a lot of problems
throughout the banking industry if it went through bankruptcy
instead of orderly liquidation.
Mr. Gruenberg. Yes, sir.
Senator Corker. Mr. Chairman, thank you for your
generosity. I think the witnesses have been outstanding and I
do hope we will pursue a technical corrections bill at the
right time.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you, Mr. Chair.
I wanted to begin, Ms. Mesa, with following up on Senator
Hagan's thoughts. Under Dodd-Frank, CFTC was given power to
establish position limits and there has been a lot of
frustration with how slowly the CFTC has moved, and although
you have got the rule done, you still have not implemented it.
And we have seen growth from 30 percent of folks trading in the
market not having an end use, if you will, to 70 percent. In
recent months, a lot of folks seeing the conflict in the Middle
East and the conflict regarding Iran have said, well, a lot of
other folks are going through the same thing and they are going
to worry about oil and they are all going to bet, so I will get
in and bet, too. So we see this huge surge in speculation and
the CFTC sitting on your hands. Can you explain why you have
been so slow and missed the deadline and at great cost to
American consumers at the pump?
Ms. Mesa. We have, actually, as you noted, passed our final
rule on position limits. The final rule talks about aggregating
futures positions with swaps positions, and in the final rule,
we said that we would collect 1 year of data of swaps positions
before the position limits would be effective, and so that 1
year has not run yet. When it does, they will go into effect.
So that----
Senator Merkley. All right. Well, there is a big sense in
America that while CFTC fiddles, the American consumer is
getting burned, and I just want to express that concern because
I hear my constituents on each and every trip----
Ms. Mesa. I will take that concern back.
Senator Merkley. ----back home. Thank you.
Ms. Walter, I wanted to address a little bit the issue of
crowdfunding. We are going to be voting on it later today. The
House laid out a strategy for folks being able to invest over
the Internet in small dollar amounts that involved no
requirements on companies for information, no accountability
for whatever information the companies did put out there, full
legal permission for companies to hire people to pump their
stocks with no consequences, and it looked to me like a path,
really, a paved path to predatory activity that would damage a
lot of folks who are thinking they are participating in a fair
market but would not be. Do you share any of those concerns
about the House legislation?
Ms. Walter. Well, first, I must say that the Commission
itself has not voted on this, so I am speaking for myself. I
welcome adding investor protection provisions to the
crowdfunding aspect. I see some value in crowdfunding itself,
but I do think it should be done with appropriate investor
protections attached to it, and those are terribly important.
Senator Merkley. Have you had a chance to look at the bill,
the amendment that Senator Bennet and I have worked on to
provide those investor protections?
Ms. Walter. Unfortunately, I have not. I have been told
about certain aspects of it, but I have not had the opportunity
to read it.
Senator Merkley. Well, we are going to be voting--I was
going to get your wisdom before I vote on my own amendment this
afternoon.
Ms. Walter. And I have missed my opportunity to influence
you.
[Laughter.]
Senator Merkley. Well, I do appreciate your general
sentiment, we should add some investor protections, and we do
require three different levels of information, depending on how
much a company is raising. We hold the officers and directors
accountable for the accuracy of that information. We set up a
streamlined Web portal of structure so people cannot simply
sell without any structure, which was true in the House bill,
and a number of other factors.
But one of the things that we also do is set up a cycle for
the SEC to be right on top of predatory practices that develop
and be able to develop rules to address those predatory
practices because this is a new, uncharted territory, and to
make capital formation work well, it has to be something
investors believe that they are getting a fair shake on. And so
we are going to be counting on you all.
Ms. Walter. We will do our best, as always.
Senator Merkley. Thank you very much, and Mr. Chair, thank
you for holding the hearing and I appreciate you all's input on
these very complicated and very important issues for capital
across the planet and the strengthening of our collective
economies.
Chairman Johnson. Thank you all, all the witnesses for your
testimony and for being here today.
There is no doubt that continued cooperation and
harmonization of financial regulatory reforms is important to
the stability of our global economy. The recent years have
highlighted the interconnected nature of the global financial
system and the importance of international coordination. I look
forward to continuing to work with all of you and the Members
of the Committee to ensure the successful implementation of
these important reforms.
This hearing is adjourned.
[Whereupon, at 11:51 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF LAEL BRAINARD
Under Secretary for International Affairs, Department of the Treasury
March 22, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for the opportunity to discuss our international
financial reform agenda.
In the wake of the financial crisis, the United States responded
swiftly and aggressively. We took forceful measures to stabilize
financial markets, including through transparent and groundbreaking
stress tests. Congress moved rapidly to enact the Dodd-Frank Act--which
provides the most significant set of financial reforms in generations.
And in parallel we secured unprecedented commitments from our
international partners in the G20 and the Financial Stability Board--
the same commitments from the emerging economies as from the advanced
economies.
There is a vigorous debate over the merits of moving slow or fast--
of moving first or last. This is an important debate with direct
bearing on the pace and tone of the recovery, the safety and soundness
of our financial system, and the fairness of the international playing
field. The United States moved fast and first to repair and reform our
financial system, and we believe that strategy is already beginning to
demonstrate its effectiveness.
Some argued that strengthening the safety and soundness of our
financial institutions should wait until after the recovery is
complete. I disagree. A strong and stable financial system is a
precondition for a growing and competitive U.S. economy. It was
important to take action while the urgency of the crisis was still
fresh in our memories. There are substantial lead times built into many
of these reforms, allowing markets time to adapt. Now is not the time
to increase uncertainty in the market by backtracking.
Making Our Financial System Stronger, Safer, and More Transparent
U.S. supervisors responded early and forcefully by compelling U.S.
financial institutions to build capital, reduce leverage, and
strengthen liquidity buffers. Far from disadvantaging U.S. institutions
and harming credit, these early actions built greater resilience and
helped to safeguard credit flows in the face of elevated financial
stress in the second half of 2011.
Because we acted early and fast, U.S. banks built larger and
higher-quality capital buffers. Tier 1 common equity at large bank
holding companies increased by more than $400 billion to $960 billion
from the first quarter of 2009 through the fourth quarter of 2011, a
more than 70 percent increase. The ratio of Tier 1 common equity to
risk-weighted assets at these institutions has increased from 6 percent
to over 10 percent during this period.
U.S. financial institutions have strengthened their funding models:
short-term wholesale financial debt has decreased as a share of total
financial institution assets from a peak of 29 percent in 2007 to 17
percent in the fourth quarter of 2011, and regulatory filings show that
short-term wholesale funding at the four largest bank holding companies
has decreased from a peak of 36 percent of total assets to 20 percent
over this period. Depository institutions have built a more stable base
of funding. Core deposits as a share of total liabilities at FDIC-
insured institutions increased from a low of 44 percent in 2008 to 64
percent in the fourth quarter of 2011.
Risks have diminished outside of the banking sector as well. The
size of the U.S. shadow banking system has fallen substantially, with
prime money market funds shrinking by 32 percent and the triparty repo
market shrinking by nearly 40 percent since their peaks in 2008.
And credit availability has improved during this time, even as
safety and soundness have materially strengthened. Bank credit to U.S.
companies increased by annual rates of 11-12 percent in the third and
fourth quarters of 2011.
By contrast, Europe opted to move more slowly on stress test
disclosures and measures to build capital and improve funding. As a
result, many euro area banks were less resilient in the face of shocks
last year, putting pressure on funding and credit and raising financial
stress in a negative spiral. Since that time, European authorities have
taken steps to strengthen the capital position of euro area banks.
These actions, and the critically important actions taken by the
European Central Bank to strengthen liquidity, have helped to reduce
financial stress.
Far from disadvantaging our firms, the early actions to strengthen
bank balance sheets and improve funding put U.S. banks in a stronger
position to withstand financial stress relative to many of their
international peers, while supporting credit flows to U.S. households
and businesses at a critical time for the recovery.
International Convergence on Financial Reform
Some argue that by moving first, we have put the United States at a
competitive disadvantage. To the contrary, by moving early, we have
been able to lead from a position of strength in setting the
international reform agenda and elevating the world's standards to our
own. The alternative would have been to follow the reform standards set
by other countries or subject our firms to a divergent set of
standards. Of course, we will need to be vigilant in addressing the
inevitable inconsistencies and lags on implementation. But this should
not detract from the remarkable degree of convergence we are seeing on
a comprehensive reform agenda spanning bank capital and liquidity,
resolution, and over-the-counter (OTC) derivatives markets for the
first time. This common, comprehensive set of reform commitments
encompasses not only the established financial centers in advanced
economies but also up-and-coming financial centers in emerging markets.
Moving first and ensuring that others enact reforms consistent with our
own are the best ways to reduce opportunities for regulatory arbitrage
and a race to the bottom, to prevent firms from exploiting gaps in
regulation, to provide a fair and level playing field for U.S. firms,
and to protect our economy from risks emanating beyond our shores.
Going into the crisis, too many financial institutions had too much
leverage, too little liquidity, and inadequate loss absorbing capacity.
This led to a downward spiral in confidence among counterparties. Going
forward, we have agreed to new global capital standards that raise the
quality and quantity of capital so that banks can withstand losses of
the magnitude seen in the crisis and reduce the risks of financial
system collapse as a result of financial excesses. We have also secured
agreement internationally to strengthen liquidity standards and limit
leverage. We have identified the globally systemically important banks,
agreed to a capital surcharge for these institutions, and developed a
comprehensive set of enhanced prudential measures to address risks from
globally active financial institutions.
However, there is much more work that needs to be done. We must
remain vigilant against attempts to soften the national application of
new capital, liquidity, and leverage rules. It is essential for banks
across the world to measure risk-weighted assets similarly, to ensure
that markets and investors can be confident that the capital adequacy
ratios stated by banks are consistent across borders. The United States
is pursuing comparability by urging greater visibility into
supervisors' scrutiny of how banks measure risk-weighted assets. We are
pleased that the Basel Committee has added this important work to its
agenda for 2012.
Going into the crisis, few understood the magnitude of aggregate
derivatives exposures in the system because derivatives such as credit
default swaps (CDS) were traded over the counter on a bilateral basis
and without transparency. Going forward, we have agreed to stronger
international standards for the OTC derivatives markets, including
requiring greater transparency, moving their trading onto exchanges,
and requiring them to be centrally cleared.
Now we must ensure that national authorities continue to coordinate
closely to align implementation; our frameworks for derivatives must be
tightly aligned or differences could lead firms to move activities to
jurisdictions with lower standards, increasing risks to the global
financial system. We must guard against fragmentation of the global
payments infrastructure, ensuring that global infrastructure is
adequately safeguarded, and avoid geographic mandates for clearing. It
is critical that others across the globe follow the U.S. lead and
accelerate timetables where needed.
We must also finalize work on a global standard for posting
collateral (or margin) on uncleared derivatives transactions. To
reinforce the push towards central clearing and enhance safety and
soundness, the charges associated with uncleared derivative
transactions must exceed those on cleared transactions. Both the United
States and the European Commission are developing margin requirements
for OTC derivatives that are not centrally cleared, and the G20 and the
FSB have committed to developing a global standard.
Going into the crisis, countries lacked tools to resolve
systemically important financial institutions, effectively rendering
them too big to fail. Going forward, we have reached an important
agreement that all major financial jurisdictions should have the tools
to resolve large cross-border firms without the risk of severe
disruption or taxpayer exposure to loss. The FSB is working actively to
see that this international commitment is implemented on a national
level to ensure that in addition to national resolution regimes,
regulators and the major global banks develop cross-border recovery and
resolution plans by the end of 2012; develop criteria to improve the
``resolvability'' of systemically important institutions; and negotiate
institution-specific cross-border resolution cooperation arrangements.
Strengthening cross-border resolution is a difficult issue given
the diverse national laws and the infeasibility of a single global
bankruptcy regime. The UK, Germany, and Canada have already passed
resolution legislation, and the European Commission is developing a
draft for the second quarter of 2012. We are working to put in place
cross border cooperation agreements; establish cross border crisis
management groups for the largest, most complex institutions; and
finalize recovery and resolution plans by the end of this year.
Going into the crisis, supervisors and market participants did not
have adequate visibility into the buildup of concentrations of risky
activities in the financial markets. Going forward, a global Legal
Entity Identifier (LEI) system will uniquely identify parties to
financial transactions, ensuring greater transparency and more
efficient data collection across the global financial system, and
enabling better understanding and management of systemic risk. Working
with our international counterparts and the financial industry, we must
finalize the global LEI framework and the reporting systems to support
it by the G20 Leaders Summit in June.
New laws and rules aimed at the home market of any major financial
center will inevitably impact other jurisdictions, given the globalized
nature of cross-border flows. In these circumstances, aligning the
substance and timing of reforms across jurisdictions will be critical.
Regulators will have to sort out whose rules apply, how, and where. We
need to figure out sensible ways to apply and enforce rules across
major jurisdictions in consistent ways. The greater the degree of
convergence around high quality standards, the greater the scope for
deferring to foreign jurisdictions that have regulatory regimes as
strong as that of the United States.
Regulators are grappling with common issues pertaining to the
structure of risk-taking in their national markets. The Volcker rule,
which limits proprietary trading and hedge fund activities for banks,
is a good example of where the United States has moved ahead of others,
continuing in a long tradition of recognizing structural differences
across countries, reflecting national history and laws. The U.S.
Federal depository insurance net--which has served our country well--
was not designed to be extended to the riskiest trading activities of
U.S. banks. But even in this instance, while regulators are sifting
through the 16,000 comments that were submitted on the rule, other
jurisdictions are grappling with the same issues. In the UK, the
Vickers Commission proposed rules to insulate core financial
intermediation activities from riskier business lines in order to
promote financial stability. In the European Union, Commissioner
Barnier has assembled a commission to explore possible regulations for
proprietary trading.
Conclusion
With financial markets that are more globally integrated than ever,
we need financial reforms that are more globally convergent than ever.
In today's highly interconnected global financial markets, the risk
of regulatory arbitrage carries real impact. It means the potential
loss of jobs if firms seek to move overseas where regulation is weaker.
It means a race to the bottom for standards and protections. And it may
mean a heightened risk of a future financial crisis if riskier
activities migrate to areas with less transparency and laxer
supervision.
In cooperation with the regulatory agencies represented here today,
Treasury is intensely focused on ensuring global convergence on
regulation and resolution of large, complex financial institutions and
on regulation of derivatives markets--the three areas with the greatest
potential for discrepancies in national regulations to create
disproportionate dislocations in global markets that could negatively
impact our economy and our firms. This is a necessary response to the
crisis.
Since the outset of the crisis, the G20 and the FSB have played an
increasingly critical and welcome role, alongside the international
standard setting bodies, in shaping the international regulatory reform
agenda and promoting sound regulation and more resilient financial
markets. Recognizing there will be discrepancies when it comes to
implementation at the national level, the Treasury and U.S. regulatory
agencies buttress our cooperation through the G20 and the FSB with
extensive bilateral engagement. Each day, we talk with our colleagues
in Europe and conduct ongoing dialogues across the major financial
centers. This helps us get the details right. Additionally, the FSB and
the standard-setting bodies have jointly developed an implementation
monitoring framework that will report annually on our collective
progress to the FSB, the G20, and the public.
Undoubtedly, we will not attain perfect alignment and we will not
get everything right. Despite this, nothing could be more costly than
backtracking on reforms. We cannot lose sight of the costs of the last
crisis--millions of jobs and trillions of dollars in lost wealth. Nor
can we lose sight of the causes--inadequate risk management, imprudent-
risk taking, opaque instruments whose risks were not understood or
overseen, and failures by our regulators. This is why it is necessary
to complete the work that is underway in the United States and
internationally. The system is stronger today and will continue to
strengthen in the future as a result of our efforts.
______
PREPARED STATEMENT OF DANIEL K. TARULLO
Member, Board of Governors of the Federal Reserve System
March 22, 2012
Chairman Johnson, Ranking Member Shelby, and other Members of the
Committee, thank you for the opportunity to testify on implementation
of the Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (Dodd-Frank Act) and its international implications.
Although banking regulation has long included an important
international dimension, the recent financial crisis has brought
renewed attention, both in the United States and abroad, to the
interconnectedness among national financial markets and, consequently,
the importance of international cooperation in safeguarding those
markets. In recognition of the fact that financial distress can quickly
and dramatically cross national borders, we seek to protect our own
financial system by promoting the global adoption of strong, common
regulatory standards and effective supervisory practices. Such common
standards and practices should also help prevent major competitive
disadvantages for U.S. firms.
Today I will touch on several aspects of the implementation of the
Dodd-Frank Act that have significant international implications:
regulation of systemically important financial institutions (SIFis),
reform of the over-the-counter (OTC) derivatives market, and a number
of discrete issues that are arising as we work to implement the Dodd-
Frank Act.
Regulation of SIFIs
The Dodd-Frank Act and postcrisis international regulatory reform
efforts both place great emphasis on containing the systemic risk
potentially posed by major financial institutions. The most important
points of intersection include efforts to strengthen capital
requirements, to develop international quantitative liquidity
standards, and to put in place mechanisms for the orderly resolution of
these firms.
Capital Regulation
Strong capital requirements remain the cornerstone of prudential
regulation because capital can provide a buffer against losses at
financial firms from any source or activity. The best way to safeguard
against taxpayer-funded bailouts in the future is for our large
financial institutions to have adequate capital buffers, sized to
reflect their own risk profiles and the damage that would be done to
the financial system were such institutions to fail. Achievement of
this aim requires both improvement of the traditional, firm-based
approach to capital regulation and creation of a more systemic, or
macroprudential, component of capital regulation.
With respect to improving the traditional approach to capital
regulation, international work on common, global standards was already
quite advanced by the time the Dodd-Frank Act was enacted in July 2010.
The so-called Basel 2.5 agreement, which strengthened the market risk
capital requirements ofBasel II, had already been finished. Just a few
months after the Dodd-Frank Act was enacted, agreement was reached on
the Basel III reforms, which require improvement of the quality of
regulatory capital, an increase in the quantity of minimum required
capital, maintenance of a capital conservation buffer, and--for the
first time internationally--compliance with a minimum leverage ratio.
In the coming months, the banking agencies will be finalizing
regulations to implement Basel 2.5 in the United States and will be
proposing regulations to implement Basel III in the United States.
With respect to macroprudential capital regulation, section 165 of
the Dodd-Frank Act mandated that the Board establish enhanced risk-
based capital standards for large bank holding companies that would be
graduated based on the relative systemic importance of those companies.
Consistent with this requirement, we espoused proposals in the Basel
Committee for capital surcharges on the world's largest, most
interconnected banking organizations based on their global systemic
importance. Last year, agreement was reached on a framework for such
surcharges, to be implemented during the same transition period
applicable to Basel III. The Board's aim has been to fashion the
enhanced capital requirements of section 165 and the associated
international framework in a simultaneous and congruent manner. Both
the Dodd-Frank Act provision and the Basel systemic surcharge framework
are motivated by the fact that the failure of a systemically important
firm would have dramatically greater negative consequences on the
financial system and the economy than the failure of other firms.
Stricter capital requirements on systemically important firms should
also have the benefit of helping offset any funding advantage these
firms derive from their perceived status as too-big-to-fail and
providing an incentive for such firms to reduce their systemic
footprint.
If the benefits of all these improvements to existing capital
requirements are to be realized, it is crucial that capital standards
be not only agreed upon globally, but also implemented consistently
across jurisdictional boundaries. We have strongly supported efforts
within the Basel Committee to monitor implementation--not only in the
laws and regulations of member countries, but also at the level of
individual large banking organizations, including an assessment of the
consistency of risk-weighting practices by banks. We look forward to
the evolution of the Basel Committee's new plans for conducting this
monitoring exercise, which are considerably more ambitious than any
pursued in the past.
Liquidity Standards
In recognition of the fact that liquidity squeezes at some
financial institutions played a key role in the financial crisis, the
Basel III agreements also introduced, for the first time, quantitative
liquidity requirements for application to internationally active banks.
One standard, the Liquidity Coverage Ratio (LCR), is designed to ensure
a firm's ability to withstand short term liquidity shocks through
adequate holdings of highly liquid assets. The other standard, the Net
Stable Funding Ratio (NSFR), is intended to avoid significant maturity
mismatches over longer-term horizons. Again, there is a parallel to
this international initiative in section 165 of the Dodd-Frank Act,
which calls for enhanced, graduated liquidity standards for large bank
holding companies.
Precisely because this was the first effort on quantitative
liquidity regulation by the Basel Committee, there were some questions
about potential unintended consequences, as well as a desire to ensure
that the new standards reflected actual experience with the stability
of various funding sources and the relative liquidity of different
financial instruments during the financial crisis. For these reasons,
the Federal Reserve, with support from a number of other central banks
and supervisors, suggested at the time of adoption of Basel III in 2010
a multiyear study period before the rules take effect. Since then, the
U.S. banking agencies and a Basel Committee working group have been
collecting data, analyzing the potential effects of the LCR on
financial markets and the broader economy, and considering what
amendments might be warranted. The Basel Committee will likely suggest
a set of changes to the LCR later this year, with a goal of introducing
the LCR in 2015. Work on the NSFR is on a considerably slower track;
the current plan is for implementation in 2018.
Resolution of SIFIs
A third core regulatory reform goal of both the Dodd-Frank Act and
international policy makers is to enhance the ability of regulators to
resolve failing SIFis. The Basel Committee and the Financial Stability
Board (FSB) have set forth standards for national resolution regimes
that will allow resolution of SIFis in an orderly fashion, without
taxpayer exposure to losses through solvency support. Here in the
United States, the Dodd-Frank Act provides for an orderly resolution
process to be administered by the Federal Deposit Insurance Corporation
(FDIC), and resolution planning by SIFis to be overseen by the FDIC and
the Federal Reserve. Together these provisions of the Dodd-Frank Act
are fully consistent with the Basel Committee and FSB standards.
In developing the orderly liquidation authority established by
Title II of the Dodd-Frank Act, the FDIC has recently expressed a
preference for resolving a failed SIFI under a single receivership and
internal recapitalization model. Under this model, the parent company
of the failed SIFI is placed into receivership; all, or substantially
all, of the assets of the parent company are transferred to a bridge
entity; the parent company and its residual assets are liquidated; and
the bridge entity is capitalized, in part, by converting the holders of
long-term unsecured debt of the parent company into equity holders in
the bridge. Under the single receivership model, the major subsidiaries
of the SIFI continue to operate as going concerns. This approach holds
great promise, but ensuring its viability as a resolution option
requires, among other things, that each SIFI maintain an amount of
long-term unsecured debt that is sufficient to absorb very significant
losses at the firm.
Some other jurisdictions have, or are planning to, put in place
special resolution mechanisms that conform to the emerging
international standards. But even continued progress along this path
may not solve all the possible problems associated with failure of a
SIFI. The coexistence of internationally active firms with nationally
based insolvency regimes means that there could be important cross-
border legal complications when a home jurisdiction places into
receivership a firm with significant assets, subsidiaries, and
contractual arrangements in other countries. A comprehensive, treaty-
like instrument for a global bank resolution regime to address these
issues is surely an unrealistic prospect for the foreseeable future.
The Federal Reserve and the FDIC are working together with counterparts
from other countries to identify opportunities for more limited
cooperation agreements, coordinated supervisory work on resolution
plans, and other devices to make the orderly resolution of a large,
internationally active firm more feasible.
OTC Derivatives Regulatory Reforms
Another key part of the Dodd-Frank Act that involves significant
international considerations is OTC derivatives reform. In the United
States, administrative agencies are implementing the requirements of
the Dodd-Frank Act to strengthen the infrastructure and regulation of
the OTC derivatives market. This task includes enhancing the role of
central counterparties, which can be an important tool for managing
counterparty credit risk in the derivatives market; improving
regulation and supervision of dealers and key market participants;
introducing minimum margin requirements for certain derivatives
transactions that are not cleared with a central counterparty; and
increasing transparency.
A roughly parallel international initiative got under way in 2009,
when the Group of Twenty (G20) leaders set out commitments related to
reform of the OTC derivatives markets. Since work on the G20
commitments is being pursued in a number of international groups and
foreign jurisdictions, continued attention will be required to ensure
that the global convergence process continues in a timely fashion. Such
attention will be particularly important in areas where international
convergence is desirable to avoid a significant fracturing or
regionalization of the existing global structure of the swaps market,
or to prevent undue constraints on the ability of U.S. firms to compete
in foreign markets. A good example of this is the introduction of
margin requirements for uncleared derivatives. U.S. and foreign
regulators have formed a joint working group of the Basel Committee and
the International Organization of Securities Commissions (IOSCO) to
develop internationally consistent margin standards that appropriately
address the risks of uncleared derivatives while ensuring that U.S. and
foreign firms compete on a level playing field.
Other key areas of OTC derivatives reform present similar
international challenges and will demand similar levels of
international collaboration. These areas include the creation and
regulation of central counterparties, swap execution facilities, and
swap data repositories, including mutual recognition by U.S. and
foreign regulators where appropriate. Issues also arise around the
treatment of governmental entities in derivatives reforms in the United
States and abroad. For example, title VII of the Dodd-Frank Act
generally exempts from swaps regulation any transaction to which the
Federal Reserve is a party, but does not contain a similar exemption
for transactions to which a foreign central bank is party. Foreign
central banks have expressed concerns that the application of certain
parts of title VII may interfere with the manner in which they conduct
their national monetary policies.
In addition to its involvement in specific derivatives reforms
related to the Dodd-Frank Act, the Federal Reserve also participates in
a variety of international groups that serve as broader forums for
coordinating policies related to the participants and the
infrastructure of derivatives markets. These forums include the Basel
Committee, which has recently enhanced international capital, leverage,
and liquidity standards for derivatives, as well as the Committee on
Payment and Settlement Systems, which is working with IOSCO to update
international standards for systemically important clearing systems,
including central counterparties that clear derivatives instruments,
and trade repositories. These collaborative exercises are intended to
support the development of a consistent international approach to the
regulation and supervision of derivatives products, dealers, and market
infrastructures. Here, as in other international contexts, our aims are
to promote the financial stability of the United States and fair
competitive conditions for U.S. financial institutions.
Other Implementation Issues
As noted in the preceding discussion, even where there is broad
international consensus to adopt a particular regulatory approach,
there can be discrete issues raised as countries implement that
approach in the context of their own legal, financial, and political
systems. This circumstance is hardly unique to the area of financial
regulation; it is familiar to anyone who has worked on virtually any
regulatory issues that affect international trade and investment. There
are also some elements of the Dodd-Frank Act that are unlikely to be
pursued internationally in any comparable form. These areas of U.S.-
only regulatory reform can present particular challenges in
implementation, both in terms of the potential impact that they may
have on the ability of U.S. financial institutions to compete abroad
and the extent to which they may affect the activities of foreign
financial institutions in U.S. markets and with U.S. counterparties. In
these instances of regulatory reforms being pursued only in the United
States, there are not likely to be obvious answers to the resulting
international complexities.
For example, there has been considerable recent attention paid to
the international aspects of section 619 of the Dodd-Frank Act, more
commonly known as the ``Volcker Rule''. Concerns have been expressed
about the Volcker Rule's potential international implications in three
principal areas. First, because the Volcker Rule applies to the
worldwide operations of U.S. banking entities, but only to the U.S.-
connected operations of foreign banks, concerns have been raised
regarding the relative competitiveness of U.S. firms that have
significant operations in overseas markets. Second, and conversely,
because the Volcker Rule also applies to the activities of foreign
banks unless such activities are ``solely outside the United States,''
several foreign banks and their supervisors have expressed concern
regarding the potential extraterritorial impact that those restrictions
may have on trading or fund activity of foreign banks that has both
U.S. and non-U.S. characteristics. Third, because the Volcker Rule
includes a statutory exemption for proprietary trading in U.S.
Government debt securities, but not in foreign sovereign debt
securities, several constituencies have raised concerns regarding this
asymmetry. In each of these areas, U.S. regulators will need to
carefully consider the concerns that have been raised and the broader
international implications of the Volcker Rule as we work to finalize
our implementing rules.
Similarly, the swaps ``push-out'' requirement in section 716 of the
Dodd-Frank Act also appears unlikely to be pursued internationally.
Under section 716, U.S. insured depository institutions and U.S.
branches and agencies of foreign banks will be required to ``push out''
certain types of derivatives dealing activities to affiliated entities.
The global effects of the swaps push-out provision are multifaceted. On
the one hand, the provision will require U.S. banking firms to
restructure their global derivatives dealing activities in ways that
will not be required of foreign banks abroad. At the same time, the
provision may require U.S. branches and agencies of foreign banks to
restructure their derivatives dealing activities in ways that will not
be required of U.S. banks.
Thank you very much for your attention. I would be pleased to
answer any questions you might have.
______
PREPARED STATEMENT OF ELISSE B. WALTER
Member, Securities and Exchange Commission
March 22, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for inviting me to testify on behalf of the
Securities and Exchange Commission (SEC) about international
cooperation in the realm of financial regulation.
Markets are global, and regulators have long been mindful that
domestic changes can have an impact outside their own countries. The
impact of regulation across borders has become ever more important as
business has become increasingly global. As part of our rulemaking
efforts to implement the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act), the SEC has been actively engaged in
discussions with our counterparts abroad to encourage international
coordination of regulatory reforms.
Our international efforts include both informal and formal
bilateral discussions and arrangements, and we also work through
multilateral organizations, where we have leadership roles in several
task forces and working groups.
My testimony will highlight some of the key areas in which the SEC
is working internationally to identify risks to the global markets,
what regulatory responses might be desirable, and how to best
coordinate such cross-border regulatory responses.
International Coordination Efforts
Since the financial crisis began, the G20 has identified major
financial issues it believes should be addressed by the individual
member jurisdictions to mitigate risks in the global financial system.
As an independent agency, the SEC does not participate directly in G20
Leaders' or Finance Ministers' meetings, but we coordinate with our
domestic and international counterparts who participate in these
meetings to identify concerns in the global capital markets that are
relevant to the work we do.
The G20 often asks other multilateral organizations to conduct in-
depth studies of the concerns that impact the global financial markets,
which have taken the form of surveying various approaches in different
jurisdictions and developing broad policies or principles to guide
regulatory authorities as they develop their own rules and regulations
consistent with their unique national mandates.
In recent years, the Financial Stability Board (FSB) has played an
increasingly active role in coordinating international efforts to
implement G20 objectives. The FSB includes officials from banking
supervisors and capital markets regulators around the globe, along with
representatives from finance ministries and central banks and the
international financial institutions, and aims to identify and discuss
broad trends affecting the financial system.
Currently, I represent the SEC in the FSB. My colleagues from the
Federal Reserve Board and the Department of the Treasury, Governor
Tarullo and Under Secretary Brainard, respectively, also represent the
United States in the FSB. The SEC staff regularly communicates with
staffs of these agencies as well as the staffs of the Office of the
Comptroller of the Currency, the Commodity Futures Trading Commission
(CFTC), and the Federal Reserve Bank of New York in order to present
unified positions in FSB policy discussions and working groups.
The G20 and, in turn, the FSB also seek input from other
international bodies, including the International Organization of
Securities Commissions (IOSCO) and other standard setters. I also serve
as the SEC's Head of Delegation to IOSCO.
Due to the extensive international coordination efforts undertaken
by the SEC and other U.S. financial regulatory agencies within the
context of these international bodies, the recommendations and
international standards being developed by these groups are broadly
consistent with the Dodd-Frank Act and the G20 objectives.
The SEC also participates in multilateral discussions with regional
authorities, and the SEC facilitates targeted, multilateral discussions
with key jurisdictions on its highest priority topics. For example, the
SEC is active in the Council of Securities Regulators of the Americas
(COSRA) on issues of regional importance in the Americas.
We also recognize the need and value of holding discussions outside
of the FSB and IOSCO with regulators from other jurisdictions. While
bodies such as the G20, FSB, and IOSCO play an important role in the
international policy dialogue, national regulatory bodies such as the
SEC continue to exercise the authority granted to them in a manner that
is necessary and appropriate to carry out their statutory missions and
legislative mandates. International bodies, such as the G20, FSB, and
IOSCO, neither legislate nor write governing rules; rather, mandates
for regulation come from national authorities. In addressing the risks
identified by the G20, all jurisdictions do not necessarily follow the
same approach. Additionally, not all jurisdictions are members of the
G20 and FSB. Within IOSCO, market regulators from around the world
participate, but not all entities with the authority to shape relevant
rules and regulations are members.
Because of the detailed nature of the discussions required or the
country-specific nature of the issues involved, certain regulatory
initiatives have proven to be managed more effectively in smaller
forums or on a bilateral basis. To this end, the SEC has several
ongoing bilateral dialogues with regulators in key international
regulatory jurisdictions, including the United Kingdom, India, China,
Korea, Turkey, and Japan.
These dialogues are intended to facilitate identification and
discussion of common issues of regulatory concern, enhance enforcement
cooperation, and, in some cases, expand on existing training and
technical assistance efforts. The dialogues have taken on increasing
importance as regulators around the globe engage in financial
regulatory reform efforts in their respective jurisdictions.
For example, the SEC participates alongside the Department of the
Treasury and the Federal Reserve Board in the Financial Markets
Regulatory Dialogue (FMRD) with the European Union. The FMRD was
created in 2002 as a forum to discuss regulatory initiatives in their
early stages with a focus on avoiding unnecessary conflicts of law
between the United States and the European Union. It has evolved into a
vehicle for in-depth discussion of regulatory issues of mutual concern,
enhancement of understanding of each other's regulatory systems, and
exploration of areas of regulatory cooperation and convergence in the
development of high-quality regulation.
OTC Derivatives
One area where international coordination is particularly important
is reform of the global OTC derivatives markets. After the 2008
financial crisis, Congress recognized the need to bring transparency to
these markets, and the G20 Leaders shared this concern. At the
Pittsburgh Summit in September 2009, the G20 Leaders called for global
improvements in the functioning, transparency and regulatory oversight
of OTC derivatives markets. Specifically, the G20 stated that:
[a]ll standardized OTC derivative contracts should be traded on
exchanges or electronic trading platforms, where appropriate,
and cleared through central counterparties by end-2012 at the
latest. OTC derivative contracts should be reported to trade
repositories. Noncentrally cleared contracts should be subject
to higher capital requirements. We ask the FSB and its relevant
members to assess regularly implementation and whether it is
sufficient to improve transparency in the derivatives markets,
mitigate systemic risk, and protect against market abuse. \1\
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\1\ G20 Meeting, Pittsburgh, 25 September 2009. Available at
http://www.treasury.gov/resource-center/international/g7-g20/Documents/
pittsburgh_summit_leaders_statement_250909.pdf.
In subsequent summits, the G20 Leaders have reiterated their
commitment to OTC derivatives regulatory reform and have asked the FSB
to monitor OTC derivatives reform progress.
Congress also recognized the need for coordination in this area and
directed the SEC to consult with its foreign counterparts, as
appropriate, in several key areas under Title VII of the Dodd-Frank
Act. Specifically, the Dodd-Frank Act states that
in order to promote effective and consistent global regulation
of swaps and security-based swaps, the CFTC, the SEC, and the
prudential regulators . . . , as appropriate, shall consult and
coordinate with foreign regulatory authorities on the
establishment of consistent international standards with
respect to the regulation (including fees) of swaps,
securities-based swap, swap entities, and security-based swaps
entities and may agree to such information-sharing agreements
as may be deemed to be necessary or appropriate in the public
interest or for the protection of investors, swap
counterparties, and securities-based swap counterparties. \2\
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\2\ Dodd-Frank Wall Street Reform and Consumer Protection Act 752
(Pub. L. 111-203, H.R. 4173) (2010).
The SEC and the CFTC have conducted staff studies to assess
developments in OTC derivatives regulation abroad. For example, as
directed by Congress in Section 719(c) of the Dodd-Frank Act, \3\ on
January 31, 2012, the SEC and CFTC jointly submitted to Congress a
``Report on International Swap Regulation'' (Swap Report). \4\ The Swap
Report discusses swap and security-based swap regulation and
clearinghouse regulation in the Americas, Asia, and European Union and
identifies areas of regulation that are similar and other areas of
regulation that could be harmonized. The Swap Report also identifies
major clearinghouses, clearing members, and regulators in each
geographic area and describes the major contracts (including clearing
volumes and notional values), methods for clearing swaps, and the
systems used for setting margin in each geographic area. \5\ In
addition, on April 8, 2011, SEC and CFTC staff submitted a joint study
to Congress on the feasibility of requiring the derivatives industry to
adopt standardized computer-readable algorithmic descriptions which may
be used to describe complex and standardized financial derivatives. \6\
In preparing this report, staff coordinated extensively with
international financial institutions and foreign regulators.
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\3\ Dodd-Frank Wall Street Reform and Consumer Protection Act
719(c) (Pub. L. 111-203, H.R. 4173) (2010).
\4\ Available at http://www.sec.gov/news/studies/2012/sec-cftc-
intlswapreg.pdf.
\5\ The Swap Report points out that major dealers could not be
identified as of the date of the report because rules requiring swap
dealers to register as such had not been adopted yet. Neither could any
major swap exchanges be identified in the report as no exchange was
offering swaps or security-based swaps for trading as of the date of
the report.
\6\ Available at http://www.sec.gov/news/studies/2011/719b-
study.pdf.
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SEC and CFTC staff have also been working on a bilateral basis with
counterparts from Canada, the European Union, Hong Kong, Japan, and
Singapore to coordinate technical issues that are in the interest of
leveling the playing field for the regulation of derivatives
transactions. In December, leaders and senior representatives of the
authorities responsible for the regulation of the OTC derivatives
markets in these jurisdictions met in Paris to discuss significant
cross-border issues related to the implementation of new legislation
and rules governing the OTC derivatives markets, including concerns
about possible regulatory gaps, conflicts, arbitrage, and duplication.
In addition to agreeing to continue staff-level bilateral technical
dialogues, the leaders are planning to meet again as a group this
spring.
We also have worked through multilateral organizations to
facilitate further international cooperation. SEC staff represents
IOSCO as a cochair of the FSB's OTC Derivatives Working Group (ODWG).
The FSB published a report on implementing OTC derivatives market
reforms in October 2010. \7\ This report, which was endorsed by the G20
Leaders, \8\ includes 21 recommendations addressing practical issues
that authorities may encounter in implementing the G20 commitments
concerning standardization, central clearing, exchange or electronic
platform trading, and reporting OTC derivatives transactions to trade
repositories. The ODWG conducts semi-annual reviews of jurisdictions'
efforts to implement the G20 objectives for OTC derivatives reforms and
submits reports on its findings to the G20.
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\7\ Available at http://www.financialstabilityboard.org/
publications/r_101025.pdf.
\8\ G20 Leaders' Meeting, Seoul, Korea, 12 November 2010.
Available at http://www.treasury.gov/resource-center/international/
Documents/1%20%20FINAL%20SEOUL%20COMMUNIQUE.pdf.
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In October 2010, IOSCO formed a Task Force on OTC Derivatives
Regulation to take a leading role in coordinating market regulators'
efforts to work together in the development of supervisory and
oversight structures related to the derivatives markets.
Representatives from the SEC, CFTC, United Kingdom Financial Services
Authority (UK FSA), and the Securities and Exchange Board of India
(SEBI) serve as cochairs of this Task Force. The Task Force was formed
primarily to assist regulators in coordinating their derivatives
legislative and regulatory reform efforts and in developing consistent
regulatory standards, with a focus on derivatives clearing, trading,
trade data collection and reporting, and the oversight of certain
derivatives market participants.
In February 2011, the Task Force published a ``Report on Trading of
OTC Derivatives'' (Report on Trading). \9\ The Report on Trading sets
out a framework for international regulators to consider when
implementing the G20 Leaders' commitment to trade all standardized OTC
derivatives on exchanges or electronic trading platforms, where
appropriate, by the end of 2012. The Report on Trading analyzes the
benefits, costs, and challenges associated with increasing exchange and
electronic trading of OTC derivative products and contains
recommendations aimed at assisting the transition of the trading of
standardized derivatives products from OTC venues onto exchanges and
electronic trading platforms (organized platforms) while preserving the
efficacy of those transactions for counterparties. Following on that
effort, earlier this year, the Task Force completed the ``Follow-On
Analysis to the Report on Trading'', which describes the different
types of organized platforms currently available for the execution of
OTC derivatives transactions in IOSCO member jurisdictions and seeks to
highlight the different approaches global regulators are taking or
envisage taking to mandate the use of organized platforms for trading
OTC derivatives. \10\
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\9\ Available at http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD345.pdf.
\10\ Available at http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD368.pdf.
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The Task Force also collaborated with the Basel-based Committee on
Payment and Settlement Services (CPSS) to publish the ``Report on OTC
Derivatives Data Reporting and Aggregation Requirements'' earlier this
year (Data Report). \11\ The Data Report specifies minimum requirements
for the reporting of data to trade repositories and for trade
repositories reporting to regulators, as well as types of acceptable
data formats, and discusses issues relating to authorities' and
reporting entities' access to data and the dissemination of OTC
derivatives data to the public. The Data Report also describes data
aggregation mechanisms and tools needed to enable authorities to
aggregate data in a manner that fulfills their regulatory mandates,
including methods, rationales and possible tools to implement data
aggregation, such as legal entity identifiers. The Task Force plans to
complete its work later this year when it finalizes reports setting
forth international standards for mandatory clearing and the oversight
of derivative market intermediaries.
---------------------------------------------------------------------------
\11\ Available at http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD366.pdf.
---------------------------------------------------------------------------
Additionally, the SEC is working through IOSCO to review and
improve international standards for financial market infrastructures.
This project is a joint effort of IOSCO and the CPSS. In March 2011,
CPSS-IOSCO issued a ``Consultation Report on Principles for Financial
Market Infrastructures'' (FMI Report). \12\ The FMI Report proposes new
and more demanding international standards for systemically important
payment systems, central securities depositories, securities and
settlement systems, central counterparties and trade repositories
(collectively, financial market infrastructures, or FMIs).
---------------------------------------------------------------------------
\12\ Available at http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD350.pdf.
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The new standards (referred to as principles) presented in the FMI
Report are designed to ensure that the essential payment and
settlements infrastructure supporting global financial markets is more
robust and better placed to withstand financial shocks. The FMI Report
contains a comprehensive set of 24 principles designed to apply to all
systemically important FMIs and five responsibilities for central
banks, market regulators, and other relevant authorities. CPSS-IOSCO
plans to publish the final report this spring.
Finally, given the global nature of the derivatives market, the SEC
intends to address the international implications of its rules arising
under Subtitle B of Title VII in a single proposal in order to give
interested parties, including investors, market participants, and
foreign regulators, an opportunity to consider as an integrated whole
our approach to the registration and regulation of foreign entities
engaged in cross-border security-based swap transactions involving U.S.
parties. We understand that our approach to the cross-border
application of Title VII must both achieve effective domestic
regulatory oversight and reflect the realities of the global
derivatives market. As we do so, the SEC is continuing to actively
coordinate with our counterparts in other jurisdictions to help achieve
consistency and compatibility among approaches to derivatives
regulation.
Identification and Mitigation of Systemic Risk
A second area that requires robust international cooperation is the
identification and mitigation of risks that could have cross-border
impact on markets. The SEC has worked to enhance our capability to spot
emerging issues and to address proactively these issues before they
have the potential to cause serious harm to the U.S. financial markets
and the global financial system. For example, we have open lines of
communication with our international counterparts to discuss emerging
risks and to promptly react to new developments. In addition, our
bilateral efforts and work in multilateral organizations also give us
insight into concerns faced by other jurisdictions.
The ability to collect and share compatible data is also essential
to regulators' efforts to identify and mitigate systemic risk. An
example of this information sharing is the Commission's work with other
regulators, including the UK FSA and the Hong Kong Securities and
Futures Commission, to develop an internationally agreed upon template
that would form the basis for future data collection efforts to better
understand the hedge fund industry.
We worked through IOSCO first, to survey the role of hedge funds in
other markets and to develop high-level, international general
principles for regulation of the hedge fund sector. The template was
published in February 2010 and contains a list of broad proposed
categories of information (with examples of potential data points) that
regulators could collect for general supervisory purposes and to help
in the assessment of systemic risk (including, for example, product
exposure and asset class concentration, geographic exposure, liquidity
information, extent of borrowing, and credit counterparty exposure).
After the Dodd-Frank Act was passed, we continued to work closely
with the UK FSA, the EC, and the European Securities and Markets
Authority (ESMA) to discuss cross-border issues that have emerged as we
implemented Title IV, including the development of Form PF. At the same
time we were developing Form PF, which was finalized on October 31,
2011, \13\ ESMA was developing its data collection form, which was
published on November 11, 2011, as part of ESMA's formal advice to the
EC on implementation of its Alternative Investment Fund Managers
Directive. Given that each regulator must develop its reporting
requirements based on its unique mandates, policies, and objectives,
the forms are understandably not exactly the same. Nevertheless, due to
our extensive coordination efforts, the two forms generally are
compatible and will facilitate international efforts to compare,
aggregate, and learn from the data.
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\13\ Summary and final rule are available at http://www.sec.gov/
news/press/2011/2011-226.htm and http://www.sec.gov/rules/final/2011/
ia-3308.pdf.
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In addition to our bilateral coordination efforts, we have worked
in multilateral organizations to ensure that future efforts to identify
and mitigate risk will benefit from international coordination. For
example, early last year, IOSCO published a discussion paper entitled
``Mitigating Systemic Risk--A Role for Securities Regulators''
(Systemic Risk Paper), which focused on the role securities regulators
play in addressing systemic risk. \14\ The Systemic Risk Paper was
intended to promote discussion among securities regulators on the ways
in which systemic risk intersects with their mandates and to provide
insight on how IOSCO and its members can better identify, monitor,
mitigate, and manage systemic risk. We are also playing a lead role in
IOSCO's new Standing Committee on Risk Research, created to bring
together economists from major market regulators to discuss these
issues on a regular basis. We continue to work internationally to
facilitate dialogue about systemic risk among securities regulators as
well as with the broader international regulatory community.
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\14\ Available at http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD347.pdf.
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Volcker Rule
Section 619 of the Dodd-Frank Act, commonly referred to as the
Volcker Rule, may also have international implications. The Volcker
Rule generally prohibits a banking entity from engaging in proprietary
trading and having certain interests in, or relationships with, a hedge
fund or private equity fund (covered funds), subject to certain
exemptions. The defined term ``banking entity'' determines the scope of
entities subject to the Volcker Rule and includes any: (i) insured
depository institution, (ii) company that controls an insured
depository institution, (iii) foreign bank with a branch, agency or
subsidiary in the United States, and (iv) affiliates and subsidiaries
of the foregoing entities. The Commission proposed a rule jointly with
the Federal banking agencies to implement the Volcker Rule in October
2011 (Proposed Rule), and the CFTC issued its proposal in January 2012.
In the Proposed Rule, the five regulatory agencies requested and
received comment on several international issues. For example, the
Proposed Rule, which closely follows statutory construction, includes
an exemption for proprietary trading in certain U.S. and municipal
Government obligations, but does not establish an additional exemption
for proprietary trading in foreign Government obligations. Many
commenters, including some foreign Governments, have requested that
such an exemption be adopted and have expressed concerns about the
proposed rule's potential impact on liquidity in foreign sovereign debt
markets. Moreover, consistent with the statute's exemptive authority,
some of these commenters have suggested ways that such an exemption
would promote and protect the safety and soundness of banking entities
and the financial stability of the United States. However, some
commenters have indicated that such an exemption would not be necessary
or would not meet such standards.
In addition, the proposal also includes the statutory exemptions
for foreign banking entities' activities conducted ``solely outside of
the United States.'' The Proposed Rule sets forth certain requirements
for these exemptions that are intended to give effect to the statutory
language. Some commenters have stated that the exemption's requirements
may result in unintended extraterritorial application of the Volcker
Rule's restrictions on a foreign banking entity's offshore activity.
The proposed definition of ``covered funds'' also includes certain non-
U.S. funds, and this may have international implications. In an effort
to prevent circumvention of the Volcker Rule's general prohibition on
covered fund activities by simply relocating covered fund-related
activities offshore, the proposal defined ``covered fund'' to include
certain types of non-U.S. funds. Some commenters have stated that this
definition may be too broad and could include foreign retail mutual
funds or other types of regulated pooled investment vehicles.
Commission staff is reviewing and considering the comment letters
that we have received on this proposal, including comments on the
international implications of the Proposed Rule. I anticipate that
staffs of the five regulatory agencies will have in-depth discussions
about these topics as they work together through the next steps of the
rulemaking process.
Market Efficiency and Integrity
A fourth area where we and our foreign counterparts have an
interest is market efficiency and integrity. In early 2010, the SEC
issued a Concept Release on Equity Market Structure to begin an in-
depth review to ensure that the U.S. equity markets remain fair,
transparent and efficient in light of new technology and trading
strategies. \15\ Not surprisingly, many other jurisdictions face
similar challenges. The rapid developments in trading technologies and
trading platforms have had a profound impact on the structure of
markets around the world.
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\15\ Available at http://www.sec.gov/rules/concept/2010/34-
61358fr.pdf.
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As we have considered these issues, the EC also has been reviewing
its Markets in Financial Instruments Directive (MiFID) in light of new
technology, and in October 2011, the EC issued proposals to amend
MiFID, focusing on developing safeguards for algorithmic and high
frequency trading activities. Throughout this process, we have had
ongoing discussions with our international counterparts.
On October 14, 2011, Chairman Schapiro and her regulatory
counterparts in Europe, the Americas, Asia, and Australia spent a full
day discussing the impact of advances in technology, new trading
strategies, and the increasing integration and globalization of markets
as part of an international roundtable of regulators that the SEC
cohosted with the UK FSA in London. The discussion focused on sharing
views about automated trading strategies, high frequency trading,
market fragmentation, and dark pools.
Last year, the SEC also adopted a large trader reporting system,
providing us with access to better data to help us assess the impact of
high frequency traders and other major market participants on the
quality of our markets, as well as to assist in our surveillance and
enforcement efforts. \16\ In addition, we are continuing to work toward
the adoption of a consolidated audit trail system to further help
regulators keep pace with new technology and trading patterns in the
markets. \17\ As we utilize and develop new tools, we are also
coordinating with our international counterparts to share knowledge and
develop complementary strategies that will ultimately facilitate the
sharing of information for supervisory and enforcement purposes.
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\16\ See, Securities Exchange Act Release No. 64976 (July 27,
2011), 76 FR 46960 (August 3, 2011).
\17\ See, Securities Exchange Act Release No. 62174 (May 26,
2010), 75 FR 32556 (June 8, 2010).
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To that end, SEC staff also is engaged actively with IOSCO to
address the continuing challenges that technological changes pose for
regulators in their market surveillance, including: the fragmentation
of markets and the resulting dispersal of trading information; the
increased speed of trading; and regulators' ability to gather and
process the increased volume of trading data.
In addition, in the fall of 2010, the G20 Leaders asked IOSCO to
develop ``recommendations to promote markets' integrity and efficiency
to mitigate the risks posed to the financial system by the latest
technological developments.'' In response, IOSCO undertook a review of
global perspectives on the impact of technological developments,
including work on trading halts, direct electronic access, dark
liquidity, and high frequency trading. In April 2011, IOSCO published
principles to assist regulators in minimizing the potential adverse
effects of the increased use of dark liquidity, focusing on
transparency and price discovery, market fragmentation, knowledge of
trading intentions, fair access, and the ability to assess actual
trading volume in dark pools.
In October, IOSCO published the ``Report on Regulatory Issues
Raised by the Impact of Technological Changes on Market Integrity and
Efficiency'' (Technological Changes Report). \18\ The Technological
Changes Report analyzes significant technological developments and
related microstructural issues that have arisen in financial markets in
recent years, notably high frequency trading, and their impact on
market structure, participants' behavior, price discovery and
formation, and the availability and accessibility of liquidity. In
addition, the Technological Changes Report recognizes the benefits of
technology, including facilitating the establishment of globally
competitive markets, enabling market participants to reduce transaction
time, generation of electronic audit trails, enhancement of order and
trade transparency, enabling markets and market participants to develop
and apply (and regulators to monitor) automated risk controls.
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\18\ See, http://www.iosco.org/library/pubdocs/pdf/IOSCOPD361.pdf
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Supervisory Cooperation
Another key priority for the G20 is increasing the effectiveness of
global supervision of financial institutions and other market
participants. In a world with interconnected markets and actors with
cross-border operations, more effective supervision will require
increased international supervisory cooperation.
The SEC has long recognized the importance of international
cooperation to its own supervisory mission, especially in our
examination program. The SEC staff has been developing arrangements
and, where possible, entering into formal Memoranda of Understanding
(MOUs), to facilitate supervisory cooperation with foreign regulators.
These agreements generally establish clear mechanisms for consultation,
cooperation and the exchange of supervisory information. Such
mechanisms minimize the need to address supervisory information sharing
on an ad hoc basis and seek to address new information sharing needs
created by globally active firms and cross-border affiliated markets.
The SEC's supervisory cooperation agreements can vary in scope and
purpose. To date, the SEC has entered into bilateral MOUs that cover
information sharing and cooperation related to, among other things,
firms registered with both the SEC and a foreign authority; the
oversight of markets in the U.S. and a foreign jurisdiction affiliated
through common ownership structure; and the sharing of nonpublic issuer
specific information relating to the application of International
Financial Reporting Standards.
This month, the SEC entered in a supervisory MOU with the Cayman
Islands Monetary Authority (CIMA) Concerning Consultation, Cooperation
and the Exchange of Information Related to the Supervision of Cross-
Border Regulated Entities (CIMA MOU). The CIMA MOU covers those
entities that are regulated by the SEC and the CIMA and operate or
provide services across our respective borders. It also sets forth the
terms and conditions for the sharing of information regarding regulated
entities, such as broker-dealers and investment advisers. The scope of
the CIMA MOU is broad, allowing our cooperation to evolve and adapt to
a changing regulatory landscape and covers not only regulated entities
that currently operate on a cross-border basis, but also those that may
come under our respective jurisdictions in the future.
In September 2011, the SEC entered into an expanded supervisory MOU
with its Canadian counterparts. The Canadian MOU is a comprehensive
arrangement that will help to facilitate the supervision of regulated
entities that operate across the U.S.-Canadian border. The SEC and
Canadian provincial securities authorities have a long history of
cooperation, particularly in securities enforcement matters. The
Canadian MOU extends this cooperation beyond enforcement by
establishing a framework for consultation, cooperation, and information
sharing related to the day-to-day supervision and oversight of
regulated entities. The supervision of regulated entities is critical
to encouraging compliance with the securities laws, which in turn helps
to protect investors and the securities markets generally.
The SEC is also actively engaging its regulatory counterparts
abroad to develop new supervisory cooperation tools. For example, the
SEC and the European Securities Markets Authority recently concluded an
MOU that would allow us to share information regarding the oversight of
credit rating agencies that are registered in both our markets. The MOU
lays out the processes by which we could conduct examinations of the
offices of credit rating agencies located in each other's
jurisdictions. In addition, the MOU provides a clear mechanism by which
the SEC and ESMA staffs can share observations about the compliance
cultures of registered credit rating agencies to better inform both
agencies.
The SEC also has comprehensive supervisory MOUs with the securities
regulators in the United Kingdom, Germany, and Australia, as well as
several tailored arrangements and protocols for information sharing
with other regulators. \19\ Under these agreements, SEC staff is
increasingly able to obtain and exchange documents and information
about cross-border regulated entities and globally active market
participants. SEC staff has also conducted many on-site examinations of
SEC registrants located overseas in cooperation with foreign
authorities. These types of arrangements improve our ability to share
information at the operational level and to have frank, open
discussions with our counterparts abroad about the entities we
regulate, such as broker-dealers and investment advisers.
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\19\ See, Cooperative Arrangements With Foreign Regulators at
http://www.sec.gov/about/offices/oia/oia_cooparrangements.shtml.
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To complement our bilateral supervisory cooperation efforts, the
SEC worked within IOSCO to establish a Task Force on Supervisory
Cooperation. This SEC-led task force developed principles for
supervisory cooperation and a model MOU that was endorsed by IOSCO's
Technical Committee and published in 2010. \20\ The model MOU was
designed to assist securities regulators in building and maintaining
cross-border cooperative relationships with one another and has proven
helpful in our ongoing efforts to expand the number of bilateral
agreements focused on supervision.
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\20\ Available at http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD322.pdf.
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With the SEC's authority under the Dodd-Frank Act to supervise
additional market participants such as hedge fund advisers, security-
based swaps dealers, and major security-based swaps participants, SEC
staff will seek to expand its cooperative networks with foreign
counterparts on supervisory matters. We also anticipate that the FSB
and IOSCO will continue to consider ways to improve international
supervisory cooperation, and we will continue to work in these
multilateral forums to support our bilateral efforts and fulfill our
supervisory mission.
In addition to enhancing our ability to oversee registrants that
operate cross-border, SEC staff has assisted other U.S. regulators in
carrying out their mandates. As you know, the SEC also has oversight
responsibilities for the Public Company Accounting Oversight Board
(PCAOB), which oversees both foreign and domestic public accounting
firms that audit U.S. public companies. The Commission continues to
work closely with the PCAOB on efforts to achieve meaningful inspection
of PCAOB registered firms overseas.
Unfortunately, at the present time, the PCAOB is unable to conduct
inspections in a number of European countries, as well as the People's
Republic of China. While the PCAOB continues its efforts to enable
inspections of registered firms to be conducted in these countries, the
Board has taken a number of interim steps to help protect investors.
These steps include regularly publishing information that provides
transparency around the status of firms' ability to be inspected, such
as the jurisdictions that are not allowing PCAOB inspections, the firms
that are overdue for inspections and are in jurisdictions that will not
allow those inspections to go forward, as well as a list of companies
whose audit firms have not been inspected by the PCAOB. In addition,
the PCAOB has reevaluated its approach to considering registration
applications from firms in jurisdictions where the PCAOB is unable to
conduct inspections. The inability to conduct inspections can and has
resulted in the PCAOB determining to disapprove a registration
application. The PCAOB continues to work, with SEC support and at the
urging of the Commission, to achieve the goal of accomplishing
meaningful oversight of registrant firms wherever they may be.
Enforcement Cooperation
Finally, the cornerstone of any effective regulatory regime is its
enforcement. In global markets, bad actors can wreak havoc both at home
and abroad, and the proceeds of their violations can and do move
throughout our global marketplace. No matter how robust and coordinated
global regulation and supervision may be, if those rules are not
enforced, or if investors are not confident that the markets are fair,
the global financial system will not function efficiently. The SEC has
over 35 bilateral MOUs with its counterparts for information sharing
for enforcement purposes. These agreements vary in scope, but generally
allow for broad information sharing, including provisions for
assistance with locating individuals of interest and conducting
testimony abroad.
While international enforcement cooperation has long been important
to our mission, and many of our enforcement cooperation agreements are
now more than 20 years old, I want to highlight our international
enforcement cooperation for two reasons. First, now more than ever, it
is essential to the success of our enforcement program. Last year,
nearly 30 percent of the SEC's enforcement cases had an international
element that required the agency to reach out to foreign authorities.
As just one example, in a major insider trading case where we charged a
doctor in France with tipping a U.S. hedge fund manager about clinical
drug trials, the French Autorite des marches financiers (AMF)
accomplished the important task of helping us obtain bank records,
phone records, and compelled testimony--key evidence crucial to our
success in the case. \21\
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\21\ SEC v. Yves Benhamou, Lit. Rel. No. 21721 (November 2, 2010),
available at http://www.sec.gov/litigation/litreleases/2010/
lr21721.htm; see, also related action SEC v. Joseph ``Chip'' Skowron
Lit. Rel. No. 22158 (November 17, 2011), available at http://
www.sec.gov/litigation/litreleases/2011/lr22158.htm.
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During fiscal year 2011, the SEC made 772 formal requests to
foreign authorities for enforcement assistance, and frequently
conducted informal discussions with our partners about investigations
with cross-border elements. Importantly, our cooperation is not one-
way; in the same year, the SEC responded to 492 requests from abroad.
We are less than halfway through FY2012 and are well on track to meet
or exceed these record numbers yet again.
Second, our international enforcement cooperation efforts also
illustrate the efficacy of the multifaceted international coordination
strategies we employ. In May 2002, IOSCO developed a Multilateral
Memorandum of Understanding Concerning Consultation and Cooperation and
the Exchange of Information (MMoU). The MMoU is a multilateral
enforcement information-sharing and cooperation arrangement. It
provides an international benchmark for the types of information
securities regulators should have authority to share as well as the
terms under which information sharing should occur. The MMoU provides a
baseline as to what is expected of a regulator in order to cooperate
fully in global efforts to combat securities fraud. When a jurisdiction
applies to become a signatory, IOSCO conducts a rigorous review to
assess the jurisdiction's ability to fulfill its obligations under the
MMoU.
This multilateral effort also has expanded significantly the number
of securities regulators who have the ability to gather information and
share information with the SEC for enforcement investigations and
proceedings. The international pressure on nonsignatory jurisdictions
increased after the financial crisis, when IOSCO set a goal of January
1, 2013, for all of its members to acquire the powers and authorities
necessary to become full signatories to the MMoU. As of the 2011 IOSCO
Annual Meeting, over 80 securities regulatory authorities have become
signatories to the MMoU, and another 30 have made the necessary
commitment to seek national legislative changes to allow them to do so
by the 2013 deadline.
Similarly, the FSB is actively encouraging global cooperation in
information sharing. In 2010, the FSB launched an initiative to
encourage the adherence of all countries and jurisdictions to
international cooperation and information exchange standards. As part
of this initiative, the FSB reviewed the policies and practices of 61
jurisdictions to evaluate and rate compliance with international
cooperation and information exchange standards. This past November, the
FSB published the results of its review, including the names and
categories of the evaluated jurisdictions. The United States was
referenced as a jurisdiction demonstrating sufficiently strong
adherence.
In addition to participating in multilateral efforts to raise
standards for cooperation, the SEC has a long-standing commitment to
training foreign regulatory and law enforcement officials in
enforcement strategies and techniques. Every fall, we hold an
International Enforcement Institute (Enforcement Institute), a flagship
event for securities enforcement professionals worldwide that provides
an excellent opportunity to develop important relationships with our
counterparts, while serving to strengthen their capacity to conduct
effective enforcement in their respective jurisdictions. Similarly, we
also host an annual International Institute on Securities Market
Development, which is a key part of our efforts to strengthen global
capital markets and lays a strong foundation for bilateral engagement
around the world. In addition to these successful outreach efforts, we
continue to work bilaterally and regionally to provide technical
assistance to regulators around the world in many topic areas.
Finally, I want to highlight one of the SEC's major current efforts
focused in the enforcement arena, the Cross-Border Working Group, an
interdivisional team that brings various experiences and expertise to
address risks associated with U.S. issuers whose primary operations are
located overseas. This team emerged out of an SEC proactive risk-based
inquiry into U.S. audit firms with a significant number of issuer
clients with primarily foreign operations. That inquiry revealed
serious accounting irregularities among certain U.S. issuers based
abroad. The efforts of this group have resulted in a wide array of
actions to protect U.S. investors, including suspending trading in at
least 20 foreign-based entities because of deficiencies in information
about the companies, instituting stop orders against foreign-based
entities to prevent further stock sales under materially misleading and
deficient offering documents, revoking the securities registration of
at least a dozen foreign-based issuers, and instituting administrative
proceedings to determine whether to suspend or revoke the registrations
of 27 more. The majority of issuers in the United States whose
operations are primarily overseas are located in the PRC region;
accordingly, most of these actions have involved companies based in
China. The Cross-Border Working Group's endeavors also extend outside
of the enforcement area and include reaching across borders to enhance
cooperation with SEC counterparts.
Conclusion
Our ability to develop shared objectives and cooperative
relationships with our counterparts abroad is a critical part of our
mission, and increasingly more so every year. Since the 2008 financial
crisis, through the SEC's work in the FSB and IOSCO, participation in
bilateral dialogues, and discussions with SEC staff who work on these
issues on a day-to-day basis, I have observed a reinvigorated global
commitment to the core objectives shared by securities regulators:
protecting investors; promoting fair, efficient, and transparent
markets; and facilitating capital formation to fuel global economic
growth. However, shared objectives alone are not sufficient. We must
also pursue a shared commitment to work together to identify compatible
regulatory approaches in pursuit of those objectives. The SEC works
tirelessly to pursue such commitment through cooperation with
counterparts throughout the international regulatory landscape and will
continue to pursue and promote international cooperation.
Thank you for the opportunity to testify today on this important
set of issues. I am happy to answer any questions you may have.
______
PREPARED STATEMENT OF MARTIN J. GRUENBERG
Acting Chairman, Federal Deposit Insurance Corporation
March 22, 2012
Good morning Chairman Johnson, Ranking Member Shelby, and Members
of the Committee. Thank you for the opportunity to testify on
international harmonization issues related to Wall Street reform.
The financial crisis of 2008 exposed a number of serious
vulnerabilities in the U.S. financial system and in other financial
systems around the world. In the years leading up to the crisis,
misaligned incentives, excessive leverage and risk taking, and gaps in
regulation all contributed to a serious and, at the time, unrecognized
increase in systemic risk. The financial crisis that followed in 2008-
09 led to the most severe economic downturn since the 1930s.
In the immediate wake of the financial crisis, the Group of Twenty
(G20) Nations, through the Financial Stability Board, jointly resolved
to strengthen financial regulation across jurisdictions and enhance
cross-border cooperation among financial regulators. \1\ This broad-
based commitment to reform recognized both the highly interconnected
nature of the global financial system and the enormous economic costs
of the financial crisis. The intended result is to reduce the
likelihood and severity of future financial crises, and to enhance the
effectiveness of the international regulatory response should crises
occur. As implementation of the Dodd-Frank Act proceeds in the United
States, the FDIC continues to work with our international counterparts
to undertake reforms that will be needed for a stronger and more stable
global financial system in the future.
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\1\ The G20 is comprised of the finance ministers and central bank
governors from 19 countries (including the United States) and the
European Union, with representatives of the International Monetary Fund
and the World Bank. Collectively, the countries represent more than 80
percent of the global gross national product.
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My testimony today will discuss three key areas where the
postcrisis implementation of financial reforms in the United States
have an important international component: (1) the cross-border
resolution of large, systemically important financial institutions; (2)
capital standards; and (3) capital market reforms.
Cross-Border Resolution of Large, Systemically Important Financial
Institutions (SIFIs)
Section 210 of the Dodd-Frank Act requires the FDIC to
``coordinate, to the maximum extent possible'' with appropriate foreign
regulatory authorities in the event of a resolution of a covered
financial company with cross-border operations. The FDIC has been
working diligently on both multilateral and bilateral bases with our
foreign counterparts in supervision and resolution to address these
crucial cross-border issues.
The FDIC has participated in the work of the Financial Stability
Board through its membership on the Resolution Steering Group, the
Cross-border Crisis Management Group and a number of technical working
groups. The FDIC also has cochaired the Basel Committee's Cross-border
Bank Resolution Group since its inception in 2007.
Key Attributes
In October 2011, the Financial Stability Board released ``Key
Attributes of Effective Resolution Regimes for Financial
Institutions''. The Key Attributes build on the set of recommendations
developed by the Cross-border Bank Resolution Group that were published
in March 2010 following its assessment of lessons learned during the
crisis. The Key Attributes set out the parameters of a legal and
regulatory regime that would allow authorities to resolve financial
institutions in an orderly manner without taxpayer exposure to loss
while maintaining continuity of vital economic functions. They address
such critical issues as the scope and independence of the resolution
authority, the essential powers and authorities that a resolution
authority must possess, and how jurisdictions can facilitate cross-
border cooperation in resolutions of significant financial
institutions. The Key Attributes also provide guidelines for how
jurisdictions should develop recovery and resolution plans for specific
institutions and for assessing the resolvability of their institutions.
The FDIC was deeply involved in the development of the Key Attributes
and many of them parallel the provisions of the U.S. resolution regime
under Title II of the Dodd-Frank Act. The United States has been
recognized for its leadership in developing a credible resolution
process for large nonbank financial companies.
In November 2011, the G20 endorsed the Key Attributes. As a result,
financial regulators from the G20 member Nations are required to move
toward a resolution framework to resolve SIFIs in an orderly manner
that protects global financial stability. A methodology to assess
countries' progress toward implementing the Key Attributes is now under
development.
Crisis Management Groups
The FDIC and its U.S. and foreign financial regulatory counterparts
have formed Crisis Management Groups under the auspices of the
Financial Stability Board for each of the internationally active SIFIs
(termed Global SIFIs or G-SIFIs) identified by the G20 at their
November 4, 2011, meeting. These Crisis Management Groups, consisting
of both home and host country authorities, are intended to enhance
institution-specific planning for possible future resolution. These
groups allow regulators to identify impediments to a more effective
resolution based on the unique characteristics of a particular
financial company.
The FDIC has participated in Crisis Management Group meetings
hosted by authorities in various foreign jurisdictions. These meetings
have focused on crisis management, recovery and resolution planning,
and implementation issues associated with G-SIFIs from those
jurisdictions. The FDIC has also hosted Crisis Management Group
meetings for the five largest U.S. G-SIFIs and met with specific
foreign regulators to discuss the progress these firms have made on
their recovery and resolution plans as well as other related cross-
border issues. The Crisis Management Group meetings have provided
opportunities for the exchange of information on resolution planning
and policy. We expect these meetings to assist the FDIC in developing
and refining its resolution strategies for G-SIFIs and to help
regulators in identifying and overcoming impediments to resolution,
particularly with respect to cross-border issues.
FDIC Bilateral Discussions and Agreements
Since G-SIFIs present complex international legal and operational
issues, the FDIC is also actively reaching out on a bilateral basis to
the foreign supervisors and resolution authorities with jurisdiction
over the foreign operations of key U.S. firms. The goal is to be
prepared to address issues regarding cross-border regulatory
requirements and to gain an in-depth understanding of cross-border
resolution regimes and the concerns that face our international
counterparts in approaching the resolution of these large international
organizations. As we evaluate the opportunities for cooperation in any
future resolution, and the ways that such cooperation will benefit
creditors in all countries, we are forging a more collaborative process
as well as laying the foundation for more reliable cooperation based on
mutual interests in national and global financial stability.
It is worth noting that although U.S. SIFIs have foreign operations
in dozens of countries around the world, those operations tend to be
concentrated in a relatively small number of key foreign jurisdictions,
particularly the United Kingdom (UK). While the challenges to cross-
border resolution are formidable, they may be more amenable than is
commonly thought to effective management through bilateral cooperation.
The focus of our bilateral discussions is to: (i) identify
impediments to orderly resolution that are unique to specific
jurisdictions and discuss how to mitigate such impediments through rule
changes or bilateral cooperation and (ii) examine possible resolution
strategies and practical issues related to implementation of such
strategies with respect to particular jurisdictions. This work entails
gaining a clear understanding of how U.S. and foreign laws governing
cross-border companies will interact in any crisis. Our initial work
with foreign authorities has been encouraging. In particular, the U.S.
financial regulatory agencies have made substantial progress with
authorities in the UK in understanding how possible U.S. resolution
structures might be treated under existing UK legal and policy
frameworks. We have engaged in in-depth examinations of potential
impediments to efficient resolutions and are, on a cooperative basis,
in the process of exploring methods of resolving them.
To facilitate bilateral discussions and cooperation, the FDIC is
negotiating the terms of memoranda of understanding pertaining to
resolutions with regulators in various countries. These memoranda of
understanding will provide a formal basis for information sharing and
cooperation relating to our resolution planning and implementation
functions under the legal framework of the Dodd-Frank Act.
Resolution Planning Progress in the United States and Impact on Foreign
Banking Organizations
In the United States, we are far along in the process of
implementing the SIFI resolution provisions of the Dodd-Frank Act. We
issued a final rule on our Title II orderly liquidation authority (OLA)
in July 2011, and a joint final rule with the Board of Governors of the
Federal Reserve System (Federal Reserve Board) on Title I financial
company resolution plans in November 2011. These combined provisions
give the FDIC new authorities and responsibilities for planning and
implementing the orderly liquidation of a SIFI.
Since the enactment of the Dodd-Frank Act in 2010, the FDIC has
been developing detailed resolution plans pursuant to our Title II
resolution authorities. In addition, Title I of the Dodd-Frank Act
requires SIFIs to submit resolution plans for review by the FDIC and
the Federal Reserve Board. These plans detail how the firms could be
resolved under the U.S. Bankruptcy Code. The FDIC would act under the
Dodd-Frank Title II orderly liquidation authority only where the
necessary parties agree that resolution under the Bankruptcy Code would
have serious adverse effects on U.S. financial stability. If the firms
are successful in their resolution planning, the likelihood of such
action would be greatly reduced.
Similar to its application to U.S. based G-SIFIs, Section 165(d) of
the Dodd-Frank Act requires foreign banking organizations (FBOs) with
$50 billion or more in total consolidated assets to submit resolution
plans. However, the plans submitted by the FBOs and any other specified
foreign-based covered companies will focus their information and
strategic analysis upon the firms' U.S. operations.
Submission of resolution plans will be staggered based on the asset
size of a covered financial company's U.S. operations. Financial
companies with $250 billion or more in U.S. nonbank assets must submit
plans on or before July 1, 2012. All of the SIFIs in this initial group
have been designated G-SIFIs by the Financial Stability Board.
Companies with $100 to $250 billion in total U.S. nonbank assets must
submit plans on or before July 1, 2013; and all other covered financial
companies must submit plans on or before December 31, 2013. A company's
plan is required to be updated annually or as directed by the FDIC and
the Federal Reserve Board.
As with U.S. G-SIFIs, FBOs are to submit their plans in phases
according to the size of their U.S. nonbank assets. Thus, FBOs with a
U.S. footprint of $250 billion or more in U.S. nonbank assets will be
required to submit plans by July 1, 2012. Those having $100 billion or
more in U.S. nonbank assets will be required to submit plans by July 1,
2013, and the remaining covered FBOs will submit their plans by
December 31, 2013.
If a resolution plan does not meet the statutory standards, after
affording the covered company an opportunity to remedy its
deficiencies, the agencies may jointly decide to impose more stringent
regulatory requirements--such as increased liquidity requirements or
limits on credit exposures--on the covered company. Further, after 2
years following the imposition of the more stringent standards, if the
resolution plan still does not meet the statutory standards, the FDIC
and the Federal Reserve Board may--in consultation with the Financial
Stability Oversight Council (FSOC)--direct a covered financial company
to divest certain assets or operations.
In addition, in January 2012, the FDIC issued a final rule
requiring any FDIC-insured depository institution with assets of $50
billion or more to develop, maintain, and periodically submit
contingency plans outlining how depository institutions could be
resolved under the FDIC's traditional authority in the Federal Deposit
Insurance Act. While not required by the Dodd-Frank Act, this
complements the joint final rule on resolution plans for SIFIs.
These two resolution plan requirements are designed to ensure
comprehensive and coordinated resolution planning for the insured
depository institution, its holding company and any affiliates in the
event that an orderly liquidation is required. Both of these
requirements will improve efficiencies, risk management and contingency
planning at the institutions themselves. The process of developing
resolution plans also provides the FDIC important information for the
refinement of our potential resolution strategies for SIFIs under the
OLA.
FSOC Joint Rulemaking and Guidance on SIFI Designations
While all bank holding companies with more than $50 billion in
assets are automatically designated as SIFIs by the Dodd-Frank Act, the
Act also authorized the FSOC to determine whether a nonbank financial
company is systemically important. The FDIC has been working with the
other FSOC members to finalize the rule and interpretative guidance to
implement this authority. When the rule and guidance are finalized,
which is expected in the near future, the FSOC will begin the process
of evaluating nonbank financial companies to determine whether material
financial distress at one or more of them would pose a threat to the
financial stability of the United States. The nonbank designation rule
applies to U.S. nonbank financial companies and to foreign nonbank
financial companies operating in the United States. Once designated as
a SIFI, a nonbank financial company will be subject to all the
supervisory and resolution requirements that apply to systemically
important bank holding companies.
Improvements in Capital Standards
In the aftermath of the financial crisis, there has been an
intensive international effort to strengthen bank capital standards.
The result of these efforts is the Basel III capital agreement. In
broad terms, the Basel III capital standards aim to improve the quality
and increase the level of bank capital. Collectively, Basel III and
other standards published by the Basel Committee address a number of
features of capital regulation that allowed for an excessive use of
leverage in the years leading up to the crisis. There are a number of
such issues that are being addressed by Basel III and in a
complementary way by the Dodd-Frank Act.
One of the lessons of the crisis was that high quality, loss-
absorbing capital is essential to ensuring the safety and soundness of
financial institutions. Basel III addresses this by establishing
regulatory capital as ``common equity tier 1.'' This results in a
measure that is much closer to pure tangible common equity than the
present tier 1 definition. Meeting regulatory requirements for common
equity tier 1 capital will provide a much more realistic and meaningful
assurance of a bank's ability to absorb losses.
In addition to the definition and quality of capital, Basel III
also addresses the level of capital. At the beginning of the crisis, as
today, the minimum tier 1 risk-based capital requirement was 4 percent
of risk-weighted assets. Tier 1 capital was required to be
``predominantly'' equity. Thus, equity could comprise as little as 2
percent of risk-weighted assets.
Basel III increases the numerical minimum risk-based capital
ratios. For the new concept of common equity tier 1, the Basel III
minimum ratio is 4.5 percent of risk-weighted assets. For tier 1 and
total capital the Basel III minimums are 6 percent and 8 percent,
respectively. Capital buffers comprising common equity equal to 2.5
percent of risk-weighted assets are added to each of these minimums to
enable banks to absorb losses during a stressed period while remaining
above their regulatory minimum ratios.
Basel III also includes a ``countercyclical buffer'' intended to
act as a stabilizer against significant asset bubbles as they develop.
Specifically, regulators could increase the capital buffers by up to an
additional 2.5 percent if they deem the economy to be in a period of
excessive credit creation.
Basel III establishes, for the first time, an international
leverage ratio. The Basel III leverage ratio is an important tool to
ensure that capital exists to cover losses that the risk-based rules
may categorize as minimal, but that can sometimes materialize anyway.
The Basel Committee has also agreed that the largest internationally
active banks should be subject to additional capital charges ranging
from 1 percent to 2.5 percent of riskweighted assets to account for the
additional risk they pose to the financial system should they
experience difficulties. \2\
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\2\ The Basel Committee also established an ``empty bucket'' with
a 3.5 percent additional capital charge designed to discourage banks
from becoming more systemic.
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In addition, to strengthen capital standards for trading book risk,
the U.S. banking agencies issued a Notice of Proposed Rulemaking (NPR)
in January 2011, to implement important reforms agreed to by the Basel
Committee. These reforms will increase capital requirements to levels
more appropriate for trading book assets. A second Market Risk NPR was
issued in December 2011 to respond to section 939A of the Dodd-Frank
Act. This NPR provides an alternative to credit ratings in computing
trading book capital requirements. We are committed to working with our
fellow regulators to finalize the important reforms to trading book
capital requirements as soon as possible upon reviewing and
appropriately addressing the public comments we receive.
The Basel Committee agreed that Basel III would be phased-in over a
5-year period starting in 2013, and the banking agencies are drafting
an NPR to implement Basel III in the United States. We believe that
most U.S. banks currently hold sufficient capital to meet the Basel III
capital standards. Banks that need more time by and large appear well
positioned to meet the standards far ahead of the Basel timeline and
mostly with retained earnings. Now that agreement has been reached on a
more robust international capital standard, it is vital that the
standard be implemented in a uniform manner. A comprehensive monitoring
framework will be coordinated by the Basel Committee's Standards
Implementation Group and will rely on peer reviews. It entails a review
of members' domestic adoption and implementation timelines for the
Basel regulatory capital framework.
Capital Market Reforms in the Dodd-Frank Act
Beyond the development of an effective resolution regime for SIFIs,
and the capital reforms of Basel III, two provisions of the Dodd-Frank
Act with potential international implications are Section 619, relating
to proprietary trading, and the margin and capital requirements for
over-the-counter derivatives found in Title VII.
The Volcker Rule
Section 619 of the Dodd-Frank Act, known as the Volcker Rule, is
designed to strengthen the financial system and constrain the level of
risk undertaken by firms that benefit, either directly or indirectly,
from the Federal safety net provided by Federal deposit insurance or
access to the Federal Reserve's discount window. The Volcker Rule
prohibits proprietary trading by banking organizations and limits
investments in hedge funds and private equity funds that they organize
and offer, subject to certain exemptions for such permissible banking
activities as underwriting, market making, and risk-mitigating hedging.
The challenge for regulators in implementing the Volcker Rule is to
prohibit the types of proprietary trading and investment activity that
Congress intended to limit, allowing banking organizations to provide
legitimate intermediation in the capital markets and maintain market
liquidity.
Last November, the FDIC, jointly with the Federal Reserve Board,
the Office of the Comptroller of the Currency (OCC), and the Securities
and Exchange Commission (SEC), published an NPR requesting public
comment on a proposed regulation implementing the Volcker Rule
requirements. On December 23, 2011, the agencies extended the comment
period for an additional 30 days until February 13, 2012. The comment
period was extended as part of an interagency effort to allow
interested persons more time to analyze the issues and prepare their
comments, and to facilitate coordination of the rulemaking among the
responsible agencies.
The agencies have received a significant number of comments from
international banking organizations and foreign financial services
regulators regarding concerns about the potential extraterritorial
reach of the Volcker Rule and the proposed regulations. Commentators
have raised concerns about the proposed regulation's potential effects
on foreign sovereign debt markets, the ability of foreign organizations
to continue to utilize U.S. market infrastructure, and the difficulties
associated with properly distinguishing permissible foreign funds from
impermissible funds. The agencies are in the process of reviewing and
carefully considering all of the comments received as we work toward
the development of a final regulation.
As of February 13, 2012, the agencies had received approximately
17,500 comment letters from a wide variety of stakeholders. The FDIC is
committed to developing a final rule that meets the objectives of the
statute while preserving the ability of banking entities to perform
important underwriting and market-making functions, including the
ability to effectively carry out these functions in less-liquid
markets.
Margin and Capital Requirements for Covered Swap Entities
In June 2010, the G20 leaders reaffirmed a global commitment to
clearing standardized OTC derivatives through a clearinghouse, and this
commitment was incorporated into the Dodd-Frank Act. For derivatives
that lack sufficient standardization for clearing, the Dodd-Frank Act
requires dealers and major participants in such transactions to
register with the Commodities Futures Trading Commission or SEC, as
applicable. The Dodd-Frank Act also requires the prudential
regulators--the FDIC, the Federal Reserve Board, the OCC, the Farm
Credit Administration, and the Federal Housing Finance Agency--to
jointly adopt margin requirements for uncleared OTC derivatives entered
into by entities they regulate that also fall within the Dodd-Frank
Act's dealer and major participant terms. In May 2011, the prudential
regulators published an NPR proposing these margin requirements and
have received numerous comments that are being carefully considered.
Since the issuance of the NPR, the Federal Reserve Board has
initiated an effort to develop an international convergence in margin
requirements for uncleared OTC derivatives and has asked the Basel
Committee, in conjunction with the International Organization of
Securities Commissions, to develop a consultation document by June
2012. Staffs from the FDIC and the other banking agencies are actively
participating in the Working Group on Margin Requirements initiative.
In order to reduce competitive concerns, the agencies intend to take
into consideration, to the extent possible, the margin recommendations
in the consultative document in the development of a final uncleared
OTC derivative margin rule.
Conclusion
Today's testimony highlights the work of the FDIC, in conjunction
with other U.S. regulators and our international counterparts, to
improve resolution and regulatory regimes for the global financial
system. As the global reach of the financial crisis made clear, cross-
border cooperation and harmonization are essential for effective
implementation of reforms. The FDIC is committed to working with our
fellow Federal agencies as well as our foreign counterparts to achieve
this important goal.
Thank you. I would be glad to respond to your questions.
______
PREPARED STATEMENT OF JOHN G. WALSH
Acting Comptroller, Office of the Comptroller of the Currency
March 22, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, I appreciate the opportunity to provide the Committee with
the Office of the Comptroller of the Currency's (OCC) perspectives on
the international implications of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act) and on efforts currently
underway to harmonize U.S. regulatory requirements with international
standards and frameworks for the financial services sector.* In
particular, the Committee's letter of invitation requests that I
testify about areas of reform that have international implications,
such as orderly liquidation authority, derivatives oversight, and the
prohibitions on proprietary trading and private equity and hedge fund
investments commonly known as the Volcker Rule.
---------------------------------------------------------------------------
* 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.
---------------------------------------------------------------------------
Since the 2008 financial crisis, the international regulatory
community has taken many steps to strengthen the global financial
system. In particular, the G20 Governments, the Financial Stability
Board, the Basel Committee on Banking Supervision, and other
international regulatory bodies embarked upon an ambitious series of
reforms. Standards have been developed and are being introduced to
increase capital and liquidity, create better mechanisms for resolving
large financial institutions, centralize derivatives clearing, and
strengthen supervision in a number of other areas. National
implementation of this reform agenda is underway in all the G20
countries.
The Dodd-Frank Act encompasses the U.S. response to the crisis and
implements important parts of the international reform agenda. It seeks
to enhance the resiliency of the U.S. financial system, among other
ways, by requiring higher capital and liquidity standards for large
U.S. financial institutions. In the event that a bank failure were to
occur, the Dodd-Frank Act imposes steps to preclude future taxpayer
bailouts and abolish ``too big to fail'' by requiring orderly
resolution regimes for such institutions. The Dodd-Frank Act also seeks
to strengthen operations and safeguards pertaining to derivatives
activities through a variety of mechanisms, including enhanced
transparency through increased reporting and reduced counterparty
credit risks through centralized clearing arrangements and higher
margin for over-the-counter swap transactions.
Given the intersection of U.S. and international efforts, many of
the Dodd-Frank Act mandates in these areas complement work underway by
regulators internationally to enhance the resilience of the global
financial system. While most of these efforts are still works in
progress, I believe paths are available for international harmonization
in many of these areas. However, even when broad consensus on
international standards is reached, there will be areas of difference
where policy makers in individual countries have chosen to tailor
standards to their country and institutions rather than adopt the
totality of the international approach. This is the case in the U.S.,
for example, where the Dodd-Frank Act has established certain
standards--such as the prohibition on the use of credit ratings in our
regulations--that will cause our implementation of the international
capital standards to differ in some aspects from those of other
countries.
Other provisions of the Dodd-Frank Act that impose structural and
operational requirements for conducting certain financial activities
have no equivalent in international workstreams or efforts to harmonize
approaches. The most notable, in terms of potential international
effects, is the Volcker Rule prohibitions on proprietary trading and
private equity and hedge fund investments. The lack of a parallel
international workstream and the resulting implications for both U.S.
and foreign firms are areas of concern that have been raised in comment
letters that the OCC and other agencies have received on our proposed
rulemaking.
My testimony today will describe in greater detail the intersection
of Dodd-Frank and international efforts in five key areas: capital
standards, liquidity requirements, orderly resolution of large and
complex firms, derivatives activities, and the Volcker Rule.
I. Capital Standards
Since the 1980s, the Federal banking agencies have worked with
their international counterparts through the Basel Committee on Banking
Supervision (Basel Committee or BCBS) to develop and implement
regulatory capital requirements. In 1989, the Federal banking agencies
first implemented minimum risk-based capital requirements for U.S.
banking organizations based on the ``International Convergence of
Capital Measurement and Capital Standards'' (Basel I), which was
published by the Basel Committee in 1988. \1\
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\1\ BCBS, International Convergence of Capital Measurement and
Capital Standards (July 1988), available at: http://www.bis.org/publ/
bcbs04a.htm.
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In 1997, the OCC, FDIC, and Federal Reserve Board implemented
revisions to their risk-based capital rules, consistent with revisions
to Basel I published the previous year by the Basel Committee. These
provisions added a market risk framework requiring banks to address
exposures to market risk associated with foreign exchange and commodity
positions and positions located in the trading account.
On December 7, 2007, the Federal banking agencies implemented the
advanced approaches risk-based capital rules for the largest
internationally active banks based on a new international capital
adequacy framework (Basel II). \2\ The advanced approaches rules were
intended to promote improved risk measurement and management processes
and better align minimum risk-based capital requirements with risk by
incorporating certain Basel II approaches (advanced internal ratings-
based approach for credit risk and the advanced measurement approaches
for operational risk).
---------------------------------------------------------------------------
\2\ BCBS, ``International Convergence of Capital Measurement and
Capital Standards: A Revised Framework'', (June 2006), available at:
http://www.bis.org/publ/bcbs128.htm.
---------------------------------------------------------------------------
These longstanding international cooperative efforts were stepped
up in response to the financial crisis, resulting in a broad consensus
across jurisdictions that it was necessary to further enhance the
quality and quantity of bank capital. The OCC has been an active
participant in these efforts and is working with the other Federal
banking regulators to implement regulations domestically.
In 2009 and 2010, the Basel Committee published revisions to both
the market risk framework and the treatment of certain securitization
exposures (collectively, these revisions are referred to as Basel
II.5), \3\ and in December 2010, the Basel Committee published Basel
III, which represents the collective work of numerous country
participants to develop new capital standards for promoting a more
resilient banking sector. \4\ As I will describe, many of the key
provisions and objectives of Basel III complement key capital
provisions of the Dodd-Frank Act.
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\3\ The Basel Committee published the revisions in two documents
in 2009 and then updated them in June 2010. The 2009 documents
included: Revisions to the Basel II Market Risk Framework, Guidelines
for Computing Capital for Incremental Risk in the Trading Book, and
Enhancements to the Basel II Framework. The June 2010 revisions are
available at: http://bis.org/press/p100618/annex.pdf.
\4\ Bank for International Settlements, Basel Committee on Banking
Supervision, Basel III: A global regulatory framework for more
resilient banks and banking systems (December 2010, revised June 2011).
---------------------------------------------------------------------------
Among the more significant changes in Basel III is the introduction
of a new common equity tier 1 minimum risk-based capital ratio that
will require banks to hold a minimum amount of common equity to total
assets. The financial crisis demonstrated that common equity is
superior to other capital instruments in its ability to absorb losses.
Therefore, this new requirement should enhance banks' ability to
withstand periods of financial stress. As envisioned, common equity
capital requirements will increase substantially from levels preceding
the financial crisis.
The existing tier 1 and total risk-based capital requirements also
will become more rigorous due to a narrower definition of regulatory
capital that excludes funds raised through hybrid capital instruments,
such as trust preferred securities, that generally do not absorb losses
to the same extent as common equity. This provision is broadly
consistent with section 171(b) of the Dodd-Frank Act that directs the
Federal banking agencies to remove these types of instruments from the
definition of regulatory capital. Basel III also places strict limits
on the amounts of mortgage servicing assets and deferred tax assets
that may count as regulatory capital.
The amount of capital that a bank is required to hold also is a key
feature of the Basel III reforms, and implementation is to be achieved,
in part, through substantial increases to a bank's overall minimum
required risk-based capital ratios. The Basel III reforms set higher
capital requirements that essentially will move the common equity tier
1 ratio from a minimum of roughly 2 percent under current rules to 4.5
percent. These increases are to be supplemented by two regulatory
capital ``buffers''--a capital conservation buffer of 2.5 percent
common equity tier 1 (bringing the minimum common equity tier 1
requirement to 7 percent), which a bank would be expected to draw down
during times of economic stress, and a countercyclical buffer, which
banking supervisors can activate to curb excessive credit growth. As a
bank's capital levels near the minimum requirements and dip into the
buffers, the bank will face progressively more stringent restrictions
on its ability to make capital distributions (including dividends) and
to make discretionary bonus payments. The largest U.S. banks have
already made meaningful progress in reaching the higher thresholds
under Basel III as evidenced by the recently announced stress test
results.
In the U.S., the leverage ratio has always been a key component in
assessing a bank's capital adequacy, acting as a back-stop to the risk-
based capital requirements. Basel III also adds an international
leverage ratio requirement for the first time. The international
requirement is broader than the current U.S. requirement because it
will include certain off-balance sheet exposures. During the recent
financial crisis it became apparent that some banks had built-up
excessive on- and off-balance sheet leverage while continuing to
present strong risk-based capital ratios. In fact, some of the largest
financial institutions significantly increased their off-balance sheet
exposures, which were not captured in the U.S. leverage ratio
calculation. This led to a build-up of leverage that moved onto banks'
balance sheets and, in the most critical periods of the crisis, banks
were forced by the markets to reduce their leverage in a manner that
significantly increased downward pressure on asset prices, exacerbating
losses and leading to a reduction in capital levels and a contraction
in credit availability. The scope of the Basel III leverage ratio is
broadly consistent with the provisions in section 165 of the Dodd-Frank
Act that directs that off-balance-sheet activities be included in the
regulatory capital calculation for bank holding companies with total
consolidated assets equal to or greater than $50 billion.
Another way in which the capital framework was strengthened in
response to the crisis is reflected in section 171 of the Dodd-Frank
Act, the ``Collins Amendment,'' which requires bank holding companies
to be subject to strict bank-level capital requirements. In the lead up
to the crisis, capital requirements applicable to banks were more
rigorous in certain respects than those applied to bank holding
companies. The Dodd-Frank Act requires the application of the same
requirements to both banks and bank holding companies. This is
important because even though banks were generally well capitalized
leading up the financial crisis, their holding companies suffered
substantial losses, and it is the bank holding companies that were the
primary focus of efforts to shore up the financial system at that time
and of the Dodd-Frank Act's new enhanced resolution framework.
Finally, the financial crisis focused attention on the risk that
large internationally interconnected firms present to global financial
stability. Both Basel III and the Dodd-Frank Act address this concern,
but they take different approaches. Basel III calls for adopting a
capital surcharge that would apply only to the 29 largest global,
systemically important banks, 7 of which are U.S. entities. Section 165
of the Dodd-Frank Act requires the Federal Reserve Board to consult
with the other Federal banking regulators and implement heightened
prudential standards, including capital requirements, for the 34 U.S.
bank holding companies with total consolidated assets of $50 billion or
more.
The Federal banking agencies have been working diligently to assess
the key features of Basel III and to translate them into a workable and
effective set of capital standards for U.S. financial institutions.
While there are many common elements between Basel III and the capital
provisions of the Dodd-Frank Act, the Dodd-Frank Act introduces several
capital related provisions unique to U.S. financial institutions and,
therefore, the U.S. capital standards necessarily will deviate from the
international standards in several significant respects.
The Collins Amendment, as previously noted, requires the Federal
banking agencies to apply the same generally applicable minimum capital
requirements to all banks and bank holding companies. But in addition,
in a statutory requirement unique to the U.S., the Collins Amendment
provides that any regulatory capital requirement that the Federal
banking agencies apply to any subset of banks (such as the advanced
approaches rules, which are required only for large internationally
active banks) is permitted to increase the capital requirements
relative to the generally applicable minimum capital requirements, but
is not permitted to decrease them. Additionally, the Collins Amendment
requires that the generally applicable minimum capital requirements may
never be ``quantitatively lower'' than the current Basel I-based
minimum capital requirements.
Thus, for large internationally active U.S. banks, the simpler
generally applicable minimum capital rules will still govern even
though they are undertaking the complex and costly task of implementing
the more risk-sensitive advanced approaches risk-based capital
framework. Without the risk sensitivity of the advanced approaches,
banks will have less incentive to pursue safer loans or lower risk
securities because they will not obtain the capital benefit of doing
so. And a foreign bank pursuing the same strategy and operating without
the floor would enjoy a market advantage over their U.S. counterparts.
Another divergence from Basel III arises from section 939A of the
Dodd-Frank Act, which requires all Federal agencies to remove
references to, and requirements of reliance on, credit ratings from
their regulations and to replace them with appropriate alternatives for
evaluating creditworthiness. Basel III, in contrast, continues to rely
on credit ratings in many areas, making it difficult to implement those
provisions domestically.
On December 29, 2011, the Federal banking agencies published a
notice of proposed rulemaking to revise their market risk capital rule
consistent with enhancements made by the Basel Committee and with
section 939A of the Dodd-Frank Act. This proposal, which built on a
proposal that the agencies published in January 2011, was the Federal
banking agencies' first proposal to replace references to credit
ratings in their risk-based capital regulations. The Federal banking
agencies are reviewing the comments received on the December 2011
proposal and are considering how best to implement the market risk rule
in final form. The agencies also expect to propose to replace
references to credit ratings more generally in the coming months.
A common set of standards or rules is only one aspect of
international harmonization. Equally important is how those standards
or rules are implemented in practice. As I have highlighted in previous
testimony, different countries have implemented the advanced approaches
qualification requirements with varying degrees of rigor. \5\ While
many international regulators permitted large banks in their
jurisdictions to move to the advanced approaches framework several
years ago, the Federal banking agencies have held U.S. banks to more
stringent standards and have yet to approve a single U.S. bank to apply
the advanced approaches.
---------------------------------------------------------------------------
\5\ Testimony of John Walsh, Acting Comptroller of the Currency,
before the Committee on Financial Services, United States House of
Representatives (June 16, 2011), available at: http://www.occ.gov/news-
issuances/congressional-testimony/2011/pub-test-2011-73-written.pdf.
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To address the inconsistent application of its standards across
jurisdictions, the Basel Committee has initiated a peer review process
to monitor, on an ongoing basis, the status of members' adoption of the
Basel rules, including the Basel III agreement. Under this process,
teams of banking supervisors from different jurisdictions will review
the compliance of members' domestic rules or regulations with the
international minimum standards and identify differences that could
raise prudential or level playing field concerns.
The OCC is participating in this initiative and supports its
objectives. Effective implementation of the Basel standards should be a
top priority and to that end, the OCC has committed staff and resources
necessary to participate in the peer review process to the fullest
extent possible.
II. Liquidity Requirements
During the early phase of the financial crisis, many banks, despite
adequate capital levels, still experienced difficulties because of
inadequate liquidity. Consequently, the Basel Committee and the Dodd-
Frank Act, through enhanced supervision and heightened prudential
standards, sought to mitigate these concerns by focusing on the
importance of effective liquidity management to the proper functioning
of financial markets and the banking sector.
Basel III introduces two explicit quantitative minimum liquidity
ratios to assist a bank in maintaining sufficient liquidity during
periods of financial stress: the Liquidity Coverage Ratio and the Net
Stable Funding Ratio. These ratios are designed to achieve two separate
but complementary objectives. The Liquidity Coverage Ratio, with a one-
month time horizon, addresses short-term resilience by ensuring that a
bank has sufficient high quality liquid resources to offset cash
outflows under acute short-term stresses. The Net Stable Funding Ratio
is targeted toward promoting longer-term resilience by creating
additional incentives for a bank to fund its ongoing activities with
stable sources of funding. Its goal is to limit over-reliance on short-
term wholesale funding during times of robust market liquidity and
encourage better assessment of liquidity risk across all on- and off-
balance sheet items.
The Basel Committee included a lengthy implementation timeline for
both ratios to provide regulators the opportunity to conduct further
analysis and to make changes as necessary. The Federal banking agencies
currently are working together, and with the Basel Committee, to
develop and recommend changes to the Liquidity Coverage Ratio to ensure
that it will produce appropriate requirements and incentives,
especially during economic downturns, and to otherwise limit potential
unintended consequences.
As mentioned previously, the Dodd-Frank Act's heightened prudential
standards are intended to address risks to the financial stability of
the U.S. that may arise from large, interconnected financial
institutions and includes the establishment of liquidity requirements
to address some of those concerns. Section 165 of the Act requires the
Federal Reserve Board to establish prudential liquidity requirements
for nonbank financial companies supervised by the Board and bank
holding companies with total consolidated assets equal to or greater
than $50 billion. The Federal Reserve Board has issued a proposal that
builds on the 2010 Interagency Policy Statement on Funding and
Liquidity Risk Management issued by the Federal banking agencies and
the Conference of State Bank Supervisors and includes, among other
things, projected cash flows, stress testing, and contingency funding
plan requirements as well as provisions addressing board of director
and senior management responsibilities for overseeing and implementing
a company's liquidity program. The proposed standards also would
require affected firms to maintain liquidity buffers of highly liquid
assets and to establish limits on funding concentrations and
maturities--concepts that are broadly consistent with the goals of the
Basel III liquidity ratios.
Under the proposal, the liquidity requirements would increase in
stringency based on the systemic risk of a covered institution. Thus, a
covered company would take into consideration its capital structure,
risk profile, complexity, activities, size, and other appropriate risk-
related factors in implementing the proposed liquidity requirements.
Furthermore, the proposal would permit the Federal Reserve Board to
subject a covered company to additional or further enhanced liquidity
prudential standards where the Board determines that compliance with
the proposed rule does not sufficiently mitigate the risks to U.S.
financial stability posed by the failure or material financial distress
of the covered company.
While the OCC supports the more rigorous liquidity standards that
the Basel Committee and the Federal Reserve Board's proposals would
establish, we believe it is essential to calibrate these standards
appropriately and to harmonize to the fullest extent possible the
definitions and data upon which they are based. The OCC has stressed
the need to ensure that the Dodd-Frank Act and Basel III liquidity
standards being developed reflect empirical analysis and are carried
out in a coordinated manner so as to enhance the safety and soundness
of the U.S. and global banking systems, while not unduly restricting
access to credit.
III. Cross-Border Resolutions
A key objective of the Dodd-Frank Act is ending the perception that
a firm is ``too big to fail'' by requiring, among other things, more
robust resolution planning regimes. The orderly resolution of large,
complex financial institutions also is a key objective of the
international supervisory community. The international efforts have
focused, in large part, on the establishment of cooperative structures,
including crisis management groups working alongside supervisory
colleges, as a way to provide meaningful planning and timely exchange
of information.
Supervisory colleges are international working groups that assist
supervisors to develop a better understanding of the risk profile of an
international banking group. They are not formal decision-making
bodies, but rather provide a forum to discuss broader issues such as
the planning of supervisory assessments and the sharing of information
and perspectives by home country and host country participants relating
to the risk assessment of an international banking group. Colleges
facilitate effective crisis management by assisting in planning the
crisis management meeting, encouraging the banking group to produce
appropriate information for crisis management, and serving as a conduit
for information sharing.
In November 2011, the G20 endorsed a new standard (Financial
Stability Board's Key Attributes of Effective Resolution Regimes) as an
internationally agreed model for reform of national resolution regimes.
\6\ Rather than creating a single, global legal framework for the
resolution of cross-border financial institutions, the Key Attributes
set out the responsibilities, instruments, and powers that all national
resolution regimes should have to enable authorities to resolve failing
financial firms in an orderly manner. The Key Attributes include
requirements for crisis management groups, resolvability assessments,
and recovery and resolution planning for global systemically important
financial institutions (G-SIFIs), and for the development of
institution-specific cross-border cooperation agreements so that home
and host authorities of G-SIFIs are better prepared for dealing with
crises.
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\6\ ``Key Attributes of Effective Resolution Regimes for Financial
Institutions'', Nov. 4, 2011, available at: http://
www.financialstabilityboard.org/publications/r_111104cc.pdf.
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The current U.S. legal framework, as enhanced by Title II of the
Dodd-Frank Act, establishes a resolution regime that conforms with the
Key Attributes in that it applies in a clear and transparent way to
financial institutions whose failure could be systemically significant
or critical. It also authorizes U.S. regulatory agencies to require
domestically incorporated global systemically important financial
companies to develop recovery and resolution plans, including a group
resolution plan. U.S. regulatory agencies can require regular
resolvability assessments for these companies and enter institution-
specific cross-border cooperation agreements. Similarly, certain large
insured depository institutions are required to provide plans for their
resolution.
The current U.S. legal framework is also consistent with the Key
Attributes provisions concerning conditions for cross-border
cooperation. U.S. law generally permits U.S. resolution authorities to
cooperate with resolution measures by foreign home resolution
authorities. Similarly, the Dodd-Frank Act directs the Financial
Stability Oversight Council (FSOC), the Federal Reserve Board, and the
Secretary of the Treasury to consult with other international
regulatory authorities on matters related to systemic risk and
supervision of financial institutions. The Dodd-Frank Act also directs
the FDIC, as receiver for a systemically important financial company,
to coordinate, to the maximum extent possible, with appropriate foreign
financial authorities regarding the orderly liquidation of a
systemically important financial company that has assets or operations
in a country other than the U.S. The Dodd-Frank Act empowers the FDIC,
for purposes of carrying out liquidation and receivership authorities
under the Dodd-Frank Act, to request assistance from a foreign
financial authority or to assist any foreign financial authority in
conducting any investigation, examination, or enforcement action.
Consistent, harmonized implementation is critical to the
effectiveness of the model Key Attributes. Legislative changes will be
required in many jurisdictions to implement the Key Attributes and to
strengthen supervisory mandates and capabilities. Other requirements
will demand a high degree of active cooperation among authorities and
reviews by firms of their structures and operations. The Cross-Border
Crisis Management Working Group (CBCM) of the Financial Stability Board
(FSB) is conducting surveys to assess the status of work in the various
jurisdictions relating to Crisis Management Groups (CMGs), recovery and
resolution planning, and resolvability assessments. In addition, the
FSB, with the involvement of the International Monetary Fund, the World
Bank, and the standard setters, is also drawing up a methodology to
assess implementation of the Key Attributes standards, and the OCC is
participating in the development of the methodology. Supervisory
colleges and CMGs can also complement these wider peer review processes
by promoting a coherent, cross-jurisdictional approach to the
consistent and effective implementation of the Key Attributes.
IV. Derivatives Regulation
In 2009, G20 leaders committed to reforming over-the-counter (OTC)
derivatives markets by year-end 2012, to require clearing of
standardized contracts through central counterparties, and to improve
transparency of noncleared derivatives and subject them to additional
capital requirements. In Title VII of the Dodd-Frank Act, the U.S.
established the legislative infrastructure for these and other reforms
in our derivatives markets. As the U.S. makes orderly progress through
the implementation of Title VII, we also face questions about the
progress of other G20 Nations.
Effective restructuring of the derivatives market, in the manner
envisioned in Title VII, will be difficult to achieve if traders have
the option to conduct their derivative transactions in other, less
heavily regulated jurisdictions. If international efforts are
successful in implementing robust restrictions in all significant
market jurisdictions, we will protect U.S. institutions and markets
from exposure to systemic risk in the form of market contagion from
under-supervised large traders. Even with such broad harmonization, the
goals of Title VII may be affected by smaller differences with other
countries.
The G20 leaders have charged the FSB with regularly monitoring the
progress of implementation by G20 Nations towards the 2009 commitments
on OTC derivatives. The FSB, through the OTC Derivatives Working Group,
is currently in the process of wrapping up its information-collection
activities antecedent to publishing its fourth progress report. While
the reports thus far show that the U.S. and some other major market
jurisdictions have established the legislative infrastructure necessary
to meet the 2012 commitment, many other jurisdictions have not yet
undertaken this important step.
On the positive front, international regulators are making
important progress in establishing ground rules that will support a
global approach to central clearing on a cross-border basis through
recognized counterparties. This has the potential to facilitate greater
standardization and liquidity in derivatives, increasing the proportion
of contracts that can be cleared. In November of 2011, an international
working group was established to address this issue and, more broadly,
coordinate other international workstreams on OTC derivatives. Other
established international supervisory coordinating bodies, such as the
Basel Committee, the Committee on Payment and Settlement Systems, and
the International Organization of Securities Commissions (IOSCO) are
preparing standards, consultative documents, and study papers on
international derivatives implementation issues falling within their
respective jurisdictions. The Securities and Exchange Commission (SEC)
and the Commodity Futures Trading Commission also have been
coordinating with international counterparts in several major
jurisdictions to coordinate implementation issues with cross-border
impact.
Notwithstanding these preliminary moves, U.S. regulators have been
hampered in their work with regulators in other jurisdictions that have
not yet established a legislative framework for OTC market
restructuring. While it is understandable that these jurisdictions,
which currently have smaller levels of OTC market activity, might wish
to ``wait and see'' how the U.S. and European regulators complete their
approach before proceeding with their own measures, the ``wait and
see'' approach also creates the risk of regulatory arbitrage, and slows
the pace of international coordination.
Important progress also is being made on the implementation of
margin requirements backing noncleared derivatives. The OCC, along with
the other U.S. banking, commodities, and securities regulators, are
participating in an international supervisors' working group,
established in the fall of 2011 under the auspices of the BCBS and
IOSCO, to address this topic. U.S. banking and commodities regulators
were the first to issue specific proposed margin requirements, in the
spring of 2011. The banking agencies' proposal requested public comment
on the international application of U.S. margin requirements to
noncleared derivatives executed by foreign branches and subsidiaries of
U.S. banks that are swaps dealers or major swap participants.
Commenters expressed concerns that U.S. and foreign regulators must
coordinate as to the level and effective dates of their respective
margin requirements, and anticipated that unilateral U.S.
implementation of margin rules would eliminate U.S. banks' ability to
continue competing in foreign markets that are behind the U.S. in
formulating margin rules for their own dealers. We anticipate the BCBS-
IOSCO working group will be in a position to issue a consultative paper
on international margin standards by this summer.
To summarize, in the key aspects of OTC derivatives market
restructuring, the G20 leaders have committed to core changes, channels
of communication between supervisors have been established, and the
parties are working toward convergence, though the final outcome
remains to be seen. Given our commitment to convergence with
international standards, our primary concern with the ongoing efforts
to reform OTC derivatives markets is one of timing. If the U.S. is
unable to implement market reforms in a coordinated and contemporaneous
fashion with all significant derivatives market jurisdictions, we face
the risk that trades will move to an unregulated market. This would
thwart the intended result of Title VII reforms, and negatively affect
the ability of U.S. financial institutions to compete for international
market share.
In addition, there is one particular aspect of Title VII for which
there appears to be no equivalent policy among our foreign
counterparts: the ``push out'' provisions of section 716, which
dictates where in a U.S. bank holding company certain aspects of
derivatives dealing business can be conducted. The language of the
section is ambiguous in important respects, but the U.S. appears to be
alone in espousing the basic approach in section 716 of limiting the
flexibility of holding companies to conduct some aspects of their
derivatives dealing business within depository institutions.
V. Volcker Rule
The Dodd-Frank Act contains certain provisions, like section 619
(the ``Volcker Rule''), that have no foreign equivalent and, unlike
capital and liquidity requirements, currently are not the subject of
international harmonization efforts. Section 619 generally prohibits a
banking entity, which includes a U.S. banking entity and a foreign bank
with certain U.S. operations, \7\ from engaging in proprietary trading
and from making investments in, and having certain relationships with,
a hedge fund or private equity fund. The statute excepts from these
prohibitions certain activities, including market-making related
activities, underwriting, risk-mitigating hedging, trading in U.S.
Government obligations, and activities conducted by qualifying foreign
banking entities ``solely outside of the United States.''
---------------------------------------------------------------------------
\7\ Section 619 applies to any foreign bank that ``is treated as a
bank holding company for purposes of section 8 of the International
Banking Act of 1978'' and its affiliates worldwide.
---------------------------------------------------------------------------
On November 7, the Federal banking agencies and the SEC issued a
notice of proposed rulemaking to implement the Volcker Rule (the
Proposal). \8\ The public comment period on the Proposal closed on
February 13, and the agencies are now considering the over 16,000
comment letters received. These include comment letters from both U.S.
and foreign banking entities, trade associations, and governmental
authorities, including the Governments of Canada, the European Union,
France, Germany, Mexico, Japan, and the United Kingdom.
---------------------------------------------------------------------------
\8\ The CFTC published a notice of proposed rulemaking
implementing section 619 on February 14, 2012. The CFTC proposal, which
adopts the same rule text as the Proposal, is open for comment through
April 16, 2012.
---------------------------------------------------------------------------
It is clear from these comment letters and meetings with our
foreign counterparts that the U.S. restrictions on banking entities'
high-risk trading and investment activities are unique. As our foreign
counterparts have pointed out, the G20 did not endorse regulation of
proprietary trading and hedge and private equity fund investments as an
area of the financial system requiring reform and, to our knowledge,
other countries have not adopted such measures.
Instead, other countries have chosen different measures to guard
against the financial and operational risks banking entities may face
from businesses perceived as high risk. Most countries are relying
primarily on enhanced capital and liquidity requirements and new
resolution frameworks for globally systemic banks to address such
risks. The United Kingdom has proposed additional measures (known as
the ``Vickers Proposal'') to restructure its banks: its so-called
``retail ring-fencing'' measures would require banks to conduct retail
and investment banking services in separate subsidiaries, thereby
limiting capital and liquidity transfers from the retail arm of the
banking group to the wholesale side of the business. The Vickers
Proposal, in contrast to the Volcker Rule, would not prohibit
proprietary trading in a banking organization, but rather require that
it be conducted outside of the retail bank.
These comment letters also raise significant issues relating to the
international implications of the Proposal by addressing the potential
impact of the Proposal on competitiveness and on the extraterritorial
reach of U.S. laws. Some of these issues flow from the provisions of
the statute, while others are the result of how the agencies have
proposed to implement the statute. For example, U.S. banking entities
have expressed concern that they will be at a competitive disadvantage
internationally when they conform their worldwide operations to the
requirements of the Proposal because foreign banking entities not
covered by the Volcker Rule would be permitted to engage in proprietary
trading and make hedge fund and private equity investments, subject
only to applicable foreign laws. In addition, foreign banking entities
covered by the Volcker Rule may engage in proprietary trading and make
hedge fund and private equity investments ``solely outside of the
United States'' by the terms of the statute. U.S. banking entities have
pointed out that this difference in treatment could result in
regulatory arbitrage, regulatory uncertainty, and unfair competition
and could affect the competitiveness of all U.S. companies that depend
on U.S. markets for liquidity and capital formation. They have noted
that reduced liquidity, on a macroeconomic level, could restrain
economic development, job creation, and the international
competitiveness of U.S. businesses. Many of these complaints are about
the basic policy contained in the statute, but we are carefully
considering these concerns to determine the extent to which they are
exacerbated by the Proposal.
Foreign Governments and foreign banking entities have expressed
concern about the extraterritorial impact of the Proposal, including
the agencies' approach to implementing the statutory exception which
permits qualifying foreign banking entities to engage in prohibited
trading and covered fund activities ``solely outside of the United
States.'' Commenters have asserted that the Proposal construes this
exception too narrowly, and, as a result, foreign banking entities will
need to rely on other exceptions in the Proposal in order to engage in
activities outside of the U.S. Commenters have maintained that these
exceptions impose U.S. legal requirements on foreign banking entities
operating outside of the U.S., which may conflict with applicable
foreign laws and may be inconsistent with the regulatory approach
adopted by foreign regulators.
Commenters also have criticized the application of the statutory
backstops and the proposed compliance and reporting requirements to
operations of foreign banking entities outside of the U.S. The
backstops provide that a banking entity may not engage in any permitted
activity that would involve or result in a material conflict of
interest or a material exposure to a high-risk asset or trading
strategy or threaten the safety and soundness of the banking entity or
the financial stability of the U.S. Section 619 requires the agencies
to issue rules regarding internal controls and record keeping to ensure
compliance with the statute. The Proposal imposes the statutory
backstops, a detailed compliance program, and extensive reporting
requirements on all banking entities subject to section 619, including
foreign banking entities. Commenters have urged the agencies to limit
the scope of these requirements to foreign banking entities' U.S.
operations.
Finally, commenters have objected to the preferential treatment
afforded to U.S. Government obligations as compared to obligations
issued by foreign Governments. They have urged the agencies to treat
foreign sovereign bonds like U.S. Government obligations by creating an
exception for trading in foreign sovereign debt. Commenters have argued
that foreign sovereigns are used as collateral and for asset liability
management purposes and that disrupting their trading will jeopardize
banking entities' safety and soundness. In addition, they have noted
that making sovereign debt harder to trade, especially by primary
dealers, will make the market for that debt less liquid. This could
hinder central monetary operations and thereby decrease financial
stability. Moreover, the commenters have suggested that providing
preferential treatment to U.S. sovereign debt may result in retaliatory
efforts by other countries.
We plan to carefully consider all comments received in implementing
the regulation. In particular, we plan to consider both the
extraterritorial reach of the Proposal and the potential for regulatory
overlaps and inconsistencies the Proposal may create for banking
entities' worldwide operations.
Conclusion
The OCC is committed to effective implementation of international
financial regulatory agreements and the Dodd-Frank Act. As we move
forward with Dodd-Frank Act implementation and toward convergence with
international standards, we must be mindful of the need to strike an
appropriate balance between enhanced regulation, better supervision,
and market restrictions.
Achieving a level playing field for internationally active
institutions is an important objective, but it is never fully achieved,
and sometimes national policy choices, like a number of those I have
noted in the Dodd-Frank Act, place other national objectives above
competitive equity. Still, it is important to appropriately reconcile
the enhanced U.S. requirements with the enhanced international
standards wherever possible, or run the risk of placing U.S. banks at a
competitive disadvantage that may drive important elements of financial
services and financial intermediation out of the banking system or out
of the United States.
Thank you for the opportunity to discuss the international
implications of the Dodd-Frank Act and to update the Committee on the
efforts currently underway to harmonize U.S. regulatory requirements
with international standards and frameworks. I am happy to answer your
questions.
______
PREPARED STATEMENT OF JACQUELINE H. MESA
Director of the Office of International Affairs, Commodity Futures
Trading Commission
March 22, 2012
Good morning Chairman Johnson, Ranking Member Shelby, and Members
of the Committee. I am Jacqueline Mesa, the Director of the Office of
International Affairs at the Commodity Futures Trading Commission.
Thank you for the opportunity to testify today regarding international
aspects of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act). This morning, I will provide an overview of
global commitments for over-the-counter (OTC) derivatives reform, an
update on Dodd-Frank Act implementation efforts at the Commodity
Futures Trading Commission (CFTC or Commission), global initiatives to
bring financial reform to OTC derivatives, and coordination with
international regulators in regulating the swaps market.
G20 Commitment for OTC Derivatives Reform
The financial crisis generated international consensus on the need
to strengthen financial regulation by improving transparency,
mitigating systemic risk, and protecting against market abuse. As a
result of the widespread recognition that transactions in the OTC
derivatives market increased risk and uncertainty in the economy and
became a significant contributor to the financial crisis, a series of
policy initiatives were undertaken to better regulate the financial
markets.
In September 2009, leaders of the Group of 20 (G20)--whose
membership includes the European Union (EU), the United States, and 18
other countries--agreed that: (1) OTC derivatives contracts should be
reported to trade repositories; (2) all standardized OTC derivatives
contracts should be cleared through central counterparties and traded
on exchanges or electronic trading platforms, where appropriate, by the
end of 2012; and (3) noncentrally cleared contracts should be subject
to higher capital requirements. In addition, the Financial Stability
Board (FSB) issued a report in October 2010 that set forth a detailed
set of assignments to financial standard-setting bodies in order to
meet the G20 directives, and the FSB continues to publish semi-annual
reports concerning progress by major market jurisdictions to meet the
G20 mandates by the end-2012 deadline.
Dodd-Frank Act Implementation
In 2010, less than 1 year following the G20 commitment to lower
risk and increase transparency in the OTC derivatives market, Congress
broadened the CFTC's jurisdiction to include oversight of the
previously unregulated swaps marketplace and also broadened the
jurisdiction of the Securities and Exchange Commission (SEC) to cover
security-based swaps. With respect to the CFTC, Title VII of the Dodd-
Frank Act: (1) provides for the registration and comprehensive
regulation of swap dealers and major swap participants; (2) imposes
clearing and trade execution requirements on standardized swaps,
subject to certain exceptions; (3) creates record keeping and real-time
reporting regimes; and (4) enhances the CFTC's rulemaking and
enforcement authorities with respect to certain products, entities, and
intermediaries subject to the Commission's oversight.
The CFTC is developing regulations to implement the Dodd-Frank Act
and to establish a regulatory framework for overseeing the swaps
market, which is seven times the size of the futures market and far
more complex. Last summer, the CFTC moved forward from the proposal
phase for rulemaking to finalizing its regulations. The Commission has
completed 29 final rulemakings, with approximately 20 regulations
remaining.
Section 712 of the Dodd-Frank Act calls on the CFTC to consult and
coordinate with the SEC and the prudential regulators for purposes of
assuring regulatory consistency and comparability of rulemakings under
the legislation. The SEC has jurisdiction over security-based swaps,
and the CFTC is working closely with the SEC in developing regulations.
In certain areas, the CFTC and SEC are issuing joint regulations. The
Commission also is working closely with the prudential regulators,
which are charged with developing capital, margin, and other
requirements for banking entities.
One example where we are coordinating with our sister agencies is
the procedure to implement the Volcker Rule, where there is a specific
requirement in the Dodd-Frank Act mandating consultation and
coordination between the banking regulators and the CFTC and the SEC.
Section 619 of the Dodd-Frank Act prohibits certain banking entities
from engaging in proprietary trading, yet also permits certain
activities such as market making and risk-mitigating hedging. The
Office of the Comptroller of the Currency, Federal Reserve Board,
Federal Deposit Insurance Corporation, and SEC published proposed
regulations last November to implement this statutory provision. The
CFTC is charged with promulgating rules to implement Volcker Rule
requirements for CFTC-registered affiliates and subsidiaries of banking
entities. The Commission issued proposed regulations in January, with a
comment period that closes on April 16th. U.S. regulators are working
together to coordinate their approaches.
As CFTC rulemakings have progressed, one issue that has arisen is
how Dodd-Frank Act requirements might apply to swaps activities
occurring on a cross-border basis. In connection with the CFTC's and
SEC's joint proposed regulation to further define the term ``swap
dealer,'' for example, public input has been received in connection
with a range of concerns related to the application of Title VII and
the Commission's regulations to transactions in which a foreign swap
dealer is transacting with U.S. persons or to certain activities of a
U.S. swap dealer operating from a foreign location.
The CFTC recognizes that swaps business currently flows across
national borders, with agreements negotiated and executed between
counterparties in different jurisdictions and individual transactions
often booked and risk-managed in other jurisdictions. CFTC and SEC
staff held a public roundtable last August to discuss international
issues related to implementation of Title VII. The roundtable agenda
included cross-border transactions, global entities, and market
infrastructure. As required by Section 719(c) of the Dodd-Frank Act,
CFTC and SEC staff conducted a study and released a report in January
that examined international swap regulation and set forth several
issues for further monitoring across jurisdictions.
In addressing cross-border issues, the CFTC is charged with
implementing Section 722(d) of the Dodd-Frank Act, which amended the
Commodity Exchange Act (CEA) to provide that Title VII provisions
``shall not apply to activities outside the United States unless those
activities: (1) have a direct and significant connection with
activities in, or effect on, commerce of the United States; or (2)
contravene such rules or regulations as the Commission may prescribe or
promulgate as are necessary or appropriate to prevent the evasion of
any provision of [the CEA] that was enacted by the [Dodd-Frank Act]''.
The CFTC plans to provide guidance regarding the application of Title
VII and the Commission's regulations to non-U.S. entities and to swaps
activities occurring on a cross-border basis, seeking public input on
that guidance.
Another issue that has arisen involves the indemnification
requirement for registered swap data repositories in Section 21(d) of
the CEA. Some foreign regulators have raised concerns regarding their
ability to directly access information maintained in such repositories
due to the indemnification requirement. The CFTC is working to ensure
that both domestic and international regulators have access to swap
data to support their regulatory mandates, and the Commission continues
to review the indemnification provisions of the CEA. Recently, the
Chairman directed Commission staff to draft, for the Commission's
consideration, proposed interpretative guidance stating the
Commission's view that access to swap data reported to a trade
repository that is registered with the CFTC will not be subject to the
CEA's indemnification provisions if such trade repository is regulated
pursuant to foreign law and the applicable requested data is reported
to the trade repository pursuant to foreign law. Subject to the
Commission's approval, this proposed interpretative guidance would be
published for public comment.
Global Reform in the OTC Derivatives Market
In line with the G20 commitment, efforts to regulate OTC
derivatives are under way not only in the United States but also
abroad. Japan has passed reform legislation, and the EU is finalizing
the European Market Infrastructure Regulation (EMIR) that includes
mandatory clearing, reporting, and risk mitigation for OTC derivatives.
Last October, the European Commission published two draft proposals,
the Markets in Financial Instruments Directive (MiFID) and the Markets
in Financial Instruments Regulation (MiFIR), that provide for
additional requirements for swaps that will further align U.S. and EU
swaps reform. Others, such as Canada, Hong Kong, and Singapore, have
published consultation documents to gather public comment on the
appropriate regulation of OTC derivatives. CFTC staff will continue to
monitor international developments and to work with the foreign
regulators to establish consistent standards for OTC derivatives
regulation.
International Coordination
The global and interconnected nature of the swaps market makes it
imperative that the United States consult and coordinate with foreign
regulators. Market participants domiciled both inside and outside of
the United States regularly enter into swaps transactions with one
another and engage in cross-border swap activities that could be
subject to U.S. and non-U.S. regulatory oversight.
The fact that all major market jurisdictions are developing their
OTC requirements at the same time and in a coordinated fashion pursuant
to the G20 directives also provides an opportunity to create a
consistent framework. Congress directed the CFTC, SEC, and prudential
regulators in Section 752(a) of the Dodd-Frank Act to ``as appropriate
. . . consult and coordinate with foreign regulatory authorities on the
establishment of consistent international standards with respect to the
regulation . . . of swaps, security-based swaps, swap entities, and
security-based swap entities'' in order to ``promote effective and
consistent global regulation of swaps and security-based swaps.'' The
CFTC is fulfilling this statutory mandate by reaching out
internationally--in a comprehensive approach and on an ongoing basis--
to promote robust and consistent standards and to avoid conflicting
requirements wherever possible.
The CFTC has considered international standards and principles in
developing regulations, and staff has consulted and coordinated with
international counterparts throughout the rulemaking process.
Commission staff has shared comment summaries and drafts of proposed
and final regulations with the international community, and has
carefully considered the constructive feedback we have received. As the
Commission moves forward in finalizing regulations, we will continue to
do so.
CFTC Chairman Gary Gensler and Commissioners have met with foreign
regulators to discuss financial reform in the United States and abroad.
Commissioner Jill Sommers, as Chair of the CFTC's Global Markets
Advisory Committee and the Commission's representative to the
International Organization of Securities Commissions (IOSCO), has
organized advisory meetings to discuss international coordination of
financial reform. In addition, Chairman Gensler, SEC Chairman Mary
Schapiro, and senior representatives of the CFTC and SEC met with
regulators from Canada, the EU, Hong Kong, Japan, and Singapore last
December to discuss cross-border issues related to OTC derivatives, and
an even broader group of regulators will meet again in May. Last week,
the CFTC hosted a meeting with 28 foreign regulators on access to swaps
trade repository data, regulation of the OTC derivatives market and
participants, and customer fund protection.
At the staff level, ongoing bilateral discussions and technical
dialogues with foreign regulators are designed to increase the
understanding of our respective regulatory approaches and to coordinate
regulatory proposals to the greatest extent possible. CFTC and SEC
staffs have been holding an unprecedented number of dialogues with
counterparts in Canada, the EU, Hong Kong, Japan, and Singapore. These
staff discussions will continue as Dodd-Frank Act implementation
progresses and as other jurisdictions develop their own regulatory
requirements for OTC derivatives.
CFTC staff is participating in the FSB OTC Derivatives Working
Group, which monitors progress being made in implementing OTC
derivatives market reforms. The CFTC also cochairs the IOSCO Task Force
on OTC Derivatives, which recently completed work on three reports and
currently is developing a report relating to the oversight of OTC
derivatives market intermediaries. The published reports address
mandatory clearing, exchange and electronic platform trading, and
reporting to trade repositories.
CFTC staff also is engaged in several other international projects
related to OTC derivatives. For example, the Committee on Payment and
Settlement Systems and IOSCO are developing principles for financial
market infrastructures, including derivatives central counterparties
and trade repositories, which are expected to be published next month.
In addition, IOSCO and others have established a working group on
international standards regarding margin requirements for noncentrally
cleared derivatives, with a consultative report expected in June.
Regulators also are coordinating internationally with regard to
limits on speculative positions. Last September, IOSCO adopted a
commodity markets report that embraces a position management regime.
The report also includes recommendations for more transparency, similar
to aggregated position reports (Commitments of Traders) that are
published weekly by the CFTC, and enhanced enforcement authority to
pursue attempted manipulation.
Conclusion
The CFTC is working with foreign regulators in an effective way to
coordinate regulatory approaches and requirements to the greatest
extent possible. On a number of different issues, the CFTC already has
used the process of international consultation to highlight possible
differences and to work out a solution that addresses the concerns of
each jurisdiction involved in the discussion. We are committed to
working closely with our international counterparts in this effort.
Thank you, and I would be happy to answer questions.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN
FROM LAEL BRAINARD
Q.1. Primary dealers serve as trading counterparties of the New
York Fed in its implementation of monetary policy set by the
Federal Open Market Committee. These dealers distribute debt
issued by the U.S. Treasury in exchange for revenue generated
through the appreciation of financial positions they take on at
weekly auctions.
It is common for primary dealers to enter into derivative
transactions to hedge the risks that arise from participation
in an auction; however the nature of an auction makes it
difficult for dealers to perfectly predict the specific risks
that they will hold following the auction.
The Volcker Rule limits the ability of primary dealers to
trade in derivatives on Government obligations and the ability
of primary dealers to hedge risks in advance of a U.S. Treasury
auction.
Is the Treasury Department concerned that the inability of
primary dealers to use derivatives on Government obligations
could lead to lower bids and higher yields at auctions?
A.1. Primary dealers play an important role in the auction
process and market for U.S. Treasury obligations, including
through their underwriting and market making activities. In
addition to the Volcker Rule's exemption for trading in
obligations of the United States, the Volcker Rule also
explicitly permits market making, underwriting, and risk-
mitigating hedging. Regulators are in the process of analyzing
public comments, including comments from primary dealers, and
Treasury is working to coordinate the interagency effort to
develop a final rule that includes appropriate exemptions that
protects deep and liquid markets for U.S. Government
obligations.
Q.2. The list of primary dealers includes both banking entities
subject to the Volcker Rule and broker dealers that are not
subject to the rule. How would the implementation of the
Volcker Rule, as currently drafted, impact the competitive
landscape among primary dealers?
A.2. A primary dealer will generally be subject to the Volcker
Rule if it is, or is an affiliate or subsidiary of, an insured
depository institution, a company that controls an insured
depository institution, or a foreign company treated as a bank
holding company. In addition, nonbank financial companies
supervised by the Board of Governors of the Federal Reserve
System are subject to certain provisions of the Volcker Rule.
Thus, the rule provides regulators the ability to regulate
banking entities and certain nonbank financial companies in a
similar manner.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM LAEL BRAINARD
Q.1. Do you anticipate a situation where a U.S. company is not
designated a SIFI by FSOC but is designated a G-SIFI by the
Financial Stability Board? If that would occur, how would you
regulate that institution?
A.1. U.S. financial institutions will be regulated in
accordance with U.S. laws and regulations. Through active
participation in the G20 and FSB, Treasury and U.S. regulators
work to ensure that international standards of the highest
quality are aligned with our national framework. For example,
the FSB tasked the International Association of Insurance
Supervisors (IAIS) with proposing the criteria and methodology
for identifying globally systemically important insurers (G-
SIIs). Through its membership on both the Financial Stability
Oversight Council (Council) and IAIS committees involved with
development of the criteria and methodology, Treasury's Federal
Insurance Office (FIO) is pursuing an international consensus
that aligns the IAIS criteria, methodology, and timing with the
Council.
Q.2. Do property-casualty insurers regulated in the business of
insurance pose a systemic risk? If not, have you made those
arguments to the Financial Stability Board and what has been
their response?
A.2. The example of AIG illustrates that nontraditional
activities undertaken within an insurance group can expose an
insurance affiliate to harm and pose a threat to the broader
financial system. Rather than exempt an entire industry, the
FSB has tasked the insurance sector regulators, through the
IAIS, with proposing the criteria and methodology for
identifying G-SIIs. It would be inappropriate to prejudge the
work of the IAIS, especially prior to the public consultation
period through which the IAIS will obtain input from interested
parties. Through FIO, Treasury is participating in the IAIS
process and working to align the criteria, methodology, and
timing of the IAIS approach with that of the Council. To the
extent that the IAIS proposes a criteria and methodology
inconsistent with Treasury's expectations, then, working with
other FSB members, Treasury will modify or force
reconsideration of the IAIS proposal.
Q.3. The proposed Volcker Rule applies to all companies that
own an insured depository, and all subsidiaries and affiliates.
In addition to traditional banks and bank holding companies,
the rule seems to fully cover commercial companies that own a
thrift or an industrial loan company, as well as all of the
companies in which these covered entities may have a
significant investment that makes the recipient of the
investment an ``affiliate.'' (Under the Bank Holding Company
Act, investments as low as 5 percent can trigger affiliate
status.) The so-called goal of the Volcker Rule was designed to
limit risks at insured depositories so that banks wouldn't be
using Government insured deposit funds to ``gamble'' through
proprietary trading or fund investing. But it seems that in
reality, the rule will cover all sorts of industrial and
commercial companies just because they are in some way
``affiliated'' with a depository. Similarly, the rule would
cover a company that makes a large investment in another
company that controls a depository, dissuading these types of
strategic investments for fear of the investor becoming
``infected'' with the Volcker Rule.
Does it make any sense to apply the full restrictions and
regulatory requirements to nonfinancial companies?
A.3. Congress amended the Bank Holding Company Act to include
the Volcker Rule. The statute defines ``banking entities,''
which are subject to the Volcker Rule, to include any affiliate
or subsidiary of an insured depository institution or of a
company that controls an insured depository institution. The
proposed rule reflects this statutory mandate.
Q.4. What can your agencies do in the regulations, particularly
regarding your standards for determining what is an
``affiliated'' company, to make sure that the Volcker Rule does
not burden nonfinancial companies in a way that was completely
unintended by Congress?
A.4. While the Secretary of the Treasury, as Chairperson of the
Financial Stability Oversight Council, is coordinating the
regulations to be issued under the Volcker Rule, Congress did
not provide the Treasury Department with rulemaking authority
for the Volcker Rule. The rulemaking agencies--the Board of
Governors of the Federal Reserve System, the Office of the
Comptroller of the Currency, the Federal Deposit Insurance
Corporation, the Commodity Futures Trading Commission, and the
Securities and Exchange Commission--have rulemaking authority
to implement the Volcker Rule, including with respect to the
definition of terms and any additional exemptions.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM DANIEL K. TARULLO
Q.1. Do you anticipate a situation where a U.S. company is not
designated a SIFI by FSOC but is designated a G-SIFI by the
Financial Stability Board? If that would occur, how would you
regulate that institution?
A.1. In considering whether to determine that a nonbank
financial company could pose a threat to U.S. financial
stability and subject the company to Federal Reserve Board
(Board) supervision and prudential standards, the Financial
Stability Oversight Council (FSOC) is required by statute to
consider various factors set forth in the statute that could
result in a different determination (either including or
excluding a firm) by the FSOC under the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act) than a
determination that may be made by the Financial Stability Board
(FSB). For instance, one factor that the FSOC must consider is
the degree to which a firm is already regulated by another
financial regulatory agency.
The Board and the FSOC are working with the FSB on a number
of initiatives, including the process for identifying globally
systemically important financial institutions and financial
market infrastructures. Furthermore, the Board and the FSOC are
working to ensure the consistency of the approaches used by the
FSB and the FSOC for assessing whether a nonbanking company is
systemically important and to better understand the potential
for different determinations.
Systemically important nonbank firms designated by the FSOC
and bank holding companies with total consolidated assets
greater than $50 billion will be subject to enhanced prudential
standards established by the Board. By contrast, firms that are
not designated by the FSOC and are not bank holding companies
with total assets greater than $50 billion that are designated
as G-SIFis by the FSB would be subject to internationally
agreed-upon standards.
Q.2. Do property-casualty insurers regulated in the business of
insurance pose a systemic risk? If not, have you made those
arguments to the Financial Stability Board and what has been
their response?
A.2. Section 113 of the Dodd-Frank Act authorizes the FSOC to
subject a nonbank financial company to supervision by the Board
and prudential standards if either the company's material
financial distress, or the company's activities, could pose a
threat to the financial stability of the United States. The
statute requires the FSOC to consider the potential threat to
U.S. financial stability posed by an individual nonbank
financial company rather than by a particular financial
industry.
When the FSOC issued its final rule and interpretive
guidance earlier this year regarding nonbank financial company
designations, the FSOC noted that many commenters on the FSOC's
proposed rule and guidance suggested that nonbank financial
companies operating in particular financial industries do not
pose a threat to U.S. financial stability and should not
generally be subject to FSOC designation. In response to these
comments, the FSOC stated that any designation of a nonbank
financial company will be based on an evaluation of whether the
nonbank financial company meets the statutory standards, taking
into account the statutory considerations set forth in section
113 of the Dodd-Frank Act. The FSOC has not made any
determinations under section 113 of the Dodd-Frank Act but is
continuing to consider whether any nonbank financial company
could pose a threat to U.S. financial stability.
Q.3. Federal Reserve Chairman Bernanke indicated in an
appearance before the House Financial Services Committee last
month that the final rules implementing Section 619 of the
Dodd-Frank Act, commonly known as the ``Volcker Rule,'' would
not be ready by July 21, 2012. However, this section of the
Dodd-Frank Act is self-executing and has an effective date of
July 21, irrespective of whether or not the final rules are in
place. This creates a great deal of confusion and legal
uncertainty among companies that are impacted by the Volcker
Rule or that may be impacted by the Volcker Rule.
How do you plan to deal with this circumstance and do you
anticipate that the Fed and other prudential regulators will
make a formal announcement delaying enforcement of the Volcker
Rule until the final rules are published?
A.3. Section 619 required the Federal Reserve to adopt rules
governing the conformance periods for activities and
investments restricted by section 619, which the Federal
Reserve did on February 9, 2011. The conformance rules may be
found at http://www.federalreserve.gov/newsevents/press/bcreg/
2011_0209a.htm. In its final rule establishing the conformance
periods, the Federal Reserve explained that it would revisit
the conformance period rule in light of the requirements of the
final rule implementing the substantive provisions of the
Volcker Rule. Subsequently, the Federal Reserve received a
number of requests for clarification of the manner in which
this conformance period would apply and how the prohibitions
would be enforced. On April 19, 2012, the Federal Reserve
announced its approval of a statement clarifying that an entity
covered by section 619 has the full 2-year period provided by
statute to fully conform its activities and investments to the
requirements of section 619 and any implementing rules adopted
in final under that section, unless the Board extends that
conformance period. All of the Federal agencies charged with
implementing and enforcing the provisions of section 619 (i.e.,
the Federal Reserve, OCC, FDIC, SEC, and CFTC) announced that
they plan to administer their oversight of banking entities
under their respective jurisdictions in accordance with the
Federal Reserve's conformance rule and the April statement.
Q.4. At a Dodd-Frank anniversary hearing held at the Committee
last summer, Chairman Bernanke indicated that if European and
other regulators did not impose comparable margin requirements
for uncleared swaps, U.S.-domiciled financial institutions
would be placed at a significant competitive disadvantage.
Chairman Bernanke suggested that the best solution was a global
agreement.
What progress has been made towards such a global
agreement?
A.4. In October of 2011, an international group of regulators
was constituted to reach an international agreement on margin
requirements for uncleared swaps. The proposal by the Basel
Committee on Banking Supervision (BCBS) and the International
Organization of Securities Commissions (IOSCO) was developed in
consultation with, and with the active participation of, the
Committee on Payment and Settlement Systems (CPSS) and the
Committee on the Global Financial System (CGFS). This group has
been meeting regularly since October to formulate a global
proposal for margin requirements on uncleared derivatives.
The BCBS/IOSCO issued its proposal in July 2012. The
proposal is articulated through a set of key principles that
primarily seeks to ensure that appropriate margining practices
will be established for all noncentrally cleared OTC derivative
transactions. These principles will apply to all transactions
that involve either financial firms or systemically important
nonfinancial entities. The BCBS/IOSCO requested comments on the
proposal by September and expects to finalize the proposal
later this year.
Q.5. The proposed Volcker Rule applies to all companies that
own an insured depository [institution], and all subsidiaries
and affiliates. In addition to traditional banks and bank
holding companies, the rule seems to fully cover commercial
companies that own a thrift or an industrial loan company, as
well as all of the companies in which these covered entities
may have a significant investment that makes the recipient of
the investment an ``affiliate.'' (Under the Bank Holding
Company Act, investments as low as 5 percent can trigger
affiliate status.) The so-called goal of the Volcker Rule was
designed to limit risks at insured depositories so that banks
wouldn't be using Government insured deposit funds to
``gamble'' through proprietary trading or fund investing. But
it seems that in reality, the rule will cover all sorts of
industrial and commercial companies just because they are in
some way ``affiliated'' with a depository. Similarly, the rule
would cover a company that makes a large investment in another
company that controls a depository, dissuading these type of
strategic investments for fear of the investor becoming
``infected'' with the Volcker Rule.
Does it make any sense to apply the full restrictions and
regulatory requirements to nonfinancial companies?
What can your agencies do in the regulations, particularly
regarding your standards for determining what is an
``affiliated'' company, to make sure that the Volcker Rule does
not burden nonfinancial companies in a way that was completely
unintended by Congress?
A.5. Section 619 by its terms applies to any affiliate or
subsidiary of any company that controls an insured depository
institution. See 12 U.S.C. 1851(h)(l). In formulating the
proposed rule, the Agencies sought to limit the potential
impact of the proposed rule on banking entities that engage in
little or no activity prohibited by the Volcker Rule provisions
of the Dodd-Frank Act, including nonfinancial companies that
meet the definition of banking entity. In particular, the
Agencies proposed to reduce the effect of the proposed rule on
these banking entities by limiting the application of the
reporting, record keeping, and the compliance program
requirements of the proposed rule, to those banking entities
that engage in little or no covered trading activities or
covered fund activities and investments. The Agencies also
requested comment on whether an alternative definition of
banking entity would be more effective in light of the language
and purpose of the statute, the costs and burdens associated
with the proposal, and any significant alternatives that would
minimize the impact of the proposal on smaller, less-complex
banking entities. The Federal Reserve will carefully consider
the public comments received on these points and take those
comments into account in crafting a final rule consistent with
the statute.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN
FROM ELISSE B. WALTER
Q.1. Companies form joint ventures and wholly owned
subsidiaries in order to engage in ordinary course investing
and lending--including making extensions of credit, providing
internal funding within an organization, and hedging risks.
Such transactions should not be disallowed simply because they
are made through a subsidiary that relies on the exclusion
contained in section 3(c)(1) or 3(c)(7) of the Investment
Company Act.
Corporate subsidiaries allow these normal corporate
activities to be properly overseen within the larger corporate
structure, allow nonaffiliated companies to partner to spread
risk beyond a single entity, and help reduce risk.
The proposed rule provides some recognition that banking
entities form joint ventures and wholly owned subsidiaries in
order to engage in ordinary course investing and lending and
acknowledges that forcing companies to divest of these entities
would not achieve any reduction in risk.
I appreciated that in our December 6, 2011, Dodd-Frank
Oversight hearing, Chairman Schapiro acknowledged that the
agencies sought to create exemptions there for joint ventures
that are ``operating companies or vehicles that are used to
merge an entity with or into a banking entity or its
affiliates.'' However, the proposed rule still appears to leave
certain questions:
A. The Volcker rule was clearly not intended to disrupt
ordinary course investing and lending activities without an
offsetting reduction in risk to taxpayers and depositors.
Why should these activities be disallowed or
significantly impaired simply because they are made
through a corporate subsidiary?
It seems indisputable that conducting these
transactions through a corporate subsidiary permits
proper oversight, spreads risk beyond a single entity
and reduces the risk to the larger corporate entity by
any individual transaction. Accordingly, is it possible
that the elimination of these structures could increase
risk at the institutions the rule is intended to
protect?
B. The proposed rule provides exceptions for on-balance
sheet, wholly owned subsidiaries that provide liquidity
management services. Is it correct that this exception covers a
small fraction of the wholly owned subsidiaries that would
suffer disruption under the rule?
C. The proposed rule makes exceptions to the prohibitions
contained in the Volcker rule instead of simply removing these
corporate structures from the definition of ``covered funds.''
This approach leaves these entities subject to the prohibition
on ``covered transactions,'' as defined in Section 23A of the
Federal Reserve Act, without incorporating any of the
provisions in Section 23A that provide exemptions from the
prohibitions in that section for certain types of covered
transactions.
Wouldn't this approach, as a practical matter,
render the excepted entities largely useless, in effect
allowing the maintenance of the entity but prohibiting
the entity from conducting business transactions within
the larger corporate structure?
Wouldn't the better approach be for the agencies to
determine that these corporate vehicles--which look and
act nothing like a hedge fund or private equity fund--
simply are not ``covered funds'' in the first place?
A.1. The proposed definition of covered fund adheres closely to
the statutory text and includes vehicles that rely solely on
the exclusion in section 3(c)(1) or (7) of the Investment
Company Act. To the extent that a corporate vehicle relies
solely on one of these exclusions, it would be a covered fund
under the proposed rule.
The proposed rule recognizes that banking entities may
engage in traditional banking activities through the use of
vehicles that rely on the exclusions in sections 3(c)(1) and
(7), but that do not raise the safety and soundness concerns
the statute was intended to address. Therefore, the proposal
permits a banking entity to invest in or sponsor certain wholly
owned subsidiaries, joint ventures and acquisition vehicles.
However, as you point out, transactions between the banking
entity and these structures would be subject to Section 23A of
the Federal Reserve Act--a consequence of the agencies'
decision to closely track the statute.
The questions you have raised also were identified by
commenters on the proposed rule. The SEC will carefully
consider these comments before moving forward with
implementation of the Volcker Rule.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM ELISSE B. WALTER
Q.1. The proposed Volcker Rule applies to all companies that
own an insured depository, and all subsidiaries and affiliates.
In addition to traditional banks and bank holding companies,
the rule seems to fully cover commercial companies that own a
thrift or an industrial loan company, as well as all of the
companies in which these covered entities may have a
significant investment that makes the recipient of the
investment an ``affiliate.'' (Under the Bank Holding Company
Act, investments as low as 5 percent can trigger affiliate
status.) The so-called goal of the Volcker Rule was designed to
limit risks at insured depositories so that banks wouldn't be
using Government insured deposit funds to ``gamble'' through
proprietary trading or fund investing. But it seems that in
reality, the rule will cover all sorts of industrial and
commercial companies just because they are in some way
``affiliated'' with a depository. Similarly, the rule would
cover a company that makes a large investment in another
company that controls a depository, dissuading these types of
strategic investments for fear of the investor becoming
``infected'' with the Volcker Rule.
Does it make any sense to apply the full restrictions and
regulatory requirements to nonfinancial companies?
What can your agencies do in the regulations, particularly
regarding your standards for determining what is an
``affiliated'' company, to make sure that the Volcker Rule does
not burden nonfinancial companies in a way that was completely
unintended by Congress?
A.1. As you know, section 13 of the Bank Holding Company Act
(BHC Act), commonly referred to as the ``Volcker Rule,''
applies to any ``banking entity.'' The term ``banking entity''
is defined in section 13(h)(1) of the BHC Act to include any:
(i) insured depository institution (other than certain limited
purpose trust institutions), (ii) company that controls an
insured depository institution, (iii) company that is treated
as a bank holding company for purposes of section 8 of the
International Banking Act of 1978, and (iv) affiliate or
subsidiary of any of the foregoing entities. Section 13 of the
BHC Act does not separately define the terms ``affiliate'' or
``subsidiary,'' but the BHC Act includes definitions of these
terms in section 2 of the Act. The agencies proposed to
incorporate these existing definitions of ``affiliate'' and
``subsidiary'' in the Volcker proposal.
The SEC has rule-writing authority for the types of
``banking entities'' for which we are the ``primary financial
regulatory agency,'' as defined in section 2(12)(B) of the
Dodd-Frank Act, which includes SEC-registered broker-dealers,
SEC-registered investment advisers, and SEC-registered
security-based swap dealers. Thus, the SEC's proposed rule
would not cover commercial companies that own a thrift or an
industrial loan company.
That said, the Commission and staff appreciate the many
detailed comment letters we have received concerning these
important issues and will continue to carefully review and
analyze the comment letters as we consider further action on
the proposal.
Additional Material Supplied for the Record
LETTER SUBMITTED BY SENATOR MERKLEY FROM THIERRY PHILIPONNAT, SECRETARY
GENERAL, FINANCE WATCH
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]