[Senate Hearing 113-3]
[From the U.S. Government Publishing Office]
S. Hrg. 113-3
WALL STREET REFORM: OVERSIGHT OF FINANCIAL STABILITY AND CONSUMER AND
INVESTOR PROTECTIONS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE AGENCIES' OVERALL IMPLEMENTATION OF THE DODD-FRANK WALL
STREET REFORM AND CONSUMER PROTECTION ACT
__________
FEBRUARY 14, 2013
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon MARK KIRK, Illinois
KAY HAGAN, North Carolina JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota
Charles Yi, Staff Director
Gregg Richard, Republican Staff Director
Laura Swanson, Deputy Staff Director
Jeanette Quick, OCC Detailee
Greg Dean, Republican Chief Counsel
Jelena McWilliams, Republican Senior Counsel
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, FEBRUARY 14, 2013
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Crapo................................................ 2
Senator Heitkamp
Prepared statement....................................... 37
WITNESSES
Mary J. Miller, Under Secretary for Domestic Finance, Department
of the Treasury................................................ 4
Prepared statement........................................... 37
Responses to written questions of:
Senator Crapo............................................ 89
Senator Schumer.......................................... 90
Senator Warner........................................... 93
Senator Warren........................................... 94
Senator Johanns.......................................... 97
Senator Toomey........................................... 99
Daniel K. Tarullo, Governor, Board of Governors of the Federal
Reserve System................................................. 6
Prepared statement........................................... 41
Responses to written questions of:
Senator Crapo............................................ 102
Senator Warner........................................... 107
Senator Warren........................................... 111
Senator Toomey........................................... 116
Martin J. Gruenberg, Chairman, Federal Deposit Insurance
Corporation.................................................... 7
Prepared statement........................................... 45
Responses to written questions of:
Senator Crapo............................................ 118
Senator Warner........................................... 126
Senator Heitkamp......................................... 130
Senator Toomey........................................... 132
Thomas J. Curry, Comptroller, Office of the Comptroller of the
Currency....................................................... 9
Prepared statement........................................... 51
Responses to written questions of:
Senator Crapo............................................ 133
Senator Warren........................................... 137
Senator Heitkamp......................................... 141
Senator Toomey........................................... 142
Richard Cordray, Director, Consumer Financial Protection Bureau.. 10
Prepared statement........................................... 58
Responses to written questions of:
Senator Warner........................................... 142
Senator Heitkamp......................................... 143
Elisse B. Walter, Chairman, Securities and Exchange Commission... 12
Prepared statement........................................... 63
Responses to written questions of:
Senator Crapo............................................ 145
Senator Warner........................................... 147
Senator Warren........................................... 148
Senator Toomey........................................... 154
(iii)
Gary Gensler, Chairman, Commodity Futures Trading Commission..... 14
Prepared statement........................................... 82
Responses to written questions of:
Senator Crapo............................................ 156
Additional Material Supplied for the Record
Highlights of GAO-13-180: Financial Crisis Losses and Potential
Impacts of the Dodd-Frank Act, January 2013.................... 158
Submitted written testimony of Christy Romero, Special Inspector
General for the Troubled Asset Relief Program (SIGTARP)........ 159
WALL STREET REFORM: OVERSIGHT OF FINANCIAL STABILITY AND CONSUMER AND
INVESTOR PROTECTIONS
----------
THURSDAY, FEBRUARY 14, 2013
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:33 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. This Committee is called to order.
Before we begin, I would like to extend a warm welcome to
Senator Crapo as Ranking Member and to Senator Manchin, Senator
Warren, Senator Heitkamp, Senator Coburn, and Senator Heller
who are joining us this Congress. I would also like to welcome
back my friend Senator Kirk.
Earlier this week I released my agenda for this Congress,
and I look forward to this Committee's continued productivity.
I am optimistic that we can work together on a bipartisan
basis. To that end, Ranking Member Crapo and I sent a letter
yesterday to the banking regulators on the importance of
carefully implementing Basel III, and I look forward to hearing
from each of you, and working with the Ranking Member, on this
issue.
Today, this Committee continues a top priority--oversight
of Wall Street Reform implementation. Wall Street reform was
enacted to make the financial system more resilient, minimize
risk of another financial crisis, better protect consumers from
abusive financial practices, and ensure American taxpayers will
never again be called upon to bail out a failing financial
firm. This morning, we will hear from the regulators on how
their agencies are carrying out these mandates of Wall Street
reform.
Many of the law's remaining rulemakings, like QRM and the
Volcker Rule, require careful consideration of complex issues
as well as interagency and international coordination. I
appreciate your efforts to finalize these rules. To date, the
regulators have proposed or finalized over three-fourths of the
rules required by Wall Street reform. These include rules that
have recently gone ``live'' in the market, such as the data
reporting and registration rules for derivatives that mark new
oversight of a previously unregulated market. But there is
still more work to do.
That is why I have asked each of our witnesses to provide a
progress report to the Committee, both on rulemakings that your
agency has completed and those that your agency has yet to
finalize. I ask that you craft these rules in a manner that is
effective for smaller firms, like community banks, so that they
can continue to meet the needs of their customers and
communities.
The work does not end when the final rules go out the door.
Regulators must enforce the rules, and I ask that each agency
inform us how they intend to better supervise the financial
system. While concerns have been raised about whether a few
firms remain ``too big to fail,'' Wall Street reform provides
regulators with new tools to address the issue head on. This is
one of the many reasons why full implementation of the law
remains important, not just for our constituents but for future
generations.
As we approach the 5-year anniversary of the failure of
Bear Stearns, we must not lose sight of why we passed Wall
Street reform. Congress enacted the law in the wake of the most
severe financial crisis in the lifetime of most Americans. How
costly was it? I asked the GAO to study this question to better
understand the impact the crisis had on our Nation. In a report
released today, which I am entering in the record, the GAO
concluded that while the precise cost of the crisis is
difficult to calculate, the total damage to the economy may be
as high as $13 trillion. I say again, 13 trillion--with a
``T''--dollars. Thus, I urge you to consider the benefits of
avoiding another costly, devastating crisis as you continue
implementing Wall Street reform.
I would like to make one final comment on Director Cordray
and the CFPB. Since he was appointed as the head of the CFPB
last year, Director Cordray and the CFPB have worked tirelessly
to finalize many rules and policies to protect consumers in
areas such as mortgages, student lending, servicemembers'
rights, and credit cards. He has done good work, and I urge my
colleagues to confirm Director Cordray to a full term without
delay and allow the CFPB to continue its important work
protecting consumers.
I now turn to Ranking Member Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman. You and I
have a very good personal friendship and have had a good
working relationship over the years, and I look forward to
building on that and working with you as the Ranking Member of
the Committee this year, this Congress.
One of my objectives and hopes would be to work together on
the kind of commonsense bipartisan solutions that we can
achieve before this Committee in a number of areas that I think
various Members of the Committee have already identified and
discussed among ourselves.
We, you and I, as you indicated, have already sent a joint
letter to inform the regulators of our concerns about the
impact of the proposed Basel III requirements on community
banks, insurance companies, and the mortgage market, and so we
are off to a good start. I look forward to building on that.
I also want to join with you in welcoming the new Members
of our Committee: on our side, Senators Coburn and Heller; and
on your side, also Senators Manchin, Warren, and Heitkamp. We
welcome you to the Committee.
Today, the Committee will hear about the ongoing
implementation of Dodd-Frank. Academic researchers estimate
that when Dodd-Frank is fully implemented, there will be more
than 13,000 new regulatory restrictions in the Code of Federal
Regulations. Over 10,000 pages of regulations have already been
proposed, requiring, as is estimated, over 24 million
compliance hours each year, and that is just the tip of the
iceberg. Of some 400 rules required by Dodd-Frank, roughly one-
third have been finalized, about one-third have been proposed
but not finalized, and roughly one-third have not even yet been
proposed. Together, the hundreds of Dodd-Frank proposed rules
are far too complex, offering confusing and often contradictory
standards and regulatory requirements.
I am concerned that the regulators do not understand and
are not focusing aggressively enough on the cumulative effect
of the hundreds of proposed rules and that there is a lack of
coordination among the agencies, both domestically and
internationally. That is why it is important for the regulators
to perform meaningful cost/benefit analysis so that we can
understand how these rules will affect the economy as a whole,
interact with one another, and impact our global
competitiveness.
An enormous number of new rules are slated to be finalized
this year as a result of Dodd-Frank, Basel III, and other
regulatory initiatives. And at this important juncture, we need
answers to critical questions.
First, what are the anticipated cumulative effects of these
new rules to credit, liquidity, borrowing costs, and the
overall economy? Ultimately, we need rules that are strong
enough to make our financial system safer and sounder, but that
can adapt to changing market conditions and promote credit
availability and spur job growth for millions of Americans.
Second, what have the agencies done to assess how these
complicated rules will interact with each other and the
existing regulatory framework? I am hearing a lot of concern
about how the interaction of some rules will reduce mortgage
credit through the qualified mortgage rule, the proposed
qualified residential mortgage rule, and the proposed
international Basel III risk weights for mortgages, as an
example.
And, third, what steps are being taken to fix the lack of
coordination and harmonization of rules among the United States
and international regulators on cross-border issues? For
example, the CFTC has issued a number of so-called guidance
letters and related orders on cross-border issues. The CFTC's
initial proposal received widespread criticism from foreign
regulators that the guidance is confusing, expansive, and
harmful. Meanwhile, the SEC has not yet issued its cross-border
proposal.
There is bipartisan concern that some of the Dodd-Frank
rules go too far and need to be fixed. A good starting point
would be to fulfill congressional intent by providing an
explicit exemption from the margin requirements for
nonfinancial end users that qualify for the clearing exemption.
Similar language to this passed the House last year by a vote
of 370-24. Federal Reserve Chairman Bernanke has confirmed
that, regardless of congressional intent, the banking
regulators view the plain language of the statute as requiring
them to impose some kind of margin requirement on nonfinancial
end users unless Congress changes the statute.
Unless Congress acts, new regulations will make it more
expensive for farmers, manufacturers, energy producers, and
many small business owners across the country to manage their
unique business risks associated with their day-to-day
operations. An end user fix is just one example of the kind of
bipartisan actions that we can take to improve the safety and
soundness of our financial system without unnecessarily
inhibiting economic growth.
It is my hope that today's hearing is going to provide us a
starting point to address these critical issues and identify
the needed reforms that we must undertake.
Thank you, Mr. Chairman, again for holding this hearing.
Chairman Johnson. Thank you, Senator Crapo.
This morning, opening statements will be limited to the
Chairman and Ranking Member to allow more time for questions
from the Committee Members. I want to remind my colleagues that
the record will be open for the next 7 days for opening
statements and any other materials you would like to submit.
Now I would like to introduce our witnesses.
Mary Miller is the Under Secretary for Domestic Finance of
the U.S. Department of the Treasury.
Dan Tarullo is a member of the Board of Governors of the
Federal Reserve System.
Martin Gruenberg is the Chairman of the Federal Deposit
Insurance Corporation.
Tom Curry is the Comptroller of the Currency.
Richard Cordray is the Director of the Consumer Financial
Protection Bureau.
Elisse Walter is the Chairman of the Securities and
Exchange Commission.
And Gary Gensler is the Chairman of the Commodity Futures
Trading Commission.
I thank all of you 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 Miller, you may begin your testimony.
STATEMENT OF MARY J. MILLER, UNDER SECRETARY FOR DOMESTIC
FINANCE, DEPARTMENT OF THE TREASURY
Ms. Miller. Chairman Johnson, Ranking Member Crapo, and
Members of the Committee, thank you so much for the opportunity
to be here today.
The Dodd-Frank Wall Street Reform and Consumer Protection
Act represents the most comprehensive set of reforms to the
financial system since the Great Depression. Americans are
already beginning to see benefits from these reforms reflected
in a safer and stronger financial system.
Although the financial markets have recovered more
vigorously than the overall economy, the economic recovery is
also gaining traction. The financial regulators represented
here today have been making significant progress implementing
Dodd-Frank Act reforms.
Treasury's specific responsibilities under the Dodd-Frank
Act include standing up new organizations to strengthen
coordination of financial regulation both domestically and
internationally, improve information sharing, and better
address potential risks to the financial system.
Over the past 30 months, we have focused considerable
effort on creating the Financial Stability Oversight Council,
the Office of Financial Research, and the Federal Insurance
Office.
The Financial Stability Oversight Council, known as FSOC,
has become a valuable forum for collaboration among financial
regulators. Through frank discussion and early identification
of areas of common interests, the financial regulatory
community is now better able to identify issues that would
benefit from enhanced coordination. Although FSOC members are
required to meet only quarterly, the FSOC met 12 times last
year to conduct its regular business and respond to specific
market developments. Much additional work takes place at the
staff level with regular and substantive engagement to inform
FSOC leaders.
While Treasury is not a rule-writing agency, the Treasury
Secretary has a statutory coordination role for the Volcker
Rule and risk retention rule by virtue of his chairmanship of
the FSOC. We take that role very seriously and will continue to
work with the respective rulemaking agencies as they finalize
these rules.
In addition to the FSOC's coordination role, it has certain
authority to make recommendations to the responsible regulatory
agencies where a financial stability concern calls for further
action. An example along these lines is a concern about risks
in the short-term funding markets. The FSOC's focus on this
ultimately led the Council to issue proposed recommendations on
money market fund reforms for public comment.
The FSOC has also taken significant steps to designate and
increase oversight of financial companies whose failure or
distress could negatively impact financial markets or the
financial stability of the United States. Treasury has made
significant progress in establishing the Office of Financial
Research and the Federal Insurance Office. The OFR provides
important data and analytical support for the FSOC and is
developing new financial stability metrics and indicators. It
also plays a leadership role in the international initiative to
establish a Legal Entity Identifier, a code that uniquely
identifies parties to financial transactions. The planned
launch of the LEI next month will provide financial companies
and regulators worldwide a better view of companies' exposures
and counterparty risks.
With the establishment of the Federal Insurance Office, the
United States has gained a Federal voice on insurance issues,
domestically and internationally. For example, in 2012, FIO was
elected to serve on the Executive Committee of the
International Association of Insurance Supervisors and is now
providing important leadership in developing international
insurance policy.
We are also working internationally to support efforts to
make financial regulations more consistent worldwide. By moving
early with the passage and implementation of the Dodd-Frank
Act, we are leading from a position of strength in setting the
international reform agenda. This comprehensive agenda spans
global bank capital and liquidity requirements, resolution
plans for large multinational financial institutions, and
derivatives markets. We will continue to work with our partners
around the world to achieve global regulatory convergence.
As we move forward, it is critical to strike the
appropriate balance of measures to protect the strength and
stability of the U.S. financial system while preserving liquid
and efficient markets that promote access to capital and
economic growth. Completion of these reforms provides the best
path to achieving continued economic growth and prosperity
grounded in financial stability.
Thank you for the opportunity to testify today. I would
welcome any questions the Committee may have.
Chairman Johnson. Thank you.
Governor Tarullo, please proceed.
STATEMENT OF DANIEL K. TARULLO, GOVERNOR, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Tarullo. Thank you, Mr. Chairman, Senator Crapo, and
other Members of the Committee. It is a pleasure to be with all
of you here on this Valentine's Day. I just wanted to make two
points in these oral remarks.
First, I hope that 2013 will be the beginning of the end of
the major portion of rulemakings implementing Dodd-Frank and
strengthening capital rules. The rulemaking process has been
very time-consuming. In some cases, it has run beyond the
deadline set by Congress, though there have been some good
reasons for that. Joint rulemaking just takes a lot of time,
and for many of the rules, that process involves three to five
independent agencies, representing between 12 and 22
individuals who have votes at those agencies. Also, some of the
rules involve subjects that are complicated, controversial, or
both.
I think there was wide agreement that it was incumbent on
the regulators to take the time to understand the issues and to
give full consideration to the many thousands of comments that
were submitted on some of the proposals.
But it is also important to get to the point where we can
provide clarity to financial firms as to what regulatory
environment they can expect in some of these important areas so
that they can get on with planning their businesses
accordingly.
So it is my hope and my expectation that, with respect to
the Volcker Rule, the capital rules, Section 716, and many of
the special prudential requirements for systemically important
firms, we will publish final rules this year.
On Volcker, and on the standardized capital rules in
particular, I think the agencies have learned a good deal from
the formal comments and public commentaries addressed to these
proposals. Both required a difficult balance between the aims
of comprehensiveness on the one hand and administrability at
firms and at regulators on the other. I think it is pretty
clear that both proposals lean too far in the direction of
complexity, and I would expect a good bit of change in the
final rulemakings on these subjects.
Indeed, these examples prove the wisdom of those who
drafted the Administrative Procedures Act many years ago
whereby they set up a process that agencies issue proposals for
notice and comment, receive comments, consider the comments,
modify the regulations, and then finally put those regulations
into place.
We should also get out proposals this year to implement two
arrangements agreed internationally: the capital surcharge for
systemically important banks and the liquidity coverage ratio.
One exception where we will be slowing down a little--and
here ``we'' as in the Federal Reserve, not our fellow
agencies--is the Section 165 requirement for counterparty
credit risk limits. Based on the comments received and ongoing
internal staff analysis, we concluded that a quantitative
impact study was needed to help us assess better the optimal
structure of a rule that is breaking new ground in an area for
which there is a lot of hard, but heretofore uncollected, data.
So we are going to need some more time on this one.
The second point I want to make is that the feature of the
financial system that is in most need of further attention and
regulatory action is that of nondeposit short-term financing.
My greatest concern is with those parts of the so-called shadow
banking system that are susceptible to destabilizing funding
runs, something that is more likely where the recipients of the
short-term funding are highly leveraged, engaged in substantial
maturity transformation, or both. It was just these kinds of
runs that precipitated the most acute phase of the financial
crisis that the Chairman referred to a few moments ago.
We need to continue to assess the vulnerabilities posed by
this kind of funding while recognizing that many forms of
short-term funding play important roles in credit
intermediation and productive capital market activities.
But we should not wait for the emergence of a consensus on
comprehensive measures to address these kinds of funding
channels. That is why I suggest in my written testimony more
immediate action in three areas: the transparency of securities
financing, money market mutual funds, and triparty repo
markets.
Thank you all for your attention.
Chairman Johnson. Thank you.
Chairman Gruenberg, please proceed.
STATEMENT OF MARTIN J. GRUENBERG, CHAIRMAN, FEDERAL DEPOSIT
INSURANCE CORPORATION
Mr. Gruenberg. Thank you, Mr. Chairman. Chairman Johnson,
Ranking Member Crapo, and Members of the Committee, thank you
for the opportunity to testify today on the FDIC's efforts to
implement the Dodd-Frank Wall Street Reform and Consumer
Protection Act. While my prepared testimony addresses a range
of issues, I will focus my oral remarks on three areas of
responsibility specific to the FDIC: deposit insurance,
systemic resolution, and community banks.
With regard to the deposit insurance program, the Dodd-
Frank Act raised the minimum reserve ratio for the Deposit
Insurance Fund to 1.35 percent and required that the reserve
ratio reach this level by September 30, 2020. The FDIC is
currently operating under a DIF Restoration Plan that is
designed to meet this deadline, and the DIF reserve ratio is
recovering at a pace that remains on track to achieve the plan.
As of September 30, 2012, the reserve ratio stood at 0.35
percent of estimated insured deposits. That is up from 0.12
percent a year earlier. The fund balance has now grown for 11
consecutive quarters, increasing to $25.2 billion at the end of
the third quarter of 2012.
The FDIC has also made significant progress on the
rulemaking and planning for the resolution of systemically
important financial institutions, so-called SIFIs. The FDIC and
the Federal Reserve Board have jointly issued the basic
rulemaking regarding resolution plans that SIFIs are required
to prepare. These are the so-called living wills. The rule
requires bank holding companies with total consolidated assets
of $50 billion or more to develop, maintain, and periodically
submit resolution plans that are credible and that would enable
these entities to be resolved under the Bankruptcy Code. On
July 1, 2012, the first group of living will filings by the
nine largest institutions with nonbank assets over $250 billion
was received, with the second group to follow by July 1st of
this year, and the rest by December 31st. The Federal Reserve
and the FDIC are currently in the process of reviewing the
first group of plan submissions.
The FDIC has also largely completed the rulemaking
necessary to carry out its systemic resolution responsibilities
under Title II of the Dodd-Frank Act. The final rule approved
by the FDIC board addressed, among other things, the priority
of claims and the treatment of similarly situated creditors.
Section 210 of the Dodd-Frank Act expressly requires the
FDIC to coordinate, to the maximum extent possible, with
appropriate foreign regulatory authorities in the event of the
resolution of a systemic financial company with cross-border
operations.
In this regard, the FDIC and the Bank of England, in
conjunction with the prudential regulators in our respective
jurisdictions, have been working to develop contingency plans
for the failure of SIFIs that have operations in both the U.S.
and the U.K. In December, the FDIC and the Bank of England
released a joint paper, providing an overview of the work we
have been doing together.
In addition, the FDIC and the European Commission have
agreed to establish a joint working group to discuss resolution
and deposit insurance issues common to our respective
jurisdictions. The first meeting of the working group will take
place here in Washington next week.
Finally, in light of concerns raised about the future of
community banking in the aftermath of the financial crisis, as
well as the potential impact of the various rulemakings under
the Dodd-Frank Act, the FDIC engaged in a series of initiatives
during 2012 focusing on the challenges and opportunities facing
community banks in the United States. In December of last year,
the FDIC released the FDIC Community Banking Study, a
comprehensive review of the U.S. community banking sector
covering the past 27 years of data.
Our research confirms the important role that community
banks play in the U.S. financial system. Although these
institutions account for just 14 percent of the banking assets
in the United States, they hold 46 percent of all the small
loans to businesses and farms made by FDIC-insured
institutions. The study found that for over 20 percent of the
counties in the United States, community banks are the only
FDIC-insured institutions with an actual physical presence.
Importantly, the study also found that community banks that
stayed with their basic business model--careful relationship
lending funded by stable core deposits--exhibited relatively
strong and stable performance over this period and during the
recent financial crisis, and should remain an important part of
the U.S. financial system going forward.
Mr. Chairman, that concludes my oral remarks. I would be
glad to respond to your questions.
Chairman Johnson. Thank you.
Comptroller Curry, please proceed.
STATEMENT OF THOMAS J. CURRY, COMPTROLLER, OFFICE OF THE
COMPTROLLER OF THE CURRENCY
Mr. Curry. Chairman Johnson, Ranking Member Crapo, and
Members of the Committee, it is a pleasure to appear before you
today for this panel's first hearing of the new Congress. I
want to thank Chairman Johnson for his leadership in holding
this hearing, and I would also like to congratulate Senator
Crapo on his new role as the Ranking Member of this Committee.
I look forward to working with both of you on many issues
facing the banking system. There are also a number of new
Members on the Committee, and I look forward to getting to know
each of you better this session.
It has been nearly 3 years since the Dodd-Frank Act was
enacted, and both the financial condition of the banking
industry and the Federal regulatory framework have changed
significantly. The OCC supervises more than 1,800 national
banks and Federal savings associations, which together hold
more than 69 percent of all commercial bank and thrift assets.
They range in size from very small community banks with less
than $100 million in assets to the Nation's largest financial
institutions with assets exceeding $1 trillion. More than 1,600
of the banks and thrifts we supervise are small institutions
with less than $1 billion in assets, and they play a vital role
in meeting the financial needs of communities across the
Nation.
I am pleased to report that Federal banks and thrifts have
made significant strides since the financial crisis in
repairing their balance sheets through stronger capital,
improved liquidity, and timely recognition and resolution of
problem loans.
While these are encouraging developments, banks and thrifts
continue to face significant challenges, and our examiners
continue to stress the need for these institutions to remain
vigilant in monitoring the risks they take on in this
environment.
We are also mindful that we cannot let the progress that
has been made in repairing the economy and in strengthening the
banking system lessen our sense of urgency in addressing the
weaknesses and flaws that were revealed by the financial
crisis. The Dodd-Frank Act addresses major gaps in the
regulatory landscape, tackles systemic issues that contributed
to and amplified the effects of the financial crisis, and lays
the groundwork for a stronger financial system.
Like my colleagues at the table, we at the OCC are
currently engaged in numerous rulemakings, from appraisals to
Volcker and from risk retention to swaps. My written statement
provides details on each of these efforts and provides a flavor
of some of the public comments that have been submitted.
The OCC is committed to implementing fully those provisions
where we have sole rule-writing authority as quickly as
possible. We are equally committed to working cooperatively
with our colleagues on those rules that require coordinated or
joint action. I remain very hopeful that we will soon have in
place final regulations in several areas to provide the clarity
the industry needs.
Throughout this process, I have been keenly aware of the
critical role that community banks play in providing consumers
and small businesses in communities across the Nation with
essential financial services and access to credit. As the OCC
undertakes every one of these critical rulemakings, we are very
focused on ensuring that we put standards in place that promote
safety and soundness without adding unnecessary burden to
community banks.
I would like to highlight one of the most significant
milestones of the Dodd-Frank Act for the OCC, which is the
successful integration of the mission and most of the employees
from the Office of Thrift Supervision into the OCC. The
integration was accomplished smoothly and professionally,
reflecting the merger of experience with a strong vision for
the future. The final stage of this process is underway with
the integration of rules of applicable to Federal thrifts with
those that apply to national banks consistent with the
statutory differences between the two charter types. An
integrated set of rules will benefit both banks and thrifts.
In the vast majority of the rulemaking activities, the OCC
is one of several participants. The success of those
rulemakings depends on interagency cooperation, and I want to
acknowledge the work of my colleagues at this table and their
staff for approaching these efforts thoughtfully and
productively, giving careful consideration to all issues.
Working together, I believe we will be able to develop rules
that will be good for the financial system, the entities we
regulate, and the communities they serve going forward.
Thank you for your attention, and I look forward to
answering any questions you may have.
Chairman Johnson. Thank you.
Director Cordray, please proceed.
STATEMENT OF RICHARD CORDRAY, DIRECTOR, CONSUMER FINANCIAL
PROTECTION BUREAU
Mr. Cordray. Thank you, Chairman Johnson, Ranking Member
Crapo, and Members of the Committee, for inviting me back
today. My colleagues and I at the Consumer Financial Protection
Bureau are always happy to testify before the Congress,
something we have done now 30 times.
Today we are here to talk about the implementation of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, the
signature legislation that created this new consumer agency.
Since the Bureau opened for business in 2011, our team has
been hard at work. We are examining both banks and nonbank
financial institutions for compliance with the law, and we have
addressed and resolved many issues through these efforts to
date. In addition, for consumers who have been mistreated by
credit card companies, we are, in coordinated enforcement
actions with our fellow regulators, returning roughly $425
million to their pockets. For those consumers who need
information or want help in understanding financial products
and services, we have developed AskCFPB, a data base of
hundreds of answers to questions frequently asked of us by
consumers. And our Consumer Response center has helped more
than 100,000 consumers with their individual problems related
to their credit cards, mortgages, student loans, and bank
accounts.
In addition, we have been working hard to understand,
address, and resolve some of the special consumer financial
issues affecting specific populations: students,
servicemembers, older Americans, and those are unbanked or
under-banked. And we are planning a strong push in the future
for broader and more effective financial literacy in this
country. We need to change the fact that we send many thousands
of our young people out into the world every year to manage
their own affairs with little or no grounding in personal
finance education. We want to work with each of you on these
issues on behalf of your constituents.
We have also faithfully carried out the law that Congress
enacted by writing rules designed to help consumers throughout
their mortgage experience--from signing up for a loan to paying
it back. We have written rules dealing with loan originator
compensation, giving consumers better access to their appraisal
reports, and addressing escrow and appraisal requirements for
higher-priced mortgage loans.
Just last month, we released our Ability-to-Repay rule,
which protects consumers shopping for a loan by requiring
lenders to make a good faith, reasonable determination that
consumers can actually afford to pay back their mortgages. The
rule outlaws so-called and very irresponsible ``NINJA'' loans--
even with no income, no job, and no assets, you could still get
a loan--that were all too common in the lead-up to the
financial crisis. Our rule also strikes a careful balance on
access-to-credit issues that are so prevalent in the market
today by enabling safer lending and providing greater certainty
to the mortgage market.
Finally, the Bureau also recently adopted mortgage
servicing rules to protect borrowers from practices that have
plagued the industry like failing to answer phone calls,
routinely losing paperwork, and mishandling accounts. I am sure
that each of you has heard from constituents in your States who
have these kinds of stories to tell.
We know the new protections afforded by the Dodd-Frank Act
and our rules will no doubt bring great changes to the mortgage
market. We are committed to doing what we can to achieve
effective, efficient, complete implementation by engaging with
all stakeholders, especially industry, in the coming year. We
know that it is in the best interests of the consumer for the
industry to understand these rules--because if they cannot
understand, they cannot properly implement.
To this end, we have announced an implementation plan. We
will publish plain-English summaries. We will publish readiness
guides to give industry a broad checklist of things to do to
prepare for the rules taking effect next January--like updating
their policies and procedures and providing training for staff.
We are working with our fellow regulators to ensure consistency
and examinations of mortgage lenders under the new rules and to
clarify issues as needed. We also are working to finalize
further proposals in these rules to recognize that, as my
colleagues have said, the traditional lending practices of
smaller community banks and credit unions are worthy of respect
and protection.
So thank you again for the opportunity to appear before you
today and speak about the progress we are making at the
Consumer Financial Protection Bureau. We always welcome your
thoughts about our work, and I look forward to your questions.
Thank you.
Chairman Johnson. Thank you.
Chairman Walter, please proceed.
STATEMENT OF ELISSE B. WALTER, CHAIRMAN, SECURITIES AND
EXCHANGE COMMISSION
Ms. Walter. Chairman Johnson, Ranking Member Crapo, and
Members of the Committee, Thank you for inviting me to testify
on behalf of the Securities and Exchange Commission regarding
our ongoing implementation of the Dodd-Frank Act.
As you know, the act required the SEC to undertake the
largest and most complex rulemaking agenda in the history of
the agency. We have made substantial progress writing the huge
volume of new rules mandated by the act. We have proposed or
adopted over 80 percent of the more than 90 required rules, and
we have finalized almost all of the studies and reports
Congress directed us to write.
Since the law's enactment, our staff has worked closely
with other regulatory agencies and has carefully reviewed the
thousands of comments we received to ensure that we not only
get the rules done but that we get them done right. And I am
committed to doing both. Indeed, as long as I serve a Chairman,
I will continue to push the agency forward to implement Dodd-
Frank.
While my written testimony describes in greater detail what
we have achieved, I wanted to touch briefly on just a few of
the items.
Today, as a result of new rules jointly adopted with the
CFTC, systemic risk information is now being periodically
reported by registered investment advisers who manage at least
$150 million in private fund assets. This information is
providing FSOC and the Commission with a broader view of the
industry than we had in the past. Additionally, because of our
registration rules, we now have a much more comprehensive view
of the hedge fund and private fund industry.
We also adopted rules creating a new whistleblower program,
and last year our program produced its first award. We expect
future payments to further increase the visibility of the
program and lead to even more valuable tips. The program is
pulling in the type of high-quality information that reduces
the length of investigations and saves resources.
With respect to the new oversight regime Dodd-Frank
mandated for over-the-counter derivatives, we have proposed
substantially all of the core rules to regulate security-based
swaps. Last year in particular, we finalized rules regarding
product and party definitions, adopted rules relating to
clearing and reporting, and issued a road map outlining how we
plan to implement the new regime. Soon we plan to propose how
this regime will be applied in the cross-border context. The
Commission has chosen to address cross-border issues in a
single proposing release rather than through individual
rulemakings. We believe this approach will provide all
interested parties with the opportunity to consider as an
integrated whole the Commission's proposed approach to cross-
border security-based swap oversight.
Last year, the Commission, working with the CFTC and the
Fed, adopted rules requiring registered clearing agencies to
maintain certain risk management standards and also established
record keeping and financial disclosure requirements. These
rules will strengthen oversight of securities clearing agencies
and help to ensure that clearing agency regulation reduces
systemic risk in the financial markets.
Although tremendous progress has been made, work remains in
areas such as credit rating agencies, asset-backed securities,
executive compensation, and the Volcker Rule. With respect to
the Volcker Rule, the issues raised are complex, and the nearly
19,000 comment letters received in response to the proposal
speak to the multitude of viewpoints that exist. We are
actively working with the Federal banking agencies, the CFTC,
and the Treasury in an effort to expeditiously finalize this
important rule.
With respect to all of our rules, economic analysis is
critical. While certain costs or benefits may be difficult to
quantify or value with precision, we continue to be committed
to meeting these challenges and to ensuring that the Commission
engages in sound, robust economic analysis in its rulemaking.
It also has been clear to me from the outset that the act's
significant expansion of the SEC's responsibilities cannot be
handled appropriately with the agency's current resource
levels. With Congress' support, the SEC's fiscal year 2012
appropriation permitted us to begin hiring some of the new
positions needed to fulfill these responsibilities.
Despite this, the SEC does not yet have all the resources
necessary to fully implement the law. Enactment of the
President's fiscal year 2013 budget would help us to fill the
remaining gaps by hiring needed employees for frontline
positions and also would permit us, importantly, to continue
investing in technology initiatives that substantially and
cost-effectively allow us to improve our ability to police the
markets.
As you know, regardless of the amount appropriated, our
budget will be fully offset by fees we collect and will not
impact the Nation's budget deficit.
As the Commission strives to complete our remaining tasks,
we look forward to working with this Committee and others to
adopt rules that fulfill our mission of protecting investors,
maintaining fair, orderly, and efficient markets, and
facilitating capital formation.
Thank you again for inviting me to share with you our
progress to date and our plans going forward. I look forward to
answering your questions.
Chairman Johnson. Thank you.
Chairman Gensler, please proceed.
STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING
COMMISSION
Mr. Gensler. Thank you, Chairman Johnson, Ranking Member
Crapo, and Members of the Committee. I want to first just
associate myself with Governor Tarullo's comments about wishing
you well on this Valentine's Day, but also his comments about
the Administrative Procedures Act. I think we have all
benefited at the CFTC by the 39,000 comments that we have
gotten on our various rules.
This hearing is occurring at a very historic time in the
markets because, with your direction, the CFTC now oversees the
derivatives marketplace--not only the futures marketplace that
we had overseen for decades, but also this thing called the
swaps marketplace that, through Dodd-Frank, you asked us to
oversee.
Our agency has actually completed 80 percent, not just
proposed but completed 80 percent of the rules you asked us to
do. And the marketplace is increasingly shifting to
implementation of these commonsense rules of the road.
So what does it mean? Three key things:
For the first time, the public is benefiting from seeing
the price and volume of each swap transaction. This is free of
charge on a Web site. It is like a modern-day ticker tape.
Second, for the first time, the public will benefit from
greater access to the market that comes from centralized
clearing and the risk reduction that comes from that
centralized clearing. This will be phased throughout 2013, but
we are not needed to do any new rules. It is all in place.
And, third, for the first time, the public is benefiting
from the oversight of swap dealers--we have 71 of them that
registered--for sales practices and business conduct to help
lower risk to the overall economy.
Now, these swaps market reforms ultimately benefit end
users. The end users in our economy, the nonfinancial side,
employs 94 percent of private sector jobs, and these benefit
those end users through greater transparency. Greater
transparency starts to shift some information advantage from
Wall Street to Main Street, but also lowering risk. And we have
completed our rules ensuring, as Congress directed, that the
nonfinancial end users are not required to participate in
central clearing. And as Ranking Member Crapo said, at the CFTC
we have proposed margin rules that provide that end users will
not have to post margin for those uncleared swaps.
To smooth the market's transition to the reform, the
Commission has consistently been committed to phasing in
compliance based upon the input from the market participants. I
would like to highlight two areas in 2013 that we still need to
finish up the rules.
One is completing the pretrade transparency reforms. This
is so buyers and sellers meet, compete in the marketplace, just
as in the securities and futures marketplace. We have yet to
complete those rules on the swap execution facilities and block
rules.
Second, ensuring that cross-border application of swaps
market reform appropriately covers the risk of U.S. affiliates
operating offshore. We have been coordinating greatly with our
international colleagues and the SEC and the regulators at this
table, but I think in enacting financial reform, Congress
recognized a basic lesson of modern finance and the crisis.
That basic lesson is that during a crisis, during a default,
risk knows no geographic border. If a run starts in one part of
a modern financial institution, whether it is here or offshore,
it comes back to hurt us. That was true in AIG, which ran most
of its swaps business out of Mayfair--that is a part of
London--but it was also true at Lehman Brothers, Citigroup,
Bear Stearns, and Long-Term Capital Management. I think failing
to incorporate this basic lesson of modern finance into our
oversight of the swaps market would not only fall short of your
direction to the CFTC and Dodd-Frank, but I also think it would
leave the public at risk. I believe Dodd-Frank reform does
apply, and we have to complete the rules to apply to
transactions entered into branches of U.S. institutions
offshore, or their guaranteed affiliates offshore transacting
with each other, or even if it is a hedge fund that happens to
be incorporated in an island or offshore but it is really
operated here.
I would like just to turn with the remaining minute to
these cases the CFTC brought on LIBOR because it is so much of
our 2013 agenda.
Now, the U.S. Treasury collected $2 billion from the
Justice Department and CFTC fines, but that is not the key part
of this. What is really important is ensuring financial market
integrity. And when a reference rate such as LIBOR, central to
borrowing, lending, and hedging in our economy, has so readily
and pervasively been rigged, I think the public is just
shortchanged. I do not know any other way to put it. We must
ensure that reference rates are honest and reliable reflections
of observable transactions in real markets and that they cannot
be so vulnerable to misconduct.
I will close by mentioning, the same way as Chairman Walter
did, the need for resources. I would say the CFTC has been
asked to take on a market that is vast in size and much larger
than the futures market we once oversaw, and that without
sufficient funding, I think the Nation cannot be assured that
we can effectively oversee these markets.
I thank you and look forward to your questions.
Chairman Johnson. Thank you, and thank you all for your
testimony.
As we begin questions, I will ask the clerk to put 5
minutes on the clock for each Member.
Ms. Miller, what steps is the U.S. taking both at home and
abroad to complete reforms in a way that makes the financial
system safer, ends too-big-to-fail bailouts, and promotes
stable economic growth? And what are the challenges to
accomplish this?
Ms. Miller. Thank you for the question. I think the most
important thing that we can do is to restore confidence in our
financial markets and our financial system, and I think the
work that has gone on, post the Dodd-Frank reforms, has been
incredibly important in strengthening our financial
institutions, making sure that they are better capitalized,
that they are more liquid, and that they have a good plan for
failure should they not succeed.
I do not think that our reforms are intended to prevent
failure, but I think they are intended to make us much better
prepared and to make sure that our financial institutions and
the activities that they engage in are much safer and sounder.
So we have been working very hard, I think, in the U.S. and
abroad with our international counterparts to make sure that we
have put in place the necessary rules of the road to make sure
these things can happen.
So it is happening at many levels in the U.S. You have
heard of all of the activities that these financial regulators
are engaged in. But it is also happening in international
forums where we are working with our counterparts to make sure
that we have a level playing field.
As far as the challenges, this is a very comprehensive law.
It is one that addresses many parts of our financial system. I
think the number of rulemaking activities, definitions,
studies, and work that were laid out by Dodd-Frank is quite a
big workload. When I work with these regulators here, I see the
same people in many instances working on a wide range of rules.
They are working very hard. But they have a pretty big agenda
to accomplish. But I think that the spirit of cooperation is
good. I think entities like the Financial Stability Oversight
Council provide a good forum for working on these things.
Chairman Johnson. Mr. Cordray, congratulations on issuing a
final QM rule that was well received by both consumer advocates
and the industry. What approach did you take to design a final
rule to strike the right balance?
Mr. Cordray. Thank you, Mr. Chairman, and I appreciate
those observations. I think we tried to do three things.
The first is that we were very accessible to all parties
with all ranges of viewpoints on the issues. The issues were
difficult. It is not easy to write rules for the mortgage
market right now because we are in an unnaturally tight period,
and the data from a few years before was from an unnaturally
loose period, and we have some significant issues unresolved in
terms of public policy. We listened very carefully and
attentively to what people had to say to us and the great deal
of comments that we received.
Secondly we did go back and try to develop additional data
so that we could work through the numbers on our own and
understand what kind of effects different potential approaches
would have.
Third and this was quite meaningful--we consulted very
closely with our fellow agencies. They have a lot of expertise
and a lot of insight on the kinds of problems we were
addressing, and we will ultimately be examining these
institutions in parallel to one another. And the rules need to
work for everyone.
We will continue to work with the other agencies on
implementation, and I do think that that helped us
tremendously. I could point to any number of provisions in the
rules that were made better by that process.
Chairman Johnson. This question is for Mr. Gruenberg, Mr.
Curry, and Mr. Tarullo. First, I want to thank Senator Hagan
for all her hard work on QRM. Is there anything in the law that
would prohibit QRM from being defined the same as QM? And is
that something you are considering now that the QM rule is
finalized, as Mr. Cordray just described? Mr. Gruenberg, let us
begin with you.
Mr. Gruenberg. Thank you, Mr. Chairman. I do not believe
there is any prohibition in the law with regard to conforming
QRM with QM. We actually delayed consideration of the
rulemaking on QRM pending the completion of the QM rules, and I
think we will now have the ability to consider the final
rulemaking on QRM in light of that QM rulemaking.
Chairman Johnson. Mr. Tarullo and Mr. Curry, do you agree?
Mr. Tarullo. Certainly, Mr. Chairman, I agree with Chairman
Gruenberg that there is no legal bar. And I would just say
further that, as you know, the two provisions had somewhat
different motivations. The QM rule was motivated toward
protecting the individual who buys the house, and the QRM rule
was motivated toward the risk retention associated with that
mortgage and, thus, presumably trying to protect the investment
for the intermediary.
Having said that, I think given the state of the mortgage
market right now--and both you and Senator Crapo have alluded
to it--we want to be careful here about the incremental
rulemaking that we are doing not beginning to constrict credit
to middle- and lower-middle-class people who might be priced
out of the housing market if there is too much in the way of
duplicate or multiple kinds of requirements at the less than
highly creditworthy end.
So I think it is definitely the case that on the table
should be consideration of making QRM more or less congruent
with QM.
Chairman Johnson. Mr. Curry.
Mr. Curry. I share the views of both Governor Tarullo and
Chairman Gruenberg with respect to the definition. I also would
concur with Governor Tarullo that it is important to look at
the cumulative effect, the issue that Senator Crapo mentioned,
when we are talking about the mortgage market and issues of
competition, and the ability to have the widest number of
financial institutions, regardless of size, participating in it
is something that we are very concerned about and paying close
attention to.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman. Senator Corker has
a need to get to another meeting, and I am going to yield to
him.
Senator Corker. Thank you. Thank you very much. I will do
this rarely, and I will be very brief, just three questions.
Mr. Gruenberg, we talked extensively, I think, about
orderly liquidation in Title II, and I know most people thought
orderly liquidation meant that these institutions would be out
of business and gone. I think as you have gotten into it, you
have decided that you are only going to eliminate the holding
company level. And what that means is that creditors, candidly,
could issue debt to all the subsidiaries and know that they are
never going to be at a loss. And I am just wondering if you
have figured out a way to solve that, because obviously that
was not what was intended.
Mr. Gruenberg. I agree with you, Senator, and as you know,
the approach we have been looking at would impose losses--
actually wiping out shareholders, imposing losses on creditors,
and replacing culpable management. In regard to creditors, it
would be important to have a sufficient amount of unsecured
debt at the holding company level in order to make this
approach work. We have been working closely with the Federal
Reserve on this issue. Actually, Governor Tarullo in his
testimony makes reference to it, and I am hopeful we can
achieve an outcome that will allow us to impose that kind of
accountability on creditors.
Senator Corker. It seems like you would want all of your
long-term debt at the holding company level, so I just hope
that you all will work something out that is very different
than the way it is right now, because creditors could easily be
held harmless by just making those loans at the sub-level, and
that is not what anybody intended.
Second, with the FSOC, Ms. Miller and Mr. Tarullo, I know
that you are to identify and to respond to threats in the
financial system, any kind of systemic threat, and I would just
ask the two of you: Is there any institution in America today
that, if it failed, would pose a systemic risk? Any
institution.
Ms. Miller. Well, I think we learned from the financial
crisis that the failure of a large institution can create some
systemic risk, so I----
Senator Corker. But you all are to eliminate that, so I am
just wondering if any institution in America failed, would that
create systemic risk? Because your job is to ensure that that
is not the case.
Ms. Miller. I believe that all the work that we have done
and continue to do is designed to prevent that effect and to
make sure that we have in place rules and regulations that keep
firms from engaging in activities or building their business
models in ways that are going to transmit that type of
financial distress.
Senator Corker. Mr. Tarullo.
Mr. Tarullo. I think, Senator, that it is a journey and not
a single point where you can say we have addressed the too-big-
to-fail issue. I do think a lot of progress has been made. But
I would also distinguish between, if I can put it this way,
resolvability without a disorderly, major disruption to the
financial system on the one hand, and on the other the failure
of a firm that entails substantial negative externalities. So
it is the difference between bringing the whole system into
crisis on the one hand, not doing so on the other, but still
imposing lots of costs.
And I do think that there is complementarity between the
capital rules, the FDIC resolution process, and the other rules
in trying to make sure that we are dealing both with
resolvability and negative externality.
Senator Corker. I hear what you are both saying. I would
assume, though, that a big part of your role is to ensure that
there is no institution--I know that you guys have regulatory
regimes that try to keep them healthy. But I assume--and if I
am wrong--that you want to ensure that there is no institution
in America that is operating, that operates that can fail and
create systemic risk. I assume that is part of your role, and
if not, I would like a follow-up after the meeting, and maybe
we will ask that again in written testimony. I know my time is
short.
Let me just close with this. I know the Basel III rules are
really complicated as it relates to capital, and some people,
Mr. Tarullo, have come out and said that we would be much
better off with a much stronger capital ratio--some people have
said 8 percent--and do away with all the complexities that
exist, because many of the schemes, if you will, that lay out
risk really do not work so well. I am just wondering if that
would not be a better solution to Basel III, and that is, just
have much better ratios, much stronger ratios, and much less
complexity with all of these rules that so many people are
having difficulty understanding.
Mr. Tarullo. Well, Senator, I guess I would say--and I know
you are not making the observation I am about to respond to,
but it has been heard as well--the idea that if you somehow do
not completely like Basel III or think maybe more should have
been done, that we should not be for Basel III. Basel III is an
enormous advancement in improving the quantity and the quality
of capital, and those pieces of it are actually not all that
complicated. You know, making sure that the equity that is held
is real equity that can be loss absorbing and getting it up to
a 7-percent level, effectively, rather than as low as 2
percent, which that level was precrisis. I think those are
pretty straightforward.
Whether more should be done, whether as Chairman Gruenberg
was just saying, for some of the largest institutions we need
some complementary measures, we certainly think with systemic
risk you do. I agree with that. But I actually think it is
pretty straightforward, and I would also say that in the U.S.,
at least, with the Collins amendment, we are now in a position
to have a standardized floor with standardized risk weights,
not model-driven risk weights but standardized risk weights,
which applies to everybody, and my hope would be that other
countries actually see there is substantial merit in this, in
having a much simpler floor and then above that for the biggest
institutions, that is where you have the model-driven
supplemental capital requirement, not displacing the simple
one, just supplemental.
Senator Corker. Thank you. Thank you very much.
Chairman Johnson. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Chairman Gensler, I understand that you recently had a
roundtable on the futurization of swaps, and one of the
participants indicated that because the rulemaking process has
not been fully completed, many people are moving away to avoid
uncertainty in the futures markets. Can you tell us what risks
might be posed by that and also how you are going to respond to
finalizing these rules? And I know you indicated your budget
issue is probably a critical factor in that. You might even
comment on that again.
Mr. Gensler. Thank you, Senator. I think what we are seeing
in the derivatives marketplace is somewhat natural. The futures
marketplace has been regulated for seven or eight decades and
for transparency and risk reduction through clearing. The swaps
marketplace developed about 30 years ago and, in fact, is
between 80 and 90 percent of the market share in a sense of the
outstanding derivatives.
So as Congress dictated, as we bring transparency and
central clearing to the unregulated market, there has been some
relabeling, some reshifting. As you say, some people call this
futurization.
The good news is whether it is a future or a swap, we have
transparency after the transaction and in futures before the
transaction occurs. We have central clearing to lower the risk
and ensure access.
We do need to finish the rules in the swaps marketplace
around these things called swap execution facilities and the
block rule. We also in the futures world have to ensure that we
do not lose something, that what was once swaps moves over and
calls itself futures and somehow the exchanges lower the
transparency. We would not want to see that happen.
But I think whether it is called a future or a swap, we are
in better shape than we were before 2008. I thank you for
asking about resources. We desperately need more resources. It
is a hard ask when Congress is grappling with the budget
deficits, I know.
Senator Reed. Commissioner Walter, this is a related
question because it is an international market, and both you
and Chairman Gensler are working on the issue of cross-border
swaps. And in order to coordinate with international regulators
so that there is a consistent rule--and it sort of harkens back
to what Governor Tarullo said about it would be great if there
was a Collins rule across the board. Uniformity, simple
uniformity helps sometimes.
Can you comment upon what both you and Chairman Gensler are
doing with respect to these coordination efforts with respect
to the cross-border swaps?
Ms. Walter. Absolutely. Thank you, Senator Reed. It is a
tremendously important issue, perhaps more important in this
market than any other, because this market is truly a global
marketplace. Unlike other markets that we regulate which only
have certain cross-border aspects, the majority of what goes on
in this marketplace really does cross national lines.
We have worked very closely not only with the standard
multinational bodies such as IOSCO, the International
Organization of Securities Commissions, but both the CFTC and
the SEC are working very actively with the regulators around
the globe who are in the process of writing the same rules.
They are at somewhat different stages than we are. Some are
still at the legislative stage. Some are just entering the
rule-writing stage. But we all acknowledge the importance of
making sure that the business can take place across national
boundaries and that we remove unnecessary barricades.
First of all, we want no incompatibility or conflict, but
then we also want to look at ways that we can make our rules
more consonant. And we are both looking at techniques such as
what we call substituted compliance, where you could have an
entity that is registered in the United States but complies
with its U.S. obligations by complying with its home-country
laws. We think this will really ease the burdens, and we are
looking at all of it very carefully.
Senator Reed. Chairman Gensler, any comments?
Mr. Gensler. I think we are in far better shape than we
were 2 years ago if we had this hearing, or even 1 year ago,
because Europe, the European Union, now has a law called AMIR.
Canada and Japan and we, so four very significant jurisdictions
between which we probably have 85 or 90 percent of this
worldwide swaps marketplace.
We are ahead of them in the rule-writing stage, but with
some developments last week, even Europe now got their rules
through a very important process through the European
Parliament. So I think that we are starting to align better.
Senator Reed. Let me just make a final comment because my
time is expiring. One of the Dodd-Frank initiatives was to take
bilateral derivative trades and make them--put them on clearing
platforms so that they are multilateral. That helps, but it
also engenders the possibility of systemic risk from the large
concentration. That means that the collateral rules, all the
rules have to be. I just want to leave that thought with you,
that you have--you know, that is something that should be of
concern to both CFTC and SEC, that these central clearing
platforms are so grounded with capital, collateral, however you
want to describe it, lack of leverage, that they do not pose
systemic risk. I think you understand that.
Mr. Gensler. We do, and we take that very seriously, and we
consult actively with the Federal Reserve and international
regulators as well on that.
Senator Reed. Thank you very much.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman. I first
want to get into the issue of economic analysis. As I know you
are all aware, the President has issued two Executive orders
requiring the agencies to conduct economic analysis, and the
Office of Management and Budget has issued directives and
guidance on how to implement that. But, ironically, independent
agencies such as yours are not subject to those requirements or
to those Executive orders. And I know that each of your
agencies has said that you are going to follow the spirit of
those orders, but in December of 2011, the GAO found that, in
fact, in the rulemaking under Dodd-Frank the agencies were not
following the guidances put out by OMB. And in its December
report of this year, it found that the OCC and the SEC were
getting there, but that the remaining agencies still a year
later were not following the key guidances that the OMB has put
out for economic analysis.
The GAO, frankly, I think was quite critical about that, as
well as the fact that it found some coordination among the
agencies, but that the coordination was very informal in
nature, and almost none of the coordination looks at the
cumulative burden of all the new rules, regulations, and
requirements.
So my first question, or really ask, is of all of you: Can
I have your commitment that each of your agencies will act on
GAO's recommendation to incorporate OMB's guidance on cost/
benefit analysis into your proposed and final rules as well as
your interpretive guidance? I guess I would not necessarily go
through and ask each one of you for an answer, but if there is
any agency here who will not commit to comply with the GAO's
recommendation, could you speak up?
Mr. Tarullo. I am sorry. I will confess not being familiar
with the December 2012 recommendations, Senator. Certainly we
do economic analysis both on a rule-by-rule basis and more
generally, and to that we are committed. I do not know that we
are committed to everything that might be in there, and I just
would not want to leave you with that impression. So I would
prefer to be able to get back to you after the hearing.
Senator Crapo. OK. Well, I have got the report here. I am
sure you can get a copy of it. And what the GAO is saying is
that it is the OMB guidances implementing the President's
Executive orders on this issue, and each of the agencies tells
the GAO that they are doing what you just said to me, that you
are doing economic analysis. The GAO is saying that you are not
doing economic analysis the way that the OMB has directed that
it be done, according to the guidance.
So the request is that you commit that you will follow the
GAO recommendation that you simply comply with the OMB
guidances.
All right. I am going to take that as an agreement that you
will do that.
Mr. Gensler. Could I just, because I do not want to leave
it----
Senator Crapo. I guess maybe not.
Mr. Gensler. Well, no. I just want to make sure, just as
Governor Tarullo, that we did not leave you with anything but
the best impressions.
Our general counsel and our chief economist issued guidance
to the staff on all our rulemakings to ensure that our final
rules do what you are saying. I think the GAO report also is
looking at some proposals that came before, so we had to sort
of, you know, address what the recommendations were, and there
were proposals before that.
We are also in a circumstance where our statute has
explicit language about cost/benefit considerations, and that
language we have is a little different than other agencies. So
we look to Section 15(a), I think, of the Commodity Exchange
Act for our guidance on cost/benefit. But I believe and I
understand that our guidance to the staff is consistent with
the OMB, but recognizing we have to comply with the statute
that we have.
Senator Crapo. I do not think that the statute you have,
though, stops you from honoring and meeting the OMB guidances.
GAO, as I understand it, looked at 66 rulemakings altogether
that happened among the agencies law year, and that is a pretty
significant amount of the rulemakings that were there.
Let me get at this in another way. Can each of you commit
that you will provide the Committee with a description of the
specific steps your agency is taking to understand and quantify
the anticipated cumulative effect of the Dodd-Frank rules? Any
problem with that one?
Mr. Tarullo. We are using data that is available, and where
the quantification possibility exists, absolutely.
Senator Crapo. All right. I see my time is up. I have some
other issues to get into with you, but I appreciate this. And I
just want to conclude by a statement. I think GAO's report was
very clear that the kind of economic analysis that we need is
not happening, and that is why I am raising this. So although
you explained that you have other regimes or statutory
mandates, the issue here is getting at proper economic analysis
as we implement these rules. And I think GAO's report is pretty
damning in terms of the results they found on the 66 rules that
they identified.
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. Thank you to all
for your testimony.
Mr. Curry, I wanted to discuss the botched foreclosure
review process that I held a hearing on more than a year ago in
the Housing Subcommittee, and in fairness, let me start off by
saying that I realize that you were not the Comptroller when
the foreclosure review program was designed. But as the follow-
on to that period of time, you are, nevertheless, tasked with
cleaning up what I consider to be a mess.
Basically what was done here is that we replaced the
process with an $8.5 billion settlement that will not really
determine which borrowers were wronged or not, and despite
keeping their legal rights to sue the banks, most borrowers do
not have the financial means to litigate their cases if they
feel that the compensation was inadequate.
So considering this point, isn't it unfair to not review
the files of those turning in packages if they still want a
review? And would you consider mailing each borrower a check
but giving them the option to return that check in favor of a
full review of their file? And as part of the answer--I will
just give you the third part of it--how is it fair to tell a
borrower who had, for example, $10,000 in improper fees charged
to them that they are going to get $1,000 because that is the
amount that all borrowers in the improper fee category will
get?
I have been at this for over a year, and I am concerned
about how we are coming to the conclusion here. So give me some
insight.
Mr. Curry. Thank you, Senator Menendez. I share your
concerns about the entire process and its ability to meet its
original stated objectives.
What happened here is that the complexity of the review
process was much larger than was anticipated in the beginning.
It consumed a considerable amount of time with very little in
terms of results. And our concern was that having over almost
$2 billion being spent as of November of this year without
being able to even issue the first checks, that the process was
flawed and that the best equitable result was to estimate an
appropriate amount of settlement and to make as equitable a
decision as possible, taking into account the level of harm and
the borrower characteristics. The settlement is not perfect,
but we believe it is the best possible outcome under the
circumstances.
Senator Menendez. On the specific questions that I asked
you, though, is it possible for those who want a review of
their files to get a review if they are willing to forgo or at
least the check?
Mr. Curry. That is not an element of the settlement that we
reached.
Senator Menendez. So the bottom line is that they will be
foreclosed from a review?
Mr. Curry. No. Part of the settlement is--and this was the
impetus for having the $5.7 billion worth of assistance for
foreclosure relief as part of the settlement. We have made it
clear that those funds should be prioritized and that they
should be directed toward the in-scope population and toward
those individuals with the greatest risk of foreclosure. We
want people to stay in their homes.
Senator Menendez. Well, we want people to stay in their
homes, too. The question is: What recourse do they have here
other than pursuing their own litigation? They have none
through your process. That is what I want to get to.
Mr. Curry. The way the settlement is structured, we will
try to allocate the payments to the most grievous situations.
We have made----
Senator Menendez. But you will not know that without a
review of their files.
Mr. Curry. We have done an analysis, a preliminary analysis
of the level of harm in the total in-scope population. We think
we have a fair estimate of overall who would be harmed. But we
do recognize, as you stated, that certain individuals may not
get fully compensated for financial harm.
Senator Menendez. Well, we look forward to reviewing that
with you further.
Last, Secretary Miller, the President called for something
that both Senator Boxer and I have promoted and offered, the
Responsibility Homeowners Refinancing Act and said it is past
time to do it. Could you tell the Committee the value to
individuals as well as to the economy of permitting refinancing
at this time?
Ms. Miller. Thank you for that question. The population of
homeowners who today are underwater on their mortgages--we know
that is about 20 percent of all homeowners--who have not been
able to refinance in a low- interest-rate environment is a
missed opportunity, we think, to reach homeowners who should be
able to benefit from the spread of a high- interest-rate loan
that they may hold versus where rates are today. So we would
very much support any assistance that you can provide to help
reach that population.
We do have a program that is reaching homeowners whose
mortgages happen to be held or guaranteed by the GSEs. It is
called HARP. And we have seen very good take-up in the
refinancing assistance we are providing to underwater loan
holders in that population. But it is the other group of
homeowners who do not have a mortgage held at the GSEs that
have not been able to take advantage of this. So we think that
it is a priority. It would be good for homeowners. It would be
good for the mortgage market. It would be good for the economy.
Senator Menendez. Thank you.
Chairman Johnson. Senator Coburn.
Senator Coburn. Mr. Chairman, thank you. I am glad to be on
this Committee. I just one question. I will submit the rest of
my questions for the record.
This is to Mr. Cordray. You mentioned in your testimony
financial literacy and that needs to be approved. I wonder if
you are aware of how many financial literacy programs the
Congress has running right now.
Mr. Cordray. I could not tell you exactly, but I can tell
you that, by law, I am the Vice Chair of the Financial Literacy
Education Commission, and we are coordinating with other
agencies. There are 15 or 20 other agencies, and it does feel
to me that one of the issues has been a sort of piecemeal
approach to this problem. We have been given substantial
responsibilities as a new consumer agency in this area, and I
would like to work both with the Congress and with our fellow
agencies as we are doing through what is called the FLEC that I
mentioned, and also with State and local officials.
When I was a county treasurer and then State treasurer in
Ohio, we were able to get the legislature to change the law
such that every high school student in Ohio now has to have
personal finance education before they can graduate. That is
something we used to do years ago through the home economics
curriculum and like. I have seen mathematics textbooks from the
teens and twenties where a lot of the questions asked were put
in terms of household budgeting and the types of financial
issues that were around particularly farming and other
communities. I think that is something that we have lost. It is
something that has weakened our society, and it is something
that we need to focus on.
But I would agree with you. There is a very scattered and
disparate approach right now, and it has not been optimal.
Senator Coburn. It is pretty ironic the Federal Government
is teaching Americans about financial literacy given the state
of our economic situation.
There are 56 different Federal Government programs for
financial literacy, and so what I would hope you would do in
your position is really analyze this and make a recommendation
to Congress after looking at the GAO report on this and tell us
to get rid of them or get one, but not 56 sets of
administrators, offices, rules, and complications and
requirements that have to be fulfilled by people to actually
implement financial literacy.
Mr. Cordray. I appreciate the comment. I would be glad to
follow up with you and work and think about this. As we
coordinate with one another, that helps minimize some of the
problem. We have worked with the FDIC, particularly on their
Money Smart curriculum, which is a terrific curriculum. We do
not need to be reinventing the wheel. We are working with them
now on creating a new module for older Americans and seniors
who face some specific issues. I am sure your office hears
about them quite a bit, and I would be happy to work with you
on that. And I agree with the thrust of your question.
Senator Coburn. My only point is that with 56, if we start
another one or another two or three and do not change those, we
are throwing money out the door.
Mr. Cordray. I would agree with that.
Senator Coburn. Thank you.
Chairman Johnson. Senator Brown.
Senator Brown. Thank you, Chairman Johnson.
Governor Tarullo, I would like to talk to you for a moment.
Three or four years ago, in 2009, you said, and I quote,
``Limiting the size or interconnectedness of financial
institutions was more a provocative idea than a proposal.'' And
you said that in the context that there were not particularly
any well-developed ideas out there. And since then, as we have
talked, I have introduced legislation to limit the nondeposit
liabilities of any single institution relative to domestic GDP.
I have worked with Senator Vitter on that proposal, and we are
considering to see, I think, more bipartisan support.
Tell me how your thinking has evolved--your more recent
statement seems like it has. Tell me how your thinking has
evolved from 2009 and why that is.
Mr. Tarullo. You are absolutely right, Senator Brown. My
observation back in 2009 was that people would say something
like, ``Break up the banks.'' But there was not a plan behind
it that allowed people to make a judgment as to whether it
would address the kind of problems in too big to fail and
others we saw in the crisis, and what the costs associated with
it would be.
As you say, since then a lot of people have generated a lot
of plans, and I think they probably fall into three categories.
The first category is really a variant on things we already do:
strengthen the barriers between insured depository institutions
and other parts of bank holding companies; make sure that some
activities are not taking place in the banks; make sure that
there is enough capital in the rest of the holding company,
even if they get into trouble independently, do not just think
in terms of protecting the IDI itself.
Interestingly, those are a big part of some of the European
proposals like the Liikanen and Vickers proposals. As I say, to
a considerable extent, the U.S. has already gone down that
road, and indeed Dodd-Frank strengthened some of those
provisions.
The second set of proposals is what I would characterize as
a functional split, so saying that there are certain kinds of
functions that cannot be done within a bank holding company.
Obviously Glass-Steagall was exactly that kind of approach. It
separated investment banking from commercial banking. And there
are some proposals out like this now. They sort of vary. Some
of them would allow underwriting but not market making. Others
might say nothing at all other than commercial banking.
There are issues on both sides. On the one hand, we have to
ask ourselves, if we did that, would it actually address the
problem that led to the crisis. As Senator Johnson was
indicating in his introductory remarks, it was the failure of
Bear Stearns, a broker-dealer, not a bunch of IDIs or
relationships with IDIs, that precipitated the acute phase of
the crisis.
The second issue, obviously, is what would be lost. Are
there valuable roles played when, for example, an underwriter
also makes market in the securities which it underwrites? I
think most people would conclude that there are.
The third kind of example is embodied in your legislation,
and I think in some other proposals, which focuses on the point
that I tried to make at the close of my introductory oral
remarks--what I would think of as the unaddressed set of
issues, the unaddressed set of issues of large amounts of
short-term, nondeposit, runnable funding. And I think here--and
speaking personally now--my view is that is the problem we need
to address. I think your legislation takes one approach to
addressing it, which is to try to cap the amount that any
individual firm can have and thereby try to contain the risk of
the amplification of a run.
There are other complementary ideas such as restricting the
amounts based on different kinds of duration risk or having
higher requirements if you have more than a certain amount.
There are even broader ideas such as placing uniform
margins on any kind of securities lending, no matter who
participates in them.
From my point of view, the importance of what you have done
is to draw attention to that issue of short-term, nondeposit,
runnable funding, and that is the one I think we should be
debating in the context of too big to fail and in the context
of our financial system more generally.
Senator Brown. Thank you.
Mr. Chairman, if I could just make a couple of quick
comments. One, we have seen since--and thank you for that
evolution in your thinking and the way you explained it.
When Senator Kaufman and I first introduced that amendment
on the floor in 2010, it had bipartisan support, but it
obviously fell short. We have seen from columnists like George
Will and a Wall Street Journal op-ed columnist and a number of
others sort of across the political spectrum, including
colleagues that are, you know, way more conservative than I am
on this in this body come around to looking at this pretty
favorably. So we have seen a lot of momentum, and I appreciate
your thinking.
Second, I wanted to bring up really quickly, Mr. Chairman--
and I will not end with a question. But last week, Governor, I
received the Fed's response to a letter regarding the
imposition of Basel III on insurance companies. Senator Johanns
and I sent, with 22 of our colleagues last years, Senators
Johnson and Crapo sent a letter yesterday to the Fed on the
insurance issue. And you and other Fed officials have stated
several times you believe the proposed rule adequately
accommodates the business of insurance. We respectfully
disagree. I will not ask for a response now, but we will work
with you on that, if we could. Thank you.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Heller. And welcome to the
Committee.
Senator Heller. Thank you very much, Mr. Chairman, and to
the Ranking Member, it will be a pleasure to serve with you,
and thanks for making me part of this team. And I want to thank
those who have testified today. I have a lot to learn. I guess
there are two messages. This takes a team to solve these
problems that we have today. And, two, I do have a lot to
learn.
I want to concentrate my comments today more on
consolidation. We have had massive consolidation in the banking
industry in Nevada. I come from the State with the highest
unemployment, highest foreclosures, highest bankruptcies, and I
think the health of the banking industry reflects the health of
the State in its current position.
From about a 30,000-feet level looking down at this, we
only have 14 community banks left in Nevada. We only have 23
credit unions left in Nevada. Eighty-five percent of all
deposits are now concentrated in large banks, and 31 percent of
Nevadans are unbanked or under-banked, which is the highest
percentage in the country. Our housing, as, Ms. Miller, you
mentioned, underwater mortgages are about 20 percent
nationwide; it is about 60 percent in Nevada. So we are in a
tough situation here, and I am concerned about consolidation.
My question--I see a lot of you writing notes, and I
appreciate that, but what does this consolidation do? How does
it help Nevadans get these loans? If the small banks--one of
you testified--I cannot remember which one it was--that 50
percent of the small loans to businesses, to home mortgages, to
car loans come from these community banks. With the loss of
community banks--and let me make one more point before I raise
the question, and that is, the Banking Association feels in
Nevada that if you have deposits of less than $1 billion, you
are probably going away. Less than $1 billion. Do you agree
with that statement? And, two, how does it help Nevada to have
this lack of financial opportunities and to consolidate in this
manner? Mr. Gruenberg.
Mr. Gruenberg. Yes, thank you, Senator. Just on the final
point you made in terms of needing a certain level of deposits
or assets to be viable in the banking system, this is actually
one of the issues we did look at in the study we did looking at
the experience of community banks over the past 27 years. And
we tried to look closely at that particular issue because there
is a lot of talk about that issue. And for what it is worth,
based on the data that we analyzed, we could not find any
significant economies of scale once you get over $300 million
in assets. So the notion that a community bank has to be at
least $1 billion in assets, for example, in order to be viable
in the banking market was not proved out by the analysis we
did.
You raise important points in regard to Nevada's particular
situation. Nationally, Nevada had rapid expansion in commercial
real estate, and that is what really, I think, drove a lot of
the developments there. Hopefully Nevada has worked through the
worst of that. That was not typical of the rest of the country,
so I think it is fair to say Nevada was particularly impacted
there.
I think for the surviving banks, one, it is a tribute to
the work they did to manage their way through this, and I think
it is fair to say they are deserving of particular attention
and support going forward, given the role that community banks
play in terms of credit availability. That was the point I made
earlier. That is important because the particular niche for
small banks, as you know, is small business lending, which
tends to be labor intensive and highly customized. It is the
sort of lending that the large institutions--who are interested
in standardized products that they can offer in volume--are not
necessarily interested in providing. So the community banks
really have a critical role in filling that niche in the
financial system.
Senator Heller. Do you have a comment, Mr. Curry?
Mr. Curry. Yes. I have been a community bank supervisor at
the State and Federal level for 25 years, over 25 years, and I
saw firsthand in New England the importance of community banks
and their ability to help dig out of a severe recession. So I
share your concerns and also your commitment to community
banks.
I think as supervisors we can play a role in whether it is
rulemaking or in the manner in which we actually supervise and
examine these banks to eliminate unnecessary burden. It is
something that we are committed to doing at the OCC where we
have over 1,600 institutions. And the supervisory process I
think for smaller banks, when the examiners talk to CEOs and
lending officers, there is an actually an ability to share best
practices and help improve the performance of community banks.
Senator Heller. Thank you.
Mr. Chairman, thank you very much.
Chairman Johnson. Senator Warren.
Senator Warren. Thank you very much, Mr. Chairman. Thank
you, Ranking Member. It is good to be here. And thank you all
for appearing. I have sat where you sit. It is harder than it
looks. I appreciate your being here.
I want to ask a question about supervising big banks when
they break the law, including the mortgage foreclosures but
others as well. You know, we all understand why settlements are
important, that trials are expensive and we cannot dedicate
huge resources to them. But we also understand that if a party
is unwilling to go to trial, either because they are too timid
or because they lack resources, the consequence is they have a
lot less leverage in all the settlements that occur.
Now, I know there have been some landmark settlements, but
we face some very special issues with big financial
institutions. If they can break the law and drag in billions in
profits and then turn around and settle, paying out of those
profits, they do not have much incentive to follow the law.
It is also the case that every time there is a settlement
and not a trial, it means that we did not have those days and
days and days of testimony about what those financial
institutions had been up to.
So the question I really want to ask is about how tough you
are about how much leverage you really have in these
settlements. And what I would like to know is tell me a little
bit about the last few times you have taken the biggest
financial institutions on Wall Street all the way to a trial.
[Applause.]
Senator Warren. Anybody? Chairman Curry?
Mr. Curry. I would like to offer my perspective as a bank
supervisor.
Senator Warren. Sure.
Mr. Curry. We primarily view the tools that we have as
mechanisms for correcting deficiencies, so the primary motive
for our enforcement actions is really to identify the problem
and then demand a solution to it on an ongoing basis.
Senator Warren. That is right. And then you set a price for
that. I am sorry to interrupt, but I just want to move this
along. It is effectively a settlement. And what I am asking is:
When did you last take--and I know you have not been there
forever, so I am really asking about the OCC--a large financial
institution, a Wall Street bank to trial?
Mr. Curry. Well, the institutions I supervise, national
banks and Federal thrifts, we have actually had a fair number
of consent orders. We do not have to bring people to trial or--
--
Senator Warren. Well, I appreciate that you say you do not
have to bring them to trial. My question is: When did you bring
them to trial?
Mr. Curry. We have not had to do it as a practical matter
to achieve our supervisory goals.
Senator Warren. Ms. Walter.
Ms. Walter. Thank you, Senator. As you know, among our
remedies are penalties, but the penalties we can get are
limited, and my predecessor actually asked for additional
authority to raise penalties. When we look at these issues--and
we truly believe that we have a very vigorous enforcement
program--we look at the distinction between what we could get
if we go to trial and what we could get if we do not.
Senator Warren. I appreciate that. That is what everybody
does. And so the question I am really asking is: Can you
identify when you last took the Wall Street banks to trial?
Ms. Walter. I will have to get back to you with the
specific information, but we do litigate, and we do have
settlements that are either rejected by the Commission or not
put forward for approval.
Senator Warren. OK. We have got multiple people here.
Anyone else want to tell me about the last time you took a Wall
Street bank to trial?
You know, I just want to note on this, there are district
attorneys and U.S. Attorneys who are out there every day
squeezing ordinary citizens on sometimes very thin grounds and
taking them to trial in order to ``make an example,'' as they
put it. I am really concerned that ``too big to fail'' has
become ``too big for trial.'' That just seems wrong to me.
[Applause.]
Senator Warren. If I can--and I will go quickly, Chairman
Johnson--I have one more question I would like to ask, and that
is a question about why the large banks are trading at below
book value. We all understand that book value is just what the
assets are listed for, what the liabilities are and that most
big corporations trade well above book value. But many of the
Wall Street banks right now are trading below book value, and I
can only think of two reasons why that would be so.
One would be because nobody believes that the banks' books
are honest, or the second would be that nobody believes that
the banks are really manageable--that is, that they are too
complex either for their own institutions to manage them or for
the regulators to manage them.
And so the question I have is: What reassurance can you
give that these large Wall Street banks that are trading for
below book value, in fact, are adequately transparent and
adequately managed? Governor Tarullo or Ms. Miller.
Mr. Tarullo. There is certainly another reason we might add
to your list, Senator Warren, which is investor skepticism as
to whether a firm is going to make a return on equity that is
in excess of what the investor regards as the value of the
individual parts. And so I think what you would hear analysts
say is that in the wake of the crisis, there have been issues
on just that point surrounding, first, what the regulatory
environment is going to be, how much capital is going to be
required, what activities are going to be restricted, what are
not going to be restricted.
Two, for some time there have been questions about the
franchise value of some of these institutions. You know, the
crisis showed that some of the so-called synergies were not
very synergistic at all and, in fact, there really was not the
potential, at least on a sustainable basis, to make a lot of
money.
Part of it is probably just the environment of economic
uncertainty.
In some cases, we have seen some effort to get rid of large
amounts of assets at some of the large institutions. It is
indirectly in response to just this point that some of them
have concluded that they are not in a position to have a
viable, manageable, profitable franchise if they have got all
of the entities that they had before. And so a couple of them,
as I say, have actually reduced or are in the process of
reducing their balance sheets.
The other thing I would note is you are absolutely right
about the difference there. The difference actually is that the
economy has been improving and some of the firms have built up
their capital. You have seen that difference actually narrowing
in a number of cases as they seem to have a better position in
the view of the market from which to proceed in a more feasible
fashion.
Senator Warren. Good. Well, I appreciate it, and I
apologize for going over, Mr. Chairman. Thank you.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman. Chairman Johnson, I
appreciate your comments on QRM earlier.
For the U.S. housing market to continue on its path to
recovery, consumers, lenders, and investors need clarity
regarding the boundaries of mortgage lending. The recent action
by the Consumer Financial Protection Bureau to finalize rules
implementing the ability to repay provisions of Dodd-Frank was,
I think, an important step toward certainty and access. Now
that the CFPB has successfully finalized its work on the
qualified mortgage definition, I urge you to work quickly to
finalize the QRM definition in a way that ensures responsible
borrowers have ongoing access to prudent, sustainable mortgages
that for decades have been the cornerstone of a stable and
strong U.S. housing market.
Earlier this week, we saw data showing that home loans that
would be exempt from the ability-to-repay requirements and the
proposed risk retention standard, even with a 10-percent
downpayment requirement, made up less than half the market in
2010. Importantly, it should be noted that these loans rarely
went into default.
Now that QM is finalized, can you assure me that your
agencies will work diligently to complete a QRM rule in a
manner consistent with that legislative intent? I would love
your thoughts.
Mr. Curry. Senator Hagan, we view the QRM rulemaking, the
risk retention rulemaking process as an important one. With QM
in place, we are looking forward to adopt an appropriate
regulation as quickly as possible.
Senator Hagan. ``As quickly as possible'' is defined as
when?
Mr. Curry. I think Governor Tarullo mentioned earlier we
expect to wrap up most of the Dodd-Frank rulemaking this year.
Mr. Tarullo. Oh, I would hope on that one it would be
sooner than the end of the year.
Senator Hagan. The sooner the better.
Mr. Tarullo. Because the QM coming out, Senator, really now
does allow us to go and finish it. Most of the other issues--
the way these processes work is at a staff level people go
through all the various issues and they try to either work them
through or present them to their commissioners or Governors for
resolution. There, most of that process has already proceeded,
so there are a couple of things that are going to have to be
considered by the people at this table and our colleagues in
our various agencies. But it really was having QM final which
lets us now go to completion.
Senator Hagan. Under Secretary Miller, at the request of
the Financial Stability Oversight Council (FSOC), the Office of
Financial Research has been studying the asset management
industry. This study is intended to help the FSOC to determine
what risks, if any, this industry might pose to the U.S.
financial system and whether any such risks are best addressed
through designation of asset managers as nonbank systemically
important financial institutions.
My question is: Can you talk about the transparency of the
process? Will the results of the analysis be made public? And,
will interested parties be provided the opportunity to comment
formally on the results?
Ms. Miller. Thank you. As you are aware, the FSOC has some
responsibilities to designate nonbank financial institutions.
In the course of doing that, in April of 2012 we published some
criteria for exactly how that activity would proceed. At the
time, we said that asset managers are large financial
institutions, but they appeared different than some of the
other financial institutions we were looking at, and we took
that off the table to go off and do some additional work.
So the OFR has been doing that work, has been working with
the market participants as well as members of the FSOC to
complete that. I expect that if there is a plan to go forward
with designation on an asset manager or an activity of an asset
manager, there would have to be further publication of the
criteria for doing that and the terms on which that would be
considered. So we have been clear that we would be transparent
and public about that.
Senator Hagan. When you said you ``took it off the table,''
what did you mean by that?
Ms. Miller. We meant that we set it aside from the criteria
that were established at the time for nonbank financial
institutions to say that we wanted to study the asset
management industry further to learn more about the activities
and risks that they might present.
Senator Hagan. Will the FSOC provide the public with an
opportunity to comment on any metrics and thresholds relating
to the potential designation of asset management companies as
nonbank systemically important financial institutions--if you
went to the point--prior to any designation of such a company?
Ms. Miller. Well, I cannot speak for all the members of the
FSOC and what they would want to do, but I think that that
would be a reasonable course if we move forward in that
direction.
Senator Hagan. Thank you, Mr. Chairman.
Chairman Johnson. Senator Manchin.
Senator Manchin. Thank you, Mr. Chairman. First, I want to
start by saying how excited I am about being a new Member of
the Senate Banking Committee with all my colleagues, and I look
forward to working with you all. And I want to thank both you,
Chairman Johnson, and Ranking Member Crapo, my good friend, for
allowing me to be part of this.
I would like to start out by saying that in West Virginia
we have a lot of community banks that have been basically
really stable and done a good job, but they are caught up in
this, if you will, the whole banking changes and regulations.
And with that being said, I know there have been some things
that have helped by the Dodd-Frank, but I think most of the
community banks believe that it has been very onerous on them.
Federal Reserve Board Governor Elizabeth Duke recently gave
a speech in favor of the community banks where she said that a
one-size-fits-all regulatory environment makes it difficult for
community banks and that hiring compliance experts can put an
enormous burden on small banks. She also went on to say that
hiring one additional employee would reduce the return on
assets by 23 basis points for many small banks. In other words,
13 percent of the banks with assets less than $50 million,
these are the banks that did not cause this problem that we got
into in 2008. But they have been lumped in with all the bad
actors, if you will, and all the bad practices.
What we are saying on that--how are you all, because you
all--if I look across this and me being brand new to the
Committee, you pretty much have every aspect of regulations.
How are you dealing with that? Anybody can start. Mr. Gensler.
Mr. Gensler. Well, I would just say Congress gave us the
authority to exempt what Congress said was small financial
institutions, anything less than $10 billion in size, from the
central clearing requirement. We went through a rulemaking, and
we did just that. We exempted about 15,000 institutions from--
we do not oversee the banks, but we did our share on the
community banks.
Senator Manchin. The only thing I could say on that is that
you could, but they are just saying to comply with the massive
amount of paperwork regulations and the people they would have
to hire to do that when they were not at fault. And I think
every--they are saying this across the board.
Mr. Gensler. Yes. I was just saying what the CFTC did. We
just exempted them from the one provision that, you know,
Congress gave us authority.
Senator Manchin. Anybody else? Anybody feel like exempting
them?
Mr. Cordray. Senator, I would be happy to mention--so on
the mortgage rules that we just completed, the qualified
mortgage rule and our mortgage servicing rules are the most
significant and substantive rules. We were convinced--as you
say, and I have said it many times--that the smaller community
banks and credit unions did not do the kinds of things that
caused the crisis and, therefore, we should take account of
that and protect their lending model as we now regulate to
prevent the crisis from happening again.
On the servicing rules, we exempted smaller servicers from
having to comply with big chunks of that rule in consultation
with people. And on the qualified mortgage rule, we have done a
reproposal that would allow smaller banks that keep loans in
portfolios--many of them do--to be deemed qualified mortgages,
and I think that that is quite important. It has been well
received, and we are looking to finalize that proposal----
Senator Manchin. Thank you. Since my time is short, I would
like to ask this question, and maybe the people who have not--
Glass-Steagall was put in place in 1933 to prevent exactly what
happened to us. It was in place, I think, for approximately 66
years until it was repealed. Up until the 1970s, it worked
pretty well. We started seeing some changes and chipping away
with new rules that took some powers away from Glass-Steagall.
And then we finally repealed it in 1999, and the collapse in
2008.
How do you all--I mean, the Volcker Rule--and I know it
does not do what the Glass-Steagall does, but why would we have
those protections? And if it worked so well for so many years,
why do you all not believe it is something we should return to
or look at very--Governor.
Mr. Tarullo. Let me take a shot at that, Senator. I think
you have put your finger on the time frame at which what had
been a quite safe, pretty stable, not particularly innovative
financial system began to change. One of the big reasons,
though, it began to change was that commercial banks were
facing increasing competition on both the asset and liability
sides of their demand sheet--their balance sheet.
You had, on the one hand--and this is essentially a good
development--the growth of capital markets----
Senator Manchin. Where was the competition coming from?
Mr. Tarullo. I was about to say the growth of public
capital markets that were allowing more and more corporations
to issue public debt, to issue bonds, so they did not rely as
much on bank lending, borrowing from banks as they used to.
And, on the other side, you saw the growth of savings vehicles
like money market funds which provided higher returns than an
insured deposit in one of those institutions. So the banks felt
themselves squeezed on both sides by what in some respects were
very benign, very good developments, which is to say more
options for people. Where I think----
Senator Manchin. So we changed the rule basically to allow
them to get into risky ventures.
Mr. Tarullo. Well, in some cases it was risky ventures,
that is right. There definitely was a deregulatory movement in
bank regulation beginning in about the mid-1970s for an
extended period of time. And I guess what I would say is that
it would--if I had to identify a collective mistake by the
country as a whole, it was not in trying to preserve a set of
rules and structures which were just being eroded by everything
that was going on in the unregulated sector. I would say the
mistake lay in not substituting a new, more robust set of
structures and measures that could take account of the
intertwining of conventional lending with capital markets. And
that process of pulling away old regulation but not putting in
place new modernized responsive regulation, I think that is
what left us vulnerable.
Senator Manchin. Thank you, Mr. Chairman.
Chairman Johnson. Senator Tester.
Senator Tester. Thank you, Mr. Chairman. I want to thank
the Ranking Member and you for your service on this Committee,
and I look forward to working with you both on issues of
consequence here. And I want to thank everybody that is on the
Committee.
I am going to start out with some questions to Chairman
Walter, if I might. Investor protection was clearly one of the
most significant issues contemplated by Dodd-Frank, including
direction to the SEC to examine the standards of care for
broker-dealers and investor advisers in providing investor
advice. The SEC released a study on the subject that
recommended that the Commission exercise its rulemaking
authority to implement uniform fiduciary standards while
preserving investor choice.
It has been 2 years since that study was released. In your
testimony, you mentioned that the SEC is drafting a public
request for information to gather more data regarding this
provision.
I guess, first of all, do you anticipate the SEC will move
forward on this issue? And when?
Ms. Walter. I expect that the request for comment that is
referenced in my testimony will go out in the near future, in
the next month or two.
Senator Tester. OK.
Ms. Walter. With respect to the substance of the issue,
speaking only for myself, I would love to move forward on this
issue as soon as possible. Opinions at the Commission vary a
great deal in terms of the potential costs it imposes. My own
personal view is that it is the right thing to do and we should
proceed, and that we should then go on or perhaps at the same
time take a very hard look--and there is, I think, more support
for this at the Commission--at the different rules that are
applicable to the two different professions, the investment
adviser and the broker-dealer professions, to see where they
should be harmonized and where, in fact, the differences in the
regulatory structures are justified.
Senator Tester. Well, first of all, I appreciate your
position on this issue. I would encourage the Commissioners to
make this a priority because I think there is absolute benefit
to investors. And if you can help push it. I do not speak for
the Chairman of Ranking Member, but if we find it as a
priority, maybe we can help push it. But I think it is very,
very important.
Ms. Walter. I appreciate that, and I agree with you
completely.
Senator Tester. Thank you.
Another question deals with the JOBS Act that was signed
about 10 months ago, and a few of those provisions were
effective immediately. The SEC has really blown by most of the
statutory deadlines for rulemaking and rules have yet to be
proposed. The SEC I think put out one proposed rule on general
solicitation in August with the comment period that closed in
October. Since then, there has not been much talk about
finalizing the rule or the rest of the rulemaking requested by
that act.
I am troubled by rumblings that I have heard suggesting
that implementation of the portion of the bill that the
Commission has dubbed as ``Regulation A Plus'' may not be a
priority for the SEC. And I appreciate you do have a lot on
your plate--I understand that--in the way of rulemaking. But we
need the SEC to make progress so that small businesses that
this law was intended to benefit can better access capital
markets.
Can you outline the Commission's timeline for JOBS Act
implementation including Regulation A Plus, including when you
anticipate the SEC staff will present draft rules to the
Commissioners?
Ms. Walter. Our rulemaking priorities start with Dodd-Frank
and the JOBS Act, and then beyond that we see what else we can
accomplish at the same time. So we are looking very closely
now, particularly in how to proceed with the general
solicitation provisions of the law, which received rather
interesting and divided comment. We have to make a decision as
to whether to proceed with lifting the ban on general
solicitation in a stark way or whether to accompany it with a
number of protections that were offered by various commenters,
including unanimously by our Investor Advisory Committee with
respect to suggestions as to how to implement with additional
investor protections. That is actively at the top of our plate
right now.
Following closely behind that, we are working in the next
few months on putting together a crowdfunding proposal. I will
say, although we very much regret not meeting the statutory
deadlines, we have learned a lot by meeting with people both
from this country and from abroad who have engaged actively in
crowdfunding in the securities sphere, and I think that will
help to illuminate our proposal and to make it the best
proposal that it can be.
Senator Tester. Well, I just have to say, the JOBS Act was
said by some to be the most important jobs bill that we have
done in a while as far as actually creating jobs. I can tell
you, in my State of Montana, which is incredibly rural, folks
are hungry to get going. And I think we are holding the process
up. And like I said, I know you are pushed in a lot of
different directions and you are very, very busy, but I would
certainly hope that, once again, we can get some things out
very, very quickly, because I do not think we get the full
benefit of the act until we do.
And I assume since I am the last questioner I can just keep
going, right, Mr. Chairman?
[Laughter.]
Chairman Johnson. No.
Senator Tester. I have more questions, but I just want to
say thank you all for what you do, and just because I did not
ask you a question does not mean I do not still love you.
[Laughter.]
Senator Tester. Thank you.
Chairman Johnson. Thank you all for your testimony and for
being here with us today. I appreciate your hard work in
implementing those implement reforms.
Also, Senator Crapo has additional questions he would like
to submit.
This hearing is adjourned.
[Whereupon, at 12:33 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR HEIDI HEITKAMP
Chairman Johnson and Ranking Member Crapo, thank you for holding
this important hearing, and thank you to our many witnesses for
appearing today. I look forward to working with all of you as a Member
of this Committee.
After spending the last year traveling across North Dakota and
talking with community banks and credit unions across my great State,
it is clear that small financial institutions are struggling. As active
members in their communities, they provide crucial services in rural
communities and underserved areas. Yet, burdensome and complicated
regulation is contributing to an environment where the cost of business
is overwhelming and consolidation is too often the answer.
I applaud the efforts of some regulators to work with the community
banking industry to ensure the industry is strong and their regulation
is efficient and effective. We must encourage this trend to continue
and facilitate a dialogue to ensure smaller institutions are not
adversely affected by regulations targeted at large, complex ones. We
must create a banking system that supports community banks and credit
unions rather than stymies their ability to thrive.
As more rules are finalized to work toward financial stability and
increase investor and consumer protections, I look forward to working
with the appropriate regulators to make sure our smaller financial
institutions receive the consideration they deserve and can continue to
serve the many communities in North Dakota that rely on their services.
______
PREPARED STATEMENT OF MARY J. MILLER
Under Secretary for Domestic Finance, Department of the Treasury
February 14, 2013
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for the opportunity to appear here today to
discuss progress implementing the Dodd-Frank Wall Street Reform and
Consumer Protection Act.
The Dodd-Frank Act represents the most comprehensive set of reforms
to the financial system since the Great Depression. The package of
reforms President Obama signed into law 2\1/2\ years ago was a needed
antidote for regulations that were too antiquated and weak to prevent
or respond effectively to a financial crisis that inflicted devastating
damage on the U.S. economy and American families. The inadequacy of our
previous financial regulatory system was a major reason the crisis was
so severe and why the recovery has taken so long.
Americans are already beginning to see benefits of the reforms
implemented in the wake of the crisis reflected in a safer and stronger
financial system and a broader economic recovery. Although the
financial markets have recovered more vigorously than the overall
economy, with the stock market near its October 2007 all-time high, the
economic recovery is gaining traction. Private-sector payrolls have
increased by more than 6 million jobs from the low point in February
2010, marking the 35th consecutive month of private-sector job growth.
The unemployment rate, while still too high at 7.9 percent, has fallen
more than two percentage points since its October 2009 peak of 10.0
percent. The recovery in the housing market also still has further to
go, but it appears to be taking firmer hold as measured by rising home
prices, stronger sales, and declining numbers of delinquencies and
defaults.
The financial regulators represented here today have been making
significant progress implementing Dodd-Frank Act reforms. Consumers
have access to better information about financial products and are
benefiting from new protections. Financial markets and companies have
become more transparent. Regulators have become better equipped to
monitor, mitigate, and respond to threats to the financial system.
Our financial system has also become smaller as a share of the
economy and significantly less leveraged, reducing our vulnerability to
a future crisis. Capital requirements for the largest banks have
increased substantially, and U.S. banks have raised their capital
levels to approximately $1 trillion, up 75 percent from 3 years ago. We
have a new framework in place for protecting the financial system, the
economy, and taxpayers from the consequences of the failure of a large
financial company.
Eleven of the largest bank holding companies have already submitted
their living wills to the Federal Reserve and Federal Deposit Insurance
Corporation, and the other firms required to submit living wills will
follow suit by the end of this year, providing their regulators with a
roadmap to wind them down should they fail. The costs of resolving a
failed financial company will not be borne by taxpayers, but by the
company's stockholders, creditors, and culpable management--and if
necessary by the financial services industry.
The newly created Consumer Financial Protection Bureau (CFPB) has
taken important steps to provide clarity on consumer financial products
for ordinary Americans. The CFPB is cracking down on abusive practices
and helping to level the playing field between banks and nonbanks, so
that they play by the same rules when dealing with customers.
Expanded enforcement authorities at the Securities and Exchange
Commission (SEC) and the Commodity Futures Trading Commission (CFTC),
along with their new whistleblower rules, are providing investors with
increased protections, and the agencies' vigorous enforcement efforts
should serve as a greater deterrent to misconduct. Investors in
thousands of publicly traded companies have exercised new rights to
vote on executive compensation packages as a result of Dodd-Frank's
say-on-pay provisions.
A new framework for regulatory oversight of the over-the-counter
(OTC) derivatives market is largely in place. It will significantly
reduce the risks associated with these products and will provide much-
needed transparency for both market participants and regulators. As a
result of trade-reporting requirements, the price and volume of certain
swap transactions are now available to regulators and the public, at no
charge, and reporting for additional asset classes will begin at the
end of this month. Swap dealers now have to register with the CFTC and
adhere to new standards for business conduct and record keeping.
Beginning next month, certain types of financial institutions
transacting in clearable interest-rate or credit-index swaps must move
those transactions to central clearinghouses, reducing overall risk to
the financial system.
Treasury's responsibilities under the Dodd-Frank Act include
standing up new organizations to strengthen coordination of financial
regulation both domestically and internationally, improve information
sharing, and better identify and respond to potential risks to the
financial system. Over the past 30 months, we have focused considerable
effort on creating the Financial Stability Oversight Council, the
Office of Financial Research, and the Federal Insurance Office and
making them effective and efficient organizations that fulfill the
objectives established in the Dodd-Frank Act.
The Financial Stability Oversight Council
The Financial Stability Oversight Council (FSOC) has become a
valuable forum for collaboration among financial regulators and,
despite its relative youth, has become a central figure in the
implementation of financial regulatory reform and in addressing risks
to the financial system.
Although FSOC members by law are required to meet only quarterly,
the FSOC has been far more active than that. In 2012, FSOC principals
met 12 times to conduct their regular business and respond to specific
market developments. Additionally, the FSOC facilitates significant
collaboration and information-sharing at the staff level through
regular meetings of its Deputies Committee, which meets on a bi-weekly
basis, and its Systemic Risk Committee, which meets monthly.
These are key forums for coordination among regulators. There is
steady and understandable demand from the financial industry for
enhanced regulatory coordination. Given the different statutory
mandates and supervisory responsibilities of the various independent
financial regulators, they are not always able to achieve as much
alignment as regulated entities and market participants might desire.
However, by having a regular forum available for frank discussion and
early identification of areas of mutual or potentially overlapping
interests, the financial regulatory community has been able to better
identify issues that would benefit from enhanced coordination. On the
international front, for example, the U.S. representatives to groups
such as the Financial Stability Board and the International Association
of Insurance Supervisors are able to use the FSOC as a means of sharing
information and collaborating with a broader group of domestic
colleagues on international efforts.
The benefits of strengthened coordination go beyond regulatory
implementation. One of the strongest attributes of the FSOC has been
its ability to quickly bring the key regulators together to respond to
events such as the failure of MF Global and the disruption to financial
markets caused by Superstorm Sandy.
In addition to the FSOC's coordination role, it has certain
authority to provide for more stringent regulation of a financial
activity by issuing recommendations to the responsible regulatory
agencies. An example along these lines is vulnerability in the short-
term funding markets, which the FSOC first addressed in its 2011 annual
report and then again in 2012. The focus on this exposure ultimately
led to the FSOC's issuance for public comment of proposed
recommendations on money market mutual fund reforms. The comment period
on those proposed recommendations closes tomorrow, February 15.
The FSOC has also taken significant steps to designate and increase
oversight of financial companies whose failure or distress could
negatively impact financial markets or the financial stability of the
United States. In July 2012, the FSOC designated eight financial market
utilities, companies that play important roles in our clearing,
payment, and settlement systems, as systemically important. These
companies are now subject to higher risk-management standards and
coordinated oversight by the Federal Reserve, the SEC, and the CFTC.
The FSOC is also in the final stages of evaluating an initial set of
nonbank financial companies for potential designation, and completing
that work is an important priority for 2013. Designated nonbank
financial companies will be subject to enhanced prudential standards
and supervision by the Federal Reserve, closing an important regulatory
gap.
The Office of Financial Research
Treasury has made significant progress in establishing the Office
of Financial Research (OFR), which has been further strengthened with
the confirmation of Richard Berner early this year as its first
Director.
The OFR provides important support for the FSOC, including data for
the FSOC annual report as well as data and analysis relating to the
designation of nonbank financial companies. In collaboration with FSOC
members, the OFR is also developing new dashboards of financial
stability metrics and indicators for use by the FSOC's Systemic Risk
Committee.
A key part of the OFR mission is to fill the gaps in existing data
and analysis. The OFR has accordingly completed an initial inventory of
purchased and collected data among FSOC member agencies and an
inventory of internally developed data is underway. To improve the
quality and scope of data available to policy makers, the OFR has
established data-sharing agreements with a number of FSOC member
agencies and continues to work on new ones as needed.
The OFR plays a leadership role in the international initiative to
establish a global Legal Entity Identifier (LEI), a code that uniquely
identifies parties to financial transactions. The OFR's chief counsel
was recently named Chair of the LEI Regulatory Oversight Committee.
With the planned launch of the global system next month, the goal of
standardizing the identification of these entities will become a
reality. Financial companies and financial regulators worldwide will
gain a better view of true exposures and counterparty risks across the
global financial system.
In July 2012, the OFR issued its first annual report assessing the
state of the U.S. financial system, the status of the efforts by the
OFR to meet its mission, and key findings of the OFR's research and
analysis. We have also established the Financial Research Advisory
Committee, composed of 30 distinguished professionals in economics,
finance, financial services, data management, risk management, and
information technology to provide advice and recommendations to the
OFR.
Federal Insurance Office
Treasury has also worked to establish the Federal Insurance Office
(FIO) and develop its ability to serve as the Federal voice on
insurance issues, both domestically and internationally.
FIO is responsible for monitoring all aspects of the insurance
industry, including identifying issues or gaps in regulation that could
contribute to a systemic crisis in the insurance industry or financial
system. FIO coordinates and develops Federal policy on prudential
aspects of international insurance matters; represents the United
States at the International Association of Insurance Supervisors
(IAIS); and, along with the independent insurance expert and a State
insurance commissioner, the FIO Director contributes insurance
expertise to the FSOC as a nonvoting member. FIO also monitors the
accessibility and affordability of nonhealth insurance products to
traditionally underserved communities.
Until the establishment of FIO, the United States was not
represented by a single, unified Federal voice in the development of
international insurance supervisory standards. FIO now provides
important leadership in developing international insurance policy. In
2012, FIO was elected to serve on the IAIS Executive Committee and as
Chair of its Technical Committee. FIO is involved with the IAIS's
development of the methodology to identify global systemically
important insurers and the policy measures to be applied to any
designated firm. Apart from its work with the IAIS, FIO established and
has provided leadership in the European Union-United States insurance
project regarding matters such as group supervision, capital
requirements, reinsurance, and financial reporting. FIO has worked and
will continue to work closely and consult with State insurance
regulators and other Federal agencies in this work.
FIO will soon release its first annual report on the insurance
industry and its report on how to modernize and improve the system of
insurance regulation in the United States. FIO is working diligently to
release these and several other reports in the coming months.
Coordination
In the year ahead, Treasury will continue to build on the FSOC's
existing strengths as a key forum for information-sharing and
collaboration among regulators and continue to develop the expertise
and capacity of the OFR and FIO.
Although we are not a rulemaking agency for either the Dodd-Frank
Act's Volcker Rule or risk-retention rule, the Treasury Secretary, in
his capacity as Chairperson of the FSOC, has an explicit statutory
coordination role with respect to both of those rulemakings. We take
that role very seriously and will continue to work with the respective
rulemaking agencies as they finalize those rules.
Another area where we continue to engage in significant
coordination with other agencies is with respect to the Dodd-Frank
Act's new orderly liquidation authority. We have participated in
extensive planning exercises and preparations with the Federal Reserve
and FDIC to be fully prepared to wind down a company whose failure
could have serious adverse effects on U.S. financial stability.
International
Our progress on domestic implementation is mirrored by our work
internationally to support efforts to make financial regulations more
consistent worldwide through the G20 and the Financial Stability Board
(FSB). By moving early with the passage and implementation of the Dodd-
Frank Act, 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. We remain attentive to the inevitable
inconsistencies and lags on implementation and continue to emphasize
that successful implementation of global financial regulatory reforms
is essential for promoting U.S. financial sector competitiveness;
building a stable, secure, and more resilient financial system; and
avoiding regulatory arbitrage and a race to the bottom.
We are pursuing a comprehensive reform agenda internationally
spanning bank capital and liquidity, resolution, and OTC derivatives
markets.
On capital and liquidity, the Basel III standards raise the quality
and quantity of capital and strengthen liquidity requirements so that
banks can better protect themselves against losses of the magnitude
seen in the crisis. These form the bulwark of core reforms that will
enhance the stability of the international banking system. In June
2012, the Federal banking agencies issued proposed rules and currently
are working to adopt final rules to implement the Basel III standards
in 2013. It is critical that our international partners implement Basel
III faithfully as soon as possible. In fact, the majority of the
largest U.S. banks already meet Basel III capital targets--well ahead
of schedule.
On resolution, we have reached an important agreement that key
financial jurisdictions should have the tools to resolve large cross-
border financial firms without the risk of severe disruption or
taxpayer exposure to loss. The FSB is working actively to see that this
international commitment by regulators will drive major global banks to
develop cross-border recovery and resolution plans; develop criteria to
improve the ``resolvability'' of systemically important institutions;
and negotiate institution-specific cross-border resolution cooperation
arrangements.
On derivatives, U.S. regulators have led with implementation of
reforms to centrally clear derivatives and require transaction
reporting. We have also led the call for the development of a global
margin standard for OTC derivatives that are not centrally cleared, and
the G20 and the FSB are making steady progress in their efforts to
develop such a standard.
We have made real progress internationally on all of these fronts
and must continue to do so. As the global economy heals from the
devastation of the crisis, the urgency for reform may wane. Progress
remains uneven internationally and significant work remains. We must
redouble efforts domestically and urge our partners internationally to
continue this essential work. In particular, we must be careful to
avoid a fragmentation in financial regulation internationally, which
can lead to uneven regulation, unequal treatment, constrained capital
flows, and increased uncertainty. Treasury will continue to work with
our partners around the world to achieve global regulatory convergence.
Conclusion
Financial regulatory reform implementation has presented one of the
most challenging sets of responsibilities for regulators in nearly 80
years. We have a highly complex, international financial system with
many intricately linked parts. While the demand for simple rules has a
superficial appeal, simple rules do not suffice to address the nuances
of a complex financial system. Also, as the work of regulatory reform
implementation proceeds, issues inevitably arise such as MF Global's
failure, the so-called ``London Whale'' trading losses, and LIBOR
manipulation that inform the work of regulators in important ways but
that also require significant attention in and of themselves.
As we move forward, it is critical to strike the appropriate
balance of measures to protect the strength and stability of the U.S.
financial system while preserving liquid and efficient markets that
promote access to capital and economic growth. Rules must also be
properly calibrated to risks, taking into account, for example, the
reduced risks that community banks pose compared to large, complex
financial institutions.
Finally, we cannot afford to succumb to complacency now as the
financial markets and economy slowly continue to recover. Efforts to
repeal the Dodd-Frank Act in whole or piecemeal or to starve regulators
by underfunding them will hamper growth, allow uncertainty to fester,
and be corrosive to the strength and stability of our financial system.
The progress we have made so far is because of the reforms that we are
putting in place, not in spite of them. Completion of these reforms
provides the best path to building a sounder foundation for continued
economic growth and prosperity.
______
PREPARED STATEMENT OF DANIEL K. TARULLO
Governor, Board of Governors of the Federal Reserve System
February 14, 2013
Chairman Johnson, Ranking Member Crapo, 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). In today's testimony, I will provide an update
on the Federal Reserve's recent activities pertinent to the Dodd-Frank
Act and describe our regulatory and supervisory priorities for 2013.
The Federal Reserve, in many cases jointly with other regulatory
agencies, has made steady and considerable progress in implementing the
Congressional mandates in the Dodd-Frank Act, though obviously some
work remains. Throughout this effort, the Federal Reserve has
maintained a focus on financial stability. In the process of rule
development, we have placed particular emphasis on mitigating systemic
risks. Thus, among other things, we have proposed varying the
application of the Dodd-Frank Act's special prudential rules based on
the relative size and complexity of regulated financial firms. This
focus on systemic risk is also reflected in our increasingly systematic
supervision of the largest banking firms.
Recent Regulatory Reform Milestones
Strong bank capital requirements, while not alone sufficient to
guarantee the safety and soundness of our banking system, are central
to promoting the resiliency of banking firms and the financial sector
as a whole. Capital provides a cushion to absorb a firm's expected and
unexpected losses, helping to ensure that those losses are borne by
shareholders rather than taxpayers. The financial crisis revealed,
however, that the regulatory capital requirements for banking firms
were not sufficiently robust. It also confirmed that no single capital
measure adequately captures a banking firm's risks of credit and
trading losses. A good bit of progress has now been made in
strengthening and updating traditional capital requirements, as well as
devising some complementary measures for larger firms.
As you know, in December 2010 the Basel Committee on Banking
Supervision (Basel Committee) issued the Basel III package of reforms
to its framework for minimum capital requirements, supplementing an
earlier set of changes that increased requirements for important
classes of traded assets. Last summer, the Federal Reserve, the Office
of the Comptroller of the Currency (OCC), and the Federal Deposit
Insurance Corporation (FDIC) issued for comment a set of proposals to
implement the Basel III capital standards for all large,
internationally active U.S. banking firms. In addition, the proposals
would apply risk-based and leverage capital requirements to savings and
loan holding companies for the first time. The proposals also would
modernize and harmonize the existing regulatory capital standards for
all U.S. banking firms, which have not been comprehensively updated
since their introduction 25 years ago, and incorporate certain new
legislative provisions, including elements of sections 171 and 939A of
the Dodd-Frank Act.
To help ensure that all U.S. banking firms maintain strong capital
positions, the Basel III proposals would introduce a new common equity
capital requirement, raise the existing tier 1 capital minimum
requirement, implement a capital conservation buffer on top of the
regulatory minimums, and introduce a more risk-sensitive standardized
approach for calculating risk-weighted assets. Large, internationally
active banking firms also would be subject to a supplementary leverage
ratio and a countercyclical capital buffer and would face higher
capital requirements for derivatives and certain other capital markets
exposures they hold. Taken together, these proposals should materially
reduce the probability of failure of U.S. banking firms--particularly
the probability of failure of the largest, most complex U.S. banking
firms.
In October 2012, the Federal Reserve finalized rules implementing
stress testing requirements under section 165 of the Dodd-Frank Act.
Consistent with the statute, the rules require annual supervisory
stress tests for bank holding companies with $50 billion or more in
assets and any nonbank financial companies designated by the Financial
Stability Oversight Council (Council). The rules also require company-
run stress tests for a broader set of regulated financial firms that
have $10 billion or more in assets. The new Dodd-Frank Act supervisory
stress test requirements are generally consistent with the stress tests
that the Federal Reserve has been conducting on the largest U.S. bank
holding companies since the Supervisory Capital Assessment Program in
the spring of 2009. The stress tests allow supervisors to assess
whether firms have enough capital to weather a severe economic downturn
and contribute to the Federal Reserve's ability to make assessments of
the resilience of the U.S. banking system under adverse economic
scenarios. The stress tests are an integral part of our capital plan
requirement, which provides a structured way to make horizontal
evaluations of the capital planning abilities of large banking firms.
The Federal Reserve also issued in December of last year a proposal
to implement enhanced prudential standards and early remediation
requirements for foreign banks under sections 165 and 166 of the Dodd-
Frank Act. The proposal is generally consistent with the set of
standards previously proposed for large U.S. bank holding companies.
The proposal generally would require foreign banks with a large U.S.
presence to organize their U.S. subsidiaries under a single
intermediate holding company that would serve as a platform for
consistent supervision and regulation. The U.S. intermediate holding
companies of foreign banks would be subject to the same risk-based
capital and leverage requirements as U.S. bank holding companies. In
addition, U.S. intermediate holding companies and the U.S. branches and
agencies of foreign banks with a large U.S. presence would be required
to meet liquidity requirements similar to those applicable to large
U.S. bank holding companies. The proposals respond to fundamental
changes in the scope and scale of foreign bank activities in the United
States in the last 15 years. They would increase the resiliency and
resolvability of the U.S. operations of foreign banks, help protect
U.S. financial stability, and promote competitive equity for all large
banking firms operating in the United States. The comment period for
this proposal closes at the end of March.
Priorities for 2013
The Federal Reserve's supervisory and regulatory program in 2013
will concentrate on four tasks: (1) continuing key Dodd-Frank Act and
Basel III regulatory implementation work; (2) further developing
systematic supervision of large banking firms; (3) improving the
resolvability of large banking firms; and (4) reducing systemic risk in
the shadow banking system.
Carrying Forward the Key Dodd-Frank Act and Basel III Regulatory
Implementation Work
Capital, Liquidity, and Other Prudential Requirements for Large
Banking Firms. Given the centrality of strong capital standards, a top
priority this year will be to update the bank regulatory capital
framework with a final rule implementing Basel III and the updated
rules for standardized risk-weighted capital requirements. The banking
agencies have received more than 2,000 comments on the Basel III
capital proposal. Many of the comments have been directed at certain
features of the proposed rule considered especially troubling by
community and smaller regional banks, such as the new standardized risk
weights for mortgages and the treatment of unrealized gains and losses
on certain debt securities. These criticisms underscore the difficulty
in fashioning standardized requirements applicable to all banks that
balance risk sensitivity with the need to avoid excessive complexity.
Here, though, I think there is a widespread view that the proposed rule
erred on the side of too much complexity. The three banking agencies
are carefully considering these and all comments received on the
proposal and hope to finalize the rulemaking this spring.
The Federal Reserve also intends to work this year toward
finalization of its proposals to implement the enhanced prudential
standards and early remediation requirements for large banking firms
under sections 165 and 166 of the Dodd-Frank Act. As part of this
process, we intend to conduct shortly a quantitative impact study of
the single-counterparty credit limits element of the proposal. Once
finalized, these comprehensive standards will represent a core part of
the new regulatory framework that mitigates risks posed by systemically
important financial firms and offsets any benefits that these firms may
gain from being perceived as ``too big to fail.''
We also anticipate issuing notices of some important proposed
rulemakings this year. The Federal Reserve will be working to propose a
risk-based capital surcharge applicable to systemically important
banking firms. This rulemaking will implement for U.S. firms the
approach to a systemic surcharge developed by the Basel Committee,
which varies in magnitude based on the measure of each firm's systemic
footprint. Following the passage of the Dodd-Frank Act, which called
for enhanced capital standards for systemically important firms, the
Federal Reserve joined with some other key regulators from around the
world in successfully urging the Basel Committee to adopt a requirement
of this sort for all firms of global systemic importance.
Another proposed rulemaking will cover implementation by the three
Federal banking agencies of the recently completed Basel III
quantitative liquidity requirements for large global banks. The
financial crisis exposed defects in the liquidity risk management of
large financial firms, especially those which relied heavily on short-
term wholesale funding. These new requirements include the liquidity
coverage ratio (LCR), which is designed to ensure that a firm has a
sufficient amount of high quality liquid assets to withstand a severe
standardized liquidity shock over a 30-day period. The Federal Reserve
expects that the U.S. banking agencies will issue a proposal in 2013 to
implement the LCR for large U.S. banking firms. The Basel III liquidity
standards should materially improve the liquidity risk profiles of
internationally active banks and will serve as a key element of the
enhanced liquidity standards required under the Dodd-Frank Act.
Volcker Rule, Swaps Push-out, and Risk Retention. Section 619 of
the Dodd-Frank Act, known as the ``Volcker Rule,'' generally prohibits
a banking entity from engaging in proprietary trading or acquiring an
ownership interest in, sponsoring, or having certain relationships with
a hedge fund or private equity fund. In October 2011, the Federal
banking agencies and the Securities and Exchange Commission sought
public comment on a proposal to implement the Volcker Rule. The
Commodity Futures Trading Commission subsequently issued a
substantially similar proposal. The rulemaking agencies have spent the
past year carefully analyzing the nearly 19,000 public comments on the
proposal and have made significant progress in crafting a final rule
that is faithful to the language of the statute and maximizes bank
safety and soundness and financial stability at the least cost to the
liquidity of the financial markets, credit availability, and economic
growth.
Section 716 of the Dodd-Frank Act generally prohibits the provision
of Federal assistance, such as FDIC deposit insurance or Federal
Reserve discount window credit, to swap dealers and major swap
participants. The Federal Reserve is currently working with the OCC and
the FDIC to develop a proposed rule that would provide clarity on how
and when the section 716 requirements would apply to U.S. insured
depository institutions and their affiliates and to U.S. branches of
foreign banks. We expect to issue guidance on the implementation of
section 716 before the July 21, 2013, effective date of the provision.
To implement the risk retention requirements in section 941 of the
Dodd-Frank Act, the Federal Reserve, along with other Federal
regulatory agencies, issued in March 2011 a proposal that generally
would force securitization sponsors to retain at least 5 percent of the
credit risk of the assets underlying a securitization. The agencies
have reviewed the substantial volume of comments on the proposal and
the definition of a qualified mortgage in the recent final ``ability-
to-pay'' rule of the Consumer Financial Protection Bureau (CFPB). As
you know, the CFPB's definition of qualified mortgage serves as the
floor for the definition of exempt qualified residential mortgages in
the risk retention framework. The agencies are working closely together
to determine next steps in the risk retention rulemaking process, with
a view toward crafting a definition of a qualified residential mortgage
that is consistent with the language and purposes of the statute and
helps ensure a resilient market for private-label mortgage-backed
securities.
Improving Systematic Supervision of Large Banking Firms
Given the risks to financial stability exposed by the financial
crisis, the Federal Reserve has reoriented its supervisory focus to
look more broadly at systemic risks and has strengthened its
microprudential supervision of large, complex banking firms. Within the
Federal Reserve, the Large Institution Supervision Coordinating
Committee (LISCC) was set up to centralize the supervision of large
banking firms and to facilitate the execution of horizontal, cross-firm
analysis of such firms on a consistent basis. The LISCC includes senior
staff from various divisions of the Board and from the Reserve Banks.
It fosters interdisciplinary coordination, using quantitative methods
to evaluate each firm individually, relative to other large firms, and
as part of the financial system as a whole.
One major supervisory exercise conducted by the LISCC each year is
a Comprehensive Capital Analysis and Review (CCAR) of the largest U.S.
banking firms. \1\ Building on supervisory work coming out of the
crisis, CCAR was established to ensure that each of the largest U.S.
bank holding companies (1) has rigorous, forward-looking capital
planning processes that effectively account for the unique risks of the
firm and (2) maintains sufficient capital to continue operations
throughout times of economic and financial stress. CCAR, which uses the
annual stress test as a key input, enables the Federal Reserve to make
a coordinated, horizontal assessment of the resilience and capital
planning abilities of the largest banking firms and, in doing so,
creates closer linkage between microprudential and macroprudential
supervision. Large bank supervision at the Federal Reserve will include
more of these systematic, horizontal exercises.
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\1\ For more information, see, www.federalreserve.gov/bankinforeg/
ccar.htm.
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Improving the Resolvability of Large Banking Firms
One important goal of postcrisis financial reform has been to
counter too-big-to-fail perceptions by reducing the anticipated damage
to the financial system and economy from the failure of a major
financial firm. To this end, the Dodd-Frank Act created the Orderly
Liquidation Authority (OLA), a mechanism designed to improve the
prospects for an orderly resolution of a systemic financial firm, and
required all large bank holding companies to develop, and submit to
supervisors, resolution plans. Certain other countries that are home to
large, globally active banking firms are working along roughly parallel
lines. The Basel Committee and the Financial Stability Board have
devoted considerable attention to the orderly resolution objective by
developing new standards for statutory resolution frameworks, firm-
specific resolution planning, and cross-border cooperation. Although
much work remains to be done by all countries, the Dodd-Frank Act
reforms have generally put the United States ahead of its global peers
on the resolution front.
Since the passage of the Dodd-Frank Act, the FDIC has been
developing a single-point-of-entry strategy for resolving systemic
financial firms under the OLA. As explained by the FDIC, this strategy
is intended to effect a creditor-funded holding company
recapitalization of the failed financial firm, in which the critical
operations of the firm continue, but shareholders and unsecured
creditors absorb the losses, culpable management is removed, and
taxpayers are protected. Key to the ability of the FDIC to execute this
approach is the availability of sufficient amounts of unsecured long-
term debt to supplement equity in providing loss absorption in a failed
firm. In consultation with the FDIC, the Federal Reserve is considering
the merits of a regulatory requirement that the largest, most complex
U.S. banking firms maintain a minimum amount of long-term unsecured
debt. A minimum long-term debt requirement could lend greater
confidence that the combination of equity owners and long-term debt
holders would be sufficient to bear all losses at the consolidated
firm, thereby counteracting the moral hazard associated with taxpayer
bailouts while avoiding disorderly failures.
Reducing Systemic Risk in the Shadow Banking System
Most of the reforms I have discussed are aimed at addressing
systemic risk posed by regulated banking organizations, and all involve
action the Federal Reserve can take under its current authorities.
Important as these measures are, however, it is worth recalling that
the trigger for the acute phase of the financial crisis was the rapid
unwinding of large amounts of short-term funding that had been made
available to firms not subject to consolidated prudential supervision.
Today, although some of the most fragile investment vehicles and
instruments that were involved in the precrisis shadow banking system
have disappeared, nondeposit short-term funding remains significant. In
some instances it involves prudentially regulated firms, directly or
indirectly. In others it does not. The key condition of the so-called
``shadow banking system'' that makes it of systemic concern is its
susceptibility to destabilizing funding runs, something that is more
likely when the recipients of the short-term funding are highly
leveraged, engage in substantial maturity transformation, or both.
Many of the key issues related to shadow banking and their
potential solutions are still being debated domestically and
internationally. U.S. and global regulators need to take a hard,
comprehensive look at the systemic risks present in wholesale short-
term funding markets. Analysis of the appropriate ways to address these
vulnerabilities continues as a priority this year for the Federal
Reserve. In the short term, though, there are several key steps that
should be taken with respect to shadow banking to improve the
resilience of our financial system.
First, the regulatory and public transparency of shadow banking
markets, especially securities financing transactions, should be
increased. Second, additional measures should be taken to reduce the
risk of runs on money market mutual funds. The Council recently
proposed a set of serious reform options to address the structural
vulnerabilities in money market mutual funds.
Third, we should continue to push the private sector to reduce the
risks in the settlement process for triparty repurchase agreements.
Although an industry-led task force made some progress on these issues,
the Federal Reserve concluded that important problems were not likely
to be successfully addressed in this process and has been using
supervisory authority over the past year to press for further and
faster action by the clearing banks and the dealer affiliates of bank
holding companies. \2\ The amount of intraday credit being provided by
the clearing banks in the triparty repo market has been reduced and is
scheduled to be reduced much further in the coming years as a result of
these efforts. But vulnerabilities in this market remain a concern, and
addressing these vulnerabilities will require the cooperation of the
broad array of participants in this market and their Federal
regulators. The Federal Reserve will continue to report to Congress and
publicly on progress made to address the risks in the triparty repo
market.
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\2\ For additional information, see, www.newyorkfed.org/banking/
tpr_infr_reform.html.
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In addition to these concrete steps to address concrete problems,
regulators must continue to closely monitor the shadow banking sector
and be wary of signs that excessive leverage and maturity
transformation are developing outside of the banking system.
Conclusion
The financial regulatory architecture is stronger today than it was
in the years leading up to the crisis, but considerable work remains to
complete implementation of the Dodd-Frank Act and the postcrisis global
financial reform program. Over the coming year, the Federal Reserve
will be working with other U.S. financial regulatory agencies, and with
foreign central banks and regulators, to propose and finalize a number
of ongoing initiatives. In this endeavor, our goal is to preserve
financial stability at the least cost to credit availability and
economic growth. We are focused on the monitoring of emerging systemic
risks, reducing the probability of failure of systemic financial firms,
improving the resolvability of systemic financial firms, and building
up buffers throughout the financial system to enable the system to
absorb shocks.
As we take this work forward, it is important to remember that
preventing a financial crisis is not an end in itself. Financial crises
are profoundly debilitating to the economic well-being of the Nation.
Thank you for your attention. I would be pleased to answer any
questions you might have.
______
PREPARED STATEMENT OF MARTIN J. GRUENBERG
Chairman, Federal Deposit Insurance Corporation
February 14, 2013
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for the opportunity to testify today on the
Federal Deposit Insurance Corporation's (FDIC) efforts to implement the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act).
The economic dislocations experienced in recent years, which far
exceeded any since the 1930s, were the direct result of the financial
crisis of 2007-08. The reforms enacted by Congress in the Dodd-Frank
Act were aimed at addressing the causes of the crisis. The reforms
included changes to the FDIC's deposit insurance program, a series of
measures to curb excessive risk-taking at large, complex banks and
nonbank financial companies and a mechanism for orderly resolution of
large, nonbank financial companies.
The regulatory changes mandated by the Dodd-Frank Act require
careful implementation to ensure they address the risks posed by the
largest, most complex institutions while being sensitive to the impact
on community banks that did not contribute significantly to the crisis.
As implementation moves forward, the FDIC has been engaged as well in
an extensive effort to better understand the forces driving long-term
change among U.S. community banks and to solicit input from community
bankers on these trends and on the regulatory process.
My testimony will address the impact of the Dodd-Frank Act on the
restoration of the Deposit Insurance Fund (DIF), our efforts to carry
out the requirement of the Act to develop the ability to resolve large,
systemic financial institutions, and our progress on some of the key
rulemakings. In addition, I will briefly discuss the results of our
recent community banking initiative.
Condition of the FDIC Deposit Insurance Fund (DIF)
Restoring the DIF
The Dodd-Frank Act raised the minimum reserve ratio for the DIF
from 1.15 percent of estimated insured deposits to 1.35 percent, and
required that the reserve ratio reach 1.35 percent by September 30,
2020. The FDIC is currently operating under a DIF Restoration Plan that
is designed to meet this deadline, and the DIF reserve ratio is
recovering at a pace that remains on track under the Plan. As of
September 30, 2012, the DIF reserve ratio stood at 0.35 percent of
estimated insured deposits, up from 0.12 percent a year earlier. The
fund balance has grown for 11 consecutive quarters, increasing to $25.2
billion at the end of the third quarter of 2012. Assessment revenue,
fewer anticipated bank failures, and the transfer of fees previously
set aside for the Temporary Liquidity Guarantee Program (TLGP) have
helped to increase the fund balance.
Expiration of the Transaction Account Guarantee (TAG) Program
The Dodd-Frank Act provided temporary unlimited deposit insurance
coverage for non- interest-bearing transaction accounts from December
31, 2010, through December 31, 2012. This unlimited coverage was
available to all depositors, including consumers, businesses, and
Government entities, as long as the accounts were truly non- interest
bearing. As the TAG came to a conclusion, the FDIC worked closely with
banks to ensure that they would continue to be able to meet their
funding and liquidity needs after expiration of the program. Thus far,
the transition away from this emergency program has proceeded smoothly.
Expiration of the Debt Guarantee Program
Although not established by the Dodd-Frank Act, another program
created in response to the crisis, the Debt Guarantee Program (DGP),
was established under emergency authority to provide an FDIC guarantee
of certain newly issued senior unsecured debt. The program enabled
financial institutions to meet their financing needs during a period of
record high credit spreads and aided the successful return of the
credit markets to near normalcy, despite the recession and slow
economic recovery. By providing the ability to issue debt guaranteed by
the FDIC, the DGP allowed institutions to extend maturities and obtain
more stable unsecured funding.
As with the Dodd-Frank TAG program, the DGP came to a close at the
end of 2012. One hundred twenty-two banks and other financial companies
participated in the DGP, and the volume of guaranteed debt peaked in
early 2009 at $345.8 billion. The FDIC collected $10.4 billion in fees
and surcharges under the program. Ultimately, over $9.3 billion in fees
collected under the DGP have been transferred to assist in the
restoration of the DIF to its statutorily mandated reserve ratio of
1.35 percent of insured deposits.
Implementation of Title I ``Living Wills''
In 2011, the FDIC and the Federal Reserve Board (FRB) jointly
issued the basic rulemaking regarding resolution plans that
systemically important financial institutions (SIFIs) are required to
prepare--the so-called ``living wills.'' The rule requires bank holding
companies with total consolidated assets of $50 billion or more, and
certain nonbank financial companies that the Financial Stability
Oversight Council (FSOC) designates as systemic, to develop, maintain
and periodically submit to the FDIC and the FRB resolution plans that
are credible and that would enable these entities to be resolved under
the Bankruptcy Code. Complementing this joint rulemaking, the FDIC also
issued a rule requiring any FDIC-insured depository institution with
assets over $50 billion to develop, maintain and periodically submit
plans outlining how the FDIC could resolve the institution using the
traditional resolution powers under the Federal Deposit Insurance Act.
The two resolution plan rulemakings are designed to work in tandem
by covering the full range of business lines, legal entities and
capital-structure combinations within a large financial firm. The
rulemakings establish a schedule for staggered annual filings. On July
1, 2012, the first group of living wills, generally involving bank
holding companies and foreign banking organizations with $250 billion
or more in nonbank assets, was received. Banking organizations with
less than $250 billion, but $100 billion or more, in assets will file
by July 1 of this year, and all other banking organizations with assets
over $50 billion will file by December 31.
The Dodd-Frank Act requires that at the end of this process these
plans be credible and facilitate an orderly resolution of these firms
under the Bankruptcy Code. In 2013, the 11 firms that submitted initial
plans in 2012 will be expected to refine and clarify their submissions.
The agencies expect the refined plans to focus on key issues and
obstacles to an orderly resolution in bankruptcy including global
cooperation and the risk of ring-fencing or other precipitous actions.
To assess this potential risk, the firms will need to provide detailed,
jurisdiction-by-jurisdiction analyses of the actions each would need to
take in a resolution, as well as the discretionary actions or
forbearances required to be taken by host authorities. Other key issues
include the continuity of critical operations, particularly maintaining
access to shared services and payment and clearing systems, the
potential systemic consequences of counterparty actions, and global
liquidity and funding with an emphasis on providing a detailed
understanding of the firm's funding operations and flows.
Implementation of Title II Orderly Liquidation Authority
Coordination With Foreign Resolution Authorities
The FDIC has largely completed the rulemaking necessary to carry
out its systemic resolution responsibilities under Title II of the
Dodd-Frank Act. In July 2011, the FDIC Board approved a final rule
implementing the Title II Orderly Liquidation Authority. This
rulemaking addressed, among other things, the priority of claims and
the treatment of similarly situated creditors.
The experience of the financial crisis highlighted the importance
of coordinating resolution strategies across national jurisdictions.
Section 210 of the Dodd-Frank Act expressly requires the FDIC to
``coordinate, to the maximum extent possible'' with appropriate foreign
regulatory authorities in the event of the resolution of a covered
financial company with cross-border operations. As we plan internally
for such a resolution, the FDIC has continued to work on both
multilateral and bilateral bases with our foreign counterparts in
supervision and resolution. The aim is to promote cross-border
cooperation and coordination associated with planning for an orderly
resolution of a globally active, systemically important financial
institution (G-SIFIs).
As part of our bilateral efforts, the FDIC and the Bank of England,
in conjunction with the prudential regulators in our jurisdictions,
have been working to develop contingency plans for the failure of G-
SIFIs that have operations in both the U.S. and the U.K. Of the 28 G-
SIFIs designated by the Financial Stability Board of the G20 countries,
4 are headquartered in the U.K., and another 8 are headquartered in the
U.S. Moreover, around two-thirds of the reported foreign activities of
the 8 U.S. SIFIs emanates from the U.K. \1\ The magnitude of these
financial relationships makes the U.S.-U.K. bilateral relationship by
far the most important with regard to global financial stability. As a
result, our two countries have a strong mutual interest in ensuring
that, if such an institution should fail, it can be resolved at no cost
to taxpayers and without placing the financial system at risk. An
indication of the close working relationship between the FDIC and U.K.
authorities is the joint paper on resolution strategies that we
released in December. \2\
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\1\ Reported foreign activities encompass sum of assets, the
notional value of off-balance-sheet derivatives, and other off-balance-
sheet items of foreign subsidiaries and branches.
\2\ ``Resolving Globally Active, Systemically Important, Financial
Institutions'', http://www.fdic.gov/about/srac/2012/gsifi.pdf.
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In addition to the close working relationship with the U.K., the
FDIC and the European Commission (E.C.) have agreed to establish a
joint Working Group comprised of senior staff to discuss resolution and
deposit guarantee issues common to our respective jurisdictions. The
Working Group will convene twice a year, once in Washington, once in
Brussels, with less formal communications continuing in between. The
first of these meetings will take place later this month. We expect
that these meetings will enhance close coordination on resolution
related matters between the FDIC and the E.C., as well as European
Union Member States.
While there is clearly much more work to be done in coordinating
SIFI resolution strategies across major jurisdictions, these
developments mark significant progress in fulfilling the mandate of
section 210 of the Dodd-Frank Act and achieving the type of
international coordination that would be needed to effectively resolve
a G-SIFI in some future crisis situation.
Stress Testing Final Rule
Section 165(i) of the Dodd Frank Act requires the FRB to conduct
annual stress tests of Bank Holding Companies with assets of $50
billion or more and nonbank SIFIs designated by FSOC for FRB
supervision. This section of the Act also requires financial
institutions with assets greater than $10 billion, including insured
depository institutions, to conduct company run stress tests in
accordance with regulations developed by their primary Federal
regulator. The FDIC views the stress tests as an important source of
forward-looking analysis of institutions' risk exposures that will
enhance the supervisory process for these institutions. We also have
clarified that these requirements apply only to institutions with
assets greater than $10 billion, and not to smaller institutions.
The FDIC issued a proposed rule to implement the requirements of
section 165(i) in January 2012, and a final rule in October 2012. The
rule, which is substantially similar to rules issued by the Office of
the Comptroller of the Currency (OCC) and the FRB, tailors the
timelines and requirements of the stress testing process to the size of
the institutions, as requested by commenters on the proposed rule.
The agencies are closely coordinating their efforts in the
promulgation of scenarios and the review of stress testing results. The
first round of stress tests, for certain insured institutions and Bank
Holding Companies with assets of $50 billion or more, is underway.
Institutions were asked to develop financial projections under defined
stress scenarios provided by the agencies in November 2012, based on
their September 30, 2012, financial data. Institutions with assets
greater than $10 billion, but less than $50 billion, and larger
institutions that have not had previous experience with stress testing,
will conduct their first round of stress tests this fall.
Other Dodd-Frank Act Rulemakings
The Volcker Rule
The Dodd-Frank Act requires the Securities and Exchange Commission
(SEC), the Commodities Futures Trading Commission (CFTC), and the
Federal banking agencies to adopt regulations generally prohibiting
proprietary trading and certain acquisitions of interest in hedge funds
or private equity funds. The FDIC, jointly with the FRB, OCC, and SEC,
published a notice of proposed rulemaking (NPR) requesting public
comment on a proposed regulation implementing the prohibition against
proprietary trading. The CFTC separately approved the issuance of its
NPR to implement the Volcker Rule, with a substantially identical
proposed rule text.
The proposed rule also requires banking entities with significant
covered trading activities to furnish periodic reports with
quantitative measurements designed to help differentiate permitted
market-making-related activities from prohibited proprietary trading.
Under the proposed rule, these requirements contain important
exclusions for banking organizations with trading assets and
liabilities less than $1 billion, and reduced reporting requirements
for organizations with trading assets and liabilities of less than $5
billion. These thresholds are designed to reduce the burden on smaller,
less complex banking entities, which generally engage in limited
market-making and other trading activities.
The agencies are evaluating a large body of comments on whether the
proposed rule represents a balanced and effective approach or whether
alternative approaches exist that would provide greater benefits or
implement the statutory requirements with fewer costs. 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. Most community banks do not engage in trading activities that
would be subject to the proposed rule.
Appraisal-Related Provisions
The final rule regarding appraisals for higher-risk mortgages,
which implements section 1471 of the Dodd-Frank Act, was adopted by the
FDIC and five other agencies earlier this year. \3\ The final rule,
which will become effective on January 18, 2014, requires creditors
making higher-risk mortgages to use a licensed or certified appraiser
who prepares a written appraisal report based on a physical visit of
the interior of the property. The rule also requires creditors to
disclose to applicants information about the purpose of the appraisal
and provide consumers with a free copy of any appraisal report.
Finally, if the seller acquired the property for a lower price during
the prior 6 months and the price difference exceeds certain thresholds,
creditors will have to obtain a second appraisal at no cost to the
consumer. This requirement is intended to address fraudulent property
flipping by seeking to ensure that the value of the property
legitimately increased. Certain types of loans are exempted from the
rule, such as qualified mortgages, and there are limited exemptions
from the second appraisal requirement. By ensuring that homes secured
by higher-risk mortgages are appraised at their true market value by a
qualified appraiser, the rule will benefit both lenders and consumers.
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\3\ The other agencies are: the FRB, the Consumer Financial
Protection Bureau, the Federal Housing Finance Agency, the National
Credit Union Administration, and the OCC.
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The agencies also are developing notices of proposed rulemaking to
address other appraisal-related provisions of the Dodd-Frank Act. These
provisions include registration and operating requirements for
appraisal management companies and quality controls for automated
valuation models. We look forward to considering the public comments we
receive on these proposals.
Rulemaking on Risk Retention in Mortgage Securitization
Six agencies, \4\ including the FDIC, previously issued a joint
notice of proposed rulemaking seeking comment on a proposal to
implement section 941 of the Dodd-Frank Act. The proposed rule would
require sponsors of asset-backed securities to retain at least 5
percent of the credit risk of the assets underlying the securities and
not permit sponsors to transfer or hedge that credit risk. The proposed
rule would provide sponsors with various options for meeting the risk-
retention requirements. It also provides, as required by section 941,
proposed standards for a Qualified Residential Mortgage (QRM) which, if
met, would result in exemption from the risk retention requirement.
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\4\ The rule was proposed by the FRB, the OCC, the FDIC, the SEC,
the Federal Housing Finance Agency, and the Department of Housing and
Urban Development.
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The interagency staff group addressing the credit risk retention
rule under section 941 of DFA has been working to address the numerous
issues raised by the many comments received on the proposed rule. After
initial discussions about QRM, in view of the fact that the statute
provides that the definition of QRM can be no broader than the
definition of QM, staff turned its attention to the non-QRM issues
pending issuance by the Consumer Financial Protection Bureau (CFPB) of
its QM rule. With the recent issuance of the QM rule by the CFPB, the
interagency group plans to turn its attention back to issues regarding
QRM.
Community Banking Initiatives
In light of concerns raised about the future of community banking
in the aftermath of the financial crisis, as well as the potential
impact of the various rulemakings under the Dodd-Frank Act, the FDIC
engaged in a series of initiatives during 2012 focusing on the
challenges and opportunities facing community banks in the United
States.
FDIC Community Banking Study
In December 2012, the FDIC released the FDIC Community Banking
Study, a comprehensive review of the U.S. community banking sector
covering 27 years of data. The study set out to explore some of the
important trends that have shaped the operating environment for
community banks over this period, including: long-term industry
consolidation; the geographic footprint of community banks; their
comparative financial performance overall and by lending specialty
group; efficiency and economies of scale; and access to capital. This
research was based on a new definition of community bank that goes
beyond size, and also accounts for the types of lending and deposit
gathering activities and limited geographic scope that are
characteristic of community banks.
Our research confirms the crucial role that community banks play in
the American financial system. As defined by the Study, community banks
represented 95 percent of all U.S. banking organizations in 2011. These
institutions account for just 14 percent of the U.S. banking assets in
our Nation, but hold 46 percent of all the small loans to businesses
and farms made by FDIC-insured institutions. While their share of total
deposits has declined over time, community banks still hold the
majority of bank deposits in rural and micropolitan counties. \5\ The
Study showed that in 629 U.S. counties (or almost one-fifth of all U.S.
counties), the only banking offices operated by FDIC-insured
institutions at year-end 2011 were those operated by community banks.
Without community banks, many rural areas, small towns, and even
certain urban neighborhoods, would have little or no physical access to
mainstream banking services.
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\5\ The 3,238 U.S. counties in 2010 included 694 micropolitan
counties centered on an urban core with population between 10,000 and
50,000 people, and 1,376 rural counties with populations less than
10,000 people.
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Our Study took an in-depth look at the long-term trend of banking
industry consolidation that has reduced the number of federally insured
banks and thrifts from 17,901 in 1984 to 7,357 in 2011. All of this net
consolidation can be accounted for by an even larger decline in the
number of institutions with assets less than $100 million. But a closer
look casts significant doubt on the notion that future consolidation
will continue at this same pace, or that the community banking model is
in any way obsolete.
More than 2,500 institutions have failed since 1984, with the vast
majority failing in the crisis periods of the 1980s and early 1990s and
the period since 2007. To the extent that future crises can be avoided
or mitigated, bank failures should contribute much less to future
consolidation. In addition, about one third of the consolidation that
has taken place since 1984 is the result of charter consolidation
within bank holding companies, while just under half is the result of
voluntary mergers. But both of these trends were greatly facilitated by
the gradual relaxation of restrictions on intrastate branching at the
State level in the 1980s and early 1990s, as well as the interstate
branching that came about following enactment of the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994. The pace of
voluntary consolidation has indeed slowed over the past 15 years as the
effects of these one-time changes were realized. Finally, the Study
questions whether the rapid precrisis growth of some of the Nation's
largest banks, which came about largely due to mergers and acquisitions
and a focus on retail lending, can continue at the same pace going
forward. Some of the precrisis cost savings realized by large banks
have proven to be unsustainable in the postcrisis period, and a return
to precrisis rates of growth in consumer and mortgage lending appears,
for now anyway, to be a questionable assumption.
The Study finds that community banks that grew slowly and
maintained diversified portfolios or otherwise stuck to their core
lending competencies during the study period exhibited relatively
strong and stable performance over time. Other institutions that
pursued higher-growth strategies--frequently through commercial real
estate or construction and development lending--encountered severe
problems during real estate downturns and generally underperformed over
the long run. Moreover, the Study finds that economies of scale play a
limited role in the viability of community banks. While average costs
are found to be higher for very small community banks, economies of
scale are largely realized by the time an institution reaches $100
million in size, and there is no indication of any significant cost
savings beyond $500 million in size. These results comport well with
the experience of banking industry consolidation since 1984, in which
the number of bank and thrift charters with assets less than $25
million has declined by 96 percent, while the number of charters with
assets between $100 million and $10 billion has grown by 19 percent.
In summary, the FDIC Study finds that despite the challenges of the
current operating environment, the community banking sector remains a
viable and vital component of the overall U.S. financial system. It
identifies a number of issues for future research, including the role
of commercial real estate lending at community banks, their use of new
technologies, and how additional information might be obtained on
regulatory compliance costs.
Examination and Rulemaking Review
The FDIC also reviewed examination, rulemaking, and guidance
processes during 2012 with a goal of identifying ways to make the
supervisory process more efficient, consistent, and transparent--
especially with regard to community banks--consistent with safe and
sound banking practices. This review was informed by a series of
nationwide roundtable discussions with community bankers, and with the
FDIC's Advisory Committee on Community Banking.
Based on concerns raised, the FDIC has implemented a number of
enhancements to our supervisory and rulemaking processes. First, the
FDIC has revamped the preexam process to better scope examinations,
define expectations and improve efficiency. Second, the FDIC is taking
steps to improve communication by using Web-based tools to provide
critical information regarding new or changing rules and regulations as
well as comment deadlines. Finally, the FDIC has instituted a number of
outreach and technical assistance efforts, including increased direct
communication between examinations, increased opportunities for
attendance at training workshops and symposiums, and current and
planned conference calls and training videos on complex subjects of
interest. The FDIC considers its review of examination and rulemaking
processes ongoing, and additional enhancements and modifications to our
processes will likely continue.
Conclusion
Successful implementation of the various provisions of the Dodd-
Frank Act will provide a foundation for a financial system that is more
stable and less susceptible to crises, and a regulatory system that is
better able to respond to future crises. Significant progress has been
made in implementing these reforms. The FDIC has completed the core
rulemakings for carrying out its lead responsibilities under the Act
regarding deposit insurance and systemic resolution. As we move forward
in completing this process, we will continue to rely on constructive
input from the regulatory comment process and our other outreach
initiatives.
______
PREPARED STATEMENT OF THOMAS J. CURRY
Comptroller, Office of the Comptroller of the Currency
February 14, 2013
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for the opportunity to report on the Office of the
Comptroller of the Currency's (OCC) progress in implementing the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or
Act).* Before providing that progress report, however, I would like to
begin with a brief review of current conditions in the portions of the
banking industry that the OCC supervises.
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* 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.
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The OCC supervises more than 1,800 national banks and Federal
savings associations, constituting approximately 26 percent of all
federally insured banks and savings associations which, together, hold
more than 69 percent of all commercial bank and thrift assets. These
institutions range in size from over 1,600 community banks with assets
of $1 billion or less to the Nation's largest and most complex
financial institutions with assets exceeding $1 trillion. I am pleased
to report that the institutions we supervise have made significant
strides since the financial crisis in repairing their balance sheets
through stronger capital, improved liquidity, and timely recognition
and resolution of problem loans. For national banks and Federal savings
associations, Tier 1 common equity is at 12.5 percent of risk-weighted
assets, up from its low of just over 9 percent in the fall of 2008. \1\
The current capital leverage ratio is now about 9 percent, which is up
almost a third from its recent low. Reliance on volatile funding
sources has dropped from its fall 2006 peak of 46 percent of total
liabilities to 24 percent today. Asset quality indicators are improving
with charge-off rates declining for all major loan categories. Indeed,
for all but residential mortgages, charge-off rates have now dropped
below their post-1990 averages. Reflecting these positive trends, the
number of problem institutions on the Federal Deposit Insurance
Corporation's (FDIC) problem bank list has dropped from 888 in March
2011 to 694 in September 2012. Problem national banks and Federal
savings associations dropped from 192 in March 2011 to 165 in September
2012. There were 146 problem national banks and Federal savings
associations in January 2013.
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\1\ Performance and financial data are based on September 30,
2012, Call Report information.
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While these are encouraging developments, banks and thrifts
continue to face significant challenges. Net interest margins are being
squeezed for both large and small banks. This problem is especially
acute for banks under $1 billion in asset size--a group that represents
90 percent of the institutions we supervise--whose margins are near
their 20-year low point. Loan growth, while improved, is still only
about one-half its historical average pace. We are monitoring these
conditions closely and are stressing that, in this environment,
institutions should be especially vigilant about monitoring the risks
they are taking on. This is certainly not the time to let up on risk
management.
We are also mindful that we cannot let the progress that has been
made lessen our sense of urgency in addressing the weaknesses and flaws
the crisis revealed in our financial system. The global financial
crisis was unprecedented in severity and duration, and the depth of the
associated recession was the most severe we have experienced in the
U.S. since the Great Depression of the 1930s. These financial and
economic developments led to a reconsideration of the ways financial
markets and financial firms operate and gave impetus to efforts to
reform the financial system and its oversight. The Dodd-Frank Act
addresses major gaps and flaws in the regulatory landscape, tackles
systemic issues that contributed to, or accentuated and amplified, the
effects of the recent financial crisis, and built a stronger financial
system. The Act requires the Federal regulators to put in place new
buffers and safeguards to protect against future financial crises and
to revise and rewrite many of the rules governing the most complex
areas of finance. Additionally, it consolidates authority that had been
spread among multiple agencies, and it provides the Federal regulators
a number of new tools that should help us avoid problems in the future.
The OCC is committed to fully implementing those provisions where
we have sole rule-writing authority as expeditiously as possible, and
to working cooperatively with our regulatory colleagues on those rules
and provisions that require coordinated or joint action. As I testified
before this Committee in June, I am keenly aware of the critical role
that community banks play in providing consumers and small businesses
in communities across the Nation with essential financial services and
access to credit. As we move forward with Dodd-Frank Act
implementation, I have directed my staff to look for ways to minimize
potential burden on community institutions, and to organize and explain
our rulemaking documents to facilitate community bankers' understanding
of how the rules affect their institutions.
In response to the Committee's letter of invitation, my testimony
will focus on the OCC's overall implementation of the Dodd-Frank Act by
providing an update on key provisions of the Act where the OCC has
direct rulemaking or other implementation responsibilities.
OCC/OTS Integration
General
One of the most significant of the OCC's milestones in implementing
the Dodd-Frank Act has been the successful integration of former Office
of Thrift Supervision (OTS) employees and the supervision of Federal
savings associations into the OCC. The commitment of all involved
resulted in a smooth transition, reflecting a merger of experience with
a strong vision for the future. This combination was helped by the
close relationship forged over the years through our work on common
problems and issues. In this spirit of continuity, the OCC has renewed
the charters of two advisory committees that the OTS established. I
recently attended the first meeting of the Mutual Savings Associations
Advisory Committee, where participants engaged in a robust discussion
about the challenges that mutual savings associations confront. At next
month's Minority Depository Institutions Advisory Committee meeting, I
look forward to a productive exchange about the issues that minority-
owned depository institutions are facing.
Integration of Regulations
As we have reported previously to the Committee, the OCC also is
engaged in a comprehensive effort to integrate the rules applicable to
Federal savings associations with those that apply to national banks.
Our objectives are, first, to develop a single rulebook applicable to
both national banks and Federal savings associations (except where
statutory differences between the two charter types require otherwise);
and, second, for both charter types, to identify and eliminate
regulatory requirements that are unnecessarily burdensome.
As I have noted before, while we believe a single set of rules will
benefit both national banks and Federal savings associations, we
recognize that change can create uncertainty. We are aiming to begin
proposing these integrated rules over the course of this year. As part
of our proposals, we will be seeking comments on ways that we can make
our rules easier to implement and reduce burden, and I look forward to
receiving comments from interested parties on this important issue.
Completed Rulemakings
Final Rule To Revise OCC Regulations To Remove References to Credit
Ratings
On June 13, 2012, the OCC published in the Federal Register a final
rule to implement section 939A of the Dodd-Frank Act by removing
references to credit ratings from the OCC's noncapital regulations,
including the OCC's investment securities regulation, which sets forth
the types of investment securities that national banks and Federal
savings associations may purchase, sell, deal in, underwrite, and hold.
\2\ These revisions became effective on January 1, 2013.
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\2\ The Federal banking agencies' June 2012 proposed capital
rulemakings include provisions to remove references to credit ratings
from the agencies' capital regulations.
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Under prior OCC rules, permissible investment securities generally
included Treasury securities, agency securities, municipal bonds, and
other securities rated ``investment grade'' by nationally recognized
statistical rating organizations such as Moody's, S&P, or Fitch
Ratings. The OCC's final rule revised the definition of ``investment
grade'' to remove the reference to credit ratings and replaced it with
a new nonratings based creditworthiness standard. To determine that a
security is ``investment grade'' under the new standard, a bank must
perform due diligence necessary to establish: (1) that the risk of
default by the obligor is low; and (2) that full and timely repayment
of principal and interest is expected. Generally, securities with good
to very strong credit quality will meet this standard.
In comments on the proposed rule, banks and industry groups
expressed concern about the amount of due diligence the OCC will
require a bank to conduct to determine whether the issuer of a security
has an adequate capacity to meet financial commitments under the
security. The OCC believes that the due diligence required to meet the
new standard is consistent with our prior due diligence requirements
and guidance. Under the prior ratings-based standards, national banks
and Federal savings associations of all sizes should not have relied
solely on credit ratings to evaluate the credit risk of a security, and
were advised to supplement any use of credit ratings with additional
diligence to independently assess the credit risk of a particular
security. Nevertheless, the OCC recognized that some national banks and
Federal savings associations needed time to make the adjustments
necessary to make ``investment grade'' determinations under the new
standard. Therefore, the OCC allowed institutions nearly 6 months to
come into compliance with the final rule.
To aid this adjustment process, the OCC also published guidance to
assist banks in interpreting the new standard and to clarify the steps
banks can take to demonstrate that they meet their diligence
requirements when purchasing investment securities and conducting
ongoing reviews of their investment portfolios.
Final Rule on Dodd-Frank Stress Tests
On October 9, 2012, the OCC published a final rule that implements
section 165(i)(2) of the Dodd-Frank Act and requires certain companies
to conduct annual stress tests pursuant to regulations prescribed by
their respective primary financial regulator. Specifically, this rule
requires national banks and Federal savings associations with total
consolidated assets over $10 billion (covered institutions) to conduct
an annual stress test as prescribed by the rule.
Consistent with the requirements of section 165(i)(2), the final
rule defines ``stress test,'' establishes methods for the conduct of
the company-run stress test that must include at least three different
scenarios (baseline, adverse, and severely adverse), establishes the
form and content of reporting, and compels the covered institutions to
publish a summary of the results of the stress tests. Commenters on the
proposal expressed concern that developing robust procedures for stress
testing might require more time at some banks, particularly those that
had not participated in the Supervisory Capital Assessment Program or
Comprehensive Capital Analysis and Review program. Therefore, the final
rule provided that covered institutions with assets over $50 billion
were required to start stress testing under the rule in 2012, while
covered institutions with assets from $10 to $50 billion are not
required to start stress testing until 2013. The final rules of the
Board of Governors of the Federal Reserve System (FRB) and the FDIC
adopted similar transition provisions.
The requirements for these company-run stress tests are separate
and distinct from the supervisory stress tests required under section
165(i)(1) that are conducted by the FRB. Nevertheless, we believe these
efforts are complementary and as a result we are committed to working
closely with the FRB and the FDIC in coordinating the timing of, and
the scenarios for, these tests.
The company-run stress tests under this rule began with the release
of stress scenarios by the OCC and other regulators on November 15,
2012, with scenarios covering baseline, adverse, and severely adverse
conditions as required under the rule. The rule required covered
institutions with more than $50 billion in assets to report the results
of the stress tests to the OCC and the FRB by January 5, 2013. The OCC
is in the process of reviewing those results. Covered institutions are
required to disclose a summary of the results in March of this year.
Interim Final Rule on Lending Limits
The OCC also recently completed a rulemaking to implement Dodd-
Frank Act changes to the lending limit rules. Under the National Bank
Act, the total loans and extensions of credit by a national bank to a
person outstanding at one time may not exceed 15 percent of the
unimpaired capital and unimpaired surplus of the bank if the loan is
not fully secured plus an additional 10 percent of unimpaired capital
and unimpaired surplus if the loan is fully secured. The Home Owners'
Loan Act applies this lending limits rule to savings associations, with
some exceptions.
Section 610 of the Dodd-Frank Act amended the definition of ``loans
and extensions of credit'' to include any credit exposure to a person
arising from a derivative transaction, or a repurchase agreement,
reverse repurchase agreement, securities lending transaction, or
securities borrowing transaction (securities financing transaction)
between a national bank and that person. This new definition also
applies to savings associations. This amendment was effective July 21,
2012.
On June 21, 2012, the OCC issued an interim final rule and request
for comments that amended the OCC's lending limits regulation to
implement section 610 of the Dodd-Frank Act and to provide guidance on
how to measure the fluctuating credit exposure of derivatives and
securities financing transactions for purposes of the lending limit.
This interim rule also consolidated the OCC's lending limits rules
applicable to national banks and savings associations. Specifically,
the interim final rule provides national banks and savings associations
with three methods for calculating the credit exposure of derivative
transactions other than credit derivatives, and two methods for
calculating such exposure for securities financing transactions. These
methods vary in complexity and permit institutions to adopt compliance
alternatives that fit their size and risk management requirements,
consistent with safety and soundness and the goals of the statute.
Providing these options is intended to reduce regulatory burden,
particularly for smaller and midsize banks and savings associations. To
permit institutions the time necessary to conform their operations to
the amendments implementing section 610, the OCC has provided a
temporary exception from the lending limit rules for extensions of
credit arising from derivative transactions or securities financing
transactions until July 1, 2013. The OCC expects to publish a final
rule that amends and finalizes this interim rule in the near future.
Final Rule on Appraisals for Higher Priced Mortgage Loans
In the years leading up to the financial crisis, several
consecutive periods of rapid increases in home prices put increasing
pressure on the Nation's infrastructure for determining the value of
properties in connection with underwriting mortgages. The Dodd-Frank
Act reflects congressional concern about appraiser independence,
appraisal management companies, and alternative property valuation
techniques, and adopts several reform measures on these and related
topics. Section 1471 of the Dodd-Frank Act, in particular, focuses on
property valuation in connection with so-called ``higher priced
mortgage loans,'' (HPMLs) which are consumer mortgages made at interest
rates that are typically indicative of subprime credit status of the
borrower.
Section 1471 amended the Truth in Lending Act to require the OCC,
along with the other Federal banking agencies, the Bureau of Consumer
Financial Protection (CFPB), and the Federal Housing Finance Agency
(FHFA), to issue regulations implementing three main requirements for
HPML home valuations. First, a creditor is prohibited from extending an
HPML to any consumer without first obtaining a full written appraisal
performed by a certified or licensed appraiser who conducts a physical
property visit of the interior of the property. Second, the creditor
must obtain an additional written appraisal from a different certified
or licensed appraiser if the HPML finances the purchase or acquisition
of a ``flipped'' property--that is, a property being bought from a
seller at a higher price than the seller paid, within 180 days of the
seller's purchase or acquisition. The creditor may not charge the
consumer for this additional appraisal. Third, the creditor must also
provide the applicant with disclosures at the time of the initial
mortgage application about the purpose of the appraisal, and must give
the borrower a copy of each appraisal at least three days prior to the
transaction closing date.
The agencies issued a joint final rule to implement section 1471 on
January 18, 2013. Creditors have 1 year to come into compliance with
the new rule's requirements. Consistent with the statute, the final
rule exempts all HPMLs that meet the CFPB's definition of a ``qualified
mortgage'' (QM) under the CFPB's ``ability to repay'' mortgage rules.
The CFPB has indicated that this QM exemption will cover a significant
portion of the current mortgage market. The agencies also incorporated
exemptions from the second appraisal requirement for a number of
different types of transactions, including sales in rural areas, and
sales by servicemembers who receive deployment or change of station
orders.
The agencies also included two key provisions in the final rule to
provide creditors with clear guidance on their obligations under the
statute. First, the rule provides a specific set of standards the
creditor can apply in determining whether the appraiser has submitted
an appraisal report that meets the requirements of the statute for an
appraisal prepared in accordance with the Uniform Standards of
Appraisal Practice and the banking agencies' appraisal regulations
pursuant to Title XI of the Financial Institutions Recovery, Reform,
and Enforcement Act of 1989. Creditors applying these standards in
connection with their review of each appraisal are afforded a safe
harbor under the rule. Second, for HPMLs that are originated to fund
the purchase of a dwelling, the rule provides numerous examples of the
types of documents a creditor may rely upon in determining whether the
seller is ``flipping'' the property within the meaning of the statute.
Final Rule on Retail Foreign Exchange Transactions
On July 14, 2011, the OCC published in the Federal Register its
final retail foreign exchange transactions rule (Retail Forex Rule) for
national banks and Federal branches and agencies of foreign banks. The
Retail Forex Rule imposes a variety of consumer protections--including
margin requirements, required disclosures, and business conduct
standards--on foreign exchange options, futures, and futures-like
transactions with retail customers (persons that are not eligible
contract participants under the Commodity Exchange Act). To promote
regulatory comparability, the OCC worked closely with the Commodity
Futures Trading Commission (CFTC), Securities Exchange Commission
(SEC), FDIC, and FRB in developing the OCC Retail Forex Rule and
modeled the OCC Retail Forex Rule on the CFTC's rule.
After the transfer of regulatory authority from the OTS, the OCC
updated its Retail Forex Rule to apply to Federal savings associations.
This interim final rule with request for comments was published in the
Federal Register on September 12, 2011. The OCC also proposed last
October to update its Retail Forex Rule to incorporate the CFTC's and
SEC's recent further definition of ``eligible contract participant''
and related guidance. The OCC is currently working to finalize that
proposal.
Ongoing Dodd-Frank Act Rulemakings
The OCC also is continuing to work closely with other Federal
financial agencies on a number of important regulations to implement
provisions of the Dodd-Frank Act where we have joint rulemaking
responsibility. I am committed to completing these rulemakings as
quickly as possible while recognizing the need to carefully consider
and address the important issues that commenters have raised with the
proposals.
Volcker Rule
Section 619 of the Dodd-Frank Act added a new section 13 to the
Bank Holding Company Act that contains certain prohibitions and
limitations on the ability of a banking entity and a nonbank financial
company supervised by the FRB to engage in proprietary trading and to
have certain interests in, or relationships with, a hedge fund or
private equity fund. The OCC, FDIC, FRB, and the SEC issued proposed
rules implementing that section's requirements on October 11, 2011. On
January 3, 2012, the period for filing public comments on this proposal
was extended for an additional 30 days, until February 13, 2012. On
January 11, 2012, the CFTC issued a substantively similar proposed rule
implementing section 619 and invited public comment through April 16,
2012. The agencies received more than 18,000 comments regarding the
proposed implementing rules and are carefully considering these
comments as they work toward development of final rules.
Commenters, including members of Congress, representatives of
Federal and State agencies, foreign Governments, domestic and foreign
banking entities and industry trade associations, public interest
groups, academics and private citizens, offered a wide range of
perspectives on nearly every aspect of the proposed rule. Overall,
commenters urged the agencies to simplify the final rule, to reduce
compliance burdens for entities that do not engage in significant
trading or covered fund activities, and to address unintended
consequences of the proposed rule. Some commenters urged the agencies
to adopt a final rule that would set forth fairly prescriptive
standards and narrowly construed exemptions as they believed this would
minimize potential loopholes and the possibility of evasion. Other
commenters urged the agencies to adopt a more flexible, principles-
based approach in the final rule as they believed this would reduce
burden and lessen possible unintended consequences.
For example, an area that has drawn much attention from commenters
is the proposed approach for distinguishing permissible market-making-
related activities from prohibited proprietary trading. Commenters
expressed concern that the proposed rule could have an adverse impact
on financial markets, investors, and customers that rely on such
markets for liquidity. Other commenters advocated that the market-
making exemption should be narrowed. Commenters also highlighted issues
with the proposed approach for implementing the prohibition on
investing in and having certain relationships with a hedge fund and
private equity funds, in particular with the manner in which the
proposal defines what is a covered fund. Some commenters thought the
proposed definition of covered fund was over-inclusive, while others
felt it was under-inclusive. Finally, commenters addressed the
international implications of the proposal, both in terms of
competitiveness of U.S. banking entities and the extraterritorial
impact of the proposal on activities of non-U.S. banking entities
conducted solely outside of the United States.
Section 619, by its terms, became effective on July 21, 2012. The
FRB, in consultation with the other agencies, issued rules governing
the period for conforming with Section 619 and in a statement issued on
April 19, 2012, further clarified that covered entities have a period
of 2 years after the statutory effective date, which would be until
July 21, 2014, to fully conform their activities to the statutory
provisions and any final rules adopted, unless the period is extended
by the FRB. The OCC, FDIC, SEC, and the CFTC confirmed that they plan
to administer their oversight of banking entities under their
respective jurisdiction in accordance with the FRB's statement of April
19.
The OCC, together with the other agencies, continues to work
diligently in reviewing the comments submitted during the rulemaking
process and toward the development of final rules consistent with the
statutory language. To ensure, to the extent possible, that the rules
implementing section 619 are comparable and provide for consistent
application, the OCC has been regularly consulting with the other
agencies and will continue to do so.
Credit Risk Retention Rulemaking
Securitization markets are an important source of credit to U.S.
households, businesses, and State and local governments. When properly
structured, securitization provides economic benefits that lower the
cost of credit. However, when incentives are not properly aligned and
there is a lack of discipline in the origination process,
securitization can result in harm to investors, consumers, financial
institutions, and the financial system. During the financial crisis,
securitization displayed significant vulnerabilities, including
informational asymmetries and incentive problems among various parties
involved in the process. To address these concerns, section 941 of the
Dodd-Frank Act requires the OCC, together with the other Federal
banking agencies, as well as the Department of Housing and Urban
Development, FHFA, and the SEC, to require sponsors of asset-backed
securities to retain at least 5 percent of the credit risk of the
assets they securitize. The purpose of this new regulatory regime is to
correct adverse market incentive structures by giving securitizers
direct financial disincentives against packaging loans that are
underwritten poorly.
Pursuant to this requirement, the agencies issued a joint proposed
rulemaking in the Federal Register on April 29, 2011. The proposal
includes a number of options by which securitization sponsors could
satisfy the statute's central requirement to retain at least 5 percent
of the credit risk of securitized assets. This aspect of the proposal
is designed to recognize that the securitization markets have evolved
over time to foster liquidity in a wide diversity of different credit
products, using different types of securitization structures and to
avoid a ``one size fits all'' approach that would disrupt private
securitization and restrict credit availability.
The proposal would also establish certain exemptions from the risk
retention requirement, most notably, an exemption for securitizations
backed entirely by ``qualified residential mortgages'' (QRMs).
Consistent with the statutory provision, the definition of QRM includes
underwriting and product features that historical loan performance data
indicate result in a low risk of default. The proposed QRM definition
seeks to set out a conservative, verifiable set of underwriting
standards that would provide clarity and confidence to mortgage
originators, securitizers, and investors about the loans that would
qualify for the exemption. The standards are also designed to
simultaneously foster securitization of non-QRM loans, by leaving room
for a liquid and competitive market of soundly underwritten non-QRM
loans sufficient to support robust securitization activity.
The proposal generated significant levels of comment on a number of
key issues from loan originators, securitizers, consumers, and policy
makers. These comments included the role of risk retention and the QRM
exemption in the future of the residential mortgage market. Most
commenters on the QRM criteria expressed great concern that the QRM
criteria were too stringent, particularly the 80 percent loan-to-value
requirement for purchase money mortgages. Several commenters also were
divided on the current risk retention practices of Fannie Mae and
Freddie Mac, with some opposing the difference in treatment from
private securitizers and others favoring it in recognition of the
market liquidity the GSEs presently provide. We recognize this is a
significant policy area and are continuing to review the issue.
The proposed menu of risk retention alternatives also attracted
significant comment. While many commenters supported the overall
approach, securitizers raised numerous concerns about whether the
particular options would accommodate established structures for risk
retention in differing types of securitization transactions. These
commenters recommended a number of structural modifications to the
details of the risk retention alternatives.
The agencies have carefully evaluated this extensive body of
comments. In addition, the agencies have reviewed the QM criteria
issued by the CFPB in January, to which the QRM criteria are
statutorily linked. With the QM criteria completing the picture, the
agencies are now in a position to consolidate the analytical work done
since the comment period closed and finalize the rule.
Margin and Capital Requirements for Covered Swap Entities
During the financial crisis, the lack of transparency in
derivatives transactions among dealer banks and between dealer banks
and their counterparties created uncertainty about whether market
participants were significantly exposed to the risk of a default by a
swap counterparty. To address this uncertainty, sections 731 and 764 of
the Dodd-Frank Act require the OCC, together with the FRB, FDIC, FHFA,
and Farm Credit Administration, to impose minimum margin requirements
on noncleared derivatives.
The OCC, together with the FRB, FDIC, FHFA, and Farm Credit
Administration, published a proposal in the Federal Register on May 11,
2011, to establish minimum margin and capital requirements for
registered swap dealers, major swap participants, security-based swap
dealers, and major security-based swap participants (swap entities)
subject to agency supervision. To address systemic risk concerns,
consistent with the Dodd-Frank Act requirement, the agencies proposed
to require swaps entities to collect margin for all uncleared
transactions with other swaps entities, and with financial
counterparties. However, for low-risk financial counterparties, the
agencies proposed that swap entities would not be required to collect
margin as long as its margin exposure to a particular low-risk
financial counterparty does not exceed a specific threshold amount of
margin. Consistent with the minimal risk that derivatives with
commercial end users pose to the safety and soundness of swap entities
and the U.S. financial system, the proposal also included a margin
threshold approach for these end users, with the swap entity setting a
margin threshold for each commercial end user in light of the swap
entity's assessment of credit risk of the end user. The proposed margin
requirements would apply to new, noncleared swaps or security-based
swaps entered into after the proposed rule's effective date.
With very limited exception, commenters opposed the agencies'
proposed treatment of commercial end users. They urged the agencies to
implement a categorical exemption, like the statutory exception from
clearing requirements for commercial end users. They also indicated
that the agencies' proposal on documentation of margin obligations was
a departure from existing practice and burdensome to implement. They
further indicated that, as drafted, the agencies' proposed threshold-
based approach was inconsistent with the current credit assessment-
based practices of swaps entities. Commenters also raised a number of
other important issues, including the types of collateral eligible to
be posted for margin obligations, and concerns that the agencies'
proposed margin calculation methodology was not properly calibrated to
the level of risk presented by the underlying transactions. They also
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.
Given the global nature of major derivatives markets and
activities, we agree that international harmonization of margin
requirements is critical, and we are participating in efforts by the
Basel Committee on Bank Supervision (BCBS) and International
Organization of Securities Commissions (IOSCO), to address coordinated
implementation of margin requirements across G20 Nations. The BCBS-
IOSCO working group issued a consultative document in July of 2012,
seeking public feedback on a broad policy framework for margin
requirements on uncleared swap transactions that would be applied on a
coordinated and nonduplicative basis across international regulatory
jurisdictions. We and the other U.S. banking agencies and the CFTC re-
opened the comment periods on our margin proposals to give interested
persons additional time to analyze those proposals in light of the
BCBS-IOSCO consultative framework. The banking agencies' comment period
closed on November 26, 2012. Most commenters once again focused on the
treatment of commercial end users, urging the agencies to adopt the
exemptive approach suggested by the BCBS-IOSCO proposal. The BCBS-IOSCO
working group continues its discussions with its parent committees to
analyze the questions and alternatives presented in the working group's
consultative document, and to formulate a regulatory template to guide
the participating jurisdictions to a coordinated regulatory structure
on uncleared swap margin issues.
Also notable with regard to swap entities, section 716 of the Dodd-
Frank Act prohibits the provision of Federal assistance (i.e., use of
certain FRB advances and FDIC insurance or guarantees for certain
purposes) to swaps entities with respect to any swap, security-based
swap or other activity of the swaps entity. On May 10, 2012, the OCC,
FRB, and FDIC published joint guidance for those entities for which
they are each the prudential regulator to clarify that the effective
date of section 716, i.e., the date on which the prohibition would take
effect, is July 16, 2013. Under section 716, following consultation
with the CFTC or the SEC, the Federal banking agencies shall permit
insured depository institutions that qualify as swap entities subject
to the prohibition on Federal assistance, a transition period of up to
24 months to either divest the swaps entity or cease the activities
that would require registration as a swaps entity. The transition
period may be extended for up to one additional year by the Federal
banking agencies after consultation with the CFTC or SEC. The OCC has
received a number of requests from national banks for transition
periods under section 716 and we are in the process of reviewing and
evaluating these requests pursuant to the statutory requirements.
Incentive-Based Compensation
Pursuant to section 956 of the Dodd-Frank Act, in April 2011, the
OCC, FRB, FDIC, OTS, National Credit Union Association (NCUA), SEC, and
the FHFA (the agencies) issued a joint proposed rule that would require
the reporting of certain incentive-based compensation arrangements by a
covered financial institution and prohibit incentive-based compensation
arrangements at a covered financial institution that provide excessive
compensation or that could expose the institution to inappropriate
risks that could lead to a material financial loss. \3\
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\3\ A ``covered financial institution'' is a depository
institution or depository institution holding company; a registered
broker-dealer; a credit union; an investment adviser; Fannie Mae;
Freddie Mac; and ``any other financial institution'' that the
regulators jointly determine, by rule, should be covered by section
956.
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The material financial loss provisions of the proposed rule would
establish general requirements applicable to all covered institutions
and additional proposed requirements applicable to certain larger
covered financial institutions. The generally applicable requirements
would provide that an incentive-based compensation arrangement, or any
feature of any such arrangement, established or maintained by any
covered financial institution for one or more covered persons, must
balance risk and financial rewards and be compatible with effective
controls and risk management, and supported by strong corporate
governance.
The proposed rule included two additional requirements for ``larger
financial institutions,'' which for the Federal banking agencies, NCUA
and the SEC means those covered financial institutions with total
consolidated assets of $50 billion or more. First, a larger financial
institution would be required to defer 50 percent of incentive-based
compensation for its executive officers for a period of at least 3
years. Second, the board of directors (or a committee thereof) of a
larger financial institution also would be required to identify, and
approve the incentive-based compensation arrangements for, individuals
(other than executive officers) who have the ability to expose the
institution to possible losses that are substantial in relation to the
institution's size, capital, or overall risk tolerance. These
individuals may include, for example, traders with large position
limits relative to the institution's overall risk tolerance and other
individuals that have the authority to place at risk a substantial part
of the capital of the covered financial institution.
The agencies received thousands of comments on the proposal, many
of which concerned the additional requirements for larger financial
institutions. The agencies are continuing to work together to prepare a
final rule that will address the many issues raised by the commenters.
Conclusion
I appreciate the opportunity to update the Committee on the work
the OCC has done to implement the provisions of the Dodd-Frank Act, in
particular, the completion of a number of important rulemakings and the
significant progress that has been made on ongoing regulatory projects.
While much has been accomplished, we will continue to move these
ongoing projects toward completion. We look forward to keeping the
Committee apprised of our progress.
______
PREPARED STATEMENT OF RICHARD CORDRAY
Director, Consumer Financial Protection Bureau
February 14, 2013
Introduction
Thank you Chairman Johnson, Ranking Member Crapo, and Members of
the Committee for inviting me back today to testify about
implementation of the Dodd-Frank Wall Street Reform and Consumer
Protection Act. My colleagues and I at the Consumer Financial
Protection Bureau are always happy to testify before the Congress,
something we have done now 30 times.
Congress created the Bureau in the wake of the greatest financial
crisis since the Great Depression. Our mission is to make consumer
financial markets work for both consumers and responsible businesses.
Since the Bureau opened for business in 2011, our team has been
hard at work. We are examining both banks and nonbank financial
institutions for compliance with the law and we have addressed and
resolved many issues through these efforts. In addition, for consumers
who have been mistreated by credit card companies, we have worked in
coordination with our fellow regulators to return roughly $425 million
to their pockets. For those consumers who need information or help in
understanding financial products and services, we have developed
AskCFPB, a database of hundreds of answers to questions frequently
asked by consumers. And our Consumer Response center has helped more
than 100,000 consumers with their individual problems related to their
credit cards, mortgages, student loans, and bank accounts.
We have also faithfully carried out the law that Congress enacted
by writing rules designed to help consumers throughout their mortgage
experience--from signing up for a loan to paying it off. In the Dodd-
Frank Act, Congress gave the Bureau the responsibility to adopt
specific mortgage rules with a legal deadline of January 21, 2013. If
we had failed to do so, there were specific statutory provisions that
would have automatically taken effect, which would have been
problematic in various respects for consumers and the financial
industry alike. We worked hard to meet our deadlines on those rules,
which are the focus of my testimony today.
Ability-to-Repay
As we all know now, one of the reasons for the collapse of the
housing market in 2007 and 2008 was the dramatic decline in
underwriting standards in the mortgage market in the years leading up
to the crisis. It became a race to the bottom, and in the end it was
the American public and the American economy who were the losers in
that unappetizing race. Many mortgage lenders made loans that borrowers
had little realistic chance of being able to pay back. Some of those
loans were high priced; many contained risky features. For example,
lenders were selling ``no-doc'' (no documentation) and ``low-doc''
(little documentation) mortgages to consumers who were ``qualifying''
for loans beyond their means. Far too many borrowers found they had no
problem getting so-called ``NINJA'' loans--even if you had no income,
no job, and no assets, you still could get a loan.
The Dodd-Frank Act contains a provision to protect consumers from
irresponsible mortgage lending by requiring lenders to make a
reasonable, good faith determination based upon verified and documented
information that prospective borrowers have the ability to repay their
mortgages. Last month, the Bureau issued a rule to implement that
requirement and provide further clarity as to what will be required of
lenders.
In writing the Ability-to-Repay rule, we recognized that today's
consumers are faced with a very different problem than the one that
consumers faced before the crisis. Access to credit has become so
constrained that many consumers--even those with strong credit--cannot
refinance or buy a house.
So our rule strikes a balance and addresses both problems by
enabling safer lending and providing certainty to the market. It rests
on two basic, commonsense precepts: Lenders will have to check on the
numbers and make sure the numbers check out. It is the essence of
responsible lending.
Under the rule, lenders will have to evaluate the borrower's
income, savings, other assets, and debts. No-doc loans are prohibited,
and affordability cannot be evaluated based only on low introductory
``teaser'' interest rates. By rooting out reckless and unsustainable
lending, while enabling safer lending, the rule protects consumers and
strengthens the housing market.
In addition, Congress created a category of ``Qualified Mortgages''
that are presumed to meet the ability-to-repay requirements because
they are subject to additional safeguards. Congress defined some of the
criteria for these Qualified Mortgages, but recognized that it may be
necessary for the Bureau to prescribe further specifics.
Our rule prohibits certain features that often have harmed
consumers. Qualified mortgages cannot be negative-amortization loans--
where the principal amount actually increases for some period because
the borrower does not even pay the interest, and the unpaid interest
gets added to the amount borrowed--or have interest-only periods. They
cannot have up-front costs in points and fees above the level specified
by Congress.
The rules also require that lenders carefully assess the burden
that the loan places on the borrower. The consumer's total monthly
debts--including the mortgage payment and related housing expenses such
as taxes and insurance--generally cannot add up to more than 43 percent
of a consumer's monthly gross income. The Bureau believes that this
standard will help to draw a clear line that will provide a real
measure of protection to borrowers and increased certainty to the
mortgage market.
Loan Origination
The second rule I want to tell you about today has to do with
mortgage loan originators.
Mortgage loan originators, which include mortgage brokers and
retail loan officers, perform a variety of valuable services. They can
assist consumers in obtaining or applying for mortgage loans, and they
can offer or negotiate terms of those loans, whether the loans are for
buying a home or refinancing an existing one. The financial reform law
placed certain restrictions on a mortgage loan originator's
qualifications and compensation. Building on rules issued earlier by
the Federal Reserve, the Bureau applied what it heard from industry and
consumers across the country to implement the new statutory
restrictions.
The rules address critical conflicts of interest created by certain
compensation practices in the run-up to the financial crisis, such as
paying loan originators more money whenever they steered consumers into
a more expensive loan and allowing them to take payments from both
consumers and creditors in the same transaction. These practices gave
loan originators strong incentives to steer borrowers toward risky and
high-cost loans, and they created confusion among consumers about loan
originators' loyalties. Restricting these practices will help ensure
the mortgage market is more stable and sustainable.
Specifically, our mortgage loan origination rules help ensure that
loan originator compensation may not be based on the terms of the
mortgage transaction. At the same time, the rules spell out legitimate
and permissible compensation practices, such as allowing certain
profit-sharing plans. The rules say a broker or loan officer cannot get
paid more by directing the consumer toward a loan with a higher
interest rate, a prepayment penalty, or higher fees. The loan
originator cannot get paid more for directing the consumer to buy an
additional product like title insurance from the lender's affiliate.
The rules also ban ``dual compensation,'' whereby a broker gets paid by
both the consumer and the creditor for the same transaction. Finally,
our rules make existing requirements more consistent on matters such as
screening, background checks, and training of loan originators, to
provide more confidence to consumers.
Mortgage Servicing
For consumers who already have mortgage loans and are paying them
back, the Bureau has adopted mortgage servicing rules to give them
greater protections. The rules require commonsense policies and
procedures for servicers' handling of consumer accounts.
By bearing responsibility for managing mortgage loans, mortgage
servicers play a central role in homeowners' lives. They collect and
apply payments to loans. They can work out modifications to loan terms.
And they handle the difficult foreclosure process.
Even before the mortgage crisis unfolded, many servicers failed to
provide a basic level of customer service. As the crisis unfolded,
problems worsened. Servicers were unprepared to work with the number of
borrowers who needed help. People did not get the help or support they
needed, such as timely and accurate information about their options for
saving their homes. Servicers failed to answer phone calls, lost
paperwork, and mishandled accounts. Communication and coordination were
poor, leading many homeowners to think they were on their way to a
solution, only to find later that their homes had been foreclosed on
and sold. In some cases, people arrived home to find they had been
locked out unexpectedly.
To compound the frustrations, often the consumer's relationship
with a mortgage servicer is not a matter of choice. After a borrower
picks a lender and takes on a mortgage, the responsibility for managing
that loan can be transferred to another provider without any approval
from the borrower. So if consumers are dissatisfied with their customer
service, they cannot protect themselves by switching to another
servicer.
In this market, as in every other, consumers have the right to
expect information that is clear, timely, and accurate. The Dodd-Frank
Act added protections to consumers by establishing new servicer
requirements. Last month, the Bureau issued rules to implement these
provisions.
These provisions require that payments must be credited the day
they are received. They require servicers to deal promptly with
consumer complaints about errors. They require servicers to provide
periodic statements to mortgage borrowers that break downpayments by
principal, interest, fees, and escrow. They require disclosure of the
amount and due date of the next payment. (To help industry on this
requirement, the Bureau is providing model forms that we developed and
tested with consumers.)
Our servicing rules also implement Dodd-Frank Act requirements that
mortgage servicers provide earlier advance notice the first time an
interest rates adjusts for most adjustable-rate mortgages. The
disclosure must provide an estimate of the new interest rate, the
payment amount, and when that payment is due. It must also include
information about alternatives and counseling services, which can
provide valuable assistance for consumers in all circumstances, and
particularly if the new payment turns out to be unaffordable.
All of these Dodd-Frank provisions address normal mortgage
servicing. They protect everyday mortgage borrowers from costly
surprises and runarounds by their servicers. But the Dodd-Frank Act did
not speak specifically or comprehensively to the unique problems faced
by borrowers who fall behind on their mortgages. Instead, Congress gave
the Bureau general rulemaking authority to address these kinds of
consumer protection problems.
Many American homeowners are struggling to stay on top of their
mortgages. Our Office of Consumer Response has already fielded more
than 47,000 complaints about mortgages. More than half were about
problems people have when they are unable to make their payments, such
as issues relating to loan modifications, collections, or foreclosure.
Accordingly, the Bureau's mortgage servicing rules put into place
fairer and more effective processes for troubled borrowers. Beginning
with the early stage of delinquency, we are providing new protections
to help consumers save their homes.
Under our rules, servicers will be required to establish policies
and procedures to ensure that their records are accurate and
accessible. The idea is that servicers should be able to provide
correct and timely information to borrowers, mortgage owners (including
investors), and the courts. This provision will help prevent the
egregious ``robo-signing'' practices that were found to be rampant in
the marketplace. The rules also require servicers to have policies and
procedures that assure a smooth transfer of information--including
pending applications for foreclosure alternatives--when an account
transfers from one servicer to another.
Our rules also require that servicers reach out to borrowers within
the first 36 days after a payment is delinquent to determine whether
the borrowers may need assistance. After 45 days, servicers must
provide information about loss mitigation options and make staff
available who will be responsible for helping borrowers apply for loan
modifications or other foreclosure alternatives. The rules also
carefully regulate the process for evaluating borrowers' loss
mitigation applications and so-called ``dual tracking,'' where a
consumer is being evaluated for loss mitigation at the same time that
the servicer is taking steps to foreclose on the property. The rules
are designed to ensure that borrowers who submit a complete application
by specified timelines are assessed for all available loss mitigation
options and have an opportunity to appeal mistakes to their servicer.
The rules also require servicers to maintain policies and
procedures that will ensure better coordination with loan owners to
ensure that servicers offer all loss mitigation options that the owners
permit, correctly apply the criteria for the loss mitigation options,
and report back to the loan owners about how borrower applications are
resolved. The goal is to avoid needless foreclosures--which is in the
best interest of the borrower, the lender, and our entire economy.
In pursuing these rules, the Bureau struck a carefully calibrated
balance. The rules mandate a fair process but do not require that a
servicer, or an investor, offer any particular type of loss mitigation
option or apply any particular criteria in considering such options.
The rules likewise balance private and public enforcement.
Importantly, the rules apply to the entire market, not just to
banks and other depository institutions. Many provisions are subject to
private enforcement directly by consumers, and others will be monitored
closely by the Bureau and other regulators. The rules also ensure
better communications with loan owners, including investors, so that
they too can be more effective in monitoring servicers' activities.
We will be vigilant about monitoring and enforcing these rules, and
are coordinating on an ongoing basis with other Federal agencies to
address servicing issues. These rules mean a brand-new day for
effective oversight of mortgage servicers by ensuring that no servicer
can act in a manner that is indifferent to the plight of consumers.
Other Rules
The Bureau has also issued rules to implement a number of other
provisions in the Dodd-Frank Act to strengthen consumer protections and
address problematic practices that existed in the run-up to the
financial crisis. For instance, the rules implement strict limitations
on prepayment penalties that may have discouraged or disabled consumers
from refinancing expensive or risky loans. The rules require creditors
to maintain escrow accounts for borrowers who take out higher-priced
mortgage loans for a longer period to help borrowers set aside money
for taxes and property insurance. We also adopted new rules
implementing the statutory requirement that mortgage lenders
automatically provide applicants with free copies of all appraisals and
other home-value estimates, as well as new and broader protections for
high-cost ``HOEPA'' loans.
And in partnership with the Federal Reserve, Federal Deposit
Insurance Corporation, Federal Housing Finance Agency, National Credit
Union Administration, and Office of the Comptroller of the Currency,
the Consumer Bureau adopted a new rule that implements Dodd-Frank's
special requirements for appraisals of certain higher-priced mortgage
loans. By requiring that creditors use a licensed or certified
appraiser to prepare the written appraisal report based on a physical
inspection of the property, the new rule creates an additional level of
due diligence. The rule also requires creditors to disclose to
applicants information about the purpose of the appraisal and provide
consumers with a free copy of any appraisal report.
Smaller Institutions
As the Bureau worked through the requirements Congress imposed in
the Dodd-Frank Act, we paid attention to the potential impacts on
different types and sizes of creditors, servicers, and other financial
service providers. To inform its work, the Bureau received input from
banks, other lenders, mortgage brokers, service providers, trade
associations, consumer groups, nonprofits, and other Government
stakeholders. We also convened small business review panels for input
on various rules as prescribed by statute.
It is widely accepted that with few exceptions, community banks and
credit unions did not engage in the kind of misdeeds that led to the
mortgage crisis. Data available to the Bureau indicates that these
institutions have lower severe delinquency rates and loss rates. At the
same time, the Bureau knows these institutions may be more likely to
retreat from the mortgage market if the regulations implementing the
Dodd-Frank Act are too burdensome.
Accordingly, the Bureau created specific exceptions and tailored
various rules to encourage small providers such as community banks and
credit unions to continue providing credit and other services, while
carefully balancing consumer protections. For example, we expanded
earlier proposals to exempt certain small creditors operating
predominantly in rural or underserved areas from the escrow rule
requirements. We also issued a further proposal along with the Ability-
to-Repay rule, which would treat various loans held by small creditors
in portfolio as ``Qualified Mortgages'' subject to protections against
any potential liability. We also finalized exceptions to substantial
portions of our servicing rules for small companies such as community
banks and credit unions that are servicing loans they originated or
own.
We have carefully calibrated concerns about consumer protection and
access to credit in making these distinctions. We know community banks
and credit unions have strong practical reasons to provide responsible
credit and have a long tradition of excellent customer service, both to
protect their own balance sheets and because they care deeply about
their reputations in their local communities. We know they provide
vital financial services in rural areas, small towns, and underserved
communities across this country. We believe the rules strike an
appropriate balance to ensure consumers can continue to access this
source of valuable and responsible credit.
Conclusion
As the Bureau has been working to finalize these mortgage rules by
the statutory deadline, we have also been thinking hard about the
process for implementing them. We know the new protections afforded by
the Dodd-Frank Act and our rules will no doubt bring great change to
the mortgage market, and we are committed to doing what we can to
achieve effective, efficient, complete implementation by engaging with
all stakeholders in the coming year. We know that it is in the best
interests of the consumer for the industry to understand these rules--
because if they cannot understand, they cannot properly implement.
To this end, we have announced an implementation support plan. We
will publish plain-English summaries. We will publish readiness guides
to help industry run through check-lists of things to do prior to the
rules going into effect--like updating their policies and procedures
and providing training for staff. We will work with other Government
agencies to prepare in a transparent manner for both our and their
examinations. And we will publish clarifications of the rules as needed
to respond to questions and inquiries.
Most importantly, we will continue to listen to consumers and
businesses as we work to help the mortgage market--and American
consumers--recover from the financial crisis.
I am very proud of the tremendous work our team has done on
rulemaking and implementation efforts under the Dodd-Frank Act. And as
I have said to you before, we always welcome your questions and your
thoughts about our work.
Thank you.
______
PREPARED STATEMENT OF ELISSE B. WALTER
Chairman, Securities and Exchange Commission
February 14, 2013
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee: Thank you for inviting me to testify on behalf of the
Securities and Exchange Commission regarding our ongoing implementation
of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act'' or ``Act''). We appreciate the opportunity to share
with you the steps we have been taking and the procedures we have
followed.
As you know, the Dodd-Frank Act added significant new
responsibilities to the SEC's portfolio, as well as creating new tools
for use in executing those and other responsibilities. To date, the
Commission has made substantial progress in writing the huge volume of
new rules the Act directs, as well as in conducting the various studies
required by the Act. Of the more than 90 Dodd-Frank provisions that
require SEC rulemaking, the SEC has proposed or adopted rules for over
80 percent of them, and also has finalized 17 of the more than 20
studies and reports that the Act directs us to complete. While this has
been a challenge, the considerable progress the Commission has made is
a direct result of the thoughtful, thorough, and professional efforts
of our staff, whose efforts in fulfilling the Dodd-Frank Act mandates
have come in addition to carrying their normal workloads.
My testimony today will provide an overview of the Commission's
Dodd-Frank Act activities, emphasizing our accomplishments over the
past year.
Hedge Fund and Other Private Fund Adviser Registration and Reporting
The Dodd-Frank Act mandated that the Commission require private
fund advisers (including hedge and private equity fund advisers) to
confidentially report information about the private funds they manage
for the protection of investors or for the assessment of systemic risk
by the Financial Stability Oversight Council (FSOC). On October 31,
2011, in a joint release with the Commodity Futures Trading Commission
(CFTC), the Commission adopted a new rule that requires hedge fund
advisers and other private fund advisers registered with the Commission
periodically to report systemic risk information on a new form, ``Form
PF''. \1\
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\1\ See, Release No. IA-3308, ``Reporting by Investment Advisers
to Private Funds and Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF'' (October 31, 2011), http://www.sec.gov/
rules/final/2011/ia-3308.pdf.
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Under the rule, registered investment advisers managing at least
$150 million in private fund assets must periodically file Form PF.
Both the amount of information required to be reported and the
frequency with which Form PF must be filed are scaled to the size of
the adviser and the nature of its advisory activities. \2\ This scaled
approach will provide FSOC and the Commission with a broad view of the
industry while relieving smaller advisers from much of the reporting
burden. In addition, the reporting requirements are tailored to the
types of funds an adviser manages and the potential risks those funds
may present, meaning that an adviser will respond only to questions
relevant to its business model. The Dodd-Frank Act provides special
confidentiality protections for this data. To ensure that the data is
handled in a manner that reflects its sensitivity and statutory
confidentiality protections, a Steering Committee composed of senior
officers from various Divisions and Offices within the Commission has
been established to implement a consistent approach regarding the
access to, and use, sharing, and data security of, information
collected through Form PF. The Steering Committee is also working with
FINRA (the contractor that operates the Form PF filing system) and the
Office of Financial Research (the FSOC entity that will receive and use
the data on behalf of FSOC) to implement appropriate controls to
protect it.
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\2\ To the extent an investment adviser is currently required to
file Form PF, examination staff review the individual filings prior to
conducting investment adviser examinations. The review of Form PF
assists in identifying additional risk areas and may highlight
particular funds for focus during the exam.
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The largest advisers to liquidity funds and hedge funds began
filing Form PF reports in the summer of 2012. As of December 31, 2012,
the Commission received filings from 228 registered advisers of private
funds. Smaller private fund advisers generally must begin filing with
the Commission in March and April of this year.
In addition to Form PF, the Commission has implemented a number of
other Dodd-Frank provisions that serve to enhance oversight of private
funds advisers. These enable, for the first time, regulators and
investors to have a more comprehensive view of the private fund
universe and the investment advisers managing those assets.
In June 2011, the Commission adopted rules that require the
registration of, and reporting by, advisers to hedge funds and
other private funds and other advisers previously exempt from
SEC registration. As a result, the number of private fund
advisers registered with the Commission--advisers that manage
one or more private funds--increased significantly. As of
January 2, 2013, the number of SEC-registered private fund
advisers had increased by more than 50 percent from the
effective date of the Dodd-Frank Act to 4,020 advisers. These
advisers now represent approximately 37 percent of all SEC-
registered investment advisers and collectively manage over
24,000 private funds with total assets of $8 trillion. \3\
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\3\ For more information on investment advisers registered with
the Commission and advisers required to report information to the
Commission after the Dodd-Frank Act, as well as the private funds they
manage, see, ``Dodd-Frank Act Changes to Investment Adviser
Registration Requirements'', http://www.sec.gov/divisions/investment/
imissues/df-iaregistration.pdf.
Concurrently, the Commission adopted rules to implement new
adviser registration exemptions created by the Dodd-Frank Act.
The new rules implement exemptions for: (i) advisers solely to
venture capital funds; (ii) advisers solely to private funds
with less than $150 million in assets under management in the
United States; and (iii) certain foreign advisers without a
place of business in the U.S. and with only de minimis U.S.
business. \4\
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\4\ See, Release No. IA-3222 ``Exemptions for Advisers to Venture
Capital Funds, Private Fund Advisers With Less Than $150 Million in
Assets Under Management, and Foreign Private Advisers'' (June 22,
2011), http://www.sec.gov/rules/final/2011/IA-3222.pdf.
These new rules also implement the Dodd-Frank requirement
for public reporting by investment advisers to venture capital
---------------------------------------------------------------------------
funds and others that are exempt from SEC registration.
The rules also reallocate regulatory responsibility to
State securities authorities for advisers with between $25
million and $100 million in assets under management. \5\ To
facilitate the reallocation of regulatory responsibility, the
Commission issued an order in February 2013 canceling the
registrations of certain SEC-registered investment advisers no
longer eligible to remain registered. \6\
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\5\ See, Release No. IA-3221, ``Rules Implementing Amendments to
the Investment Advisers Act'' (June 22, 2011), http://www.sec.gov/
rules/final/2011/ia-3221.pdf.
\6\ See, Release No. IA-3547, ``Order Cancelling Registrations of
Certain Investment Advisers Pursuant to Section 203(h) of the
Investment Advisers Act of 1940'' (February 6, 2013), http://
www.sec.gov/rules/other/2013/ia-3547.pdf.
In June 2012, the Commission also adopted a new rule
defining ``family offices,'' a group that historically has not
been required to register as advisers and that is now excluded
by rule from the Investment Advisers Act of 1940 (Advisers Act)
definition of an investment adviser. \7\
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\7\ See, Release No. IA-3220, ``Family Offices'' (June 22, 2011),
http://www.sec.gov/rules/final/ia-3220.pdf.
In February 2012, the Commission adopted amendments to the
rule that permits investment advisers to charge performance
fees to ``qualified clients.'' \8\ The amendments codified the
Commission's 2011 inflation adjustments to the net worth and
assets-under-management thresholds that clients must satisfy
for the adviser to charge these fees. The amendments also
excluded the value of a person's primary residence from the
rule's net worth test and provided that, as required by the
Dodd-Frank Act, the Commission will issue an order every 5
years adjusting the rule's dollar amount thresholds for
inflation.
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\8\ See, Release No. IA-3372, ``Investment Adviser Performance
Compensation'' (February 15, 2012), http://www.sec.gov/rules/final/
2012/ia-3372.pdf.
Since the Act became effective, approximately 2,250 formerly SEC
registered advisers have transitioned to State registration and
approximately 1,500 advisers to hedge funds and private equity funds
have registered with the Commission. These new adviser registrants
report over $3 trillion in assets under management, while those that
transitioned to State registration manage about $115 billion. Most of
these new registrants had never been registered, regulated, or examined
and many have complex business models, investment programs and trading
strategies. Commission staff, through our National Exam Program, has
developed and begun implementing a program for these new advisers which
includes outreach, examination, and, ultimately, where appropriate,
written reports highlighting exam findings.
Whistleblower Program
Pursuant to Section 922 of the Dodd-Frank Act, the SEC established
a whistleblower program to pay awards to eligible whistleblowers that
voluntarily provide the agency with original information about a
violation of the Federal securities laws that leads to a successful SEC
enforcement action. The SEC's Office of the Whistleblower filed its
second Annual Report to Congress on November 15, 2012, detailing the
Office's activities during the fiscal year. \9\ As detailed in the
Annual Report, during fiscal year 2012 the Commission received 3,001
tips from whistleblowers in the U.S. and 49 other countries. Among
other things, the Office (1) regularly communicates with
whistleblowers, returning over 3,050 phone calls to the public hotline
during fiscal year 2012; (2) identifies and tracks whistleblower tips
that may lead to enforcement actions; (3) reviews and processes
applications for whistleblower awards; (4) facilitates meetings between
whistleblowers and SEC Enforcement staff; and (5) provides extensive
guidance to Enforcement staff on various aspects of the program,
including proper handling of confidential whistleblower identifying
information.
---------------------------------------------------------------------------
\9\ ``Annual Report on the Dodd-Frank Whistleblower Program Fiscal
2012'' (November 2012), http://www.sec.gov/about/offices/owb/annual-
report-2012.pdf.
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The high quality information that we have been receiving from
whistleblowers has, in many instances, allowed our investigative staff
to work more efficiently and permitted us to better utilize agency
resources.
In August, 2012, the Commission made its first award under the
whistleblower program. \10\ We expect future payments to further
increase the visibility and effectiveness of this important Enforcement
initiative.
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\10\ A whistleblower who helped the Commission stop a multimillion
dollar fraud received an award of 30 percent of the amount collected in
the Commission's enforcement action against the perpetrators of the
scheme, the maximum amount permitted by the Act. The award recipient in
this matter submitted a tip concerning the fraud and then provided
documents and other significant information that allowed the
Commission's investigation to move at an accelerated pace and
ultimately led to the filing of an emergency action in Federal court to
prevent the defendants from ensnaring additional victims and further
dissipating investor funds. See, ``In the Matter of the Claim for
Award'', Release No. 34-67698 (August 21, 2012), http://www.sec.gov/
rules/other/2012/34-67698.pdf, and ``In the Matter of the Claim for
Award'', SEC Release No. 34-67699 (August 21, 2012), http://
www.sec.gov/rules/other/2012/34-67699.pdf.
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OTC Derivatives
Among the key provisions of the Dodd-Frank Act are those that
establish a new oversight regime for the over-the-counter (OTC)
derivatives marketplace. Title VII of the Act requires the Commission
to regulate ``security-based swaps'' and to write rules that address,
among other things, mandatory clearing, reporting and trade execution,
the operation of clearing agencies, data repositories and trade
execution facilities, capital and margin requirements and business
conduct standards for dealers and major market participants, and public
transparency for transactional information. Among other things, such
rules are intended to:
Facilitate the centralized clearing of swaps, with the
intent of reducing counterparty and systemic risk;
Increase market transparency;
Increase security-based swap transaction disclosure; and
Address potential conflict of issues relating to security-
based swaps.
Title VII Implementation Generally
The Commission has proposed substantially all of the core rules
required by Title VII. In addition, the Commission has adopted a number
of final rules and interpretations, provided a ``roadmap'' to
implementation of Title VII, and taken other actions to provide legal
certainty to market participants during the implementation process. In
implementing Title VII, Commission staff is in regular contact with the
staffs of the CFTC, the Board of Governors of the Federal Reserve
System (Board), and other Federal financial regulators, and in
particular has consulted and coordinated extensively with CFTC staff.
Adoption of Key Definitional Rules
In July 2012, the Commission adopted final rules and
interpretations jointly with the CFTC regarding key product definitions
under Title VII. \11\ This effort follows the Commission's work on the
entity definitions rules, which the Commission adopted jointly with the
CFTC in April 2012. \12\ The completions of these joint rulemakings are
foundational steps toward the complete implementation of Title VII.
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\11\ See, Release No. 33-9338, ``Further Definition of `Swap',
`Security-Based Swap', and `Security-Based Swap Agreement'; Mixed
Swaps; Security-Based Swap Agreement Recordkeeping'' (July 18, 2012)
http://www.sec.gov/rules/final/2012/33-9338.pdf.
\12\ See, Release No. 34-66868, ``Further Definition of `Swap
Dealer', `Security-Based Swap Dealer', `Major Swap Participant', `Major
Security-Based Swap Participant', and `Eligible Contract Participant'
'' (April 27, 2012) http://www.sec.gov/rules/final/2012/34-66868.pdf.
---------------------------------------------------------------------------
The July joint rulemaking addressed certain product definitions and
further defined the key terms ``swap,'' ``security-based swap,'' and
``security-based swap agreement.'' It also adopted rules regarding the
regulation of ``mixed swaps'' and the books and records requirements
for security-based swap agreements. The April joint rulemaking further
defined the key terms ``swap dealer'' and ``security-based swap
dealer,'' providing guidance as to what constitutes dealing activity,
and distinguishing dealing from nondealing activities such as hedging.
The rulemaking also implemented the Dodd-Frank Act's statutory de
minimis exception to the security-based swap dealer definition in a way
tailored to reflect the different types of security-based swaps.
Additionally, the rulemaking implemented the Dodd-Frank Act's ``major
security-based swap participant'' definition through the use of three
objective tests.
While foundational, these final rules did not trigger compliance
with the other rules the Commission is adopting under Title VII.
Instead, the compliance dates applicable to each final rule will be set
forth in the adopting release for the applicable rule. In this way, the
Commission is better able to provide for an orderly implementation of
the various Title VII rules.
Adoption of Rules and Other Action Related to Clearing
In addition to the key definitional rules, the Commission has
adopted rules under Title VII relating to clearing infrastructure. In
October 2012, the Commission adopted a rule that establishes
operational and risk management standards for clearing agencies,
including clearing agencies that clear security-based swaps. \13\ The
rule, discussed in more detail below, is designed to help ensure that
clearing agencies will be able to fulfill their responsibilities in the
multitrillion dollar derivatives market as well as in more traditional
securities markets.
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\13\ See, Release No. 34-68080, ``Clearing Agency Standards''
(October 22, 2012), http://www.sec.gov/rules/final/2012/34-68080.pdf.
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In June 2012, the Commission adopted rules that establish
procedures for its review of certain actions undertaken by clearing
agencies. \14\ These rules detail how clearing agencies will provide
information to the Commission about the security-based swaps the
clearing agencies plan to accept for clearing, which will then be used
by the Commission to aid in determining whether those security-based
swaps are required to be cleared. The adopted rules also include rules
requiring clearing agencies that are designated as ``systemically
important'' under Title VIII of the Dodd-Frank Act to submit advance
notice of changes to their rules, procedures, or operations if the
changes could materially affect the nature or level of risk at those
clearing agencies.
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\14\ See, Release No. 34-67286, ``Process for Submissions for
Review of Security-Based Swaps for Mandatory Clearing and Notice Filing
Requirements for Clearing Agencies; Technical Amendments to Rule 19b-4
and Form 19b-4 Applicable to All Self-Regulatory Organizations'' (June
28, 2012), http://www.sec.gov/rules/final/2012/34-67286.pdf.
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In addition, in December 2012, the Commission issued an order
providing exemptive relief in connection with a program to commingle
and portfolio margin customer positions in cleared credit default swaps
which include both swaps and security-based swaps. \15\ Portfolio
margining may be of benefit to investors and the market by, among other
things, promoting greater efficiency in clearing, helping to alleviate
excessive margin calls, improving cash flow and liquidity, and reducing
volatility. Previously, in March 2012, the Commission had adopted rules
providing exemptions under the Securities Act of 1933 (Securities Act),
the Securities Exchange Act of 1934 (Exchange Act), and the Trust
Indenture Act of 1939 for security-based swaps transactions involving
certain clearing agencies satisfying certain conditions. \16\
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\15\ See, Release No. 34-68433, ``Order Granting Conditional
Exemptions Under the Securities Exchange Act of 1934 in connection with
Portfolio Margining of Swaps and Security-Based Swaps'' (December 14,
2012), http://sec.gov/rules/exorders/2012/34-68433.pdf.
\16\ See, Release No. 33-9308, ``Exemptions for Security-Based
Swaps Issued by Certain Clearing Agencies'' (March 30, 2012), http://
www.sec.gov/rules/final/2012/33-9308.pdf.
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Adoption of Rules Related to Reporting
In 2010, the Commission adopted an interim final temporary rule
regarding the reporting of certain information relating to outstanding
security-based swap transactions entered into prior to the date of
enactment of the Dodd-Frank Act. \17\ In 2011, we also readopted
certain of our beneficial ownership rules to preserve their application
to persons who purchase or sell security-based swaps. \18\
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\17\ See, Release No. 34-63094, ``Reporting of Security-Based Swap
Transaction Data'' (October 13, 2010), http://www.sec.gov/rules/
interim/2010/34-63094.pdf.
\18\ See, Release No. 34-64628, ``Beneficial Ownership Reporting
Requirements and Security-Based Swaps'' (June 8, 2011), http://
www.sec.gov/rules/final/2011/34-64628.pdf.
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Issuance of Implementation Policy Statement
In addition to its work to propose and adopt Title VII rules, the
Commission issued a policy statement in June 2012, describing and
requesting public comment on the order in which it expects to require
compliance by market participants with the final Title VII rules. \19\
The Commission's approach aims to avoid the disruption and cost that
could result if compliance with all of the rules were required
simultaneously or haphazardly. More generally, the policy statement is
part of our overall commitment to making sure that market participants
know what the ``rules of the road'' are before requiring compliance
with those rules.
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\19\ See, Release No. 34-37177, ``Statement of General Policy on
the Sequencing of the Compliance Dates for Rules Applicable to
Security-Based Swaps'' (June 11, 2012), http://www.sec.gov/rules/
policy/2012/34-67177.pdf.
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The implementation policy statement is divided into five broad
categories of final rules to be adopted by the Commission and explains
how the compliance dates of these rules would be sequenced in relative
terms by describing the dependencies that exist within and among the
categories. The statement emphasizes that those subject to the new
regulatory requirements arising from these rules will be given
adequate, but not excessive, time to come into compliance with them.
The statement also discusses the timing of the expiration of
temporary relief the Commission previously granted security-based swap
market participants from certain provisions of the Federal securities
laws. The expiration of much of this relief is tied to the effective or
compliance dates of certain rules to be adopted pursuant to Title VII.
Market participants have provided comments on the sequencing set
out in the policy statement, and we are taking those into account as we
work toward completing the Title VII adoption process.
Provision of Legal Certainty
Consistent with our commitment to an orderly Title VII
implementation process, the Commission has taken a number of steps to
provide legal certainty and avoid unnecessary market disruption that
might otherwise have arisen as a result of final rules not having been
adopted by the July 16, 2011, effective date of Title VII.
Specifically, we have:
Provided guidance regarding which provisions in Title VII
governing security-based swaps became operable as of the
effective date and provided temporary relief from several of
these provisions; \20\
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\20\ See, Release No. 34-64678, ``Temporary Exemptions and Other
Temporary Relief, Together With Information on Compliance Dates for New
Provisions of the Securities Exchange Act of 1934 Applicable to
Security-Based Swaps'' (June 15, 2011), http://www.sec.gov/rules/
exorders/2011/34-64678.pdf.
Provided guidance regarding--and, where appropriate,
interim exemptions from--the various pre- Dodd-Frank provisions
that otherwise would have applied to security-based swaps on
July 16, 2011; \21\ and
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\21\ See, Release No. 34-64795, ``Order Granting Temporary
Exemptions Under the Securities Exchange Act of 1934 in Connection with
the Pending Revision of the Definition of `Security' to Encompass
Security-Based Swaps, and Request for Comment'' (July 1, 2011), http://
sec.gov/rules/exorders/2011/34-64795.pdf; Release No. 33-9231,
``Exemptions for Security-Based Swaps'' (July 1, 2011), http://
www.sec.gov/rules/interim/2011/33-9231.pdf; and Release No. 33-9383,
``Extension of Exemptions for Security-Based Swaps'' (January 29,
2013), http://www.sec.gov/rules/interim/2013/33-9383.pdf.
Provided temporary relief for entities providing certain
clearing services for security-based swaps. \22\
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\22\ See, Release No. 34-64796, ``Order Pursuant to Section 36 of
the Securities Exchange Act of 1934 Granting Temporary Exemptions From
Clearing Agency Registration Requirements Under Section 17A(b) of the
Exchange Act for Entities Providing Certain Clearing Services for
Security-Based Swaps'' (July 1, 2011), http://sec.gov/rules/exorders/
2011/34-64796.pdf.
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Next Steps for Implementation of Title VII: Application of Title VII in
the Cross-Border Context
With very limited exceptions, the Commission has not addressed the
application of the security-based swap provisions of Title VII in the
cross-border context in its proposed or final rules. Rather than
addressing these issues in a piecemeal fashion through each of the
various substantive rulemakings implementing Title VII, we instead plan
to address them holistically in a single proposing release. We believe
this approach will provide investors, market participants, foreign
regulators, and other interested parties with the opportunity to
consider, as an integrated whole, the Commission's proposed approach to
the application of the security-based swap provisions of Title VII in
the cross-border context.
As we have indicated previously, we expect the scope of the effort
to be broad. The proposal will address the application of Title VII in
the cross-border context with respect to each of the major registration
categories covered by Title VII for security-based swaps: security-
based swap dealers; major security-based swap participants; security-
based swap clearing agencies; security-based swap data repositories;
and security-based swap execution facilities. It also will address the
application of Title VII in connection with reporting and
dissemination, clearing, and trade execution, as well as the sharing of
information with regulators and related preservation of confidentiality
with respect to data collected and maintained by security-based swap
data repositories.
The cross-border release will involve notice-and-comment
rulemaking, not just interpretive guidance. As a rulemaking proposal,
the release will consider investor protection and incorporate an
economic analysis that considers, among other things, the effects of
the proposal on efficiency, competition, and capital formation.
Although the rulemaking approach takes more time, we believe there are
a number of benefits to this approach, including the opportunity to
benefit from public input and the opportunity to provide a full
articulation of the rationales for, and consideration of reasonable
alternatives to, particular approaches that achieve the statutory
purpose.
The Dodd-Frank Act specifically requires that the Commission, the
CFTC, and the prudential regulators ``consult and coordinate with
foreign regulatory authorities on the establishment of consistent
international standards'' with respect to the regulation of OTC
derivatives. The Commission has been actively working on a bilateral
and multilateral basis with our fellow regulators abroad in such groups
as the International Organization of Securities Commissions, the
Financial Stability Board, and the OTC Derivatives Regulators Group, as
we develop our proposed approach to cross-border issues under Title
VII. Through these discussions and our participation in various
international task forces and working groups, we also have gathered
extensive information about foreign regulatory reform efforts,
identified potential gaps, overlaps, and conflicts between U.S. and
foreign regulatory regimes, and encouraged foreign regulators to
develop rules and standards complementary to our own under the Dodd-
Frank Act.
Additional Steps
In addition to proposing rules and interpretive guidance addressing
the international implications of Title VII, the Commission expects to
propose rules relating to books and records and reporting requirements
for security-based swap dealers and major security-based swap
participants. The Commission also expects soon to consider the
application of mandatory clearing requirements to single-name credit
default swaps, starting with those that were first cleared prior to the
enactment of the Dodd-Frank Act.
Finally, the Commission staff continues to work diligently to
develop recommendations for final rules required by Title VII that have
been proposed but not yet been adopted, including rules relating to:
Security-Based Swap Dealers and Major Security-Based Swap
Participant Requirements; \23\
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\23\ See, Release No. 34-65543, ``Registration of Security-Based
Swap Dealers and Major Security-Based Swap Participants'' (October 12,
2011), http://www.sec.gov/rules/proposed/2011/34-65543.pdf; Release No.
34-68071, ``Capital, Margin, and Segregation Requirements for Security-
Based Swap Dealers and Major Security-Based Swap Participants and
Capital Requirements for Broker-Dealers'' (October 18, 2012), http://
www.sec.gov/rules/proposed/2012/34-68071.pdf; Release No. 34-64766,
``Business Conduct Standards for Security-Based Swaps Dealer and Major
Security-Based Swap Participants'' (June 29, 2011), http://www.sec.gov/
rules/proposed/2011/34-64766.pdf; and Release No. 34-63727, ``Trade
Acknowledgment and Verification on Security-Based Swap Transactions''
(January 14, 2011), http://www.sec.gov/rules/proposed/2011/34-
63727.pdf.
Regulatory Reporting and Post-Trade Public Transparency;
\24\
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\24\ See, Release No. 34-63346, ``Regulation SBSR--Reporting and
Dissemination of Security-Based Swap Information'' (November 19, 2010),
http://www.sec.gov/rules/proposed/2010/34-63346.pdf; and Release No.
34-63347, ``Security-Based Swap Data Repository Registration, Duties,
and Core Principles'' (November 19, 2010), http://www.sec.gov/rules/
proposed/2010/34-63347.pdf.
Mandatory Clearing and Trade Execution and the Regulation
of Clearing Agencies and Security-Based Swap Execution
Facilities; \25\ and
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\25\ See, Release No. 34-63556, ``End-User Exception of Mandatory
Clearing of Security-Based Swaps'' (December 15, 2010), http://
www.sec.gov/rules/proposed/2010/34-63556.pdf; Release No. 34-63107,
``Ownership Limitations and Governance Requirements for Security-Based
Swap Clearing Agencies, Security-Based Swap Execution Facilities, and
National Securities Exchanges with Respect to Security-Based Swaps
under Regulation MC'' (October 14, 2010), http://www.sec.gov/rules/
proposed/2010/34-63107.pdf; and ``Registration and Regulation of
Security-Based Swap Execution Facilities'' (February 2, 2011), http://
www.sec.gov/rules/proposed/2011/34-63825.pdf.
Enforcement and Market Integrity. \26\
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\26\ See, Release No. 34-63236, ``Prohibition Against Fraud,
Manipulation, and Deception in Connection with Security-Based Swaps''
(November 3, 2010), http://www.sec.gov/rules/proposed/2010/34-
63236.pdf.
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Clearing Agencies
Title VIII of the Dodd-Frank Act provides for increased regulation
of financial market utilities \27\ (FMUs) and financial institutions
that engage in payment, clearing, and settlement activities that are
designated as systemically important. The purpose of Title VIII is to
mitigate systemic risk in the financial system and promote financial
stability. In addition, Title VII of the Dodd-Frank Act requires, among
other things, that an entity acting as a clearing agency with respect
to security-based swaps register with the Commission and that the
Commission adopt rules with respect to clearing agencies that clear
security-based swaps.
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\27\ Section 803(6) of the Dodd-Frank Act defines a financial
market utility as ``any person that manages or operates a multilateral
system for the purpose of transferring, clearing, or settling payments,
securities, or other financial transactions among financial
institutions or between financial institutions and the person.''
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Adoption of Clearing Agency Standards
Clearing agencies play a critical role in the financial markets by
ensuring that transactions settle on time and on agreed-upon terms. To
promote the integrity of clearing agency operations and governance, the
Commission adopted rules requiring all registered clearing agencies to
maintain certain standards with respect to risk management and certain
operational matters. \28\ The rules also contain specific requirements
for clearing agencies that perform central counterparty services. For
example, such clearing agencies must have in place written policies and
procedures reasonably designed to:
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\28\ See, Release No. 34-68080, ``Clearing Agency Standards''
(October 22, 2012), http://www.sec.gov/rules/final/2012/34-68080.pdf.
Measure their credit exposures to participants at least
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once a day;
Use margin requirements to limit their credit exposures to
participants, to be reviewed at least monthly;
Maintain sufficient financial resources to withstand, at a
minimum, a default by the participant family to which the
clearing agency has the largest exposure in extreme but
plausible market conditions (with a higher requirement that
agencies clearing security-based swaps maintain sufficient
resources to cover the two largest participant family
exposures); and
Provide the opportunity to obtain membership in the
clearing agency for persons who are not dealers or security-
based swap dealers on fair and reasonable terms.
The rules also establish record keeping and financial disclosure
requirements for all registered clearing agencies as well as several
new standards for clearance and settlement.
The new rules were the result of close work between the Commission
staff and staffs of the CFTC and the Board. The requirements take into
consideration recognized international standards, and they are designed
to further strengthen the Commission's oversight of securities clearing
agencies, promote consistency in the regulation of clearing
organizations generally, and thereby help to ensure that clearing
agency regulation reduces systemic risk in the financial markets.
Systemically Important Clearing Agencies
SEC staff has worked with colleagues at the CFTC, the Board, the
Department of Treasury, and other U.S. financial agencies on the
designation of certain clearing agencies as systemically important
FMUs. Title VIII of the Dodd-Frank Act provides important new
enhancements to the regulation and supervision of designated FMUs that
are designed to provide consistency, promote robust risk management and
safety and soundness, reduce systemic risks, and support the stability
of the broader financial system. \29\
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\29\ See, Dodd-Frank Act 802.
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Under Title VIII, FSOC is authorized to designate an FMU as
systemically important if the failure or a disruption to the
functioning of the FMU could create or increase the risk of significant
liquidity or credit problems spreading among financial institutions or
markets and thereby threaten the stability of the U.S. financial
system. Since FSOC established an interagency FMU designations
committee to develop a framework for the designation of systemically
important FMUs, SEC staff has actively participated in the designations
committee. In July 2012, FSOC designated six clearing agencies
registered with the Commission as systemically important FMUs under
Title VIII. \30\ The SEC staff played an important role in preparing
the analysis that provided the basis for these designations.
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\30\ Clearing agencies that have been designated systemically
important are Chicago Mercantile Exchange, Inc., The Depository Trust
Company, Fixed Income Clearing Corporation, ICE Clear Credit LLC,
National Securities Clearing Corporation, and The Options Clearing
Corporation. Two payment systems were also designated systemically
important: The Clearing House Payments Company L.L.C. on the basis of
its role as operation of the Clearing House Interbank Payments System
and CLS Bank International.
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In addition, as directed by Title VIII and prior to the completion
of the designation process, the SEC staff worked jointly with the
staffs of the CFTC and the Board to develop a report to Congress
containing recommendations regarding risk management supervision of
clearing entities designated as systemically important. The staffs of
the agencies met regularly to develop a framework for (1) improving
consistency in the clearing entity oversight programs of the SEC and
CFTC; (2) promoting robust risk management by designated clearing
agencies; and (3) improving regulators' ability to monitor the
potential effects of such risk management on the stability of the U.S.
financial system. The joint report was submitted to Congress in July
2011. \31\ Consistent with the framework set out in the report, the SEC
has been engaged in ongoing consultation and cooperation in clearing
agency oversight with the staffs of the CFTC and the Board.
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\31\ ``Risk Management Supervision of Designated Clearing
Entities'', http://www.sec.gov/news/studies/2011/813study.pdf.
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Staff Studies Regarding Investment Advisers and Broker-Dealers
In January 2011, the Commission submitted to Congress two staff
studies in the investment management area required by the Dodd-Frank
Act.
The first study, mandated by Section 914, analyzed the need for
enhanced examination and enforcement resources for investment advisers
registered with the Commission. \32\ It found that the Commission
likely will not have sufficient capacity in the near or long term to
conduct effective examinations of registered investment advisers with
adequate frequency. Therefore, the study stated that the Commission's
examination program requires a source of funding adequate to permit the
Commission to meet new examination challenges and sufficiently stable
to prevent adviser examination resources from continuously being
outstripped by growth in the number of registered investment advisers.
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\32\ See, ``Study on Enhancing Investor Adviser Examinations''
(January 2011), http://www.sec.gov/news/studies/2011/914studyfinal.pdf;
see also, Commissioner Elisse B. Walter, Statement on Study Enhancing
Investment Adviser Examinations (Required by Section 914 of Title IX of
the Dodd-Frank Wall Street Reform and Consumer Protection Act) (Jan.
2010), http://www.sec.gov/news/speech/2011/spch011911ebw.pdf.
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The study outlined the following three options for strengthening
the Commission's investment adviser examination program: (1) imposing
user fees on Commission-registered investment advisers to fund their
examinations; (2) authorizing one or more self-regulatory organizations
that assess fees on their members to examine, subject to Commission
oversight, all Commission-registered investment advisers; or (3)
authorizing FINRA to examine a subset of advisers--specifically, dually
registered investment advisers and broker-dealers--for compliance with
the Advisers Act.
The second staff study, required by Section 913 of the Dodd-Frank
Act (the ``IA/BD Study''), addressed the obligations of investment
advisers and broker-dealers when providing personalized investment
advice about securities to retail customers. \33\ The staff study noted
that retail investors generally are not aware of the differences
between the regulation of investment advisers and broker-dealers, or
the legal implications of those differences. The staff study also noted
that many investors are confused by the different standards of care
that apply to investment advisers and broker-dealers. The IA/BD Study
made two primary recommendations: that the Commission (1) exercise the
discretionary rulemaking authority provided by Section 913 of the Dodd-
Frank Act to implement a uniform fiduciary standard of conduct for
broker-dealers and investment advisers when they are providing
personalized investment advice about securities to retail investors;
and (2) consider harmonization of broker-dealer and investment adviser
regulation when broker-dealers and investment advisers provide the same
or substantially similar services to retail investors and when such
harmonization adds meaningfully to investor protection.
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\33\ See, ``Study on Investment Advisers and Broker-Dealers''
(January 2011), http://www.sec.gov/news/studies/2011/913studyfinal.pdf;
see also, Statement by SEC Commissioners Kathleen L. Casey and Troy A.
Paredes Regarding Study on Investment Advisers and Broker-Dealers
(January 21, 2011), http://www.sec.gov/news/speech/2011/
spch012211klctap.htm.
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Under Section 913, the uniform fiduciary standard to which broker-
dealers and investment advisers would be subject would be ``to act in
the best interest of the customer without regard to the financial or
other interest of the broker, dealer, or investment adviser providing
the advice.'' The uniform fiduciary standard would be ``no less
stringent'' than the standard that applies to investment advisers
today.
We are giving serious consideration to the study's recommendations.
Since publishing the IA/BD Study, the staff, including the Commission's
economists, continues to review current information and available data
about the marketplace for personalized investment advice and the
potential impact of the study's recommendations. While we have
extensive experience in the regulation of broker-dealers and investment
advisers, we believe the public can provide further data and other
information to assist us in determining whether or not to adopt a
uniform fiduciary standard of conduct or otherwise use the authority
provided under Section 913 of the Dodd-Frank Act. To this end, the
staff is drafting a public request for information to obtain data
specific to the provision of retail financial advice and the regulatory
alternatives. The request aims to seek information from commenters--
including retail investors, as well as industry participants--that will
be helpful to us as we continue to analyze the various components of
the market for retail financial advice.
Credit Rating Agencies
Under the Dodd-Frank Act, the Commission is required to undertake
approximately a dozen rulemakings related to nationally recognized
statistical rating organizations (NRSROs). The Act requires the SEC to
address, among other things, internal controls and procedures,
conflicts of interest, credit rating methodologies, transparency,
ratings performance, analyst training, credit rating symbols and
definitions, and disclosures accompanying the publication of credit
ratings. The Commission adopted the first of these required rulemakings
in January 2011, \34\ and in May 2011 published for public comment a
series of proposed rules that would further implement this requirement.
\35\ The proposed rules are intended to strengthen the integrity of
credit ratings by, among other things, improving their transparency.
Under the Commission's proposals, NRSROs would, among other things, be
required to:
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\34\ See, Release No. 33-9175, ``Disclosure for Asset-Backed
Securities Required by Section 943 of the Dodd-Frank Wall Street Reform
and Consumer Protection Act'' (January 20, 2011), http://www.sec.gov/
rules/final/2011/33-9175.pdf. In addition, in September 2010, the
Commission issued an amendment to Regulation FD that implements Section
939B of the Act, which requires that the SEC amend Regulation FD to
remove the specific exemption from the rule for disclosures made to
NRSROs and credit rating agencies for the purpose of determining or
monitoring credit ratings. See, Release No. 33-9146, ``Removal From
Regulation FD of the Exemption for Credit Rating Agencies'' (September
29, 2010), http://www.sec.gov/rules/final/2010/33-9146.pdf.
\35\ See, Release No. 34-64514, ``Proposed Rules for Nationally
Recognized Statistical Rating Organizations'' (May 18, 2011), http://
www.sec.gov/rules/proposed/2011/34-64514.pdf.
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Report on their internal controls;
Better protect against conflicts of interest;
Establish professional standards for their credit analysts;
Provide, along with the publication of any credit rating,
public disclosure about the credit rating and the methodology
used to determine it; and
Provide enhanced public disclosures about the performance
of their credit ratings.
The Dodd-Frank Act also mandated three studies relating to credit
rating agencies: (1) a study on the feasibility and desirability of
standardizing credit rating terminology, which was published in
September 2012; \36\ (2) a study on alternative compensation models for
rating structured finance products, which was published in December
2012; \37\ and (3) a study on NRSRO independence, which the Commission
staff is actively developing and which is due in July 2013. \38\
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\36\ ``Credit Rating Standardization Study'' (September 2012),
http://www.sec.gov/news/studies/2012/
939h_credit_rating_standardization.pdf.
\37\ ``Report to Congress on Assigned Credit Ratings'' (December
2012), http://www.sec.gov/news/studies/2012/assigned-credit-ratings-
study.pdf. The staff is currently in the process of organizing a public
roundtable to invite discussion from proponents and critics of the
three courses of action discussed in the report.
\38\ See, Dodd-Frank Act 939C.
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The Act also requires every Federal agency to review its
regulations that require use of credit ratings as an assessment of the
credit-worthiness of a security and undertake rulemakings to remove
these references and replace them with other standards of
creditworthiness deemed appropriate. In July 2011, the staff published
a report discussing the following steps the Commission has taken to
fulfill this requirement: \39\
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\39\ ``Report on Review of Reliance on Credit Ratings'' (July
2011), http://www.sec.gov/news/studies/2011/939astudy.pdf.
In July 2011, the Commission adopted rule amendments
removing credit ratings as conditions for companies seeking to
use short-form registration when registering nonconvertible
securities for public sale. \40\ In addition, prior to adoption
of the Act, in April 2010, the Commission proposed new
requirements to replace the current credit rating references in
shelf eligibility criteria for asset-backed security issuers
with new shelf eligibility criteria. \41\ In light of the Act
and comment received on the April 2010 proposal, in July 2011,
the Commission reproposed the shelf eligibility criteria for
offerings of asset-backed securities.
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\40\ See, Release No. 33-9245, ``Security Ratings'' (July 27,
2011), http://www.sec.gov/rules/final/2011/33-9245.pdf.
\41\ See, Release No. 33-9117, ``Asset-Backed Securities'' (April
7, 2010), http://www.sec.gov/rules/proposed/2010/33-9117.pdf.
In April 2011, the Commission proposed removing references
to credit ratings in rules concerning broker-dealer financial
responsibility, distributions of securities, and confirmations
of transactions. \42\ Also, in July 2012, the Commission issued
an Interpretive Release in response to Section 939(e) of the
Dodd-Frank Act, which removes references to credit ratings by
NRSROs in two definitions in the Exchange Act. \43\
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\42\ See, Release No. 34-64352, ``Removal of Certain References to
Credit Ratings Under the Securities Exchange Act of 1934'' (April 27,
2011), http://www.sec.gov/rules/proposed/2011/34-64352.pdf.
\43\ See, Release No. 34-67448, ``Commission Guidance Regarding
Definitions of Mortgage Related Security and Small Business Related
Security'' (July 17, 2012), http://www.sec.gov/rules/interp/2012/34-
67448.pdf.
In March 2011, the Commission proposed to remove credit
ratings from rules relating to the types of securities in which
a money market fund can invest and the treatment of repurchase
agreements for certain purposes under the Investment Company
Act as well as from the disclosure forms that certain
investment companies must use. \44\
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\44\ See, Release Nos. 33-9193; IC-29592, ``References to Credit
Ratings in Certain Investment Company Act Rules and Forms'' (March 3,
2011), http://www.sec.gov/rules/proposed/2011/33-9193.pdf. In addition,
in November 2012, the Commission adopted a rule establishing a credit
quality standard that certain investments by business and industrial
development companies must satisfy for those companies to qualify for
an exemption from most provisions of the Investment Company Act.
``Purchase of Certain Debt Securities by Business and Industrial
Development Companies Relying on an Investment Company Act Exception''
(November 19, 2012), http://www.sec.gov/rules/final/2012/ic-30268.pdf.
In September 2010, the Commission also adopted a rule amendment
removing communications with credit rating agencies from the list of
excepted communications in Regulation FD, as required by Section 939B
of the Dodd-Frank Act. \45\
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\45\ See, Release No. 33-9146, ``Removal From Regulation FD of the
Exemption for Credit Rating Agencies'' (September 29, 2010), http://
www.sec.gov/rules/final/2010/33-9146.pdf.
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Finally, the Dodd-Frank Act requires the Commission to conduct
staff examinations of each NRSRO at least annually and to issue an
annual report summarizing the exam findings. As discussed in greater
detail below, our staff recently completed the second cycle of these
exams, and, following approval by the Commission, the staff's summary
report of the examinations was published in November 2012. \46\ The
staff will continue to focus on completing the statutorily mandated
annual examinations of each NRSRO, including follow-up from prior
examinations, and making public the summary report of those
examinations to promote compliance with statutory and Commission
requirements. It also is taking steps in response to a recent
International Organization of Securities Commissions preliminary
recommendation to establish ``colleges'' of regulators to provide a
framework for information exchange and collaboration with foreign
counterparts regarding large globally active credit rating agencies.
\47\
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\46\ ``2012 Summary Report of Commission Staff's Examinations of
Each Nationally Recognized Statistical Rating Organization'' (November
2012), http://www.sec.gov/news/studies/2012/nrsro-summary-report-
2012.pdf.
\47\ See, Release No. IOSCO/MR/34/2012, ``IOSCO Publishes Two
Reports Advancing Its Work on Credit Rating Agencies'' (Dec. 21, 2012)
http://www.iosco.org/news/pdf/IOSCONEWS261.pdf.
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Volcker Rule
In October 2011, the Commission proposed a rule jointly with the
Board, the Federal Deposit Insurance Corporation, and the Office of the
Comptroller of the Currency (collectively, the ``Federal banking
agencies'') to implement Section 619 of the Dodd-Frank Act, commonly
referred to as the ``Volcker Rule.'' \48\ This proposal reflects an
extensive, collaborative effort among the Federal banking agencies, the
SEC, and the CFTC, under the coordination of the Department of the
Treasury (Treasury), to design a rule to implement the Volcker Rule's
prohibitions and restrictions in a manner that is consistent with the
language and purpose of the statute. \49\
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\48\ See, Release No. 34-65545, ``Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships With,
Hedge Funds and Private Equity Funds'' (October 12, 2011), http://
www.sec.gov/rules/proposed/2011/34-65545.pdf. The CFTC issued a
substantially similar proposal in January 2012, which was published in
the Federal Register in February 2012. See, 77 FR 8332 (February 14,
2012), http://www.cftc.gov/LawRegulation/FederalRegister/ProposedRules/
2012-935.
\49\ In developing this proposal, interagency staffs gave close
and thoughtful consideration to the FSOC's January 2011 study and its
recommendations for implementing Section 619, which can be found at
http://www.treasury.gov/initiatives/Documents/
Volcker%20sec%20%20619%20study%20final%201%2018%2011%20rg.pdf. As a
result, the joint proposal builds upon many of the recommendations set
forth in the FSOC study.
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As required by Section 619, the joint proposal generally prohibits
banking entities--including bank-affiliated, SEC-registered broker-
dealers, security-based swap dealers, and investment advisers--from
engaging in proprietary trading and having certain interests in, and
relationships with, hedge funds and private equity funds (covered
funds). \50\ Like the statute, the proposed rule provides certain
exceptions to these general prohibitions. For example, the proposal
permits a banking entity to engage in underwriting, market making-
related activity, risk-mitigating hedging, and organizing and offering
a covered fund, among other permitted activities, provided that
specific requirements are met. Further, consistent with the statute, an
otherwise-permitted activity would be prohibited if it involved a
material conflict of interest, high-risk assets or trading strategies,
or a threat to the safety and soundness of the banking entity or to the
financial stability of the United States. As set forth in the Dodd-
Frank Act, the Commission's rule would apply to banking entities for
which the Commission is the primary financial regulatory agency,
including, among others, certain SEC-registered broker-dealers,
investment advisers, and security-based swap dealers.
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\50\ Section 619 defines ``banking entity'' as any insured
depository institution (other than certain limited purpose trust
institutions), any company that controls an insured depository
institution, any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (i.e., a
foreign entity with a branch, agency, or subsidiary bank operation in
the U.S.), and any affiliate or subsidiary of any of the foregoing
entities. See, 12 U.S.C. 1851(h)(1).
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The joint proposal sought comment on a wide range of topics due, in
part, to the breadth of issues presented by the statute and the
proposal. In response, the Commission has received nearly 19,000
comment letters, including more than 600 unique and detailed letters.
\51\ These comments represent a wide variety of viewpoints on a number
of complex topics, and we are closely considering them as we continue
to work with the Federal banking agencies, the CFTC, and Treasury to
develop rules to implement Section 619. Staffs from each of the
regulatory agencies and Treasury are engaged in regular and active
consultation to determine how best to move forward to implement the
statute.
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\51\ The Commission and the Federal banking agencies extended the
comment period for the joint proposal from January 13, 2012 to February
13, 2012. See, Release No. 34-66057 (December 23, 2011), http://
www.sec.gov/rules/proposed/2011/34-66057.pdf. The Commission's public
comment file is available at http://www.sec.gov/comments/s7-41-11/
s74111.shtml.
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Pursuant to the Dodd-Frank Act, the statutory requirements of
Section 619 became effective on July 21, 2012. However, the statute
also provides for a conformance period following the effective date.
Section 619 authorizes the Board to establish rules regarding the
conformance period. The Board issued a conformance rule in February
2011 \52\ and a related policy statement in April 2012, which confirmed
that banking entities have 2 years, beginning July 21, 2012, to conform
all of their activities and investments to the requirements of Section
619, unless the Board extends the conformance period. \53\
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\52\ See, 76 FR 8265 (February 14, 2011).
\53\ See, 77 FR 33949 (June 8, 2012). The Board policy statement
further provides that, during the conformance period, banking entities
should engage in good-faith planning efforts, appropriate for their
activities and investments, to enable them to conform their activities
and investments to the requirements of Section 619 and final
implementing rules by no later than the end of the conformance period.
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Municipal Advisors
Section 975 of the Dodd-Frank Act creates a new class of regulated
persons, ``municipal advisors,'' and requires these advisors to
register with the Commission. This new registration requirement, which
became effective on October 1, 2010, makes it unlawful for any
municipal advisor, among other things, to provide advice to a municipal
entity unless the advisor is registered with the Commission. In
September 2010, the Commission adopted, and subsequently extended, an
interim final rule establishing a temporary means for municipal
advisors to satisfy the registration requirement. \54\ The Commission
has received over 1,100 confirmed registrations of municipal advisors
pursuant to this temporary rule.
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\54\ See, Release No. 34-62824, ``Temporary Registration of
Municipal Advisors'' (September 1, 2010), http://www.sec.gov/rules/
interim/2010/34-62824.pdf.
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In December 2010, the Commission proposed a permanent rule to
govern municipal advisor registration with the SEC. \55\ We have
received over 1,000 comment letters on the proposal. Many expressed
concern that the proposed rules were overbroad in various respects,
including their potential impact on appointed board members of
municipal entities, municipal investments unrelated to municipal
securities, and traditional banking products and services.
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\55\ See, Release No. 34-63576, ``Registration of Municipal
Advisors'' (December 20, 2010), http://sec.gov/rules/proposed/2010/34-
63576.pdf.
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Finalizing the permanent rules for the registration of municipal
advisors is now the highest immediate priority of the SEC's newly
established Office of Municipal Securities. \56\ We anticipate that the
final rules would address, among other things, the well-publicized
concerns about the need for an exception from registration for
appointed board members of municipal entities. In addition, the staff
is continuing to discuss many interpretive issues with other regulators
and interested market participants in pursuit of a final rule that
requires appropriate registration of parties engaging in municipal
advisory activities without unnecessarily imposing additional
regulation.
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\56\ The Office of Municipal Securities is described in more
detail below.
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Asset-Backed Securities
The Commission has been active in implementing Subtitle D of Title
IX of the Dodd-Frank Act, entitled ``Improvements to the Asset-Backed
Securitization Process''. In August 2011, the Commission adopted rules
in connection with Section 942(a) of the Act, which eliminated the
automatic suspension of the duty to file reports under Section 15(d) of
the Exchange Act for asset-backed security (ABS) issuers and granted
the Commission authority to issue rules providing for the suspension or
termination of this duty to file reports. The new rules permit
suspension of the reporting obligations for ABS issuers when there are
no longer asset-backed securities of the class sold in a registered
transaction held by nonaffiliates of the depositor. \57\
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\57\ See, Release No. 34-65148, ``Suspension of the Duty to File
Reports for Classes of Asset-Backed Securities Under Section 15(d) of
the Securities Exchange Act of 1934'' (August 17, 2011), http://
www.sec.gov/rules/final/2011/34-65148.pdf.
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The Commission also is working closely with other regulators to
jointly create the risk retention rules required by Section 941 of the
Act, which will address the appropriate amount, form and duration of
required risk retention for ABS securitizers and will define qualified
residential mortgages (QRMs). On March 30, 2011, the Commission joined
its fellow regulators in issuing for public comment proposed risk
retention rules to implement Section 941. \58\
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\58\ See, Release No. 34-64148, ``Credit Risk Retention'' (March
30, 2011), http://www.sec.gov/rules/proposed/2011/34-64148.pdf. Section
941, is codified as the new Section 15G of the Exchange Act. It
generally requires the Commission, the Board, Federal Deposit Insurance
Corporation, Office of the Comptroller of the Currency and, in the case
of the securitization of any ``residential mortgage asset,'' the
Federal Housing Finance Agency and Department of Housing and Urban
Development, to jointly prescribe regulations that require a
securitizer to retain not less than 5 percent of the credit risk of any
asset that the securitizer, through the issuance of an asset-backed
security, transfers, sells, or conveys to a third party. Section 15G
also provides that the jointly prescribed regulations must prohibit a
securitizer from directly or indirectly hedging or otherwise
transferring the credit risk that the securitizer is required to
retain. See, 780-11(c)(1)(A).
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Under the proposed rules, a sponsor generally would be permitted to
choose from a menu of four risk retention options to satisfy its
minimum 5 percent risk retention requirement. These options were
designed to provide sponsors with flexibility while also ensuring that
they actually retain credit risk to align incentives. The proposed
rules also include three transaction-specific options related to
securitizations involving revolving asset master trusts, asset-backed
commercial paper conduits, and commercial mortgage-backed securities.
Also, as required by Section 941, the proposal provides a complete
exemption from the risk retention requirements for ABS collateralized
solely by QRMs and establishes the terms and conditions under which a
residential mortgage would qualify as a QRM. We have received a number
of comments regarding the QRM exemption, as well as concerning other
aspects of the proposal. \59\ The staff currently is considering those
comments and diligently working with the other agencies' staff to move
forward with this interagency rulemaking.
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\59\ The SEC received letters on the proposal from over 10,000
commentators, representing approximately 275 unique comment letters.
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In January 2011 the Commission also adopted rules on the use of
representations and warranties in the market for ABS as required by the
Act's Section 943. \60\ The rules required ABS issuers to disclose the
history of repurchase requests received and repurchases made relating
to their outstanding ABS. Issuers were required to make their initial
filing on February 14, 2012, disclosing the repurchase history for the
3 years ending December 31, 2011. The disclosure requirements apply to
issuers of registered and unregistered ABS, including municipal ABS,
though the rules provide municipal ABS an additional 3-year phase-in
period.
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\60\ See, Release No. 33-9175, ``Disclosure for Asset-Backed
Securities Required by Section 943 of the Dodd-Frank Wall Street Reform
and Consumer Protection Act'' (January 20, 2011), http://www.sec.gov/
rules/final/2011/33-9175.pdf.
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The Commission also adopted rules in January 2011 to implement
Section 945, which required an asset-backed issuer in a Securities Act
registered transaction to perform a review of the assets underlying the
ABS and disclose the nature of such review. \61\ Under the final rules,
the type of review conducted may vary, but at a minimum must be
designed and effected to provide reasonable assurance that the
prospectus disclosure about the assets is accurate in all material
respects. The final rule provided a phase-in period to allow market
participants to adjust their practices to comply with the new
requirements.
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\61\ See, Release No. 33-9176, ``Issuer Review of Assets in
Offerings of Asset-Backed Securities'' (January 20, 2011), http://
www.sec.gov/rules/final/2011/33-9176.pdf.
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Prohibition Against Conflicts of Interest in Certain Securitizations
In September 2011, the Commission proposed a rule to implement the
prohibition under Section 621 of the Act, which prohibited entities
that create and distribute ABS from engaging in transactions that
involve or result in material conflicts of interest with respect to the
investors in such ABS. \62\ The proposed rule would implement this
provision by prohibiting underwriters, placement agents, initial
purchasers, sponsors of ABS, or any affiliate or subsidiary of such
entity from engaging in any transaction that would involve or result in
any material conflicts of interest with respect to any investor in the
relevant ABS. These entities, referred to as ``securitization
participants,'' assemble, package, and distribute ABS, so they may
benefit from the activity that Section 621 is designed to prohibit. The
prohibition would apply to both nonsynthetic and synthetic asset-backed
securities and would apply to both registered and unregistered
offerings of asset-backed securities.
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\62\ See, Release No. 34-65355, ``Prohibition Against Conflicts of
Interest in Certain Securitizations'' (September 19, 2011), http://
www.sec.gov/rules/proposed/2011/34-65355.pdf.
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The proposal is not intended to prohibit legitimate securitization
activities. We asked many questions in the release to help us strike
the right balance of prohibiting the type of conduct at which the
statute is targeted without restricting legitimate securitization
activities. The Commission received a number of comments on the
proposal, and the staff is carefully considering those comments in
preparing its recommendation to the Commission.
Corporate Governance and Executive Compensation
The Dodd-Frank Act includes a number of corporate governance and
executive compensation provisions that require Commission rulemaking.
Among others, such rulemakings include:
Say on Pay. In accordance with Section 951 of the Act, in
January 2011 the Commission adopted rules that require public
companies subject to the Federal proxy rules to provide a
shareholder advisory ``say-on-pay'' vote on executive
compensation, a separate shareholder advisory vote on the
frequency of the say-on-pay vote, and disclosure about, and a
shareholder advisory vote to approve, compensation related to
merger or similar transactions, known as ``golden parachute''
arrangements. \63\ Companies (other than smaller reporting
companies) began providing these say-on-pay and ``say-on-
frequency'' advisory votes at shareholder meetings occurring on
or after January 21, 2011. The rules provided smaller reporting
companies a 2-year delayed compliance period for the say-on-pay
and ``frequency'' votes, and those companies began complying
with the rules on January 21, 2013. The Commission also
proposed rules to implement the Section 951 requirement that
institutional investment managers report their votes on these
matters at least annually. \64\
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\63\ See, Release No. 33-9178, ``Shareholder Approval of Executive
Compensation and Golden Parachute Compensation'' (January 25, 2011),
http://www.sec.gov/rules/final/2011/33-9178.pdf.
\64\ See, Release No. 34-63123, ``Reporting of Proxy Votes on
Executive Compensation and Other Matters'' (October 18, 2010), http://
www.sec.gov/rules/proposed/2010/34-63123.pdf.
Compensation Committee and Adviser Requirements. In June
2012, the Commission adopted rules to implement Section 952 of
the Act, which requires the Commission to, by rule, direct the
national securities exchanges and national securities
associations to prohibit the listing of any equity security of
an issuer that does not comply with new compensation committee
and compensation adviser requirements. \65\ The new rules
direct the exchanges to establish listing standards concerning
compensation advisers and listing standards that require each
member of a listed issuer's compensation committee to be an
``independent'' member of the board of directors. The rules
also require disclosure about the use of compensation
consultants and related conflicts of interest. Each national
securities exchange must have final rules or rule amendments
complying with the new rules approved by the Commission no
later than June 27, 2013. To conform their rules governing
independent compensation committees to the new requirements,
national securities exchanges that have rules providing for the
listing of equity securities have filed proposed rule changes
with the Commission. \66\ The Commission issued final orders
approving the proposed rule changes in January 2013. \67\
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\65\ See, Release No. 33-9330, ``Listing Standards for
Compensation Committees'' (June 20, 2012), http://www.sec.gov/rules/
final/2012/33-9330.pdf.
\66\ See, Release No. 34-68022 (October 9, 2012), http://
www.sec.gov/rules/sro/bats/2012/34-68022.pdf (BATS Exchange, Inc.);
Release No. 34-68020 (October 9, 2012), http://www.sec.gov/rules/sro/
cboe/2012/34-68020.pdf (Chicago Board of Options Exchange, Inc.);
Release No. 34-68033 (October 10, 2012), http://www.sec.gov/rules/sro/
chx/2012/34-68033.pdf (Chicago Stock Exchange, Inc.); Release No. 34-
68013 (October 9, 2012), http://www.sec.gov/rules/sro/nasdaq/2012/34-
68013.pdf (Nasdaq Stock Market LLC); Release No. 34-68018 (October 9,
2012), http://www.sec.gov/rules/sro/bx/2012/34-68018.pdf (Nasdaq OMX
BX, Inc.); Release No. 34-68039 (October 11, 2012), http://www.sec.gov/
rules/sro/nsx/2012/34-68039.pdf (National Stock Exchange, Inc.);
Release No. 34-68011 (October 9, 2012), http://www.sec.gov/rules/sro/
nyse/2012/34-68011.pdf (New York Stock Exchange LLC); Release No. 34-
68006 (October 9, 2012), http://www.sec.gov/rules/sro/nysearca/2012/34-
68006.pdf (NYSEArca LLC); Release No. 34-68007 (October 9, 2012),
http://www.sec.gov/rules/sro/nysemkt/2012/34-68007.pdf (NYSE MKT LLC).
\67\ See, Release No. 34-68643 (January 11, 2013), http://
www.sec.gov/rules/sro/bats/2013/34-68643.pdf (BATS Exchange, Inc.);
Release No. 34-68642 (January 11, 2013), http://www.sec.gov/rules/sro/
cboe/2013/34-68642.pdf (Chicago Board of Options Exchange, Inc.);
Release No. 34-68653 (January 14, 2013), http://www.sec.gov/rules/sro/
chx/2013/34-68653.pdf (Chicago Stock Exchange, Inc.); Release No. 34-
68640 (January 11, 2013), http://www.sec.gov/rules/sro/nasdaq/2013/34-
68640.pdf (Nasdaq Stock Market LLC); Release No. 34-68641 (January 11,
2012), http://www.sec.gov/rules/sro/bx/2013/34-68641.pdf (Nasdaq OMX
BX, Inc.); Release No. 34-68662 (January 15, 2012), http://www.sec.gov/
rules/sro/nsx/2013/34-68662.pdf (National Stock Exchange, Inc.);
Release No. 34-68635 (January 11, 2013), http://www.sec.gov/rules/sro/
nyse/2013/34-68635.pdf (New York Stock Exchange LLC); Release No. 34-
68638 (January 11, 2013), http://www.sec.gov/rules/sro/nysearca/2013/
34-68638.pdf (NYSEArca LLC); Release No. 34-68637 (January 11, 2013),
http://www.sec.gov/rules/sro/nysemkt/2013/34-68637.pdf (NYSE MKT LLC).
Incentive-Based Compensation Arrangements. Section 956 of
the Dodd-Frank Act requires the Commission, along with six
other financial regulators, to jointly adopt regulations or
guidelines governing the incentive-based compensation
arrangements of certain financial institutions, including
broker-dealers and investment advisers with $1 billion or more
of assets. Working with the other regulators, in March 2011 the
Commission published for public comment a proposed rule that
would address such arrangements. \68\ The Commission has
received many comment letters on the proposed rule, and the
Commission staff, together with staff from the other
regulators, is carefully considering the issues and concerns
raised in those comments before adopting final rules.
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\68\ See, Release no. 34-64140 (March 29, 2011), http://
www.sec.gov/rules/proposed/2011/34-64140.pdf.
Prohibition on Broker Voting of Uninstructed Shares.
Section 957 of the Act requires the rules of each national
securities exchange to be amended to prohibit brokers from
voting uninstructed shares in director elections (other than
uncontested elections of directors of registered investment
companies), executive compensation matters, or any other
significant matter, as determined by the Commission by rule.
The Commission has approved changes to the rules with regard to
director elections and executive compensation matters for all
of the national securities exchanges. \69\
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\69\ See, Release No. 34-62874 (September 9, 2010), http://
www.sec.gov/rules/sro/nyse/2010/34-62874.pdf (New York Stock Exchange);
Release No. 34-62992 (September 24, 2010), http://www.sec.gov/rules/
sro/nasdaq/2010/34-62992.pdf (NASDAQ Stock Market LLC); Release No. 34-
63139 (October 20, 2010), http://www.sec.gov/rules/sro/ise/2010/34-
63139.pdf (International Securities Exchange); Release No. 34-63917
(February 16, 2011), http://www.sec.gov/rules/sro/cboe/2011/34-
63917.pdf (Chicago Board Options Exchange); Release No. 34-63918
(February 16, 2011), http://www.sec.gov/rules/sro/c2/2011/34-63918.pdf
(C2 Options Exchange, Incorporated); Release No. 34-64023 (March 3,
2011), http://www.sec.gov/rules/sro/bx/2011/34-64023.pdf (NASDAQ OMX
BX, Inc.); Release No. 34-64024 (March 3, 2011), http://www.sec.gov/
rules/sro/bx/2011/34-64024.pdf (Boston Options Exchange Group, LLC);
Release No. 34-64121 (March 24, 2011), http://www.sec.gov/rules/sro/
chx/2011/34-64121.pdf (Chicago Stock Exchange); Release No. 34-64122
(March 24, 2011), http://www.sec.gov/rules/sro/phlx/2011/34-64122.pdf
(NASDAQ OMX PHLX LLC); Release No. 34-64186 (April 5, 2011), http://
www.sec.gov/rules/sro/edgx/2011/34-64186.pdf (EDGX Exchange); Release
No. 34-64187 (April 5, 2011), http://www.sec.gov/rules/sro/edga/2011/
34-64187.pdf (EDGA Exchange); Release No. 34-65449 (September 30,
2011), http://www.sec.gov/rules/sro/bats/2011/34-65449.pdf (BATS
Exchange, Inc.); Release No. 34-65448 (September 30, 2011), http://
www.sec.gov/rules/sro/byx/2011/34-65448.pdf (BATS Y-Exchange, Inc.);
Release No. 34-65804 (November 22, 2011), http://www.sec.gov/rules/sro/
nsx/2011/34-65804.pdf (National Stock Exchange, Inc.); Release No. 34-
66006 (December 20, 2011) http://www.sec.gov/rules/sro/nyseamex/2011/
34-66006.pdf (NYSE Amex LLC); Release No. 34-66192 (January 19, 2012),
http://www.sec.gov/rules/sro/nysearca/2012/34-66192.pdf (NYSE Arca,
Inc.); and Release No. 68723 (January 24, 2013) (MIAX-2013-02).
The Commission also is required by the Act to adopt several
additional rules related to corporate governance and executive
compensation, including rules mandating new listing standards relating
to specified ``claw back' policies \70\ and new disclosure requirements
about executive compensation and company performance, \71\ executive
pay ratios, \72\ and employee and director hedging. \73\ The staff is
working diligently on developing recommendations for the Commission
concerning the implementation of these provisions of the Act.
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\70\ See, Section 954 of the Dodd-Frank Act.
\71\ See, Section 953(a) of the Dodd-Frank Act.
\72\ See, Section 953(b) of the Dodd-Frank Act.
\73\ See, Section 955 of the Dodd-Frank Act.
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Specialized Disclosure Provisions
Title XV of the Act contains specialized disclosure provisions
related to conflict minerals, coal or other mine safety, and payments
by resource extraction issuers to foreign or U.S. Government entities.
The Commission adopted final rules for the mine safety provision in
December 2011, \74\ and companies are currently complying with those
rules. In addition, the Commission adopted final rules for disclosure
relating to conflict minerals and payments by resource extraction
issuers in August 2012. \75\ The conflict minerals and resource
extraction issuer rulemakings were effective in November 2012 and
established phase-in periods for compliance to provide issuers time to
establish systems and processes to comply with the new rules. Companies
subject to the conflict minerals disclosure requirement will be
required to make their first filing with the disclosure on new Form SD
on May 31, 2014, for the 2013 calendar year. Companies subject to the
resource extraction issuer disclosure requirement will be required to
comply with the rules for fiscal years ending after September 30, 2013.
The conflict minerals and resource extraction issuer rulemakings are
subject to pending litigation. \76\
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\74\ See, Release No. 33-9286, ``Mine Safety Disclosure''
(December 21, 2011), http://www.sec.gov/rules/final/2011/33-9286.pdf.
\75\ See, Release No. 34-67716, ``Conflict Minerals'' (August 22,
2012), http://www.sec.gov/rules/final/2012/34-67716.pdf and
``Disclosure of Payments by Resource Extraction Issuers'' (August 22,
2012), http://www.sec.gov/rules/final/2012/34-67717.pdf.
\76\ See, American Petroleum Institute, et al. v. United States
Securities and Exchange Commission, No. 12-1398 (D.C. Cir. filed Oct.
10, 2012) and National Association of Manufacturers, et al. v. United
States Securities and Exchange Commission, No. 12-1422 (D.C. Cir. filed
Oct. 19, 2012). The Commission received a motion requesting that it
stay the newly adopted disclosure rules for resource extraction
issuers, but the Commission declined to issue a stay order. See, http:/
/www.sec.gov/rules/final/2012/34-67717-motion-stay.pdf and Release No.
68197 (November 8, 2012), http://www.sec.gov/rules/other/2012/34-
68197.pdf. The petitioners in the litigation concerning the conflict
minerals rule did not request a stay of the newly adopted rule.
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Exempt Offerings
In December 2011, the Commission adopted rule amendments to
implement Section 413(a) of the Act, which requires the Commission to
exclude the value of an individual's primary residence when determining
if that individual's net worth exceeds the $1 million threshold
required for ``accredited investor'' status. \77\ Section 413(a) was
effective on the date of enactment of the Dodd-Frank Act and the
implementing rules clarify the requirements and codify them in the
Commission's rules.
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\77\ See, Release No. 33-9287, ``Net Worth Standard for Accredited
Investors'' (December 21, 2011) and (March 23, 2012), http://
www.sec.gov/rules/final/2011/33-9287.pdf and http://www.sec.gov/rules/
final/2012/33-9287a.pdf (technical amendment).
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Under Section 926 of the Act, the Commission is required to adopt
rules that disqualify securities offerings involving certain ``felons
and other `bad actors' '' from relying on the safe harbor from
Securities Act registration provided by Rule 506 of Regulation D. The
Commission proposed rules to implement the requirements of Section 926
on May 25, 2011. \78\ Under the proposal, the disqualifying events
include certain criminal convictions, court injunctions and restraining
orders; certain final orders of State securities, insurance, banking,
savings association or credit union regulators, Federal banking
agencies or the National Credit Union Administration; certain types of
Commission disciplinary orders; suspension or expulsion from membership
in, or from association with a member of, a securities self-regulatory
organization; and certain other securities-law related sanctions. The
comment period for this rule proposal has ended and the staff is
developing recommendations for final rules.
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\78\ See, Release No. 33-9211, ``Disqualification of Felons and
Other `Bad Actors' From Rule 506 Offerings'' (May 25, 2011), http://
www.sec.gov/rules/proposed/2011/33-9211.pdf.
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Financial Stability Oversight Council
Title I of the Dodd-Frank Act provides that the Chairman of the SEC
shall serve as a voting member of FSOC. FSOC provides a formal
structure for coordination among the various financial regulators to
monitor systemic risk and to promote financial stability across our
Nation's financial system. As Chairman of the SEC, I participate in the
systemic risk oversight activities of the Council and coordinate with
my colleagues on the Council to facilitate efficient and effective
implementation of the Dodd-Frank Act.
New Commission Offices
In addition to the Office of the Whistleblower mentioned above, the
Dodd-Frank Act required the Commission to create four new offices: the
Office of Credit Ratings, Office of the Investor Advocate, Office of
Minority and Women Inclusion, and Office of Municipal Securities. As
each of these offices is statutorily required to report directly to the
Chairman, the creation of these offices was subject to approval by the
Commission's Appropriations subcommittees.
Office of Credit Ratings
As required by Section 932, the Commission established an Office of
Credit Ratings (OCR) with the appointment of OCR's Director in June
2012. OCR is charged with administering the rules of the Commission
with respect to the practices of NRSROs in determining credit ratings
for the protection of users of credit ratings and in the public
interest, promoting accuracy in credit ratings issued by NRSROs and
ensuring that credit ratings are not unduly influenced by conflicts of
interest and that NRSROs provide greater disclosure to investors. OCR
conducts examinations of NRSROs to assess and promote compliance with
statutory and Commission requirements, monitors the activities of
NRSROs, and provides guidance with respect to the Commission's policy
and regulatory initiatives related to NRSROs.
The examination activities of OCR are focused on conducting annual,
risk-based examinations of all registered NRSROs to assess compliance
with Federal securities laws and Commission rules. OCR also conducts
special risk-targeted examinations based on credit market issues and
concerns and to follow up on tips, complaints, and NRSRO self-reported
incidents. The monitoring activities of OCR are geared towards
informing Commission policy and rulemaking and include identifying and
analyzing risks, monitoring industry trends, and administering and
monitoring the NRSRO registration process as well as the periodic
updates by existing registrants of their Forms NRSRO.
The Dodd-Frank Act requires that the SEC conduct examinations of
each NRSRO at least annually. OCR's scope for NRSRO examinations
includes covering all eight areas required by the Dodd-Frank Act.
Beginning in 2012, in an effort to be more tailored, OCR developed a
risk-based approach to exam planning, identifying different risks for
different NRSROs. During examinations, OCR also follows up on findings
from prior exams and areas of identified risks. OCR prepares an annual
public examination report as required by the Dodd-Frank Act, which
summarizes the essential findings of the examinations and provides
information on whether the NRSROs have appropriately addressed any
previous examination recommendations. In November 2012, staff issued
the second annual staff report including those findings.NRSROs have
appropriately addressed any previous examination recommendations. In
November 2012, staff issued the second annual staff report including
those findings.NRSROs have appropriately addressed any previous
examination recommendations. In November 2012, staff issued the second
annual staff report including those findings. \79\
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\79\ See, ``SEC Issues Staff Summary Report of Examinations of
Nationally Recognized Statistical Rating Organizations'', 2012-228
(November 2012), http://www.sec.gov/news/studies/2012/nrsro-summary-
report-2012.pdf.
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Office of the Investor Advocate
Section 915 requires the SEC to establish an Office of the Investor
Advocate to assist retail investors in resolving significant problems
they may have with the Commission or with SROs. The Investor Advocate
also will identify areas in which investors would benefit from changes
in Commission regulations or SRO rules; identify problems that
investors have with financial service providers and investment
products; and analyze the potential impact on investors of proposed
Commission regulations and SRO rules. The Investor Advocate also must
hire an Ombudsman, whose activities will be included in the Advocate's
reports to Congress. The Commission is in the process of filling the
position of Investor Advocate.
Office of Minority and Women Inclusion
In July 2011, shortly after the House and Senate Appropriations
Committees approved the SEC's reprogramming request to create the
office, the SEC formally established its Office of Minority and Women
Inclusion (OMWI). The OMWI Director joined the office in January 2012.
Under a broad outreach strategy developed by OMWI, the SEC has
sponsored and/or attended more than 40 career fairs, conferences, and
business matchmaking events to market the SEC to diverse suppliers and
job seekers. OMWI continues to partner with leading organizations
focused on developing employment opportunities for minorities and women
at the SEC and in the financial services industry. In addition, the
OMWI Director, along with OMWI directors from other agencies,
participated in joint roundtables with financial industry groups and
trade organizations to foster informed dialogue regarding the
development of standards for assessing the diversity policies and
practices of regulated entities.
In fiscal year 2012, OMWI provided technical assistance to over 150
vendors in its efforts to expand contracting opportunities for
minority-owned and women-owned businesses. While we are pleased that
the percentage of contracting dollars awarded to minority-owned and
women-owned businesses--as well as the percentages of minority hires
for certain demographic groups, including African Americans--increased
from fiscal year 2011, more needs to be done. OMWI and the Commission
are committed to continuing to work proactively to encourage diversity
in the workforce and increase the participation of minority-owned and
women-owned businesses in the SEC's programs and contracting
opportunities.
Office of Municipal Securities
Section 979 of the Dodd-Frank Act required the Commission to
establish an Office of Municipal Securities (OMS), reporting directly
to the Chairman, to administer the rules pertaining to broker-dealers,
advisors, investors and issuers of municipal securities, and to
coordinate with the MSRB on rulemaking and enforcement actions. In
August 2012, the Commission announced the establishment of the OMS and
appointed a director. The office was previously part of the Division of
Trading and Markets. One purpose behind this legislative mandate was to
focus priority attention on the significant municipal securities
market, which encompasses over $3.7 trillion in outstanding municipal
securities, over 44,000 municipal issuers, and an average of over
12,000 bond issues annually.
The highest immediate priority project for OMS is to work together
with the Division of Trading and Markets to finalize pending rules
regarding registration of municipal advisors. OMS's current initiatives
also include assisting with the implementation of disclosure and market
structure initiatives recommended for potential further consideration
by the Commission in its Report on the Municipal Securities Market,
issued on July 31, 2012, following a staff review of this market
sector. Briefly, these recommended initiatives include:
a series of legislative recommendations for potential
further consideration to grant the Commission direct authority
to set baseline disclosure and accounting standards for
municipal issuers;
regulatory disclosure recommendations for potential further
consideration to update the Commission's 1994 interpretative
release concerning the disclosure obligations of issuers of
municipal securities; and
a series of market structure recommendations for potential
further consideration to improve price transparency in the
municipal securities market.
As noted in this Report, further action on specific recommendations
will involve further study of relevant additional information,
including information, as applicable, related to the costs and benefits
of the recommendations and the consideration, as applicable, of public
comment.
Economic Analysis
The SEC considers economic analysis to be a critical element of its
rule-writing process. We are mindful that our rules have both costs and
benefits, and that the steps we take to protect the investing public
also impact financial markets and industry participants who must comply
with our rules. In recent years, even in the face of an unprecedented
rulemaking burden generated by the passage of the Act, the agency has
continually enhanced its economic analysis efforts by, among other
things, hiring additional Ph.D. economists and involving our economists
earlier and more comprehensively in the rulemaking process. In
addition, last year SEC staff received new guidance to inform the
manner in which they incorporate economic analysis into their
rulemaking work. \80\
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\80\ The memorandum ``Current Guidance on Economic Analysis in SEC
Rulemakings'' is available at http://www.sec.gov/divisions/riskfin/
rsfi_guidance_econ_analy_secrulemaking.pdf. The guidance is in effect
and being followed by the rule-writing teams as they develop rule
recommendations.
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Our Division of Risk, Strategy, and Financial Innovation (RSFI)
directly assists in the rulemaking process by helping develop the
conceptual framing for, and assisting in the subsequent writing of, the
economic analysis in rule releases. Economic analysis of agency rules
considers, among other things, the direct and indirect costs and
benefits of the Commission's proposed regulations and reasonable
alternative approaches, and the rule's effects on competition,
efficiency and capital formation. Of course, analysis of the likely
economic effects of proposed rules, while critical to the rulemaking
process, can be challenging, and certain costs or benefits may be
difficult to quantify or value with precision, particularly those that
are indirect or intangible. We continue to be committed to meeting
these challenges and to ensuring that the Commission engages in sound,
robust analysis in its rulemaking, and we will continue to work to
enhance both the process and substance of that analysis.
Section 967 Organizational Assessment
Section 967 of the Act directed the agency to engage the services
of an independent consultant to study a number of specific SEC internal
operations. Boston Consulting Group, Inc. (BCG) performed the
assessment and provided recommended initiatives in March 2011. \81\ The
recommendations targeted various aspects of the SEC's mission,
function, structure, and operations, including:
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\81\ The BCG Report is available at http://www.sec.gov/news/
studies/2011/967study.pdf.
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restructuring operating divisions and support offices;
reshaping roles and governance;
assessing potential reprioritization of regulatory
activities;
reviewing Commission-staff interaction processes and
delegations of authority;
enhancing the SEC's operational risk management
capabilities; and
considering potential changes in the SEC's oversight of--
and interaction with--self-regulatory organizations.
Since that time, the staff has undertaken an assessment of the
recommendations and has provided three reports to Congress detailing
the staff activities taken to implement these objectives. Thus far,
recommendations and implementation plans have been completed for 15 of
the 20 initiatives examined, and the implementation phase is complete
or in process for each.
Funding for Implementation of the Dodd-Frank Act
Since passage of the Dodd-Frank Act, \82\ the agency's existing
staff has worked extraordinarily hard to conduct the large number of
rulemakings, studies, and analyses required by the Act. But it has been
clear to me from the outset that the Act's significant expansion of the
SEC's jurisdiction over OTC derivatives, private fund advisers,
municipal advisors, clearing agencies, and credit rating agencies,
among others, could not be handled appropriately with the agency's
previous resource levels without undermining the agency's other core
duties. This is proving especially true as we turn from the first step
of rule writing to efforts to support and monitor implementation and
the ongoing process of examinations and enforcement of those rules.
With Congress's support, the SEC received a FY2012 appropriation that
permitted us to begin hiring some of the new positions needed to
fulfill these responsibilities.
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\82\ In accordance with past practice, the FY2013 budget
justification of the agency was submitted by the Chairman of the
Commission and was not voted on by the full Commission. Therefore, this
section of the testimony does not necessarily represent the views of
all SEC Commissioners.
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Despite this, I believe that the SEC does not yet have all the
resources necessary to fully implement the law, and enactment of the
President's Budget Request for FY2013 would be key for filling the
remaining gaps. The Request was for $1.566 billion, and it would permit
the agency to hire 676 additional individuals. A number of these new
hires are needed to focus on enforcement, examinations, regulatory
oversight, and economic and data analysis related to the Act.
In FY2013, the SEC also is aiming to continue investing in its
technology capabilities to implement the law and police the markets. In
particular, we hope to strengthen our ability to take in, organize, and
analyze data on the new markets and entities under the agency's
jurisdiction. The enactment of the President's Budget Request, as well
as the continued use of the agency's Reserve Fund, will be essential to
that effort.
If the SEC does not receive additional resources, I believe that
many of the issues to which the Dodd-Frank Act is directed will not be
adequately addressed. The SEC would be unable to sufficiently build out
its technology and hire the industry experts and other staff sorely
needed to oversee and police these new areas of responsibility.
It is important to keep in mind that, under the Dodd-Frank Act, the
SEC collects transaction fees that offset the annual appropriation to
the SEC. Accordingly, regardless of the amount appropriated to the SEC,
I believe that it is appropriate to note that the appropriation will be
fully offset by the fees that we collect, and therefore will have no
impact on the Nation's budget deficit.
Conclusion
The Dodd-Frank Act has required the SEC to undertake the largest
and most complex rulemaking agenda in the history of the agency. To
date, a tremendous amount of progress has been made to implement that
agenda, including significant effort intended to increase transparency,
mitigate risk, protect against market abuse in security-based swaps
markets, improve the oversight of credit rating agencies and hedge fund
and other private fund advisers, and develop a better understanding of
the systemic risk presented by large private funds. As the Commission
strives to complete the additional work that remains, we look forward
to working with this Committee and other stakeholders in the financial
marketplace to adopt rules that protect investors, maintain fair,
orderly, and efficient markets, and facilitate capital formation. Thank
you for inviting us to share with you our progress to date and our
plans going forward. I look forward to answering your questions.
______
PREPARED STATEMENT OF GARY GENSLER
Chairman, Commodity Futures Trading Commission
February 14, 2013
Good morning Chairman Johnson, Ranking Member Crapo, and Members of
the Committee. I thank you for inviting me to today's hearing on
implementation of Dodd-Frank Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act) swaps market reforms. I am pleased to testify
along with my fellow regulators. I also want to thank the CFTC
Commissioners and staff for their hard work and dedication.
The New Era of Swaps Market Reform
This hearing is occurring at an historic time in the markets. The
CFTC now oversees the derivatives marketplace--across both futures and
swaps. The marketplace is increasingly shifting to implementation of
the commonsense rules of the road for the swaps market that Congress
included in the Dodd-Frank Act.
For the first time, the public is benefiting from seeing the price
and volume of each swap transaction. This post-trade transparency
builds upon what has worked for decades in the futures and securities
markets. The new swaps market information is available free of charge
on a Web site, like a modern-day ticker tape.
For the first time, the public will benefit from the greater access
to the markets and the risk reduction that comes with central clearing.
Required clearing of interest rate and credit index swaps between
financial entities begins next month.
For the first time, the public will benefit from specific oversight
of swap dealers. As of today, 71 swap dealers are provisionally
registered. They are subject to standards for sales practices, record
keeping and business conduct to help lower risk to the economy and
protect the public from fraud and manipulation. The full list of
registered swap dealers is on the CFTC's Web site, and we will update
it as more entities register.
An earlier economic crisis led President Roosevelt and Congress to
enact similar commonsense rules of the road for the futures and
securities markets. I believe these critical reforms of the 1930s have
been at the foundation of our strong capital markets and many decades
of economic growth.
In the 1980s, the swaps market emerged. Until now, though, it had
lacked the benefit of rules to promote transparency, lower risk and
protect the public, rules that we have come to depend upon in the
securities and futures markets. What followed was the 2008 financial
crisis. Eight million American jobs were lost. In contrast, the futures
market, supported by earlier reforms, weathered the financial crisis.
Congress and President Obama responded to the worst economic crisis
since the Great Depression and carefully crafted the Dodd-Frank swaps
provisions. They borrowed from what has worked best in the futures
market for decades: transparency, clearing, and oversight of
intermediaries.
The CFTC has largely completed swaps market rule writing, with 80
percent behind us. On October 12, the CFTC and Securities and Exchange
Commission's (SEC) foundational definition rules went into effect. This
marked the new era of swaps market reform.
The CFTC is seeking to consider and finalize the remaining Dodd-
Frank swaps reforms this year. In addition, as Congress directed the
CFTC to do, I believe it's critical that we continue our efforts to put
in place aggregate speculative position limits across futures and swaps
on physical commodities.
The agency has completed each of our reforms with an eye toward
ensuring that the swaps market works for end users, America's primary
job providers. It's the end users in the nonfinancial side of our
economy that provide 94 percent of private sector jobs.
The CFTC's swaps market reforms benefit end users by lowering costs
and increasing access to the markets. They benefit end users through
greater transparency--shifting information from Wall Street to Main
Street. Following Congress' direction, end users are not required to
bring swaps into central clearing. Further, the Commission's proposed
rule on margin provides that end users will not have to post margin for
uncleared swaps. Also, nonfinancial companies, other than those
genuinely making markets in swaps, will not be required to register as
swap dealers. Lastly, when end users are required to report their
transactions, they are given more time to do so than other market
participants.
Congress also authorized the CFTC to provide relief from the Dodd-
Frank Act's swaps reforms for certain electricity and electricity-
related energy transactions between rural electric cooperatives and
Federal, State, municipal and tribal power authorities. Similarly,
Congress authorized the CFTC to provide relief for certain transactions
on markets administered by regional transmission organizations and
independent system operators. The CFTC is looking to soon finalize two
exemptive orders related to these various transactions, as Congress
authorized.
The CFTC has worked to complete the Dodd-Frank reforms in a
deliberative way--not against a clock. We have been careful to consider
significant public input, as well as the costs and benefits of each
rule. CFTC Commissioners and staff have met more than 2,000 times with
members of the public, and we have held 22 public roundtables. The
agency has received more than 39,000 comment letters on matters related
to reform. Our rules also have benefited from close consultation with
domestic and international regulators and policy makers.
Throughout this process, the Commission has sought input from
market participants on appropriate schedules to phase in compliance
with swaps reforms. Now, over 2\1/2\ years since Dodd-Frank passed and
with 80 percent of our rules finalized, the market is moving to
implementation. Thus, it's the natural order of things that market
participants have questions and have come to us for further guidance.
The CFTC welcomes inquiries from market participants, as some fine-
tuning is expected. As it is sometimes the case with human nature, the
agency receives many inquiries as compliance deadlines approach.
My fellow commissioners and I, along with CFTC staff, have listened
to market participants and thoughtfully sorted through issues as they
were brought to our attention, as we will continue to do.
I now will go into further detail on the Commission's swaps market
reform efforts.
Transparency--Lowering Cost and Increasing Liquidity, Efficiency,
Competition
Transparency--a longstanding hallmark of the futures market--both
pre- and post-trade--lowers costs for investors, consumers and
businesses. It increases liquidity, efficiency and competition. A key
benefit of swaps reform is providing this critical pricing information
to businesses and other end users across this land that use the swaps
market to lock in a price or hedge a risk.
As of December 31, 2012, provisionally registered swap dealers are
reporting in real time their interest rate and credit index swap
transactions to the public and to regulators through swap data
repositories. These are some of the same products that were at the
center of the financial crisis. Building on this, swap dealers will
begin reporting swap transactions in equity, foreign exchange and other
commodity asset classes on February 28. Other market participants will
begin reporting April 10.
With these transparency reforms, the public and regulators now have
their first full window into the swaps marketplace.
Time delays for reporting currently range from 30 minutes to
longer, but will generally be reduced to 15 minutes this October for
interest rate and credit index swaps. For other asset classes, the time
delay will be reduced next January. After the CFTC completes the block
rule for swaps, trades smaller than a block will be reported as soon as
technologically practicable.
To further enhance liquidity and price competition, the CFTC is
working to finish the pretrade transparency rules for swap execution
facilities (SEFs), as well as the block rule for swaps. SEFs would
allow market participants to view the prices of available bids and
offers prior to making their decision on a transaction. These rules
will build on the democratization of the swaps market that comes with
the clearing of standardized swaps.
Clearing--Lowering Risk and Democratizing the Market
Since the late 19th century, clearinghouses have lowered risk for
the public and fostered competition in the futures market. Clearing
also has democratized the market by fostering access for farmers,
ranchers, merchants, and other participants.
A key milestone was reached in November 2012 with the CFTC's
adoption of the first clearing requirement determinations. The vast
majority of interest rate and credit default index swaps will be
brought into central clearing. This follows through on the U.S.
commitment at the 2009 G20 meeting that standardized swaps should be
brought into central clearing by the end of 2012. Compliance will be
phased in throughout this year. Swap dealers and the largest hedge
funds will be required to clear March 11, and all other financial
entities follow June 10. Accounts managed by third party investment
managers and ERISA pension plans have until September 9 to begin
clearing.
Consistent with the direction of Dodd-Frank, the Commission in the
fall of 2011 adopted a comprehensive set of rules for the risk
management of clearinghouses. These final rules were consistent with
international standards, as evidenced by the Principles for Financial
Market Infrastructures (PFMIs) consultative document that had been
published by the Committee on Payment and Settlement Systems and the
International Organization of Securities Commissions (CPSS-IOSCO).
In April of 2012, CPSS-IOSCO issued the final PFMIs. The
Commission's clearinghouse risk management rules cover the vast
majority of the standards set forth in the final PFMIs. There are a
small number of areas where it may be appropriate to augment our rules
to meet those standards, particularly as it relates to systemically
important clearinghouses. I have directed staff to work expeditiously
to recommend the necessary steps so that the Commission may implement
any remaining items from the PFMIs not yet incorporated in our
clearinghouse rules. I look forward to the Commission considering
action on this in 2013.
I expect that soon we will complete a rule to exempt swaps between
certain affiliated entities within a corporate group from the clearing
requirement. This year, the CFTC also will be considering possible
clearing determinations for other commodity swaps, including energy
swaps.
Swap Dealer Oversight--Promoting Market Integrity and Lowering Risk
Comprehensive oversight of swap dealers, a foundational piece of
Dodd-Frank, will promote market integrity and lower risk to taxpayers
and the rest of the economy. Congress wanted end users to continue
benefiting from customized swaps (those not brought into central
clearing) while being protected through the express oversight of swap
dealers. In addition, Dodd-Frank extended the CFTC's existing oversight
of previously regulated intermediaries to include their swaps activity.
Such intermediaries have historically included futures commission
merchants, introducing brokers, commodity pool operators, and commodity
trading advisors.
As the result of CFTC rules completed in the first half of last
year, 71 swap dealers are now provisionally registered. This initial
group of dealers includes the largest domestic and international
financial institutions dealing in swaps with U.S. persons. It includes
the 16 institutions commonly referred to as the G16 dealers. Other
entities are expected to register over the course of this year once
they exceed the de minimis threshold for swap dealing activity.
In addition to reporting trades to both regulators and the public,
swap dealers will implement crucial back office standards that lower
risk and increase market integrity. These include promoting the timely
confirmation of trades and documentation of the trading relationship.
Swap dealers also will be required to implement sales practice
standards that prohibit fraud, treat customers fairly and improve
transparency. These reforms are being phased in over the course of this
year.
The CFTC is collaborating closely domestically and internationally
on a global approach to margin requirements for uncleared swaps. We are
working along with the Federal Reserve, the other U.S. banking
regulators, the SEC and our international counterparts on a final set
of standards to be published by the Basel Committee on Banking
Supervision and the International Organization of Securities
Commissions (IOSCO). The CFTC's proposed margin rules excluded
nonfinancial end users from margin requirements for uncleared swaps. We
have been advocating with global regulators for an approach consistent
with that of the CFTC. I would anticipate that the CFTC, in
consultation with European regulators, would take up a final margin
rules, as well as related rules on capital, in the second half of this
year.
Following Congress' mandate, the CFTC also is working with our
fellow domestic financial regulators to complete the Volcker Rule. In
adopting the Volcker Rule, Congress prohibited banking entities from
proprietary trading, an activity that may put taxpayers at risk. At the
same time, Congress permitted banking entities to engage in certain
activities, such as market making and risk mitigating hedging. One of
the challenges in finalizing a rule is achieving these multiple
objectives.
International Coordination on Swaps Market Reform
In enacting financial reform, Congress recognized the basic lessons
of modern finance and the 2008 crisis. During a default or crisis, risk
knows no geographic border. Risk from our housing and financial crisis
contributed to economic downturns around the globe. Further, if a run
starts on one part of a modern financial institution, almost regardless
of where it is around the globe, it invariably means a funding and
liquidity crisis rapidly spreads and infects the entire consolidated
financial entity.
This phenomenon was true with the overseas affiliates and
operations of AIG, Lehman Brothers, Citigroup, and Bear Stearns.
AIG Financial Products, for instance, was a Connecticut subsidiary
of New York insurance giant that used a French bank license to
basically run its swaps operations out of Mayfair in London. Its
collapse nearly brought down the U.S. economy.
Last year's events of JPMorgan Chase, where it executed swaps
through its London branch, are a stark reminder of this reality of
modern finance. Though many of these transactions were entered into by
an offshore office, the bank here in the United States absorbed the
losses. Yet again, this was a reminder that in modern finance, trades
booked offshore by U.S. financial institutions should not be confused
with keeping that risk offshore.
Failing to incorporate these basic lessons of modern finance into
the CFTC's oversight of the swaps market would fall short of the goals
of Dodd-Frank reform. It would leave the public at risk.
More specifically, I believe that Dodd-Frank reform applies to
transactions entered into by overseas branches of U.S. entities with
non-U.S. persons, as well as between overseas affiliates guaranteed by
U.S. entities. Failing to do so would mean American jobs and markets
may move offshore, but, particularly in times of crisis, risk would
come crashing back to our economy.
Similar lessons of modern finance were evident, as well, with the
collapse of the hedge fund Long-Term Capital Management in 1998. It was
run out of Connecticut, but its $1.2 trillion swaps were booked in its
Cayman Islands affiliate. The risk from those activities, as the events
of the time highlighted, had a direct and significant effect here in
the United States.
The same was true when Bear Stearns in 2007 bailed out two of its
sinking hedge fund affiliates, which had significant investments in
subprime mortgages. They both were organized offshore. This was just
the beginning of the end, as within months, the Federal Reserve
provided extraordinary support for the failing Bear Stearns.
We must thus ensure that collective investment vehicles, including
hedge funds, that either have their principle place of business in the
United States or are directly or indirectly majority owned by U.S.
persons are not able to avoid the clearing requirement--or any other
Dodd-Frank requirement--simply due to how they might be organized.
We are hearing, though, that some swap dealers may be promoting to
hedge funds an idea to avoid required clearing, at least during an
interim period from March until July. I would be concerned if, in an
effort to avoid clearing, swap dealers route to their foreign
affiliates trades with hedge funds organized offshore, even though such
hedge funds' principle place of business was in the United States or
they are majority owned by U.S. persons. The CFTC is working to ensure
that this idea does not prevail and develop into a practice that leaves
the American public at risk. If we don't address this, the P.O. boxes
may be offshore, but the risk will flow back here.
Congress understood these issues and addressed this reality of
modern finance in Section 722(d) of the Dodd-Frank Act, which states
that swaps reforms shall not apply to activities outside the United
States unless those activities have ``a direct and significant
connection with activities in, or effect on, commerce of the United
States.'' Congress provided this provision solely for swaps under the
CFTC's oversight and provided a different standard for securities-based
swaps under the SEC's oversight.
To give financial institutions and market participants guidance on
722(d), the CFTC last June sought public consultation on its
interpretation of this provision. The proposed guidance is a balanced,
measured approach, consistent with the cross-border provisions in Dodd-
Frank and Congress' recognition that risk easily crosses borders.
Pursuant to Commission guidance, foreign firms that do more than a
de minimis amount of swap-dealing activity with U.S. persons would be
required to register with the CFTC within about 2 months after crossing
the de minimis threshold. A number of international financial
institutions are among the 71 swap dealers that are provisionally
registered with the CFTC.
Where appropriate, we are committed to permitting, foreign firms
and, in certain circumstances, overseas branches and guaranteed
affiliates of U.S. swap dealers, to comply with Dodd-Frank through
complying with comparable and comprehensive foreign regulatory
requirements. We call this substituted compliance.
For foreign swap dealers, we would allow such substituted
compliance for requirements that apply across a swap dealer's entity,
as well as for certain transaction-level requirements when facing
overseas branches of U.S. entities and overseas affiliates guaranteed
by U.S. entities. Entity-level requirements include capital, chief
compliance officer and swap data record keeping. Transaction-level
requirements include clearing, margin, real-time public reporting,
trade execution, trading documentation and sales practices.
When foreign swaps dealers transact with a U.S. person, though,
compliance with Dodd-Frank is required.
To assist foreign swap dealers with Dodd-Frank compliance, the CFTC
recently finalized an exemptive order that applies until mid-July 2013.
This Final Order for foreign swap dealers incorporates many suggestions
from the ongoing consultation on cross-border issues with foreign
regulatory counterparts and market participants. For instance, the
definition of ``U.S. person'' in the Order benefited from the comments
in response to the July 2012 proposal.
Under this Final Order, foreign swap dealers may phase in
compliance with certain entity-level requirements. In addition, the
Order provides time-limited relief for foreign dealers from specified
transaction-level requirements when they transact with overseas
affiliates guaranteed by U.S. entities, as well as with foreign
branches of U.S. swap dealers.
The Final Order provides time for the Commission to continue
working with foreign regulators as they implement comparable swaps
reforms and as the Commission considers substituted compliance
determinations for the various foreign jurisdictions with entities that
have registered as swap dealers under Dodd-Frank.
The CFTC will continue engaging with our international counterparts
through bilateral and multilateral discussions on reform and cross-
border swaps activity. Just last week, SEC Chairman Walter and I had a
productive meeting with international market regulators in Brussels.
Given our different cultures, political systems and legislative
mandates some differences are unavoidable, but we've made great
progress internationally on an aligned approach to reform. The CFTC is
committed to working through any instances where we are made aware of a
conflict between U.S. law and that of another jurisdiction.
Customer Protection
Dodd-Frank included provisions directing the CFTC to enhance the
protection of swaps customer funds. While it was not a requirement of
Dodd-Frank, in 2009 the CFTC also reviewed our existing customer
protection rules for futures market customers. As a result, a number of
our customer protection enhancements affect both futures and swaps
market customers. I would like to review our finalized enhancements, as
well as an important customer protection proposal.
The CFTC's completed amendments to rule 1.25 regarding the
investment of customer funds benefit both futures and swaps customers.
The amendments include preventing in-house lending of customer money
through repurchase agreements. The CFTC's gross margining rules for
futures and swaps customers require clearinghouses to collect margin on
a gross basis. Futures commission merchants (FCMs) are no longer able
to offset one customer's collateral against another or to send only the
net to the clearinghouse.
Swaps customers further benefit from the new so-called LSOC (legal
segregation with operational comingling) rules, which ensure their
money is protected individually all the way to the clearinghouse.
The Commission also worked closely with market participants on new
rules for customer protection adopted by the self-regulatory
organization (SRO), the National Futures Association. These include
requiring FCMs to hold sufficient funds for U.S. foreign futures and
options customers trading on foreign contract markets (in Part 30
secured accounts). Starting last year, they must meet their total
obligations to customers trading on foreign markets computed under the
net liquidating equity method. In addition, FCMs must maintain written
policies and procedures governing the maintenance of excess funds in
customer segregated and Part 30 secured accounts. Withdrawals of 25
percent or more would necessitate preapproval in writing by senior
management and must be reported to the designated SRO and the CFTC.
These steps were significant, but market events have further
highlighted that the Commission must do everything within our
authorities and resources to strengthen oversight programs and the
protection of customers and their funds.
In the fall of 2012, the Commission sought public comment on a
proposal to further enhance the protection of customer funds.
The proposal, which the CFTC looks forward to finalizing this year,
would strengthen the controls around customer funds at FCMs. It would
set new regulatory accounting requirements and would raise minimum
standards for independent public accountants who audit FCMs. And it
would provide regulators with daily direct electronic access to the
FCMs' bank and custodial accounts for customer funds. Last week, the
CFTC held a public roundtable on this proposal, the third roundtable
focused on customer protection.
Further, the CFTC intends to finalize a rule this year on
segregation for uncleared swaps.
Benchmark Interest Rates
I'd like to now turn to the three cases the CFTC brought against
Barclays, UBS, and RBS for manipulative conduct with respect to the
London Interbank Offered Rate (LIBOR) and other benchmark interest rate
submissions. The reason it's important to focus on these matters is not
because there were $2.5 billion in fines, though the U.S. penalties
against these three banks of more than $2 billion were significant.
What this is about is the integrity of the financial markets. When a
reference rate, such as LIBOR--central to borrowing, lending and
hedging in our economy--has been so readily and pervasively rigged,
it's critical that we discuss how to best change the system. We must
ensure that reference rates are honest and reliable reflections of
observable transactions in real markets.
The three cases shared a number of common traits. Foremost, at each
institution the misconduct spanned multiple years, involved offices in
multiple cities around the globe, included numerous people, and
affected multiple benchmark rates and currencies. In each case, there
was evidence of collusion among banks. In both the UBS and RBS cases,
one or more interdealer brokers were asked to paint false pictures to
influence submissions of other banks, i.e., to spread the falsehoods
more widely. At Barclays and UBS, the banks also were reporting falsely
low borrowing rates in an effort to protect their reputation.
Why does this matter?
The derivatives marketplace that the CFTC oversees started about
150 years ago. Futures contracts initially were linked to physical
commodities, like corn and wheat. Such clear linkage ultimately comes
from the ability of farmers, ranchers and other market participants to
physically deliver the commodity at the expiration of the contract. As
the markets evolved, cash-settled contracts emerged, often linked to
markets for financial commodities, like the stock market or interest
rates. These cash-settled derivatives generally reference indices or
benchmarks.
Whether linked to physical commodities or indices, derivatives--
both futures and swaps--should ultimately be anchored to observable
prices established in real underlying cash markets. And it's only when
there are real transactions entered into at arm's length between buyers
and sellers that we can be confident that prices are discovered and set
accurately.
When market participants submit for a benchmark rate that lacks
observable underlying transactions, even if operating in good faith,
they may stray from what real transactions would reflect. When a
benchmark is separated from real transactions, it is more vulnerable to
misconduct.
Today, LIBOR is the reference rate for 70 percent of the U.S.
futures market, most of the swaps market and nearly half of U.S.
adjustable rate mortgages. It's embedded in the wiring of our financial
system.
The challenge we face is that the market for interbank, unsecured
borrowing has largely diminished over the last 5 years. Some say that
it is essentially nonexistent. In 2008, Mervyn King, the governor of
the Bank of England, said of Libor: ``It is, in many ways, the rate at
which banks do not lend to each other.''
The number of banks willing to lend to one another on such terms
has been sharply reduced because of economic turmoil, including the
2008 global financial crisis, the European debt crisis that began in
2010, and the downgrading of large banks' credit ratings. In addition,
there have been other factors that have led to unsecured, interbank
lending drying up, including changes to Basel capital rules and central
banks providing funding directly to banks.
Fortunately, much work is occurring internationally to address
these issues. I want to commend the work of Martin Wheatley and the
U.K. Financial Services Authority (FSA) on the ``Wheatley Review of
LIBOR''. Additionally, the CFTC and the FSA are cochairing the
International Organization of Securities Commissions (IOSCO) Task Force
that is developing international principles for benchmarks and
examining best mechanisms or protocols for transition, if needed. On
January 11, the IOSCO Task Force published the Consultation Report on
Financial Benchmarks.
The consultation report said: ``The Task Force is of the view that
a benchmark should as a matter of priority be anchored by observable
transactions entered into at arm's length between buyers and sellers in
order for it to function as a credible indicator of prices, rates or
index values.'' It went on to say: ``However, at some point, an
insufficient level of actual transaction data raises concerns as to
whether the benchmark continues to reflect prices or rates that have
been formed by the competitive forces of supply and demand.''
Among the questions for the public in the report are the following:
What are the best practices to ensure that benchmark rates
honestly reflect market prices?
What are best practices for benchmark administrators and
submitters?
What factors should be considered in determining whether a
current benchmark's underlying market is sufficiently robust?
For instance, what is an insufficient level of actual
transaction activity?
And what are the best mechanisms or protocols to transition
from an unreliable or obsolete benchmark?
On February 20, we are holding a public roundtable in London. On
February 26, the CFTC is hosting a second roundtable to gather input
from market participants and other interested parties. A final report
incorporating this crucial public input will be published this spring.
Resources
The CFTC's hardworking team of 690 is less than 10 percent more in
numbers than at our peak in the 1990s. Yet since that time, the futures
market has grown five-fold, and the swaps market is eight times larger
than the futures market. Market implementation of swaps reforms means
additional resources for the CFTC are all the more essential.
Investments in both technology and people are needed for effective
oversight of these markets by regulators--like having more cops on the
beat.
Though data has started to be reported to the public and to
regulators, we need the staff and technology to access, review and
analyze the data. Though 71 entities have registered as new swap
dealers, we need people to answer their questions and work with the NFA
on the necessary oversight to ensure market integrity. Furthermore, as
market participants expand their technological sophistication, CFTC
technology upgrades are critical for market surveillance and to enhance
customer fund protection programs.
Without sufficient funding for the CFTC, the Nation cannot be
assured this agency can closely monitor for the protection of customer
funds and utilize our enforcement arm to its fullest potential to go
after bad actors in the futures and swaps markets. Without sufficient
funding for the CFTC, the Nation cannot be assured that this agency can
effectively enforce essential rules that promote transparency and lower
risk to the economy.
The CFTC is currently funded at $207 million. To fulfill our
mission for the benefit of the public, the President requested $308
million for fiscal year 2013 and 1,015 full-time employees.
Thank you again for inviting me today, and I look forward to your
questions.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM MARY J. MILLER
Q.1. Given how complex it is to determine whether a trade is a
hedge or a proprietary trade, it appears the real issue is
whether a trade threatens the safety and soundness of the bank.
What benchmark does your agency use to determine whether a
particular activity is or is not ``hedging''? How does your
agency determine whether the trade presents risks to the safety
and soundness of a financial institution?
A.1. Although Treasury is responsible for coordination of the
regulations issued by the rulewriting agencies to implement the
Volcker Rule, Treasury is not itself a rulewriting agency. The
purpose of the Volcker Rule is to prohibit banking entities
that have access to the Federal safety net from engaging in
risky proprietary trading or making certain investments in
private equity or hedge funds, while preserving important
activities such as market making and hedging. As the Council
noted in its Volcker Rule study in January 2011, and as the
SEC, the CFTC, and the Federal banking agencies noted in their
proposed rules to implement the Volcker Rule, the challenge
inherent in creating a robust implementation framework is that
certain classes of permitted activities--in particular, market
making, hedging, underwriting, and other transactions on behalf
of customers--often evidence outwardly similar characteristics
to prohibited proprietary trading, even as they pursue
different objectives. Additionally, effective implementation of
the Volcker Rule requires careful attention to differences
between types of financial markets and asset classes.
Since the closing of the public comment period, the
regulators have been working to address these and other issues
raised in the thousands of comments submitted on the proposal.
Q.2. In its November 2011 report, GAO recommended that FSOC
work with the Federal financial regulators to establish formal
coordination policies for Dodd-Frank rulemakings, such as when
coordination should occur. Nonetheless, the FSOC has not
established such formal policies to date. In its September 2012
report, GAO noted that a number of industry representatives
questioned why FSOC could not play a greater role in
coordinating member agencies' rulemaking efforts since the FSOC
chairperson is responsible for regular consultation with
regulators and other appropriate organizations of foreign
Governments or international organizations. Does Treasury agree
with GAO's recommendation? If so, when will FSOC issue formal
interagency coordination policies? Is there a reason why FSOC
could not play a greater role in coordinating member agencies'
rulemaking efforts?
A.2. The Council appreciates the work of the GAO and the
important oversight function that it provides. To that end, the
Council has reviewed all recommendations made by the GAO
regarding ways in which the Council might further enhance
collaboration and coordination and has provided responses on
actions planned and taken. As noted in its responses, the
Council developed written protocols for the statutorily
required consultations that are part of certain rulemakings
required by the Dodd-Frank Act. Additionally, one of the
Council's first activities was to establish an open operational
framework that included the creation of standing committees
composed of staff of Council members and member agencies. The
interagency participation in these committees draws upon the
collective policy and supervisory expertise of all of the
Council members and institutionalizes opportunities for
discussion, collaboration, and coordination. These teams have
collaborated on the publication of three annual reports and six
additional studies or reports related to important issues such
as the Volcker Rule, the concentration limit on large financial
companies, and contingent capital, and performed work enabling
the Council to designate eight financial market utilities as
systemically important. Interagency teams continue to support
the Council on its evaluation of nonbank financial companies
for potential designation, proposed recommendations for money
market mutual fund reform, and coordination with the Federal
Reserve Board on enhanced prudential standards.
Congress did not provide the Council or its Chairperson
with the authority to require coordination in all cases among
its independent member agencies. However, the Council, the
Deputies Committee, and Council staff are committed to
identifying ways to enhance collaboration as work is conducted
through the Council's committees and working groups.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCHUMER
FROM MARY J. MILLER
Q.1. In September 2012, the Government Accountability Office
(GAO) issued a report on the Financial Stability Oversight
Council (FSOC) and the Office of Financial Research (OFR), \1\
in which it found that the FSOC has not fully leveraged outside
expertise or used its authority to convene advisory committees
comprised of industry representatives, academics, and State
regulators to help inform its work. What has FSOC and/or OFR
done since the report to address this finding? Should there be
more formal structures and processes to ensure that the voices
of key stakeholders and experts are heard?
---------------------------------------------------------------------------
\1\ GAO-12-886 (Report to Congressional Requesters ``FINANCIAL
STABILITY New Council and Research Office Should Strengthen the
Accountability and Transparency of Their Decisions'' (September 2012)).
A.1. Since the GAO issued its report, the Council and the OFR
have further leveraged outside expertise in several ways. Most
notably, in November 2012, Treasury announced the members of a
new Financial Research Advisory Committee, which will work with
the OFR to recommend ways to develop and employ best practices
for data management, data standards, and research
methodologies. The committee is made up of 30 distinguished
professionals in economics, finance, financial services, data
management, risk management, and information technology.
Members include two Nobel laureates in economics, leaders in
business and nonprofit fields, and prominent researchers at
major universities and think tanks. The committee held its
inaugural meeting in December 2012 in Washington, DC, and has
been active through subcommittees that are focused on research,
data, technology, risk management, and other issues. In
addition, through the OFR's ongoing work and symposia, the
Council is able to draw on the insights and expertise of
various industry experts and academics on cutting edge systemic
risk and financial stability analyses and methods. The OFR's
work to establish the Legal Entity Identifier has also involved
extensive collaboration with global regulatory authorities,
standards setting bodies, and industry professionals.
Additionally, the Council and its committees are committed
to continuing to facilitate information sharing among its
members and other parties through the Council's existing
collaboration and consultation practices. With respect to
seeking input from State regulators in particular, State
banking, State insurance, and State securities regulators are
Council members and participate actively in the discussions of
the Council and its committees. The Council has also
demonstrated its commitment to public input by actively seeking
public comment on a number of matters, including its rule and
guidance regarding the designation of nonbank financial
companies, and its proposed recommendations regarding money
market mutual fund reform.
Q.2. While I understand the sensitivity of many of the issues
within the FSOC's purview, the GAO report nevertheless raised
serious concerns about the FSOC's and OFR's full commitment to
transparency, a shortcoming that could undermine the ability of
FSOC and OFR to carry out their Congressionally mandated
mission. GAO observed that ``limits to FSOC's and OFR's
transparency also contribute to questions about their
effectiveness.'' \2\ What specific steps will you take to
increase transparency at FSOC and OFR going forward?
---------------------------------------------------------------------------
\2\ Id., p. 54.
A.2. The Council and the OFR have taken a number of steps in
recent months to further demonstrate their commitment to
transparency and accountability. Since the publication of the
GAO report, the OFR and the Council completed redesigns of
their Web sites to improve transparency and usability, to
improve access to Council documents and reports, and to allow
users to receive updates when new content is added. These
include the annual reports of the Council and the OFR, working
papers, Congressional testimony, Congressional briefings and
meetings, the OFR's Annual Report to Congress on Human Capital
Planning, and information about the Financial Research Advisory
Committee, the Legal Entity Identifier Initiative, and
assessments. Both redesigned Web sites were available to the
public by December 2012, with continued enhancements expected
over time. In addition, as noted above, in November 2012
Treasury announced the members of a new Financial Research
Advisory Committee, which will work with the OFR to recommend
ways to develop and employ best practices for data management,
data standards, and research methodologies. This committee has
already held one public meeting and will hold more. The OFR
also sponsored its second Web cast conference this year.
Representatives of both the Council and the OFR have also
testified publicly before Congress and responded to numerous
requests for information from various oversight bodies.
Further, the OFR has built on its strategic planning and
performance management system by finalizing and beginning to
track foundational performance measures for each of its
strategic goals.
The Council is firmly committed to holding open meetings,
and closes meetings only when appropriate. The Council's
transparency policy commits the Council to hold two open
meetings each year, and the Council has held ten open meetings
in its first 2\1/2\ years. However, the Council must continue
to balance its responsibility to be transparent with its
central mission to monitor emerging threats to financial
stability. This frequently requires discussion of supervisory
and other market-sensitive data during Council meetings,
including information about individual firms, transactions, and
markets that may only be obtained if maintained on a
confidential basis. Continued protection of this information is
necessary to prevent destabilizing market speculation that
could occur if that information were to be disclosed. However,
in light of the GAO's recommendation, the Council's Deputies
Committee will consider whether to recommend any further
changes to the Council's transparency policy.
Q.3. The FSOC stated, in April 2012, that it had requested that
the OFR conduct a study of the asset management industry, to
determine (i) what risks, if any, this industry poses to the
U.S. financial system, and (ii) whether any such risks were
best addressed through designation or some other means. The
results of the study would presumably inform the FSOC whether
to consider asset managers as potentially subject to
designation as nonbank SIFIs. What process have the FSOC and
OFR established to solicit and consider input from the public,
including industry, regulators (FSOC members and non-FSOC
members), academics, and other interested parties?
Will the results of the analysis be made public and will
interested parties be provided the opportunity to comment
formally on the results?
Will the FSOC provide the public with an opportunity to
comment on any metrics and thresholds relating to the potential
designation of asset management companies as nonbank
systemically important financial institutions prior to the
designation of any such company?
A.3. The Council is reviewing generally the activities of asset
management companies and their impact on the U.S. financial
system. The Council has asked the OFR to supply data and
analysis to inform the Council's review. As part of this
analysis, the Council and OFR staff have met with market
participants, including asset managers, to learn more about the
relevant activities and business models.
The Council's work is ongoing. Were the Council to
determine that it would be appropriate to develop additional
metrics that would be used to identify asset management firms
for further evaluation for potential designation, I expect that
it would provide the public with an opportunity to review and
comment on any such metrics, in accordance with past practice.
As demonstrated by the Council's multiple requests for comment
on its proposed rule and interpretive guidance regarding
nonbank financial company designations, the Council values the
input of all interested parties, stakeholders, and the public.
Consistent with the Dodd-Frank Act, however, the Council
does not intend to delay consideration of any nonbank financial
company for potential designation, if the Council believes that
material financial distress at the company, or the nature,
scope, size, scale, concentration, interconnectedness, or mix
of the activities of the company, could pose a threat to the
financial stability of the United States.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM MARY J. MILLER
Q.1. The statutory language for funds defined under the Volcker
Rule pointedly did not include venture funds, however the
definition in the proposed rule seemed to indicate that venture
funds would be covered. In addition to exceeding the statutory
intent of Congress, this has created uncertainty in the market
as firms await a final rule and refrain from making commitments
which might be swept up in the final version of the Volcker
Rule. Can you clarify whether venture funds are covered by the
Volcker Rule?
A.1. Congress defined private equity and hedge funds for
purposes of the Volcker Rule as those entities that rely on the
exemptions under section 3(c)(1) or 3(c)(7) of the Investment
Company Act, rather than creating a separate classification or
treatment of venture capital funds. The Council recognized the
potential overbreadth of this issue in its study and
recommended that the rulemaking agencies consider whether
certain entities should be exempted, including venture capital
funds.
The comment letters submitted in response to the proposed
rules reflect sharply diverging views on whether venture
capital funds should be exempted. As with the other issues
raised in the comment letters, we expect the rulemaking
agencies will consider these comments carefully and take them
into consideration in developing the final rules.
Q.2. You have previously commented on the progress we have made
on improving capital and the evolving market perception of too
big to fail. Do you see any changes in the behavior of
investors in distinguishing among large institutions and
variance in their borrowing costs and credit default spreads?
A.2. If investors still perceived large banks as ``too big to
fail,'' we would expect to see persistently low credit spreads
for such firms with little variation between firms, as we did
in the years leading up to the financial crisis. But in the
aftermath of the crisis, investors are both assigning a greater
likelihood of loss from default and also distinguishing between
financial institutions, as measured by higher overall levels
of, and a wider variance between credit default swap (CDS)
spreads that markets use to assess credit risk.
Also, we would expect the largest banks' borrowing costs to
be low and vary little by the size of the institution or its
activities, as was the case before the crisis. Today, while
borrowing costs generally remain low for all banks as a result
of historically low interest rates, long-term debt spreads have
increased significantly more for the largest, most complex
banks than their smaller competitors.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM MARY J. MILLER
Q.1. The latest report from the Special Inspector General for
TARP revealed that AIG, GM, and Ally recently requested pay
raises for 18 top executives. Fourteen of those 18 raises were
for more than $100,000 and the highest amount was about $1
million. Treasury approved 18 out of 18 requests.
Can you explain what Treasury looked for in evaluating
these salary increases?
What sorts of factors would cause Treasury to reject a
salary increase?
What are Treasury's views on SIGTARP's ongoing
recommendation to put in place more effective policies and
procedures for evaluating compensation at these institutions?
A.1. The Interim Final Rule on TARP Standards for Compensation
and Corporate Governance makes clear that Treasury's Office of
the Special Master (OSM) must balance limiting compensation and
making sure that pay is at levels that will permit the
exceptional assistance recipients to compete--including
maintaining the ability to attract and retain employees--so
they can exit TARP and repay taxpayers. The process that OSM
created in 2009, and that it continues to follow today,
accomplishes this objective by requesting comprehensive
submissions from the exceptional assistance companies, which it
then thoroughly and carefully examines. In reviewing these
submissions, OSM analyzes market data to determine what
constitutes competitive marketplace compensation. It is also
important to note that the companies are constantly evaluating
the performance of their top executives, and it is not unusual
for the companies to promote some individuals and propose pay
decreases for others.
Thus, OSM does not approve all pay increases. Where
appropriate, it has permitted individual pay increases based on
the unique facts and circumstances of each case, while at the
same time emphasizing limitations on cash and total pay. For
example, neither AIG nor Ally Financial proposed any net
increase in compensation for its top 25 executives for 2012.
The pay raises proposed by AIG and Ally Financial were more
than offset by the pay decreases proposed by these companies.
Although GM did propose a net increase in compensation for
2012, its pay packages nevertheless were on average at the 50th
percentile for comparable positions at comparable entities.
Moreover, OSM required that more than 97 percent of the
approved pay increases be in the form of stock compensation
rather than cash, because the ultimate value of stock
compensation is uncertain and will reflect the long-term
performance of the company. In addition, the three current CEOs
of the exceptional assistance companies subject to the 2012
determination process have not had any pay increase during
their respective tenures.
Treasury recognizes the importance of diligent oversight
and has benefited from SIGTARP's review of its work. I
understand that in its 2012 report, SIGTARP made three
recommendations and that OSM implemented two of those
recommendations and was in the process of implementing the
third when SIGTARP's 2013 report was published. With respect to
SIGTARP's most recent recommendations, Treasury responded in
writing stating that it will consider these recommendations.
Q.2. It has been more than 4 years since policy makers began
focusing on how to fix the ``too big to fail'' problem and
eliminate the implicit guarantee that, in a time of crisis, the
Federal Government would bail out large financial institutions
instead of letting them fail and pose a systemic threat to the
economy. Nonetheless, the big banks now are even bigger than
they were in the run-up to the crisis and appear to have
retained their ``too big to fail'' status and the accompanying
implicit guarantee. In addition to morale hazard that results
from ``too big to fail'' status, the implicit guarantee also
has market distorting effects. As columnist George Will
recently wrote, large financial institutions still have ``a
silent subsidy--an unfair competitive advantage relative to
community banks--inherent in being deemed by the Government,
implicitly but clearly, too big to fail.'' \1\
---------------------------------------------------------------------------
\1\ http://articles.washingtonpost.com/2012-10-12/opinions/
35501753_1_banks-andrew-haldane-systemically-important-financial-
institutions
---------------------------------------------------------------------------
Do you believe that the Financial Stability Oversight
Council (FSOC) has the necessary authorities--for example,
under Section 121 of the Dodd-Frank Act--to block expansion and
in some cases mandate divestiture of large financial
institutions to ward against the ``too big to fail'' problem?
Do you believe that FSOC should use its authorities to
order divestiture only in cases of active crisis, or are there
situations in which FSOC's authority to break up large banks
could be done to mitigate against future risks associated with
the ``too big to fail'' problem?
Do you believe there are further steps Congress should take
to fix the ``too big to fail problem?''
A.2. The Dodd-Frank Act provides the U.S. financial authorities
with a wide range of tools to mitigate risks to the U.S.
financial system. One such tool is the authority of the Board
of Governors of the Federal Reserve System under Section 121 to
take remedial measures with respect to certain financial firms
that the Federal Reserve determines pose a grave threat to the
stability of the U.S. financial system. Section 121 provides
that, if the Federal Reserve Board determines that a large bank
holding company or a nonbank financial company supervised by
the Federal Reserve Board poses a grave threat to U.S.
financial stability, then the Federal Reserve Board, upon the
affirmative vote of at least two-thirds of the voting members
of the Council then serving, must take at least one of several
actions, including potentially forbidding the company from
making further acquisitions or requiring the company to sell or
otherwise dispose of assets. While any potential use of this
authority would need to be evaluated on a company-specific
basis, the Dodd-Frank Act does not limit the exercise of
authority under Section 121 of the Dodd-Frank Act to specified
economic conditions.
The reforms put in place by the Dodd-Frank Act provide
regulators with critical tools and authorities that we lacked
before the crisis to resolve large financial firms whose
failure would have serious adverse effects on financial
stability without requiring taxpayer assistance. The emergency
resolution authority for failing firms created under Title II
expressly prohibits any bailout by taxpayers. For any financial
firm that is placed into receivership under this Dodd-Frank
emergency resolution authority, management and directors
responsible for the failed condition of the firm will be
removed and shareholders will be wiped out. In addition, the
law requires the largest bank holding companies to prepare
``living wills'' that provide a roadmap for facilitating a
rapid and orderly bankruptcy.
Financial reform has also required U.S. financial
institutions to become more resilient. Large, interconnected
financial institutions will now be required to hold
significantly higher levels of capital and liquidity. Leverage
is significantly lower, reliance on short-term funding is
lower, and liquidity positions have already improved such that
large firms are less vulnerable in the event of a downturn.
Q.3. In her written testimony to the hearing, the Special
Inspector General for TARP (SIGTARP) Christy Romero discussed
the ``threat of contagion'' to our financial system caused by
the interconnectedness of the largest institutions that existed
in the run-up to the financial crisis.
Do you believe the financial system remains vulnerable to
the interconnectedness of the largest institutions?
What is the Department of the Treasury doing to address
risks that the interconnectedness of large financial
institutions pose to our financial system?
Can you describe the metrics the Department of the Treasury
uses to monitor an institution's interconnectedness and risk
that it may pose to the financial system?
A.3. The financial crisis demonstrated the risks that can arise
when large financial institutions are too interconnected, and
showed that stress can cascade from institution to institution,
placing the entire financial system at risk. The Treasury
Department has been consulting with the financial regulators as
they implement new protections against risks of contagion.
An important area of reform here is Title VII of the Dodd-
Frank Act, which embodies comprehensive reform of derivatives.
For example, the law requires that standardized derivatives
contracts be cleared through a well-regulated central
counterparty, thereby reducing risk to the system. If a
derivatives counterparty fails, its failure is absorbed by the
clearinghouse, which requires appropriate margin for all
cleared derivatives, rather than this risk cascading to other
firms.
The Dodd-Frank Act also limits interconnections among firms
by imposing single-counterparty credit limits for the largest
bank holding companies and nonbank financial companies that are
designated for Federal Reserve Board supervision and enhanced
prudential standards. These rules, when finalized, will
restrict how much credit exposure, including exposure from
derivatives, any one of these financial companies can have to
any other unaffiliated firm. In addition, the Office of the
Comptroller of the Currency (OCC) has acted to limit the impact
of interconnectedness among certain financial institutions
through the enforcement of its lending limits. These limits
were recently strengthened by section 610 of the Dodd-Frank Act
to include derivatives in the calculation.
Q.4. Christy Romero also provided testimony about the need for
large institutions to engage in effective risk management
practices and for regulators to supervise this risk management.
Do you believe the risk management practices at the largest
financial institutions are adequate?
Can you describe what the Department of the Treasury is
doing to supervise the risk management at the largest
institutions?
A.4. I strongly believe in the importance of robust risk
management at all financial companies. The Federal banking
regulators have oversight over risk management as part of their
supervisory authority over financial institutions under their
jurisdiction. Public statements and reported regulatory actions
of the agencies indicate that risk management practices at
large financial institutions is a priority for the agencies.
Further, the Dodd-Frank Act contains important measures to
help safeguard overall financial stability through stronger
risk management practices at financial firms. The law requires
bank holding companies with $50 billion or more in assets and
nonbank financial companies supervised by the Federal Reserve
Board to comply with enhanced prudential standards. These
enhanced prudential standards require large publicly traded
bank holding companies to establish a board-level risk
management committee as part of more stringent enterprise-wide
risk management.
Ultimately, financial institutions make errors of risk and
judgment all the time, and some companies fail because of them.
The test of reform is not whether it can protect banks from
losses, but whether it can prevent broader damage to the
economy and taxpayers.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR JOHANNS
FROM MARY J. MILLER
Q.1. To the extent practicable, please update us as to the
below concerns on how Treasury and the Financial Stability
Oversight Council (FSOC) are approaching the analysis of firms
being considered for nonbank SIFI designation.
Are different metrics being applied in the evaluation of
different business models? For example, are different metrics
being used to evaluate asset managers than those being used to
evaluate insurance companies? To that end, can you assure us
that similarly rigorous standards are being used across all
nonbank business models?
A.1. The Council recognizes that a thorough evaluation of
different types of nonbank financial companies must rely on
different quantitative and qualitative considerations. The
Council has been using a broad range of quantitative and
qualitative information to evaluate nonbank financial
companies, and takes into account company-specific and
industry-specific information as appropriate. For example, the
Council's interpretive guidance notes that financial
guarantors, asset management companies, private equity firms,
and hedge funds may pose risks that are not well-measured by
the same quantitative thresholds as insurance companies or
other entities.
Q.2. Can you estimate the time frame for the first nonbank SIFI
designations to be made public? Do you anticipate them being
made before prudential standards are finalized? If so, why
would you not wait for the rules to be in place before
designations are made?
A.2. I expect that Council will vote on an initial set of
nonbank financial companies for potential designation in the
near term. This may occur before the finalization of relevant
enhanced prudential standards. The specifics of such standards,
however, are not necessary to the Council's consideration,
governed by the criteria set forth in the Dodd-Frank Act, of
whether a nonbank financial company could pose a threat to U.S.
financial stability.
Q.3. In September of last year, the GAO issued a report
containing specific recommendations to strengthen the
accountability and transparency of the FSOC's activities, as
well as to enhance collaboration both amongst FSOC members
themselves and between the council and outside stakeholders. I
am particularly concerned about the recommendation to establish
a collaborative and comprehensive framework for assessing the
impact the designation of nonbank SIFIs will have on not only
the impacted firms, but also the greater economy as a whole.
Has anything been done since this report was issued to address
this particular concern?
A.3. The Council, as described in its final rule regarding
nonbank financial company designations, will annually reassess
whether each designated nonbank financial company continues to
satisfy the statutory standards established by the Dodd-Frank
Act. Additionally, the Council intends to review, at least
every 5 years, the uniform, quantitative thresholds it applies
initially to identify nonbank financial companies for further
evaluation. Moreover, we will review the results of the GAO's
work to assess some of the impacts articulated in their
recommendation and evaluate how these impacts may be relevant
to the statutory criteria that the Council is required to
consider when evaluating nonbank financial companies for
designation.
Q.4. To a similar end, the GAO report also suggested working to
better rationalize rulemakings by using professional and
technical advisors such as State regulators, industry experts,
and academics to assist FSOC in its decision-making process.
What has been done in this regard to ensure that issues
relating to nonbank supervision are being appropriately
reviewed by subject-matter experts in the relevant nonbank
business model?
A.4. Throughout the nonbank financial company designations
process, the Council has engaged with relevant experts and
stakeholders with regard to the business models of firms under
consideration for potential designation. Council members and
their staffs have substantial expertise regarding a broad range
of financial companies and activities. With respect to State
regulators in particular, State banking, State insurance, and
State securities regulators are Council members and participate
actively in the discussions of the Council and its committees.
In addition, the Council is coordinating and consulting with
the relevant primary financial regulators, which, in the case
of insurers, includes the appropriate State insurance
supervisors. Similarly, the Council and OFR have engaged with
market participants in undertaking the analysis of asset
management.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM MARY J. MILLER
Q.1. In a September 2012 report discussing the Financial
Stability Oversight Council (FSOC), the GAO criticizes the
Council's lack of transparency regarding its deliberations on
money market fund regulation and concludes, among other things,
that the Council's minutes from a closed meeting in which the
issue was discussed ``lacked any content of the discussion.''
What steps will you take to make these policy discussions
more transparent to the public?
A.1. The Council appreciates the work of the GAO and the
important oversight function that it provides, and has taken or
plans to take a number of actions in response to the
recommendations made in its September report. Specifically,
with regard to potential money market mutual fund (MMF)
reforms, the Council recently issued proposed recommendations
under Section 120 of the Dodd-Frank Act for public comment. The
proposed recommendations' discussion of the risks posed by
MMFs, and the questions they ask about the proposed reforms,
reflect the Council's deliberations. The initial 60-day comment
period was extended by 1 month to February 15, 2013, and
approximately 150 comments were received on the proposed
reforms.
The Council is firmly committed to transparency and to
holding open meetings, and it closes meetings only when
appropriate. The Council's transparency policy commits the
Council to hold two open meetings each year, and the Council
has held ten open meetings in its first 2\1/2\ years. However,
the Council must continue to balance its responsibility to be
transparent with its central mission to monitor emerging
threats to financial stability. This frequently requires
discussion of supervisory and other market-sensitive data
during Council meetings, including information about individual
firms, transactions, and markets that may only be obtained if
maintained on a confidential basis. Continued protection of
this information is necessary in order to prevent destabilizing
market speculation that could occur if that information were to
be disclosed.
Q.2. What do you generally believe the time frame is for the
first nonbank SIFI designations to occur?
I understand that a few nonbank companies are now in
``Stage 3'' of the review process, but when do you think one or
more of those designations will become final and will be
publicly announced?
A.2. I expect that the Council will vote on an initial set of
nonbank financial companies for potential designation in the
near term. The names of any firms that are designated will be
made public after a final designation.
Q.3. Will nonbank SIFI designations occur before prudential
standards are established for nonbank SIFIs?
If so, designated firms would face uncertainty; why not
wait for rules to be in place before designations are made?
A.3. The first designations may occur before the enhanced
prudential standards are finalized. The Council does not
believe it is necessary or appropriate to postpone the
evaluation of nonbank financial companies pending finalization
of these rules, which are not essential to the Council's
consideration of whether a nonbank financial company could pose
a threat to U.S. financial stability.
Q.4. Section 120 of the Dodd-Frank Act states that ``[t]he
Council shall consult with the primary financial regulatory
agencies [ . . . ] for any proposed recommendation that the
primary financial regulatory agencies apply new or heightened
standards and safeguards for a financial activity or
practice.'' In its November 2012 release on money market fund
regulatory proposals, FSOC states that ``in accordance with
Section 120 of the Dodd-Frank Act, the Council has consulted
with the SEC staff.'' It is my understanding that FSOC did not
consult with any of the SEC Commissioners serving at the time.
Given that the SEC is solely governed by the commissioners,
and especially considering that SEC staff serves at the will of
the SEC Chairman rather than all Commissioners, how would such
consultations with staff fulfill this statutory obligation
going forward?
A.4. In developing its proposed recommendations for money
market mutual fund reform, the Council consulted with the SEC
staff. The Council takes seriously its obligation to consult
with financial regulatory agencies under statutory provisions
such as Section 120 of the Dodd-Frank Act, and the Council
regularly does so. These consultations have been discussions
and coordination with staff, including senior staff, of the
relevant agencies, which is consistent with the traditional way
that agencies Government-wide have performed interagency
consultations under numerous statutes. In addition, the Council
may consult with individuals who lead agencies, whether
individually or as members of an agency board or commission.
Certain of these individuals, including the Chairman of the
SEC, are members of the Council and participate in Council
deliberations. In all cases, the Council welcomes the input of
such individuals.
Q.5. What research has FSOC done to determine the reduction in
assets held in money market funds that could result from the
proposed section 120 recommendations?
Have you done anything to quantify the economic effect of a
substantial shift in assets from prime money market funds to
Treasury money market funds, banks, or unregulated investment
funds?
A.5. Under Section 120 of the Dodd-Frank Act, the Council is
required to ``take costs to long-term economic growth into
account'' when recommending new or heightened standards and
safeguards for a financial activity or practice. If the SEC
accepts a final recommendation issued by the Council regarding
money market mutual fund reform, it is expected that the SEC
would implement the recommendation through a rulemaking,
subject to public comment, that would consider the economic
consequences of the implementing rule as informed by the SEC
staff's own economic study and analysis.
Section VI of the FSOC's proposed recommendations outlines
the Council's preliminary analysis regarding the potential
impact of the proposed reforms on long-term economic growth and
requested comment from the public on that analysis. In that
section, the Council stated that it expects that the proposed
recommendations would significantly reduce the risk of runs on
MMFs and, accordingly, lower the risk of a significant long-
term cost to economic growth. In addition, the Council
recognizes that regulated and unregulated or less-regulated
cash management products other than MMFs may pose risks that
are similar to those posed by MMFs, and that further MMF
reforms could increase demand for non-MMF cash management
products. The Council sought comment on this issue and other
possible reforms that would address risks that might arise from
a migration to non-MMF cash management products.
The Council requested comment on its proposed analysis,
including what, if any, impact the proposed recommendations
could have on investor demand for MMFs. We are in the process
of evaluating the comments the Council received on its proposed
recommendations and will evaluate the costs to long-term
economic growth in light of these comments when formulating a
final recommendation.
Q.6. Regarding the Volcker Rule, some have suggested that the
banking agencies should just go ahead and issue their final
rule without waiting to reach agreement with the Securities and
Exchange Commission and Commodities Futures Trading Commission,
which have to issue their own rules. This scenario could result
in there being more than one Volcker Rule, which would create
significant confusion about which agency's rule would apply to
which covered activity.
Given the statutory directive in Dodd-Frank that Treasury
serve as chief coordinator of this ``coordinated rulemaking,''
can you comment on the current status of these interagency
discussions as well as your thoughts on the possibility of
multiple Volcker Rules?
A.6. Since the issuance of the Council's study on the Volcker
Rule in January 2011, Treasury has been working hard to fulfill
the statutory mandate to coordinate the regulations issued
under the Volcker Rule. To meet this obligation, Treasury staff
actively participate with the three Federal banking agencies
and the SEC and CFTC in the interagency process working to
develop these rules. This process includes regular meetings
which serve as constructive forums for the agencies to
deliberate on key aspects of the rules. This process resulted
in the issuance of proposed regulations that were substantively
identical, demonstrating a substantial commitment among the
agencies to a coordinated approach, and continues as regulators
work to finalize the rules. We take Treasury's role as
coordinator very seriously and remain committed to working with
the rulemaking agencies towards a substantively identical final
rule.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM DANIEL K. TARULLO
Q.1. Given how complex it is to determine whether a trade is a
hedge or a proprietary trade, it appears the real issue is
whether a trade threatens the safety and soundness of the bank.
What benchmark does your agency use to determine whether a
particular activity is or is not ``hedging''? How does your
agency determine whether the trade presents risks to the safety
and soundness of a financial institution?
A.1. Section 619 generally prohibits banking entities from
engaging in proprietary trading for the purpose of profiting
from short-term price movements, and from acquiring or
retaining interests in, or having certain relationships with,
hedge funds and private equity funds. In each case the statute
explicitly provides certain exemptions from these prohibitions,
as well as limitations on permitted activities. Among the
exceptions is an exception for risk-mitigating hedging
activities.
To implement the exception for risk-mitigating hedging
activities, the Federal Reserve Board, the Office of the
Comptroller of the Currency, the Federal Deposit Insurance
Corporation, the Securities and Exchange Commission, and the
Commodity Futures Trading Commission, (the Agencies) proposed
requirements designed to enhance the risk-monitoring and
management of hedging activities and to ensure that these
activities are risk-mitigating. Among the requirements the
Agencies proposed included a requirement that the banking
entity establish and follow formal policies and procedures
governing hedging activities and defining the instruments and
strategies that could be used for hedging, documentation
requirements explaining the hedging strategy, an internal
compliance audit requirement, and requirements that incentive
compensation paid to traders engaged in hedging not reward
proprietary trading. This multifaceted approach was intended to
limit potential abuse of the hedging exemption while not unduly
constraining the important risk management function that is
served by a bank entity's hedging activities.
Determining whether any trading activity represents a risk
to safety and soundness is typically made in connection with
the supervisory process and depends on the specific facts and
circumstances. In accordance with supervisory guidance on risk
management, banks are generally required to have internal
controls and written policies and procedures regarding how
their trading and hedging strategies ensure that all risks are
effectively managed and subject to limits, that risk measures
and prices are independently validated, and that risks are
reported to management as appropriate. The agencies then use
the examination process to review these policies and procedures
as they are applied to the trading and hedging activities of
the firm.
Q.2. Federal Reserve, FDIC, and OCC have issued proposed rules
to implement Dodd-Frank and Basel III capital requirements for
U.S. institutions. Late last year, your agencies pushed back
the effective date of the proposed Basel III rules beyond
January 1, 2013. Given the concerns that substantially higher
capital requirements will have a negative impact on lending,
are your agencies using this extra time to conduct a cost-
benefit analysis about the impact of the proposed rules on the
U.S. economy, availability, and cost of credit, cost of
insurance, and the regulatory burden on institutions, before
implementing the final rules?
A.2. In developing the Basel III-based capital requirements,
the Board and the other Federal banking agencies conducted an
impact analysis based on regulatory reporting data to estimate
the change in capital that banking organizations would be
required to hold to meet the proposed minimum capital
requirements. Based on the agencies' analysis, the vast
majority of banking organizations currently would meet the
fully phased-in minimum capital requirements. The agencies
proposed a transition period that would allow those
organizations that would not meet the proposed minimum
requirements to adjust their capital levels. In addition,
quantitative analysis by the Macroeconomic Assessment Group, a
working group of the Basel Committee on Banking Supervision,
found that the stronger Basel III capital requirements would
lower the probability of banking crises and their associated
economic output losses while having only a modest negative
impact on gross domestic product and lending costs, and that
the potential negative impact could be mitigated by phasing in
the requirements over time.
The agencies received over 2,500 comment letters regarding
the proposals. The original comment period was extended to
allow interested persons more time to understand, evaluate, and
prepare comments on the proposals. The Board explicitly sought
comment on significant alternatives to the proposed
requirements applicable to covered small banking organizations
that would minimize their impact on those entities, as well as
on all other aspects of its analysis. The Board is carefully
considering the commenters' views on and concerns about the
effects of the notices of proposed rulemaking on the U.S.
economy and on banking organizations. Prior to adopting any
final rule, the Board will conduct a final regulatory
flexibility analysis under the Regulatory Flexibility Act. \1\
---------------------------------------------------------------------------
\1\ 5 U.S.C. 601, et seq.
---------------------------------------------------------------------------
Before issuing any final rule, the Board will also prepare
an analysis under the Congressional Review Act (CRA). \2\ As
part of this analysis, the Board will assess whether the final
rule is a ``major rule,'' meaning the rule could (1) have an
annual effect on the economy of $100 million or more; (2)
increase significantly costs or prices for consumers,
individual industries, Federal, State, or local government
agencies, or geographic regions; or (3) have significant
adverse effects on competition, employment, investment,
productivity, or innovation. Consistent with the CRA, any such
analysis will be provided to Congress and the Government
Accountability Office.
---------------------------------------------------------------------------
\2\ 5 U.S.C. 801-808.
Q.3. Given the impact that the Qualified Mortgages (QM) rules,
the proposed Qualified Residential Mortgages (QRM) rules, the
Basel III risk-weights for mortgages, servicing, escrow, and
appraisal rules will have on the mortgage market and the
housing recovery, it is crucial that these rules work in
concert. What analysis has your agency conducted to assess how
these rules work together? What is the aggregate impact of
those three rules, as proposed and finalized, on the overall
---------------------------------------------------------------------------
mortgage market as well as on market participants?
A.3. The Dodd-Frank Act requires the Federal banking agencies
and other agencies to implement a number of requirements that
relate to mortgages and the mortgage market, such as those you
note in your question. The agencies are mindful of the
interaction and interrelationship of these requirements as we
develop rules to implement these statutory provisions.
For example, the Board is required under section 941 of the
Dodd-Frank Act, along with six other agencies (including the
Federal banking agencies), to implement risk retention
requirements and define QRM as an exemption to those
requirements. By statute, all entities that meet the statutory
definition of ``securitizer'' must meet the risk retention
requirements. Under section 941, the definition of QM serves as
the outer limit of the definition of QRM. The Board and the
other agencies that must implement section 941 are currently
discussing how to define QRM in light of the CFPB's recent
determination of the final definition of QM.
In the proposed rulemakings to revise regulatory capital
requirements released in June 2012, the Board and the other
Federal banking agencies proposed to revise the risk weighting
for residential mortgages based on loan characteristics and
loan-to-value ratio. These requirements would apply to banks,
bank holding companies, and savings and loan holding companies.
The Board and the other banking agencies have received many
comments on the proposed risk weights for mortgages and the
Board is carefully taking into consideration the concerns
raised in those comments, including concerns regarding
compliance burden from various mortgage-related regulations,
and the effect of these proposals on the availability of
mortgage credit, in its discussions with the other agencies on
how to move the proposed rulemakings forward.
The Board has long been committed to considering the costs
and benefits of its rulemaking efforts and takes into account
all comments and views from the public on the costs and
benefits of a proposed rulemaking. The Board is sensitive to
concerns that various regulatory changes could lead to more
expensive mortgages and reduce access to credit, and will
carefully consider all comments on rulemakings in which it
participates.
Q.4. Under the Basel III proposals, mortgages will be assigned
to two risk categories and several subcategories, but in their
proposals the agencies did not explain how risk weights for
those subcategories are determined and why they are
appropriate. How did your agency determine the appropriate
range for those subcategories?
A.4. During the recent market turmoil, the U.S. housing market
experienced significant deterioration and unprecedented levels
of mortgage loan defaults and home foreclosures. The causes for
the significant increase in loan defaults and home foreclosures
included inadequate underwriting standards, the proliferation
of high-risk mortgage products, expansion of the practice of
issuing mortgage loans to borrowers with undocumented income,
and a precipitous decline in housing prices coupled with a rise
in unemployment.
In the capital proposal, the agencies sought to improve the
risk sensitivity of the regulatory capital rules for mortgages
by raising capital requirements for risker mortgages, including
nontraditional product types, while lowering requirements on
traditional residential mortgage loans with lower credit risk.
The ranges of the factors were developed on an interagency
basis utilizing expert supervisory judgments including policy
experts and bank examiners. The agencies also considered
supervisory and mortgage market data in the formulation of
these risk weights, which are generally comparable to the risk
weights assigned to mortgage exposures by banking organizations
that use the internal ratings based methodology.
The Board and the other agencies have received many
comments on the mortgage proposals and the Board is carefully
taking these comments into consideration in determining capital
requirements for mortgages.
Q.5. The Senate Banking Committee Report on Dodd-Frank made it
clear that the law did not mandate insurers use GAAP
accounting. However, the proposed Basel III rules would require
insurance enterprises to switch to GAAP. How will this change
impact insurance companies, both practically and financially?
A.5. The proposed capital requirements would apply on a
consolidated basis to bank holding companies and savings and
loan holding companies (SLHCs), some of which are primarily
engaged in the insurance business. Currently, capital
requirements for insurance companies are imposed by State
insurance laws on a legal entity basis and there are no State-
based, consolidated capital requirements that cover holding
companies for insurance firms.
In the proposals, the Board sought to meet the legal
requirements of section 171 of the Dodd-Frank Act while
incorporating flexibility for depository institution holding
companies significantly engaged in the insurance business.
Section 171 of the Dodd-Frank Act requires the agencies to
apply consolidated minimum risk-based and leverage capital
requirements for depository institution holding companies,
including SLHCs, that are no less than the generally applicable
capital requirements that apply to insured depository
institutions under the prompt corrective action framework. The
``generally applicable'' rules use generally accepted
accounting principles (GAAP) as the basis for regulatory
capital calculations.
The proposed requirement that SLHCs calculate their capital
standards on a consolidated basis using a framework that is
based on GAAP standards is consistent with section 171 of the
Dodd-Frank Act and would facilitate comparability across
institutions. In contrast, the statutory accounting principles
(SAP) framework for insurance companies is a legal entity-based
framework and does not provide consolidated financial
statements.
The Board received many comments on the proposed
application of consolidated capital requirements to savings and
loan holding companies, including on cost and burden
considerations for those firms that currently prepare financial
statements based solely on SAP. The Board will consider these
comments carefully in determining how to apply regulatory
capital requirements to bank holding companies and SLHCs with
insurance operations consistent with section 171 of the Dodd-
Frank Act.
Q.6. Pursuant to Dodd-Frank, FSOC can designate as Systemically
Important Financial Institution (SIFI) certain nonbank
financial companies that are ``predominately engaged in
financial activities,'' resulting in extra scrutiny for that
company. There were considerable concerns during the Dodd-Frank
debate that a broad definition would encompass too many
entities. In April of last year those concerns were reaffirmed
when the Federal Reserve's proposed definition captured many
activities not traditionally viewed as financial or
systemically risky. Does the Federal Reserve intend to
reconsider its proposed definition of ``predominately engaged
in financial activities'' to address concerns raised in public
comment letters?
A.6. The Dodd-Frank Act defines the type of firm that is
eligible to be designated by the Financial Stability Oversight
Council (FSOC) for enhanced supervision by the Board. These
provisions apply only to firms that derive 85 percent or more
of their annual gross revenues from financial activities or
have 85 percent or more of the firm's consolidated assets in
assets related to financial activities. \3\ For purposes of
these provisions, financial activities are defined by reference
to section 4(k) of the Bank Holding Company Act (BHC Act). \4\
---------------------------------------------------------------------------
\3\ Section 102(a)(6) of the Dodd-Frank Act; 12 U.S.C.
5311(a)(6).
\4\ Id.
---------------------------------------------------------------------------
In April 2012, the Board invited public comment on a
proposed rule implementing these provisions (the April 2012
proposal). The April 2012 proposal noted that the list of
financial activities published by the Board in its Regulation Y
incorporates various conditions that the Board has imposed on
bank holding companies to ensure that they engage in these
financial activities in a safe and sound manner. Other
conditions were imposed by the Board because they were required
by other provisions of law, such as the Glass-Steagall Act. The
April 2012 proposal sought comment on whether any of these
conditions were essential to the definition of an activity as
financial. As you note, the public provided a number of
comments on the Board's proposal, including with respect to the
scope of the proposed definitions and the treatment of
physically settled derivatives transactions. The Board
carefully considered these comments in formulating the final
rule, which the Board approved on April 3, 2013. The final rule
made a number of modifications to address concerns raised by
commenters, including changes that reduced the scope of the
original proposal. It is important to note that the Board's
regulation defining activities that are ``financial'' is based
on the list of financial activities referenced by Congress in
the Dodd-Frank Act, and that the conduct of these financial
activities does not itself create any burden or obligation on
any entity until and unless the FSOC determines, in accordance
with the standards and procedures set forth in the Dodd-Frank
Act, that the entity could pose a threat to the financial
stability of the United States.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM DANIEL K. TARULLO
Q.1. As you know, a number of people including Sheila Bair have
been advocates of using a simple leverage ratio as the primary
measure of banks' capital strength. Would focusing on a simple
leverage ratio, using the Basel III definition of leverage
which includes key off balance sheet exposures, help cut
through the noise of risk weighting and models and cross border
differences, and give us all greater confidence that large
banks are holding a good amount of high quality capital?
A.1. Strong capital regulation is central to an effective
prudential regulatory regime for financial institutions.
Experience has shown that no single form of capital requirement
captures all relevant risks and, standing alone, any capital
requirement is subject to sometimes extensive regulatory
arbitrage. Consequently, banking regulation evolved
historically from a primary reliance on simple leverage ratios
to a dual focus on both leverage and risk-weighted capital
requirements. These requirements must be complementary and
mutually reinforcing. This relationship has obviously been
changed by the substantial increase in the risk-based ratio
resulting from the new minimum and conservation buffer
requirements of Basel III. The existing U.S. leverage ratio
does not take account of off-balance-sheet assets, which are
significant for many of the largest firms. The new Basel III
leverage ratio does include off-balance-sheet assets, but it
may have been set too low. Thus, the traditional
complementarity of the capital ratios might be maintained by
using Section 165 to set a higher leverage ratio for the
largest firms. Additionally, it is important to note that the
stress testing regime for large banks established by the
Federal Reserve, consistent with its mandate under Dodd-Frank,
provides an important additional capital measure--one that is
both risk-sensitive and, unlike traditional capital measures,
forward looking.
Q.2. The FDIC and Fed have joint jurisdiction over the
completion of living wills from large firms. Now, I don't think
anyone expected the first year of plans to be perfect, but can
you remind everyone, for the FDIC and Fed to approve the plans,
isn't the standard that they have to show how normal
liquidation like bankruptcy or FDIC resolution could work under
reasonable circumstances? And what progress have the plans made
in getting firms to think through their structure, better
inform you as regulators, and lead to simplification and
rationalization?
A.2. The Dodd-Frank Act requires the Federal Deposit Insurance
Corporation and the Federal Reserve Board (the ``agencies'') to
review the resolution plans, or ``living wills,'' filed by the
firms and to notify a firm that its plan is deficient if the
agencies jointly determine that the plan is not credible or
would not facilitate an orderly liquidation of the firm under
Title 11 of the U.S. bankruptcy code. The agencies issued a
joint final rule implementing the living wills requirement in
November 2011.
The agencies have received resolution plans from 11 of the
largest and most complex firms. These plans constitute the
first step in an iterative process and will provide the
foundation for developing increasingly robust annual resolution
plans. The initial submissions focused on the key elements set
out in the joint rule, including identifying critical
operations and core business lines, developing a robust
strategic analysis, and identifying and describing the
interconnections and interdependencies among the firm's
material entities.
The economic circumstances that could accompany the
financial distress or failure of a firm in the future are not
knowable in advance. Nonetheless, a resolution plan should be
sensitive to the economic conditions surrounding the financial
distress or failure of a firm. To assist in establishing
assumptions for economic conditions surrounding a firm's
financial distress or failure, filers are required to take into
account that the firm's material financial distress or failure
could occur under the ``baseline,'' ``adverse,'' and ``severely
adverse'' economic conditions developed by the Federal Reserve
Board pursuant to stress test requirements of section
165(i)(1)(B) of the Dodd-Frank Act. Firms were permitted to
assume that failure would occur only under the baseline
scenario for their initial submission with the expectation that
subsequent iterations of the resolution plans would begin to
address the other scenarios. As part of the iterative planning
process, the agencies expect to evaluate the effectiveness of
the scenarios in calibrating plan sensitivity to economic
conditions surrounding the financial distress or failure of a
firm.
The firms devoted a significant amount of time and
resources in developing their initial resolution plans as well
as in establishing the processes, procedures, and systems
necessary for annual updates. Moreover, the agencies have been
engaged in an ongoing dialogue with these firms to develop,
focus, and clarify their plans. Our initial interactions with
the firms demonstrate clearly that preparing resolution plans
is helping the firms and the supervisors learn a great deal
about the organizational structure, inter-relationships, and
exposures of these firms.
Q.3. I believe that the Basel III accords are an important tool
for reducing risks within the financial system and ensuring
level playing fields in international markets. However, I am
concerned that there are a number of areas where the agreements
and the Federal Reserve's proposals for implementing them have
not been adequately tailored to recognize differences in
accounting standards in the U.S. and other jurisdictions and
the variety of business models in the U.S. Can you describe
what steps the Federal Reserve is taking to tailor the
proposals to the insurance business model?
A.3. Section 171 of the Dodd-Frank Act requires that the
Federal Reserve Board (the ``Board'') establish minimum
leverage capital requirements and minimum risk-based capital
requirements for depository institution holding companies and
for financial companies designated by the Financial Stability
Oversight Council that are not less than the leverage and risk-
based capital requirements that were generally applicable to
banks and savings associations on July 21, 2010. In developing
these capital requirements, the Board sought to meet the
requirements of the Dodd-Frank Act, to promote capital adequacy
at all depository institution holding companies, and, to the
extent permitted by section 171, to incorporate adjustments for
depository institution holding companies significantly engaged
in the insurance business. In that regard, the Board invited
public comment on proposals to address the unique character of
insurance companies through specific risk weights for policy
loans and nonguaranteed separate accounts, which are typically
held by insurance companies, but not banks. The proposals also
would allow the inclusion of surplus notes, a type of financial
instrument issued primarily by insurance companies, in tier 2
capital, provided that the notes meet the relevant eligibility
criteria.
The Board received numerous comments on the capital
requirements proposed last year as they would apply to
insurance companies and is carefully considering information
provided and the concerns raised by commenters.
Q.4. Can you describe the steps the Federal Reserve is taking
to ensure that community and midsize banks are not forced to
comply with complex standards better suited to larger and more
complex institutions?
A.4. In developing safety and soundness rules, the Federal
Reserve Board and the other Federal banking agencies must
strike the right balance between safety and soundness concerns
and the costs associated with implementation, including the
impact on community banking. It is important to note that
numerous items in the Basel III proposal, and in other recent
regulatory reforms, are focused on larger institutions and
would not be applicable to community banking organizations.
These items include the countercyclical capital buffer, the
supplementary leverage ratio, enhanced disclosure requirements,
the advanced approaches risk-based capital framework, stress
testing requirements, the systemically important financial
institution capital surcharge, and market risk capital reforms.
This targeted approach should improve the competitive balance
between large and small banks, while improving the overall
resiliency of the financial sector.
Midsize banking organizations are also exempt from most of
the requirements referred to above, including the
countercyclical capital buffer, the supplementary leverage
ratio, and the advanced-approaches risk-based capital
framework. However, they would need to meet basic stress
testing requirements that have been specifically tailored as
required by the Dodd-Frank Act, for the midsize banking
business model, as finalized in October 2012. These
requirements are less stringent than the stress testing
framework applied to banking organizations with more than $50
billion in assets. Additionally, midsize banks have been given
a longer time frame to meet these requirements than their
larger counterparts.
Q.5. What steps is the Federal Reserve taking to examine the
appropriateness and impact of the risk weights for mortgage-
backed securities including those that contain nonrecourse
loans?
A.5. During the recent market turmoil, the U.S. housing market
experienced significant deterioration and unprecedented levels
of mortgage loan defaults and home foreclosures, which, in
turn, caused mortgage-backed securities (MBS) to incur
unprecedented losses. The causes for the significant increase
in loan defaults and home foreclosures included inadequate
underwriting standards, the proliferation of high-risk mortgage
products, the practice of issuing mortgage loans to borrowers
with undocumented income and a precipitous decline in housing
prices coupled with a rise in unemployment.
In the capital proposal, the Federal Reserve Board and the
other Federal banking agencies (the ``agencies'') sought to
improve the risk sensitivity of the regulatory capital rules
for mortgages by raising capital requirements for risker
mortgages, including nontraditional product types, while
lowering requirements on traditional residential mortgage loans
with lower credit risk. The ranges of the factors were
developed on an interagency basis utilizing expert supervisory
judgments including policy experts and bank examiners. The
agencies also considered supervisory and mortgage market data
in the formulation of these risk weights, which are generally
comparable to the risk weights assigned to mortgage exposures
by banking organizations that use the internal ratings based
methodology.
The agencies received numerous comment letters on the
proposals for risk weighting mortgages. The Federal Reserve
Board is carefully considering the commenters' views on and
concerns about the effects of the proposed mortgage treatment
on the U.S. economy and on banking organizations.
Q.6. What progress is being made to ensure that Basel III is
implemented with a reasonable degree of uniformity and
transparency across jurisdictions?
A.6. The Federal Reserve Board has consistently favored a
uniform and transparent implementation of the Basel III reforms
across jurisdictions. To this end, staff has contributed to
international assessments organized by the Basel Committee of
the participating financial jurisdictions and highlighted any
divergences they encountered in their assessments. Similarly,
our international colleagues are tracking progress by the
United States to meet the reforms. We remain committed to
ensuring consistent implementation, as this decreases
opportunities for cross-border regulatory arbitrage and keeps
U.S. banks on equal footing with their foreign competitors.
Q.7. The statutory language for funds defined under the Volcker
Rule pointedly did not include venture funds, however the
definition in the proposed rule seemed to indicate that venture
funds would be covered. In addition to exceeding the statutory
intent of Congress, this has created uncertainty in the market
as firms await a final rule and refrain from making commitments
which might be swept up in the final version of the Volcker
Rule. Can you clarify whether venture funds are covered by the
Volcker Rule?
A.7. One of the restrictions in section 619 applies to hedge
and private equity funds and prohibits a banking entity from
acquiring or retaining an interest in, or having certain
relationships with, hedge funds and private equity funds,
subject to certain exemptions. Section 619 specifically defines
the terms ``hedge fund'' and ``private equity fund'' to mean an
issuer that would be an investment company as defined in the
Investment Company Act of 1940, but for section 3(c)(1) or
3(c)(7) of that Act, or such similar funds as the Federal
Reserve Board, the Office of the Comptroller of the Currency,
the Federal Depository Insurance Corporation, the Securities
and Exchange Commission, and the Commodity Futures Trading
Commission (the ``agencies'') may, by rule, determine.
See 12 U.S.C. 1851(h)(2). The statutory language contains
no reference to venture capital funds. The agencies requested
comment on whether venture capital funds should be excluded
from the definition of covered fund, and, if so, what scope of
authority the agencies have under the statute to exempt venture
capital funds, and how to define venture capital fund. The
agencies received over 18,000 comments regarding the proposed
implementing rules, including comments that specifically
addressed the issues of venture capital funds and venture
capital investments. The agencies are currently considering
these comments as we work to finalize implementing rules.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM DANIEL K. TARULLO
Q.1. As you know, the Federal Reserve and the Office of the
Comptroller of the Currency (OCC) recently announced
settlements with mortgage servicers subject to consent orders
issued by the Federal Reserve and the OCC in April 2011
regarding unsafe and unsound practices related to residential
mortgage loan servicing and foreclosure processing. The terms
of the settlement include $3.6 billion in cash payments to more
than 4 million borrowers and $5.7 billion in additional
assistance.
Can you explain in what situations the Board of Governors
of the Federal Reserve votes on whether to accept a settlement?
A.1. Under the Federal Reserve Board's (the Board) Rules
Regarding Delegation of Authority, there is delegated authority
for Board staff to enter into or approve modifications to
consent cease-and-desist orders, such as the recently announced
agreements with mortgage servicers (12 CFR 265.6(e)(1) and
(e)(2)). Any Board member may request review of any delegated
action (12 CFR 265.3(a)). In many cases, including matters
involving significant enforcement actions, such as the mortgage
servicer agreements, staff with delegated approval authority
consult with members of the Board prior to exercising that
authority to obtain their views on whether consideration by the
Board is appropriate.
Q.2. When no vote occurs, can you indicate what official at the
Federal Reserve has decision-making authority over whether to
accept a settlement?
A.2. The Board's general counsel (or his delegee), with the
concurrence of the director of the Board's Division of Banking
Supervision and Regulation (or his delegee), has delegated
authority to approve consent cease-and-desist orders as well as
modifications to consent cease-and-desist orders, such as the
recently announced agreements with mortgage servicers (12 CFR
265.6(e)(1) and (e)(2)).
Q.3. Did a vote occur with this particular settlement?
A.3. Board staff frequently consulted with Board members before
exercising delegated authority to approve the amendments to the
foreclosure consent orders. A vote did not occur.
Q.4. It has been more than 4 years since policy makers began
focusing on how to fix the ``too big to fail'' problem and
eliminate the implicit guarantee that, in a time of crisis, the
Federal Government would bail out large financial institutions
instead of letting them fail and pose a systemic threat to the
economy. Nonetheless, the big banks now are even bigger than
they were in the run-up to the crisis and appear to have
retained their ``too big to fail'' status and the accompanying
implicit guarantee. In addition to morale hazard that results
from ``too big to fail'' status, the implicit guarantee also
has market distorting effects. As columnist George Will
recently wrote, large financial institutions still have ``a
silent subsidy--an unfair competitive advantage relative to
community banks--inherent in being deemed by the Government,
implicitly but clearly, too big to fail.''
Do you believe that the Financial Stability Oversight
Council (FSOC) has the necessary authorities--for example,
under Section 121 of the Dodd-Frank Act--to block expansion and
in some cases mandate divestiture of large financial
institutions to ward against the ``too big to fail'' problem?
A.4. The Dodd-Frank Act contains a number of provisions that
are intended to address potential threats to U.S. financial
stability and address the ``too big to fail'' problem. Of
course, the Financial Stability Oversight Council (FSOC) has
the authority under section 113 to subject a nonbank financial
company to supervision by the Federal Reserve Board (Board) if
the FSOC determines that the company's material financial
distress or its activities could pose a threat to U.S.
financial stability. The FSOC has implemented a robust process
for assessing threats posed by nonbank financial companies and
is actively reviewing companies pursuant to that process.
The Dodd-Frank Act also has a variety of provisions that
address the growth of large financial companies. Section 622
imposes a concentration limit on large financial companies,
including banks, bank holding companies, savings and loan
holding companies, companies that control an insured depository
institution, nonbank financial companies designated by the FSOC
for supervision by the Board, and foreign banks treated as bank
holding companies. Under this statutory limit, a large
financial company may not merge, consolidate with, or acquire
all or substantially all of the assets or control of another
company, if the total consolidated liabilities of the resulting
company would exceed 10 percent of the liabilities of all large
financial companies.
In addition, the Dodd-Frank Act revised various provisions
of the banking laws to require the Federal banking agencies to
consider the risk that acquisitions of insured depository
institutions and large nonbanking entities pose to the
stability of the U.S. banking or financial system. For example,
section 163 of the Dodd-Frank Act requires large bank holding
companies and nonbank financial companies supervised by the
Board to provide prior notice to the Board of a proposed
acquisition of ownership or control of any voting shares of a
financial company with assets of $10 billion or more, so that
the Board may consider the extent to which the proposed
acquisition would result in greater or more concentrated risks
to global or U.S. financial stability or the U.S. economy.
Section 121 authorizes the Board, with consent of two-
thirds of the voting members of the FSOC, to take certain steps
if the Board determines that a large bank holding company or a
nonbank financial company supervised by the Board poses a grave
threat to the financial stability of the United States. These
steps include limiting the ability of the company to grow
through mergers or acquisitions, restricting the ability of the
company to offer financial products, requiring the termination
of certain activities, or imposing conditions on the manner in
which the company conducts one or more activities. If the Board
determines that these actions are inadequate to mitigate a
threat to U.S. financial stability, the Board, with the consent
of the FSOC, may require the company to sell or otherwise
transfer assets to unaffiliated entities.
These provisions of the Dodd-Frank Act, in combination with
other provisions that establish an orderly liquidation
mechanism and enhanced prudential standards for large financial
institutions, represent important developments in addressing
threats posed by large financial companies to U.S. financial
stability. As implementation of the Dodd-Frank Act currently
remains underway, the Board believes that it is too early to
determine whether further legislative action is necessary.
Q.5. Do you believe that FSOC should use its authorities to
order divestiture only in cases of active crisis, or are there
situations in which FSOC's authority to break up large banks
could be done to mitigate against future risks associated with
the ``too big to fail'' problem?
A.5. As described previously, section 121 of the Dodd-Frank Act
authorizes the Board to take certain actions, with the approval
of two-thirds of the FSOC, to restrict an institution's
activities if the company poses a grave threat to U.S.
financial stability. The Board may require the institution to
divest assets if such action is necessary to mitigate the grave
threat posed by the company. This authority requires a finding
that the firm poses a grave threat to U.S. financial stability,
and does not require a finding that the financial system is in
active crisis.
Q.6. Do you believe there are further steps Congress should
take to fix the ``too big to fail problem''?
A.6. The Dodd-Frank Act and Basel III provide a number of
important tools for addressing the ``too big to fail'' problem,
including enhanced prudential standards and higher capital
requirements for bank holding companies with total consolidated
assets of $50 billion or more and nonbank financial companies
designated by the FSOC for Board supervision, an orderly
resolution authority for large financial firms, living wills,
stress testing, and central clearing and margin requirements
for derivatives, among other provisions. The Board and other
U.S. regulators are now in the process of implementing these
reforms.
In addition, as described previously, section 622 of the
Dodd-Frank Act imposes a concentration limit on large financial
companies that provides that a large financial company may not
merge, consolidate with, or acquire all or substantially all of
the assets or control of another company, if the total
consolidated liabilities of the resulting company would exceed
10 percent of the liabilities of all large financial companies.
In addition, the Board and the other Federal banking agencies
are required to consider the risk to the stability of the U.S.
banking or financial system of a proposed merger or acquisition
involving bank holding companies and insured depository
institutions.
Completion of this agenda will be very significant. Still,
I believe that more is needed, particularly in addressing the
risks posed by short-term wholesale funding markets. We should
be considering ways to use our existing authority in pursuit of
three complementary ends: (1) ensuring the loss absorbency
needed for a credible and effective resolution process, (2)
augmenting the going-concern capital of the largest firms, and
(3) addressing the systemic risks associated with the use of
wholesale funding.
Q.7. In her written testimony to the hearing, the Special
Inspector General for TARP (SIGTARP) Christy Romero discussed
the ``threat of contagion'' to our financial system caused by
the interconnectedness of the largest institutions that existed
in the run-up to the financial crisis.
Do you believe the financial system remains vulnerable to
the interconnectedness of the largest institutions?
A.7. As demonstrated in the 2007-2008 financial crisis,
interconnectedness among large financial institutions poses
risks to financial stability. The effects of one large
financial institution's failure or near collapse may be
transmitted and amplified by bilateral credit exposures between
large, systemically important companies. And even in the
absence of direct bilateral relationships, the failure of a
large financial institution can place other financial
institutions under stress because of indirect relationships.
For example, following the failure of a large financial
institution, short-term creditors may try to reduce their
exposure to other firms, depriving those firms of liquidity.
While there are a number of efforts underway to improve the
stability and resiliency of our financial system (see below),
interconnectedness among large financial institutions still
poses risk to the financial system.
As we implement financial reform, however, it is important
to note that interconnectedness is also a means by which
financial and economic activity is intermediated throughout the
financial system. Accordingly, efforts to address risks posed
by interconnectedness must strike a balance between the goals
of reducing systemic risk and preserving the ability of the
financial sector to provide credit to households and
businesses.
Q.8. What is the Department of the Treasury doing to address
risks that the interconnectedness of large financial
institutions pose to our financial system?
A.8. A number of regulatory initiatives are underway to limit
the risks that interconnectedness poses to the financial
system.
First, more robust prudential standards for financial
institutions will likely mitigate risks associated with
interconnectedness, both by (a) reducing the probability that
any given financial institution will fail and (b) increasing
the ability of other financial institutions to absorb the
knock-on effects of such failure. Thus, Basel III capital and
liquidity standards should reduce the chances of the kind of
financial distress among large financial institutions observed
in 2008. The Basel III reforms, in particular, will increase
the amount of capital banks are required to hold against
exposures to other financial firms and against over-the-counter
derivatives exposures. The single-counterparty concentration
limits required under section 165(e) of the Dodd-Frank Act will
also serve as a check on interconnectedness. Under the Board's
proposal to implement that section, exposures between major
covered companies and major counterparties would be subject to
a tighter limit than other exposures, reducing the risks that
arise from interconnectedness among the largest firms.
Certain market reforms that are underway will also limit
interconnectedness. Among these, derivative market reforms,
including clearing requirements and margin requirements on
uncleared derivatives, will reduce the direct credit exposure
that large financial institutions have with each other through
derivative transactions.
Finally, the supervisory process has changed since 2008 to
more closely monitor and evaluate the connections that large
financial institutions maintain with each other, putting
supervisors in a better position to respond to
interconnectedness.
Q.9. Can you describe the metrics the Department of the
Treasury uses to monitor an institution's interconnectedness
and risk that it may pose to the financial system?
A.9. Interconnectedness among financial institutions arises
from a number of distinct sources, including connections
through asset markets and funding channels. As a result, the
interconnectedness and risk of a financial institution must be
characterized using an approach that is both holistic and
systemic, but that also adapts to changing conditions and
market practices.
The Board is now engaged in a number of information
collections that are aimed at better assessing the risk and
interconnectedness of large financial institutions. For
example, the supervisory stress tests that inform the
comprehensive capital plan and review inform our view on the
risk profile of large banks. The stress tests can be useful for
identifying banks that are interconnected through common asset
exposures that are revealed during periods of financial stress,
which is when interconnectedness presents the greatest risk to
the financial system.
As another example, the Board, along with other supervisors
from other jurisdictions, has begun to collect data on the
activities of large banks to help calibrate a capital surcharge
for systemically important banks. These data include data on
interconnectedness, which will play an important role in
determining the overall capital surcharge.
Q.10. Christy Romero also provided testimony about the need for
large institutions to engage in effective risk management
practices and for regulators to supervise this risk management.
Do you believe the risk management practices at the largest
financial institutions are adequate?
A.10. In general, risk management practices and risk governance
at the largest financial institutions have improved
significantly since the crisis. They must constantly evolve,
however, to keep pace with a complex and highly dynamic
financial system. Our annual review of the capital planning
processes of the largest firms provides us a regular occasion
for assessing many of these practices, and, where appropriate,
requiring improvements.
Q.11. Can you describe what the Department of the Treasury is
doing to supervise the risk management at the largest
institutions?
A.11. Risk management is a key focus of the Board's supervision
of the largest bank holding companies. This is evidenced in
several ways, including but not limited to:
Risk management is one of the key criteria by which
large bank holding companies are rated for supervisory
purposes.
The importance of robust risk management is
highlighted throughout the recently revised guidance on
consolidated supervision of large bank holding
companies (SR 12-17).
Supervisors routinely review and assess aspects and
components of risk management when conducting exams,
which are conducted at the largest bank holding
companies on a near continual basis throughout the
year.
The qualitative assessment component of the
Comprehensive Capital Assessment and Review (CCAR)
focuses significantly on firms' risk management
practices, including with respect to stress testing.
Of course, the Board's supervision of firms' risk
management is not and cannot be a substitute for firms' own
risk management practices and governance.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM DANIEL K. TARULLO
Q.1. In response to concerns that the bank-centric Basel III
capital standards are unworkable for insurers, the Fed has
indicated that it would perform some tailoring of those
standards. However, there is continuing concern among the life
insurance industry that the proposed tailoring is inadequate
and does not properly acknowledge the wide differences between
banking and insurance.
What kinds of more substantive changes will the Fed
consider to the Basel III rulemaking to prevent negative
impacts to insurers and the policyholders, savers, and retirees
that are their customers?
A.1. Section 171 of the Dodd-Frank Act requires that the
Federal Reserve Board (the Board) establish minimum leverage
capital requirements and minimum risk-based capital
requirements for depository institution holding companies and
for financial companies designated by the Financial Stability
Oversight Council that are not ``less than'' the minimum
capital requirements for insured depository institutions. On
June 7, 2012, the Board and the other Federal banking agencies
proposed to revise their risk-based and leverage capital
requirements in three notices of proposed rulemaking (NPRs),
consistent with this statutory requirement.
The NPRs proposed flexibility to address the unique
character of insurance companies through specific risk weights
for policy loans and nonguaranteed separate accounts, which are
typically held by insurance companies, but not banks. These
specific risk weights were designed to apply appropriate
capital treatments to assets particular to the insurance
industry while complying with the requirements of section 171
of the Dodd-Frank Act.
The Board is carefully considering the comments it has
received regarding the application of section 171 of the Dodd-
Frank Act to savings and loan holding companies and bank
holding companies that are significantly engaged in the
insurance business. We will continue to consider these issues
seriously, as well as the potential implementation challenges
for depository institution holding companies with insurance
operations, as we determine how to move forward with respect to
the proposed capital requirements.
Q.2. There is also a concern that the bank standards are a
dramatic departure from the duration matching framework common
to insurance supervision.
What is your response to that concern and would the Fed
consider doing more than just tailoring bank standards?
Do you believe that, from an insurance perspective, Basel
III bank standards are an incremental or dramatic departure
from current insurance standards?
A.2. As discussed in the above answer, the Board developed the
proposed capital requirements to meet the requirements of the
Dodd-Frank Act, to promote capital adequacy at all depository
institution holding companies, and, to the extent permitted by
section 171, to incorporate adjustments for depository
institution holding companies significantly engaged in the
insurance business. The Board has received numerous comments on
the proposals with respect to insurance companies. Many of
these comments discuss suggestions for other approaches to
applying regulatory capital standards to depository institution
holding companies that have significant insurance operations.
The Board is carefully considering all of these comments.
Q.3. Regarding the Volcker Rule, some have suggested that the
banking agencies should just go ahead and issue their final
rule without waiting to reach agreement with the Securities and
Exchange Commission and Commodities Futures Trading Commission,
which have to issue their own rules. This scenario could result
in there being more than one Volcker Rule, which would create
significant confusion about which agency's rule would apply to
which covered activity.
Do you agree that there should be only one Volcker Rule?
A.3. While section 619(b)(2) of the Dodd-Frank Act divides
authority for developing and adopting regulations to implement
its prohibitions and restrictions between the Federal Reserve
Board, the Office of the Comptroller of the Currency, the
Federal Deposit Insurance Corporation, the Securities and
Exchange Commission, and the Commodity Futures Trading
Commission, (the Agencies) based on the type of entities for
which each agency is explicitly charged or is the primary
financial regulatory agency, the rule proposed by the Agencies
to implement section 619 contemplates that firms will develop
and adopt a single, enterprise-wide compliance program and that
the Agencies would strive for uniform enforcement of section
619. To enhance uniformity in both the rules that implement
section 619 and administration of the requirements of section
619, the Agencies have been regularly consulting with each
other in the development of rules and policies that implement
section 619.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM MARTIN J. GRUENBERG
Q.1. Given how complex it is to determine whether a trade is a
hedge or a proprietary trade, it appears the real issue is
whether a trade threatens the safety and soundness of the bank.
What benchmark does your agency use to determine whether a
particular activity is or is not ``hedging''? How does your
agency determine whether the trade presents risks to the safety
and soundness of a financial institution?
A.1. The FDIC does not have a single benchmark that it uses to
determine whether a particular activity constitutes hedging as
distinguished from proprietary trading. We do have certain
standards that are used to determine whether activities
constitute a hedge for purposes of financial reporting or, in
certain instances, as an input into the bank's regulatory
capital calculations. However, these standards vary based upon
the purpose for which an exposure serves as a hedge. For
example, in the context of financial reporting, banks use the
strict hedge accounting requirements set forth by the Financial
Accounting Standards Board; but, for calculating market risk
capital requirements, banks can rely on their own models for
determining whether an exposure provides hedging benefits. The
hedging requirements in the proposed Volcker Rule are important
steps forward in promoting a general standard that can be used
by the banking agencies to determine whether any particular
activity is legitimate hedging as opposed to proprietary
trading, which introduces additional risk. While our examiners
routinely review the activities of a financial institution to
determine consistency with safety and soundness standards, we
view the Volcker Rule as providing the FDIC with important
additional tools to help determine whether an activity poses
additional risk to a financial institution.
Q.2. Federal Reserve, FDIC, and OCC have issued proposed rules
to implement Dodd-Frank and Basel III capital requirements for
U.S. institutions. Late last year, your agencies pushed back
the effective date of the proposed Basel III rules beyond
January 1, 2013. Given the concerns that substantially higher
capital requirements will have a negative impact on lending,
are your agencies using this extra time to conduct a cost-
benefit analysis about the impact of the proposed rules on the
U.S. economy, availability, and cost of credit, cost of
insurance, and the regulatory burden on institutions, before
implementing the final rules?
A.2. In June 2012, the FDIC along with the other banking
agencies approved for public comment three notices of proposed
rulemaking that collectively would implement the Basel III
framework, the Basel II standardized approach, and other recent
enhancements to the international capital framework adopted by
the Basel Committee, as well as certain provisions of the Dodd-
Frank Act (the NPRs). \1\ For purposes of the NPRs, the
agencies conducted the cost and burden analyses required by the
Regulatory Flexibility Act, the Paperwork Reduction Act, and
the Unfunded Mandates Reform Act of 1995, all of which are
further detailed in the NPRs. \2\ The agencies have invited
public comment on these analyses.
---------------------------------------------------------------------------
\1\ See, 77 Fed. Reg. 52792 (Aug. 30, 2012); 77 Fed. Reg. 52888
(Aug. 30, 2012); and 77 Fed. Reg. 52978 (Aug. 30, 2012).
\2\ See, e.g., the Initial Regulatory Flexibility Analysis for the
Basel III NPR, 77 Fed. Reg. 52792, 52833 (Aug. 30, 2012).
---------------------------------------------------------------------------
The agencies also participated in the development of a
number of studies to assess the potential impact of the revised
capital requirements, including participating in the Basel
Committee's Macroeconomic Assessment Group (MAG) as well as its
Quantitative Impact Study, the results of which were made
publicly available by the Basel Committee on Banking
Supervision upon their completion. \3\ Basel Committee analysis
has suggested that stronger capital requirements could help
reduce the likelihood of banking crises while yielding positive
net economic benefits. \4\ Specifically, a better capitalized
banking system should be less vulnerable to banking crises,
which have historically been extremely harmful to economic
growth. Moreover, the MAG analysis found that the requirements
would only have a modest negative impact on the gross domestic
product of member countries, and that any such negative impact
could be significantly mitigated by phasing in the proposed
requirements over time. \5\ Taken together, these studies
suggest that a better capitalized banking system will better
support economic growth sustainably over time.
---------------------------------------------------------------------------
\3\ See, ``Assessing the Macroeconomic Impact of the Transition to
Stronger Capital and Liquidity Requirements'' (MAG Analysis), also
available at: http://www.bis.org/publ/othpl2.pdf; see also, ``Results
of the Comprehensive Quantitative Impact Study'', also available at:
http://www.bis.org/publ/bcbsl86.pdf.
\4\ See, ``An Assessment of the Long-Term Economic Impact of
Stronger Capital and Liquidity Requirements'', Executive Summary, p. 1.
\5\ See, MAG Analysis, Conclusions and open issues, pp. 9-10.
---------------------------------------------------------------------------
The agencies also sought public comment on the proposed
requirements in the NPRs to better understand their potential
costs and benefits. The agencies asked several specific
questions in the NPRs about potential costs related to the
proposals and are considering all comments carefully. During
the comment period, the agencies also participated in various
outreach efforts, such as engaging community banking
organizations and trade associations, among others, to better
understand industry participants' concerns about the NPRs and
to gather information on their potential effects. In addition,
to facilitate public comment, the agencies developed and
provided to the industry an estimation tool that would allow an
institution to estimate the regulatory capital impact of the
NPRs. These efforts have provided valuable additional
information to assist the agencies as we determine how to
proceed with the proposed rulemakings.
Q.3. Given the impact that the Qualified Mortgages (QM) rules,
the proposed Qualified Residential Mortgages (QRM) rules, the
Basel III risk-weights for mortgages, servicing, escrow and
appraisal rules will have on the mortgage market and the
housing recovery, it is crucial that these rules work in
concert. What analysis has your agency conducted to assess how
these rules work together? What is the aggregate impact of
those three rules, as proposed and finalized, on the overall
mortgage market as well as on market participants?
A.3. At the time of the release of the regulatory capital NPRs,
the QM and QRM rules had not been released in final form.
Accordingly, in connection with the proposed treatment for 1-4
family residential mortgage loans, the agencies solicited
comment on alternative criteria or approaches for
differentiating among the levels of risk inherent in different
mortgage exposures. Specifically, the agencies invited comment
on whether ``all residential mortgage loans that meet the
`qualified mortgage' criteria to be established for purposes of
the Truth in Lending Act pursuant to section 1412 of the Dodd-
Frank Act [should] be included in category 1.'' \6\ The
agencies are considering the comments received in connection
with the proposed treatment for 1-4 family residential mortgage
exposures, as well as comments received in response to the NPR
relating to Credit Risk Retention, which included proposed QRM
standards. \7\ Now that we have the benefit of the final QM
rule, the agencies can consider QRM and Basel III in light of
the QM standards. All three rules--QM, QRM, and Basel III--
could impact the mortgage market. In the FDIC's view, it is
important that the agencies endeavor in the final rulemaking on
QRM and Basel III to take into consideration the cumulative
impact of the rules on the mortgage market, including the
availability of credit.
---------------------------------------------------------------------------
\6\ 77 Fed. Reg. 52888, 52899 (Aug. 30, 2012).
\7\ 76 Fed. Reg. 24090 (April 29, 2011).
Q.4. Under the Basel III proposals mortgages will be assigned
to two risk categories and several subcategories, but in their
proposals the agencies did not explain how risk weights for
those subcategories are determined and why they are
appropriate. How did your agency determine the appropriate
---------------------------------------------------------------------------
range for those subcategories?
A.4. The agencies currently are reviewing the numerous comment
letters from banking organizations on whether the proposed
methodology and risk weights for category 1 and 2 residential
mortgages are appropriate. As stated in the preamble to the
Standardized Approach NPR, the U.S. housing market experienced
unprecedented levels of defaults and foreclosures due in part
to qualitative factors such as inadequate underwriting
standards, high risk mortgage products such as so-called
payment-option adjustable rate mortgages, negatively amortizing
loans, and the issuance of loans to borrowers with undocumented
and unverified income. In addition, the agencies noted that the
amount of equity a borrower has in a home is highly correlated
with default risk. Therefore, the agencies proposed to assign
higher risk weights to loans that have higher credit risk while
assigning lower risk weights to loans with lower credit risk.
The agencies also recognize that the use of loan-to-value
(LTV) ratios to assign risk weights to residential mortgage
exposures is not a substitute for and does not otherwise
release a banking organization from its responsibility to have
prudent loan underwriting and risk management practices
consistent with the size, type, and risk of its mortgage
business. In deliberations on the final rule, the agencies also
are reviewing the interagency supervisory guidance documents on
risk management involving residential mortgages, including the
Interagency Guidance on Nontraditional Mortgage Product Risks
(October 4, 2006); the interagency Statement on Subprime
Mortgage Lending (July 10, 2007), and the Appendix A to Subpart
A of Part 365 of the FDIC Rules and Regulations-Interagency
Guidelines for Real Estate Lending (December 31, 1992).
Q.5. In a speech last year you stated that the failure of a
systemically important financial institution will likely have
significant international operations and that this will create
a number of challenges. What specific steps have been taken to
improve the cross-border resolution of a SIFI? What additional
steps must be taken with respect to the cross-border resolution
of a SIFI?
A.5. As I stated in my testimony, the experience of the
financial crisis highlighted the importance of coordinating
resolution strategies across national jurisdictions. Section
210 of the Dodd-Frank Act expressly requires the FDIC to
``coordinate, to the maximum extent possible'' with appropriate
foreign regulatory authorities in the event of the resolution
of a covered financial company with cross-border operations. As
we plan internally for such a resolution, the FDIC has
continued to work on both multilateral and bilateral bases with
our foreign counterparts in supervision and resolution. The aim
is to promote cross-border cooperation and coordination
associated with planning for an orderly resolution of a
globally active, systemically important financial institution
(G-SIFIs).
As part of our bilateral efforts, the FDIC and the Bank of
England, in conjunction with the prudential regulators in our
jurisdictions, have been working to develop contingency plans
for the failure of G-SIFIs that have operations in both the
U.S. and the U.K. Of the 28 G-SIFIs designated by the Financial
Stability Board of the G20 countries, four are headquartered in
the U.K., and another eight are headquartered in the U.S.
Moreover, around two-thirds of the reported foreign activities
of the eight U.S. SIFTs emanate from the U.K. \8\ The magnitude
of these financial relationships makes the U.S.-U.K. bilateral
relationship by far the most important with regard to global
financial stability. As a result, our two countries have a
strong mutual interest in ensuring that, if such an institution
should fail, it can be resolved at no cost to taxpayers and
without placing the financial system at risk. An indication of
the close working relationship between the FDIC and U.K.
authorities is the joint paper on resolution strategies that we
released in December. \9\
---------------------------------------------------------------------------
\8\ Reported foreign activities encompass sum of assets, the
notional value of off-balance-sheet derivatives, and other off-balance-
sheet items of foreign subsidiaries and branches.
\9\ ``Resolving Globally Active, Systemically Important, Financial
Institutions'', http://www.fdic.gov/about/srac/2012/gsifi.pdf.
---------------------------------------------------------------------------
In addition to the close working relationship with the
U.K., the FDIC and the European Commission (E.C.) have agreed
to establish a joint Working Group comprised of senior staff to
discuss resolution and deposit guarantee issues common to our
respective jurisdictions. The Working Group will convene twice
a year, once in Washington, once in Brussels, with less formal
communications continuing in between. The first of these
meetings will take place later this month. We expect that these
meetings will enhance close coordination on resolution related
matters between the FDIC and the E.C., as well as European
Union Member States.
The FDIC also has engaged with Swiss regulatory authorities
on a bilateral and trilateral (including the U.K.) basis.
Through these meetings, the FDIC has further developed its
understanding of the Swiss resolution regime for G-SIFIs,
including an in-depth examination of the two Swiss-based G-
SIFIs with significant operations in the U.S. In part based on
the work of the FDIC, the Swiss regulatory authorities have
embraced a single point of entry approach for the Swiss based
G-SIFIs.
The FDIC also has had bilateral meetings with Japanese
authorities. FDIC staff attended meetings hosted by the Deposit
Insurance Corporation of Japan and the FDIC hosted a meeting
with representatives of the Japan Financial Services Agency to
discuss our respective resolution regimes. The Government of
Japan has proposed legislation to expand resolution authorities
for the responsible Japanese agencies. These bilateral
meetings, including an expected principal level meeting later
this year, are part of our continued effort to work with
Japanese authorities to develop a solid framework for
coordination and information-sharing with respect to
resolution, including through the identification of potential
impediments to the resolution of G-SIFIs with significant
operations in both jurisdictions.
These developments mark significant progress in fulfilling
the mandate of section 210 of the Dodd-Frank Act and achieving
the type of international coordination that would be needed to
effectively resolve a G-SIFI in some future crisis situation.
The FDIC is continuing efforts to engage our counterparts in
other countries in greater coordination to improve the ability
to achieve an orderly liquidation in the event of the failure
of a large, internationally active financial institution. We
will continue to pursue these efforts through both bilateral
and multilateral approaches.
Q.6. In June of last year, the FDIC proposed a rule that
mirrored the Federal Reserve's proposed definition of
``predominantly engaged in financial activity.'' Since this
definition triggers FDIC's ability to exercise its orderly
liquidation authority, the proposed rule has generated a
considerable amount of concern. Does the FDIC intend to
reconsider its proposed definition of ``predominately engaged
in financial activities'' to address concerns raised in public
comment letters?
A.6. Section 201(b) of the Dodd-Frank Act requires the FDIC in
consultation with the Secretary of the Treasury to establish
certain definitional criteria for determining if a company is
predominantly engaged in activities that the Board of Governors
has determined are financial in nature or incidental thereto
for purposes of section 4(k) of the Bank Holding Company Act. A
company that is predominantly engaged in such activities would
be considered a ``financial company'' for purposes of Title II
of the Act.
On March 23, 2011, the FDIC published in the Federal
Register a notice of proposed rulemaking titled ``Orderly
Liquidation Authority'' (March 2011 NPR) that proposed, among
other things, definitional criteria for determining if a
company is predominantly engaged in activities that are
financial in nature or incidental thereto for purposes of Title
II. On June 18, 2012, the FDIC published for comment a
supplemental notice of proposed rulemaking, which proposed to
clarify the scope of activities that would be considered
financial in nature or incidental thereto for purposes of the
March 2011 NPR (June 2012 NPR).
The FDIC received eight comments responding to the March
2011 NPR and seven comments responding to the June 2012 NPR.
The FDIC is currently in the process of reviewing these
comments and will consider them carefully in developing its
final rule.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM MARTIN J. GRUENBERG
Q.1. As you know, a number of people including Sheila Bair have
been advocates of using a simple leverage ratio as the primary
measure of banks' capital strength. Would focusing on a simple
leverage ratio, using the Basel III definition of leverage
which includes key off balance sheet exposures, help cut
through the noise of risk weighting and models and cross border
differences, and give us all greater confidence that large
banks are holding a good amount of high quality capital?
A.1. Maintaining a minimum ratio of capital to assets has been
a regulatory requirement for U.S. banking organizations since
the early 1980s, and a benchmark for supervisors' evaluation of
capital adequacy long before that time. Leverage ratio
requirements were part of the statutory framework of the Prompt
Corrective Action requirements introduced in the FDIC
Improvement Act of 1991. \1\ Leverage ratio requirements in the
United States exist side-by-side with risk-based capital
requirements, and each banking organization must have
sufficient capital to satisfy whichever requirement is more
stringent.
---------------------------------------------------------------------------
\1\ Pub. L. 102-242, 105 Stat. 2236. The PCA requirements were
enacted in section 38 of the Federal Deposit Insurance Act, 12 U.S.C.
1831o.
---------------------------------------------------------------------------
Over time, as risk-based capital requirements have
attempted to provide greater differentiation among types and
degrees of risk, they also have become increasingly complex,
particularly for advanced approaches banking organizations and
those subject to the market risk rule. \2\ Risk-based capital
requirements for these institutions depend largely on the
output of internal risk models and have been criticized for
being overly complex, opaque, and difficult to supervise
consistently. With only risk-based requirements, a banking
organization can increase its permissible use of leverage by
concentrating in exposures that receive favorable risk weights.
Exposures with favorable risk weights, however, can still
experience high losses.
---------------------------------------------------------------------------
\2\ Currently, the market risk capital rule is codified in 12 CFR
part 325, appendix C. As of the effective date of the Basel III
consolidated final rule, the citation for the market risk rule will be:
12 CFR part 324, subpart F.
---------------------------------------------------------------------------
Leverage ratio requirements, in contrast, directly
constrain bank leverage and thereby offset potential weaknesses
in the risk-based ratios and generate a baseline amount of
capital in a way that is readily determinable and enforceable.
The introduction of a leverage ratio in the international Basel
III capital framework is an important step that we strongly
support. It is well established that banks with higher capital
as measured by the leverage ratio are less likely to fail or
experience financial problems. Avoiding capital shortfalls at
large institutions is particularly important in containing
risks to the financial system and reducing the likelihood of
economic disruption associated with problems at these
institutions. It is therefore important and appropriate to have
a strong leverage capital framework to complement the risk-
based capital regulations. This is needed to ensure an adequate
base of capital exists in the event the risk-based ratios
either underestimate risk or do not inspire confidence among
market participants.
Q.2. The FDIC and Fed have joint jurisdiction over the
completion of living wills from large firms. Now, I don't think
anyone expected the first year of plans to be perfect, but can
you remind everyone, for the FDIC and Fed to approve the plans,
isn't the standard that they have to show how normal
liquidation like bankruptcy or FDIC resolution could work under
reasonable circumstances? And what progress have the plans made
in getting firms to think through their structure, better
inform you as regulators, and lead to simplification and
rationalization?
A.2. On July 1, 2012, the first group of living wills,
generally involving bank holding companies and foreign banking
organizations with $250 billion or more in nonbank assets, were
received. In 2013, the firms that submitted initial plans in
2012 will be expected to refine and clarify their submissions.
The Dodd-Frank Act requires that at the end of this process
these plans be credible and facilitate an orderly resolution of
these firms under the Bankruptcy Code. Four additional firms
are expected to submit plans on July 1, 2013, and approximately
115 firms are expected to file on December 31, 2013.
Last year (2012) was the first time any firms had ever
created or submitted resolution plans. There were a number of
key objectives of this initial submission including:
Identify each firm's critical operations and its
strategy to maintain them in a crisis situation;
Map critical operations and core business lines to
material legal entities;
Map cross-guarantees, service level agreements,
shared employees, intellectual property, and vendor
contracts across material legal entities;
Identify and improve understanding of the
resolution regimes for material legal entities;
Identify key obstacles to rapid and orderly
resolution; and
Use plan information to aid in Title II resolution
planning and to enhance ongoing firm supervision.
Each plan was reviewed for informational completeness to
ensure that all regulatory requirements were addressed in the
plans, and the Federal Reserve and the FDIC have been
evaluating each plan's content and analysis.
Following the review of the initial resolution plans, the
agencies developed instructions for the firms to detail what
information should be included in their 2013 resolution plan
submissions. The agencies identified an initial set of
significant obstacles to rapid and orderly resolution that
covered companies are expected to address in the plans,
including the actions or steps the company has taken or
proposes to take to remediate or otherwise mitigate each
obstacle and a timeline for any proposed actions. The agencies
extended the filing date to October 1, 2013, to give firms
additional time to develop resolution plan submissions that
address the instructions.
Resolution plans submitted in 2013 will be subject to
informational completeness reviews and reviews for
resolvability under the Bankruptcy Code. The agencies
established a set of benchmarks for assessing a resolution
under bankruptcy, including a benchmark for cross-border
cooperation to minimize the risk of ring-fencing or other
precipitous actions. Firms will need to provide a jurisdiction-
by-jurisdiction analysis of the actions each would need to take
in a resolution, as well as the actions to be taken by host
authorities, including supervisory and resolution authorities.
Other benchmarks expected to be addressed in the plans include:
the risk of multiple, competing insolvency proceedings; the
continuity of critical operations--particularly maintaining
access to shared services and payment and clearing systems; the
potential systemic consequences of counterparty actions; and
global liquidity and funding with an emphasis on providing a
detailed understanding of the firm's funding operations and
cash flows.
Through this process, firms will need to think through and
implement structural changes in order to meet the Dodd-Frank
Act objectives of resolvability through the Bankruptcy Code.
Q.3. Are you confident that Title II can work for even the
largest and most complex firms? What are the areas where we can
still make improvement, and how are we progressing on improving
the cross border issues?
A.3. We believe that Title II can work for even the largest and
most complex firms.
The FDIC has largely completed the rulemaking necessary to
carry out its systemic resolution responsibilities under Title
II of the Dodd-Frank Act. In July 2011, the FDIC Board approved
a final rule implementing the Title II Orderly Liquidation
Authority. This rulemaking addressed, among other things, the
priority of claims and the treatment of similarly situated
creditors.
The FDIC now has the legal authority, technical expertise,
and operational capability to resolve a failing systemic
resolution. The FDIC introduced its ``single entry'' strategy
for the resolution of a U.S. G-SIFI using the Order Liquidation
Authority under Title II of the Dodd Frank Act. Since then the
FDIC has been working to operationalize the strategy and
enhance FDIC preparedness.
Key activities to operationalize the strategy include:
Addressing vital issues, including valuation,
recapitalization, payments, accounting, and governance,
through ongoing internal FDIC projects.
Developing and refining Title II resolution
strategies that consider the specific characteristics
of each of the largest U.S. domiciled SIFIs. Summaries
of these plans have been shared with domestic and
international regulators.
Actively communicating this approach with key
stakeholders to ensure that the market understands what
actions the FDIC may take ahead of the failure to
minimize irrational or unnecessarily disruptive
behavior. In 2012, the FDIC participated in over 20
outreach events with academics and other thought
leaders, industry groups, rating agencies, and
financial market utilities in order to expand
(domestic) communications/outreach efforts regarding
Title II OLA.
The FDIC has made great strides in developing cooperation
with host supervisors and resolution authorities in the most
significant foreign jurisdictions for U.S. G-SIFIs to allow for
a successful implementation of the Orderly Liquidation
Authority. These dialogues with host supervisors and resolution
authorities occur at both the bilateral and multilateral level.
As part of our bilateral efforts, the FDIC and the Bank of
England, in conjunction with the prudential regulators in our
respective jurisdictions, have been working to develop
contingency plans for the failure of G-SIFIs that have
operations in both the U.S. and the U.K. Approximately 70
percent of the reported foreign activities of the eight U.S. G-
SIFIs emanates from the U.K. An indication of the close working
relationship between the FDIC and U.K. authorities is the joint
paper on resolution strategies that the FDIC and the Bank of
England released in December 2012. This joint paper focuses on
the application of ``top-down'' resolution strategies for a
U.S. or a U.K. financial group in a cross-border context and
addressed several common considerations to these resolution
strategies.
In addition to the close working relationship with the
U.K., the FDIC and the European Commission (E.C.) have agreed
to establish a joint Working Group comprised of senior staff to
discuss resolution and deposit guarantee issues common to our
respective jurisdictions. The Working Group will convene twice
a year, once in Washington, once in Brussels, with less formal
communications continuing in between. The first of these
meetings will take place later this month. We expect that these
meetings will enhance close coordination on resolution related
matters between the FDIC and the E.C., as well as European
Union Member States.
The FDIC also has engaged with Swiss regulatory authorities
on a bilateral and trilateral (including the U.K.) basis.
Through these meetings, the FDIC has further developed its
understanding of the Swiss resolution regime for G-SIFIs,
including an in-depth examination of the two Swiss-based G-
SIFIs with significant operations in the U.S. In part based on
the work of the FDIC, the Swiss regulatory authorities have
embraced a single point of entry approach for the Swiss based
U-SIFIs.
The FDIC also has had bilateral meetings with Japanese
authorities. FDIC staff attended meetings hosted by the Deposit
Insurance Corporation of Japan and the FDIC hosted a meeting
with representatives of the Japan Financial Services Agency, to
discuss our respective resolution regimes. The Government of
Japan has proposed legislation to expand resolution authorities
for the responsible Japanese Agencies. These bilateral
meetings, including an expected principal level meeting later
this year, are part of our continued effort to work with
Japanese authorities to develop a solid framework for
coordination and information-sharing with respect to
resolution, including through the identification of potential
impediments to the resolution of G-SIFIs with significant
operations in both jurisdictions.
Q.4. The statutory language for funds defined under the Volcker
Rule pointedly did not include venture funds, however the
definition in the proposed rule seemed to indicate that venture
funds would be covered. In addition to exceeding the statutory
intent of Congress, this has created uncertainty in the market
as firms await a final rule and refrain from making commitments
which might be swept up in the final version of the Volcker
Rule. Can you clarify whether venture funds are covered by the
Volcker Rule?
A.4. Section 619(h)(2) of the Dodd-Frank Act defines the terms
``hedge fund'' and ``private equity fund'' as ``an issuer that
would be an investment company, as defined in the Investment
Company Act of 1940 (15 U.S.C. 80a-1, et seq.), but for section
3(c)(1) or 3(c)(7) of that Act, or such similar funds as the
appropriate Federal banking agencies, the Securities and
Exchange Commission, and the Commodity Futures Trading
Commission may, by rule, as provided in subsection (b)(2),
determine.'' This definition, as written, would cover the
majority of venture capital funds.
As part of the NPR, the agencies sought public comment on
whether venture capital funds should be excluded from the
definition of ``hedge fund'' and ``private equity fund'' for
purposes of the Volcker Rule. In the NPR, the agencies asked:
Should venture capital funds be excluded from the
definition of ``covered fund''? Why or why not? If so,
should the definition contained in rule 203(l)-(1)
under the [Investment] Advisers Act be used? Should any
modifications to that definition of venture capital
fund be made? How would permitting a banking entity to
invest in such a fund meet the standards contained in
section 13(d)(1)(J) of the [Bank Holding Company Act]?
In conjunction with the development of the final rule, the
agencies are reviewing public comments responding to the NPR,
including comments on this question related to venture capital
funds. The agencies will give careful consideration to these
comments in the development of the final rule.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HEITKAMP
FROM MARTIN J. GRUENBERG
Q.1. Chairman Gruenberg, I thank you for understanding that as
relationship lenders in local communities, community banks are
able to provide much needed financing to both residential and
commercial borrowers in rural and underserved areas where
larger banks are unable or unwilling to participate. Have you
thoroughly considered the impact of higher risk weights from
Basel III on community banks, as well as on the local
communities where they serve?
A.1. The FDIC recognizes the important role that community
banks play in the financial system, which includes providing
credit to small businesses and homeowners throughout the
country. During the comment period, the agencies participated
in various outreach efforts, such as engaging community banking
organizations and trade associations, among others, to better
understand industry participants' concerns about the proposed
revisions to the general risk-based capital rules and to gather
information on their potential effects. To facilitate comment
on the NPRs, the agencies developed and provided to the
industry an estimation tool that would allow an institution to
estimate the regulatory capital impact of the proposals. The
FDIC conducted roundtables in each of our regional offices and
hosted a nationwide Web cast to explain the components of the
rules and answer banker questions. Lastly we developed
instructional videos on the two rulemakings applicable to
community banks. These videos received more than 7,000 full
views in the first 3 months of availability. We believe these
efforts contributed to the more than 2,500 comments we
received, which have provided valuable additional information
to assist the agencies as we determine how to proceed with the
NPRs. Particular attention is being given to the comments on
the impact of the proposed rules on community banks.
Q.2. Chairman Gruenberg, first, I'd like to thank you and the
FDIC for making the community bank industry a priority for your
agency. After conducting your study and hosting regional
roundtables, what were the most significant problems you found
on the ground? What did your agency do to address them?
A.2. Community banks play a critical role in the national and
local economies by extending credit to consumers and
businesses. As you indicate, the FDIC has launched several
initiatives to further the understanding of how community banks
have evolved during the past 25 years, current opportunities
and challenges facing community bankers, and what lies ahead.
The FDIC launched the Community Banking Initiative in February
2012 with a national conference on community banking.
Roundtable discussions were then held in the FDIC's six
regions, and the FDIC Community Banking Study was released in
December 2012. We also conducted comprehensive reviews of our
examination and rulemaking processes. Overall, the findings
from these initiatives indicate the community banking model
remains viable and that community banks will be an important
part of the financial landscape for years to come. The findings
also identified financial and operational challenges facing
community banks as well as opportunities for the FDIC to
strengthen the efficiency and effectiveness of its examination
and rulemaking processes.
The FDIC Community Banking Study is a data-driven effort to
identify and explore community bank issues. The first chapter
develops a research definition for the community bank that is
used throughout the study. Subsequent chapters address
structural change, the geography of community banking,
comparative financial performance, community bank balance sheet
strategies, and capital formation at community banks. This
study is intended to be a platform for future research and
analysis by the FDIC and other interested parties.
Community bankers identified a number of financial
challenges during the roundtable discussions, especially that
there is an insufficient volume of quality loans available in
many markets. They also stated that capital raises are
increasingly difficult in the current banking environment and
the low-rate environment is leading to a build-up of interest
rate risk. Community bankers also expressed concern about the
ability to retain quality staff and how to satisfy customers'
demands for greater availability of mobile banking
technologies. Although the vast majority of banker comments
regarding their experience with the examination process were
favorable, a general perception exists that new regulations and
heightened scrutiny of existing regulations are adding to the
cost of doing business. Community bankers also note there are
opportunities to enhance communication with examination staff
and expand and strengthen technical assistance provided by the
FDIC.
The FDIC has undertaken initiatives to address comments
received from bankers during the roundtable discussions. To
enhance our examination processes, the FDIC developed a tool
that generates pre-examination request documents tailored to a
bank's specific operations and business lines. The FDIC is
improving how information is shared electronically between
bankers and examiners through its secure Internet channel,
FDICconnect, which will ensure better access for bankers and
examiners. We also revised the classification system for citing
violations identified during compliance examinations to better
communicate to institutions the severity of violations and to
provide more consistency in the classification of violations
cited in Reports of Examination.
The FDIC also issued a Financial Institution Letter,
entitled ``Reminder on FDIC Examination Findings'' (FIL-13-2011
dated March 1, 2011), encouraging banks to provide feedback
about the supervisory process. Since then, we continue to
conduct outreach sessions and hold training workshops and
symposiums, and have created the Director's Resource Center Web
page to enhance technical assistance provided to bankers on a
range of bank regulatory issues. Also, the FDIC has developed
and posted a Regulatory Calendar on www.fdic.gov to keep
bankers current on the issuance of rules, regulations, and
guidance; and we are holding industry calls to communicate
critical information to bankers about pending regulatory
changes.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM MARTIN J. GRUENBERG
Q.1. In response to concerns that the bank-centric Basel III
capital standards are unworkable for insurers, the Fed has
indicated that it would perform some tailoring of those
standards. However, there is continuing concern among the life
insurance industry that the proposed tailoring is inadequate
and does not properly acknowledge the wide differences between
banking and insurance.
What kinds of more substantive changes will the Fed
consider to the Basel III rulemaking to prevent negative
impacts to insurers and the policyholders, savers, and retirees
that are their customers?
There is also a concern that the bank standards are a
dramatic departure from the duration matching framework common
to insurance supervision.
What is your response to that concern and would the Fed
consider doing more than just tailoring bank standards?
Do you believe that, from an insurance perspective, Basel
III bank standards are an incremental or dramatic departure
from current insurance standards?
A.1. Section 171 of the Dodd-Frank Act requires the
establishment of minimum consolidated leverage and risk-based
capital requirements for savings and loan holding companies, a
number of which have significant insurance activities. The FDIC
recognizes the distinctions between banking and insurance and
the authorities given to the States. In 2011, we amended our
general risk-based capital requirements to provide flexibility
in addressing consolidated capital requirements for low-risk
nonbank activities, including certain insurance-related
activities. We will continue to bear in mind these distinctions
as we work with our fellow regulators to ensure that the final
rule provides for an adequate transition period that is
consistent with Section 171.
Q.2. Regarding the Volcker Rule, some have suggested that the
banking agencies should just go ahead and issue their final
rule without waiting to reach agreement with the Securities and
Exchange Commission and Commodities Futures Trading Commission,
which have to issue their own rules. This scenario could result
in there being more than one Volcker Rule, which would create
significant confusion about which agency's rule would apply to
which covered activity. Do you agree that there should be only
one Volcker Rule?
A.2. All entities affected by the Volcker Rule should be
operating under similar requirements. Section 619(b)(2) of the
Dodd-Frank Act contains specific coordinated rulemaking
requirements that serve to help clarify the application of
individual agency rules, to ensure that agency regulations are
comparable, and to require coordination and consistency in the
application of the Volcker Rule. To that end, the Federal
banking agencies, the SEC, and the CFTC are currently working
together in the process of developing a final Volcker Rule.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM THOMAS J. CURRY
Q.1. Given how complex it is to determine whether a trade is a
hedge or a proprietary trade, it appears the real issue is
whether a trade threatens the safety and soundness of the bank.
What benchmark does your agency use to determine whether a
particular activity is or is not ``hedging''? How does your
agency determine whether the trade presents risks to the safety
and soundness of a financial institution?
A.1. Our agency evaluates whether particular activities are
hedging based on their effectiveness in managing risks arising
from banking activities and their conformance with the bank's
hedging policies and procedures. OCC Banking Circular 277
discusses appropriate risk management of financial derivatives.
The OCC expects banks to establish hedging policies and
procedures that clearly specify risk appetite, hedging
strategies, including the types of hedge instruments permitted,
and to document hedge positions. Documentation should include
identification of the assets or liabilities or positions being
hedged, how the hedge manages the risk associated with those
assets or liabilities or positions, and how and when the hedge
will be tested for effectiveness. As an additional control, a
bank's risk management systems should facilitate stress testing
and enable management and the OCC to assess the potential
impact of various changes in market factors on earnings and
capital. We also expect banks to establish prudent limits and
sub-limits on hedging instruments to protect against
concentrations in any particular instruments.
We expect banks to produce periodic risk, as well as
hedging profit and loss (P&L) reports, and we use those reports
to identify hedging activities that show an increase in risks
and produce material amounts of continuing profits or losses
and may warrant further review. As with any other significant
positions on or off-balance sheet, the institution's internal
risk management function should review material hedged
positions, resulting material profits or losses, and material
risk measures (e.g., stress, value-at-risk, and relevant
nonstatistical risk measures) to evaluate whether activities
are effectively mitigating risk and whether the hedging
activities present risks to the safety and soundness of the
bank.
The OCC recognizes that controls at smaller banks with
simpler hedging activity need not be as complex and
sophisticated as at larger banks. Nevertheless, at a minimum,
these banks' risk management systems should evaluate the
possible impact of hedges on earnings and capital that may
result from adverse changes in interest rates and other
relevant market conditions. We expect these banks to
periodically review the effectiveness of their hedges as a part
of the bank's overall risk management; including, where
appropriate, back testing. In addition, examiners review large
holdings in the investment and derivatives portfolios, as well
as material changes that have occurred between examinations.
We also note that the Volcker Rule provisions of the Dodd-
Frank Act prohibit proprietary trading except for certain
permitted activities, including risk-mitigating hedging. The
proposed implementing regulations issued by the agencies,
including the OCC, contain a number of requirements designed to
ensure that a banking entity's hedging activities reduce
specific risks in connection with the entity's individual or
aggregate holdings and do not give rise to new exposures that
are not simultaneously hedged. For example, the proposed
regulations require banking entities to engage in permitted
hedging activities in accordance with written policies and
procedures, subject to continuing review, monitoring and
management, and only if compensation arrangements of persons
performing hedging activities are designed not to reward
proprietary risk-taking. The interagency Volcker regulations,
when finalized, will provide standards for distinguishing a
hedge from a proprietary trade, in addition to the supervisory
standards described above.
Q.2. Federal Reserve, FDIC, and OCC have issued proposed rules
to implement Dodd-Frank and Basel III capital requirements for
U.S. institutions. Late last year, your agencies pushed back
the effective date of the proposed Basel III rules beyond
January 1, 2013. Given the concerns that substantially higher
capital requirements will have a negative impact on lending,
are your agencies using this extra time to conduct a cost-
benefit analysis about the impact of the proposed rules on the
U.S. economy, availability, and cost of credit, cost of
insurance, and the regulatory burden on institutions, before
implementing the final rules?
A.2. In response to the three notices of proposed rulemaking,
the Federal banking agencies received more than 4,000 total
comments, many of which expressed concern about the potential
impact of the rulemaking on U.S. banking organizations and, in
particular, their ability to serve as financial intermediaries.
Late last year, the ace and the other Federal banking agencies
determined that, rather than rushing to implement a final rule,
it would be prudent to delay the final rulemaking in order to
review all the comments carefully and ensure that the final
rulemaking appropriately addresses the commenters' concerns
without sacrificing the goal of implementing substantial
improvements to the agencies' respective regulatory capital
frameworks. The agencies now are working to complete the final
rule and to update and revise their analyses, as appropriate.
For the proposals, the OCC conducted those cost and burden
analyses required by the Regulatory Flexibility Act, the
Paperwork Reduction Act, and the Unfunded Mandates Reform Act
of 1995, among others, the results of which were detailed in
the proposals. For the final rulemaking, the OCC and the other
Federal banking agencies are working to update those analyses.
Additionally, the agencies must determine whether the rule is
likely to be a ``major rule'' for the purposes of the
Congressional Review Act, which is defined, in part, as any
rule that results in or is likely to result in an annual effect
on the economy of $100 million or more.
In response to several specific questions in the proposals
about potential costs related to the proposals, a substantial
number of commenters provided a great deal of feedback both on
the potential impact of specific provisions, and on the
proposed framework in its entirety. During the comment period,
the agencies also participated in various outreach efforts,
such as engaging community banking organizations and trade
associations, among others, to better understand industry
participants' concerns about the proposals and to gather
information on their potential effects. These efforts have
provided valuable additional information that the OCC and the
other Federal banking agencies are considering as we develop
the final rule and analyze its potential impact.
The CCC continues to believe that all banking organizations
need a strong capital base to enable them to withstand periods
of economic adversity and continue to fulfill their role as a
source of credit to the economy. Therefore, the CCC is working
diligently with the other Federal banking agencies to complete
the rulemaking process and develop a final rule as
expeditiously as possible.
Q.3. Given the impact that the Qualified Mortgages (QM) rules,
the proposed Qualified Residential Mortgages (QRM) rules, the
Basel III risk-weights for mortgages, servicing, escrow, and
appraisal rules will have on the mortgage market and the
housing recovery, it is crucial that these rules work in
concert. What analysis has your agency conducted to assess how
these rules work together? What is the aggregate impact of
those three rules, as proposed and finalized, on the overall
mortgage market as well as on market participants?
A.3. This body of rules, covering securitization risk
retention, risk-based capital, and consumer protection in the
origination and servicing of mortgages, are all part of the
Government's response to fundamentally unsound mortgage market
practices that were the eventual triggering mechanism for the
financial crisis. They address different aspects of the
interlinked market mechanisms through which mortgages are
created, funded, and administered. Several agencies are
involved in fashioning these rules, including the banking
agencies and the CFPB, the SEC, the FHFA, and HUD.
The OCC has not been part of the rulemaking group for all
these rules, but it has been involved in the rulemakings for
securitization risk retention, Basel III, and appraisals for
higher-risk mortgages. For each of these regulatory proposals,
the OCC and the other agencies participating in the rulemakings
have designed the proposed rules to impose new market
protections in a fashion that appropriately preserves the
availability of mortgages to creditworthy consumers at
reasonable prices. In addition, the OCC conducted cost and
burden analyses of the impact of the proposed rules on mortgage
market participants that will be subject to the new rules, as
required by the Regulatory Flexibility Act, the Paperwork
Reduction Act, and the Unfunded Mandates Reform Act of 1995.
For the final rulemaking, the OCC must determine whether the
rule is likely to be a ``major rule'' for the purposes of the
Congressional Review Act, which is defined, in part, as any
rule that results in or is likely to result in an annual effect
on the economy of $100 million or more.
In addition, in response to the agencies' request for
public comments on these proposed rules, commenters have
expressed concern to the agencies about the potential impact on
mortgage availability and prices, and in certain instances
provided quantitative analysis to support their views. We are
considering these views and information as we go forward with
the rulemakings.
Q.4. Under the Basel III proposals mortgages will be assigned
to two risk categories and several subcategories, but in their
proposals the agencies did not explain how risk weights for
those subcategories are determined and why they are
appropriate. How did your agency determine the appropriate
range for those subcategories?
A.4. An overarching concern from the many comment letters the
agencies received was the proposed treatment of residential
mortgages in the Standardized Approach NPR. As stated in the
proposal, residential mortgages would be separated into two
risk categories based on product and underwriting
characteristics and then, within each category, assigned risk
weights based on loan-to-value ratios (LTVs).
During the market turmoil, the U.S. housing market
experienced significant deterioration and unprecedented levels
of mortgage loan defaults and home foreclosures. The causes for
the significant increase in loan defaults and home foreclosures
included inadequate underwriting standards, the proliferation
of high-risk mortgage products, the practice of issuing
mortgage loans to borrowers with undocumented income, as well
as a precipitous decline in housing prices and a rise in
unemployment.
The NPR proposed to increase the risk sensitivity of the
regulatory capital rules by raising the capital requirements
for the riskiest, nontraditional mortgages while actually
lowering the requirements for relatively safer, traditional
residential mortgage loans with low LTVs. These provisions in
the Standardized Approach NPR were designed to address some of
the causes of the crisis attributed to mortgages as well as to
provide greater risk sensitivity in banks, capital
requirements.
Given the characteristics of the U.S. residential mortgage
market, the agencies believed that a wider range of risk
weights based on key risk factors including product and
underwriting characteristics and LTVs were more appropriate.
The proposed ranges and key risk factors were developed on an
interagency basis with the expert supervisory input of policy
experts and bank examiners.
The OCC recognizes that some aspects of the proposed
treatment for residential mortgages could impose a burden on
community banks and thrifts. We are considering all the issues
raised by the commenters as we develop the final rule in
conjunction with the other banking agencies.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM THOMAS J. CURRY
Q.1. Can you provide a list of OCC consent orders with the top
five national banks by asset size over the past 20 years?
A.1. Attached is a list of the top five national banks by asset
size over a 20-year period [OCC Large Banks] as well as a list
that contains all public formal enforcement actions against
those banks [Selected OCC Enforcement Actions Against Large
Banks].
Q.2. Can you also describe the process by which OCC tracks
consent orders and verifies bank compliance with the terms?
A.2. Large Bank Supervision (LBS) teams provide ongoing
supervisory oversight to ensure banks comply with Consent
Orders and implement timely corrective action. They enter
Consent Orders into LBS information systems. This includes LB-
ID, which provides a high level record of the outstanding
Consent Order. The enforcement document is housed in WISDM,
which contains all documents of record for a particular
institution. WISDM allows the examination team to create
folders that contain the full document and bank responses,
correspondence, and supporting information for each Article.
Examination teams may also use official OCC shared sites (e.g.,
Sharepoint) as a working repository in conjunction with WISDM.
Teams monitor compliance with each article of the Consent Order
through regular discussions with bank management and internal
audit, and confirm compliance through testing during the
ongoing supervisory process and/or targeted reviews. The
examiner-in-charge may assign individual examiners reporting
through the team lead the responsibility for tracking and
follow-up on particular Articles.
LBS teams formally communicate the status of corrective
actions and compliance with Articles in the Consent Order
through Supervisory Letters. An LBS team generally requires the
bank's internal audit to test for compliance and correction of
the identified weakness before the OCC will render judgment of
the adequacy of the actions. LBS teams utilize the internal
audit's findings and recommendations and also perform testing
and sampling to ensure proper remediation and sustainability of
corrective actions. If satisfactory, the examiner will provide
documentation to the examiner-in-charge to support a decision
on compliance.
Midsize and Community Bank Supervision (MCBS) examination
teams continuously track Consent Order compliance through on-
site examinations; off-site monitoring, and regular
correspondence with banks. They maintain a detailed inventory
of the individual actionable Articles within each Consent Order
under a designated file structure on Examiner View (EV). EV
allows examiners to identify and track due dates for each
Article, the documentation the bank provides in response to
each requirement, the examiners' notes on the bank's progress
in achieving compliance, and ultimately whether the bank has
achieved compliance. EV also ties each Article in an
enforcement document to the relevant Matter Requiring
Attention. if applicable. Because each Article has different
requirements for the bank to submit information, EV also
includes an inventoried location for storing all enforcement
action related follow-up documentation.
MCBS teams use EV to establish the supervisory strategy and
develop examination resource requirements for each FDICIA
cycle. Each full scope and interim examination will include an
assessment and detailed description of enforcement action
compliance. Occasionally, MCBS teams will conduct other
targeted reviews or off-site reviews that focus on a discrete
area of the enforcement action to supplement the supervisory
cycle. Generally, MCBS teams communicate their conclusions
regarding Consent Order compliance to the bank twice a year
within examination reports; however, they often will send
Supervisory Letters in response to individual bank submissions.
Q.3. Has the OCC conducted any internal research or analysis on
trade-offs to the public between settling an enforcement action
without admission of guilt and going forward with litigation as
necessary to obtain such admission?
If so, can you provide that analysis to the Committee?
A.3. The OCC does not have any internal research or analysis on
the trade-offs of settling without an admission of liability.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HEITKAMP
FROM THOMAS J. CURRY
Q.1. Comptroller Curry, I thank you for understanding that as
relationship lenders in local communities, community banks are
able to provide much needed financing to both residential and
commercial borrowers in rural and underserved areas where
larger banks are unable or unwilling to participate. Have you
thoroughly considered the impact of higher risk weights from
Basel III on community banks, as well as on the local
communities where they serve?
A.1. The OCC is very much aware of the special role that
smaller banks play in our communities in providing financing of
our country's small businesses and families. Given the vital
role that banks serve in our national economy and local
communities, we are committed to helping ensure that the
business model of banks, both large and small, remains vibrant
and viable.
As noted in the preambles to the proposals, the agencies
assessed the potential effects of the proposed rules on banks
by using regulatory reporting data and making certain key
assumptions. The agencies' assessments indicated that most
community banks hold capital well above both the existing and
the proposed regulatory minimums. Therefore, the proposed
requirements are not expected to impact significantly the
capital structure of most banks.
One of the key purposes of the notice and comment process
is to gain a better understanding of the potential impact of a
proposal on banks of all sizes. To foster feedback from
community banks on potential effects of the proposals, the
agencies developed and posted on their respective Web sites an
estimator tool that allowed a smaller bank to use bank-specific
information to assess the likely impact on the individual
institution.
The OCC remains committed to reviewing and evaluating the
issues and the comments received as we move toward a final
rule.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM THOMAS J. CURRY
Q.1. In response to concerns that the bank-centric Basel III
capital standards are unworkable for insurers, the Fed has
indicated that it would perform some tailoring of those
standards. However, there is continuing concern among the life
insurance industry that the proposed tailoring is inadequate
and does not properly acknowledge the wide differences between
banking and insurance.
What kinds of more substantive changes will the Fed
consider to the Basel III rulemaking to prevent negative
impacts to insurers and the policyholders, savers, and retirees
that are their customers?
A.1. The Federal Reserve Board is the primary regulator of bank
and savings and loan holding companies (SLHCs), including SLHCs
that have insurance companies in their corporate structures. We
therefore defer to the Federal Reserve Board to respond to this
question.
Q.2. There is also a concern that the bank standards are a
dramatic departure from the duration matching framework common
to insurance supervision.
What is your response to that concern and would the Fed
consider doing more than just tailoring bank standards?
Do you believe that, from an insurance perspective, Basel
III bank standards are an incremental or dramatic departure
from current insurance standards?
A.2. We defer to the Federal Reserve Board to respond to these
questions.
Q.3. Regarding the Volcker Rule, some have suggested that the
banking agencies should just go ahead and issue their final
rule without waiting to reach agreement with the Securities and
Exchange Commission and Commodities Futures Trading Commission,
which have to issue their own rules. This scenario could result
in there being more than one Volcker Rule, which would create
significant confusion about which agency's rule would apply to
which covered activity.
Do you agree that there should be only one Volcker Rule?
A.3. The Dodd-Frank Act envisions a coordinated effort among
the Volcker Rule rulewriting agencies. It requires the Federal
banking agencies to issue a joint regulation; it further
requires the banking agencies and the Securities and Exchange
Commission and Commodity Futures Trading Commission to consult
and coordinate with one another for the purpose of assuring
that their rules are comparable and provide for consistent
application. The agencies have been regularly consulting with
each other and will continue to do so to achieve the
consistency that Congress clearly intended.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM RICHARD CORDRAY
Q.1. I am concerned that in Virginia we have a number of low-
density areas that may not qualify for the rural or underserved
category within Qualified Mortgages based on their Urban
Influence Codes, lenders' volume, or other reasons. However,
these areas may still have high-acreage properties and
nonstandard loans that will have a hard time refinancing in the
short-term and finding new originators in the long-term. Can
you address these concerns, describe why the CFPB chose to use
UICs, and respond to whether the Bureau would consider using
borrower profiles in addition to geographical classifications?
A.1. The Bureau followed the structure of the Federal Reserve
Board's proposal to use a county-based metric based on the
Department of Agriculture's ``urban influence codes'' which
place every county in the United States into a category based
upon size and proximity to a metropolitan or micropolitan area.
This county-based definition was chosen in part because
implementing it should be fairly straightforward; by contrast,
we received some input indicating that definitions that split
counties to isolate rural areas can create greater compliance
burdens for small banks. The Bureau has expanded the list of
eligible codes to include counties in which about 9 percent of
the Nation's population lives, up from about 3 percent as
originally proposed. We expect that the vast majority of
community banks and credit unions operating predominantly in
those areas meet the definition of small creditor--
approximately 2,700 institutions in total.
The Bureau wants to preserve access to credit for small
creditors operating responsibly in rural and underserved areas.
So under the Ability-to-Repay rule, we extended Qualified
Mortgage status to certain balloon loans held in portfolio by
small creditors operating predominantly in rural or underserved
areas. We also proposed amendments to the Ability-to-Repay rule
to accommodate mortgage lending by smaller institutions,
including those operating outside of what are designated as
rural and underserved areas. Our proposal would treat loans
made by smaller lenders and held in portfolio at certain small
institutions as Qualified Mortgages even if the loans exceed 43
percent debt-to-income ratio, as long as the lender considered
debt-to-income or residual income before making the loan, and
as long as the loans meet the product feature and other
requirements for Qualified Mortgages. This proposed exemption
would cover institutions that hold less than $2 billion in
assets and, with affiliates, extend 500 or fewer first lien
mortgages per year. The Bureau estimates that approximately
9,200 community banks and credit unions would be affected by
the proposed exemption. Under the proposal, these portfolio
loans made by small creditors that are Qualified Mortgages
would have a safe harbor from Ability-to-Repay liability if the
interest rate is within 3.5 percent over the average prime
offer rate. The Bureau also proposed to extend the same
increase in the safe harbor threshold for Qualified Mortgage
balloon loans made by small institutions predominantly serving
rural and underserved areas. The comment period for our
proposal recently ended, and we are now assessing the comments
we received before finalizing this measure.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HEITKAMP
FROM RICHARD CORDRAY
Q.1. Director Cordray, as the President stated in the State of
the Union address, overlapping regulations of our mortgage
markets have the potential to constrain credit and cause
otherwise worthy borrowers from qualifying for mortgages. I'm
especially concerned about the impact that these new rules will
have on smaller institutions that serve States like North
Dakota. What will the Bureau be doing to ensure those
institutions have clear, written guidance to clarify these new
regulations and to make sure lenders have the time to comply
with them?
A.1. The Bureau recognizes that the model of relationship
lending and customer service for which small lenders such as
community banks and credit unions are known was not a driver of
the excesses in the mortgage market leading up to the financial
crisis. And we want to preserve access to credit for small
creditors operating responsibly in rural and underserved areas.
So under the Ability-to-Repay rule, we extended Qualified
Mortgage status to certain balloon loans held in portfolio by
small creditors operating predominantly in rural or underserved
areas.
The Bureau also proposed amendments to the Ability-to-Repay
rule to accommodate mortgage lending by smaller institutions--
particularly for portfolio loans made by small lenders--
including those operating outside of what are designated as
rural or underserved areas. Our proposal would treat these as
Qualified Mortgages even if the loans exceed 43 percent debt-
to-income ratio, as long as the lender considered debt-to-
income or residual income before making the loan, and as long
as the loans meet the product feature and other requirements
for Qualified Mortgages. This proposed exemption would cover
institutions that hold less than $2 billion in assets and, with
affiliates, extend 500 or fewer first lien mortgages per year.
The Bureau estimates that approximately 9,200 community banks
and credit unions would be affected by the proposed exemption.
Under the proposal, loans made by small creditors that are
Qualified Mortgages would have a safe harbor from Ability-to-
Repay liability if the interest rate is within 3.5 percent over
the average prime offer rate. The comment period for our
proposal recently ended, and we are now assessing the comments
we received before finalizing this measure.
In addition, our escrow rule includes an exemption for
small creditors in rural or underserved areas that have less
than $2 billion in assets and that, with affiliates, originate
500 or fewer mortgages a year. Small creditors that meet these
criteria and do not generally have escrow accounts for their
current mortgage customers will be exempt from the escrow
requirements with regard to loans that are not subject to a
forward commitment at origination.
Likewise, for the servicing rules, we recognize that
smaller servicers typically operate according to a business
model that is based on high-touch customer service, and that
they typically make extensive efforts to avoid foreclosures. So
smaller institutions that service 5,000 or fewer mortgage loans
originated or owned by the servicer itself, or its affiliates,
are exempted from large pieces of our servicing rules. This
exempts many small servicers from, among other provisions, the
periodic statement requirement, the general servicing policies
and procedures, and most of the loss mitigation provisions.
We are committed to doing everything we can to help achieve
effective, efficient, and comprehensive implementation by
engaging with industry stakeholders in the coming year. To this
end, we have announced an implementation plan to prepare
mortgage businesses for the new rules. We will publish plain-
English rule summaries, which should be especially helpful to
smaller institutions. Over the course of the year, we will
address questions, as appropriate, about the rules which are
raised by industry, consumer groups, or other agencies. Any
inquiries from your constituents in North Dakota about the
meaning or intent of these regulations may be directed to
[email protected] or 202-435-7700. We will also
publish readiness guides to give industry a broad checklist of
things to do to prepare for the rules taking effect--like
updating policies and procedures and providing training for
staff. And we are working with our fellow regulators to help
ensure consistency in our examinations of mortgage lenders
under the new rules and to clarify issues as needed.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM ELISSE B. WALTER
Q.1. Given how complex it is to determine whether a trade is a
hedge or a proprietary trade, it appears the real issue is
whether a trade threatens the safety and soundness of the bank.
What benchmark does your agency use to determine whether a
particular activity is or is not ``hedging''? How does your
agency determine whether the trade presents risks to the safety
and soundness of a financial institution?
A.1. In the proposed rules to implement Section 619 of the
Dodd-Frank Act, commonly referred to as the ``Volcker Rule'',
the SEC, the Federal banking agencies, and the CFTC set forth
certain criteria intended to differentiate between permitted
risk-mitigating hedging activities and prohibited proprietary
trading. In particular, the proposed risk-mitigating hedging
exemption required, among other things, that a banking entity's
hedging activities: (i) hedge or otherwise mitigate one or more
specific risks arising in connection with and related to
individual or aggregated positions, contracts, or other
holdings of the banking entity; (ii) be reasonably correlated
to the risk(s) that are intended to be hedged or otherwise
mitigated; and (iii) be subject to continuing review,
monitoring, and management. Moreover, a banking entity would be
required to establish an internal compliance program, including
reasonably designed written policies and procedures regarding
the instruments, techniques, and strategies that may be used
for hedging, internal controls and monitoring procedures, and
independent testing. Similar procedures and controls are
currently used by large firms to manage their risk and by
regulators who assess the risk of those firms. The proposed
rules also required the use of particular metrics to help
assess compliance with the Volcker Rule. Similar questions
arise when determining whether hedging activity is being
conducted in connection with market making activity in
compliance with the market making exemption under the statute.
Further, as specified in the statute, the proposed rules
included a provision that would disallow a permissible
activity, including risk-mitigating hedging, if the activity
threatens the safety or soundness of the financial institution.
We received a number of comments regarding these proposed
rules. At this time, we are working with our fellow regulators
to refine the proposed rules in response to comments.
Q.2. The SEC has not yet proposed its extraterritoriality rule
for security-based swaps. Why has there been a delay and when
do you intend to issue the proposed rules?
A.2. Since the time of this hearing, the Commission approved
publication of its cross-border proposal on May 1, 2013. With
very limited exception, the Commission had previously not
addressed the regulation of cross-border security-based swap
activities in our proposed or final rules because we believed
these issues should be addressed holistically, rather than in a
piecemeal fashion. In the Commission's view, a single proposal
would allow investors, market participants, foreign regulators,
and other interested parties with an opportunity to consider,
as an integrated whole, the Commission's proposed approach.
Doing so, however, was a time-consuming process for two
main reasons. First, we believed that the cross-border release
should involve notice-and-comment rulemaking, not only
interpretive guidance, and, as such, we needed to incorporate
an economic analysis that reflected our consideration of the
effects of the proposal on efficiency, competition, and capital
formation. Although the rulemaking approach takes more time, we
believe that this approach was worth the effort: a full
articulation of the rationales for--and consideration of any
reasonable alternative to--particular approaches should enable
the public to better understand our proposed approach and
clarify how we see the trade-offs inherent in these choices as
we continue to consult with the CFTC and our colleagues in
other jurisdictions regarding how best to regulate this global
market.
Second, the scope of the proposal is broad and addresses
the application of Title VII in the cross-border context with
respect to each of the major registration categories covered by
Title VII for security-based swaps: security-based swap
dealers; major security-based swap participants; security-based
swap clearing agencies; security-based swap data repositories;
and security-based swap execution facilities. It also addresses
the application of Title VII in connection with reporting and
dissemination, clearing, and trade execution, as well as the
sharing of information with regulators and related preservation
of confidentiality with respect to data collected and
maintained by security-based swap data repositories.
We believe that the proposal that the Commission approved
in May reflects the effort that the Commission and its staff
gave to fully considering the complex issues that invariably
arise in any attempt to regulate a complex market that spans
the globe.
Q.3. When will the SEC propose rules to implement the
provisions of the JOBS Act concerning general solicitation for
Regulation D, Rule 506 offerings? When will the SEC issue other
rule proposals to implement the law?
A.3. Section 201(a) of the JOBS Act directs the Commission to
amend Securities Act Rules 506 and 144A to eliminate, as a
condition to both safe harbors, the ban against general
solicitation. The Commission issued the rule proposal on August
29, 2012, and we received numerous comment letters with widely
divergent views from commentators on this rulemaking. The staff
has been working through the comments and developing
recommendations for the Commission on how to move forward with
this rulemaking as soon as possible. Completing this
rulemaking, along with the other rulemaking required under the
Dodd-Frank Act and the JOBS Act, is a priority for me.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM ELISSE B. WALTER
Q.1. The statutory language for funds defined under the Volcker
Rule pointedly did not include venture funds, however the
definition in the proposed rule seemed to indicate that venture
funds would be covered. In addition to exceeding the statutory
intent of Congress, this has created uncertainty in the market
as firms await a final rule and refrain from making commitments
which might be swept up in the final version of the Volcker
Rule. Can you clarify whether venture funds are covered by the
Volcker Rule?
A.1. The treatment of venture capital funds in the proposed
rule implementing Section 619 of the Dodd-Frank Act (the
Volcker Rule) is an issue that has been raised by several
commenters.
The issue arises because Section 619 of the Dodd-Frank Act
provides that a banking entity may not sponsor or invest in, or
have certain other business relationships with, a hedge fund or
private equity fund. However, Section 619 specifically defines
hedge funds and private equity funds as issuers that would be
investment companies under the Investment Company Act of 1940,
but for Section 3(c)(1) or 3(c)(7). Sections 3(c)(1) and
3(c)(7) are statutory exemptions from the definition of
investment company that are commonly used by hedge funds and
private equity funds, but also are routinely used by venture
capital funds and other entities. In addition, in Title IV of
the Dodd-Frank Act, Congress referred to venture capital as a
``subset'' of private equity when it provided venture capital
advisers (and not private equity advisers) with an exemption
from registration as investment advisers with the SEC.
The proposed rule to implement Section 619 adhered closely
to the language of the Dodd-Frank Act and defined hedge funds
and private equity funds as issuers relying on the exemption in
Section 3(c)(1) or 3(c)(7) of the Investment Company Act. Many
commenters have noted that this language would pick up many
more types of vehicles than the hedge funds and private equity
funds that are specifically referenced in the statute and that
many commenters believe should be the main focus of the Volcker
Rule prohibitions. In particular, many commenters have
recommended that the SEC and other regulators implementing
Section 619 revise the rule to exempt venture capital funds
from Section 619's prohibitions, in part in light of the impact
that venture capital funds can have on U.S. economic growth and
job creation.
Our staff continues to work closely with staff from the
bank regulatory agencies and the CFTC to determine whether the
proposed definition can be refined and whether it would be
appropriate to exempt any entities or funds in light of the
statute and its goals, including Section 619's provision that
the agencies may exempt any activity from the implementing rule
upon a finding that such activity would promote and protect the
safety and soundness of banking entities.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM ELISSE B. WALTER
Q.1. As you know, the SEC has faced repeated attempts from
Congress over the years to significantly cut its funding. Two
years ago, as one example, Republicans in the House of
Representatives sought to cut the President's proposed budget
for the Commission by $222.5 million--or about 15 percent. I am
interested, given the repeated assaults on SEC's funding, to
learn more about the impact this sort of cut would have on the
Commission's functioning.
Can you describe in particular what impact a cut of that
magnitude would have on the SEC's enforcement capacity and the
Commission's ability to hold those who break the law
accountable?
A.1. Reducing the SEC's budget at this critical juncture--in
the aftermath of the fiscal crisis and after the SEC has been
granted significant new responsibilities--would diminish both
our ability to police rapidly changing markets and the faith of
the investing public. The Commission's Enforcement program,
which is charged with investigating and prosecuting violations
of the Federal securities laws, has sought to maximize limited
resources to address ever-more complex and sophisticated
fraudulent schemes. Three years ago, the Enforcement Division
undertook a historic restructuring that, among other things,
streamlined its management and created specialized units to
pursue priority areas. As a result, the Commission has been
better able to identify, investigate, and punish wrongdoing
quickly and effectively. Our success in pursuing misconduct
during the financial crisis, hedge fund and expert network
insider trading, market structure deficiencies, and Ponzi and
other offering frauds is a testament to the effectiveness of
these efforts.
A budget cut would only serve to magnify and accentuate the
challenges brought on by the increase in the number of
individuals and entities falling within our jurisdiction, the
growing number of complex securities offered to the public, and
the accelerating pace of financial innovation that has already
fundamentally changed our markets.
Currently, the SEC oversees approximately 25,000 entities,
including about 11,000 registered investment advisers, 9,700
mutual funds and exchange traded funds, and 4,600 broker-
dealers with more than 160,000 branch offices. The SEC also has
responsibility for reviewing the disclosures and financial
statements of approximately 9,000 reporting companies. In
addition, the SEC oversees approximately 460 transfer agents,
17 national securities exchanges, 8 active clearing agencies,
and 10 nationally recognized statistical rating organizations
(NRSROs), as well as the Public Company Accounting Oversight
Board (PCAOB), Financial Industry Regulatory Authority (FINRA),
Municipal Securities Rulemaking Board (MSRB), and the
Securities Investor Protection Corporation (SIPC). The agency
also has new or expanded responsibilities over the derivatives
markets, hedge fund and other private fund advisers, municipal
advisors, credit rating agencies, and clearing agencies.
Enforcement is expected to shoulder additional work as a
result of our expanded authority under the Dodd-Frank Act. For
example, the Enforcement program is responsible for triaging
and investigating additional tips and complaints received under
the whistleblower program mandated by the Dodd-Frank Act.
Although several thousand smaller advisers are transitioning to
State registration due to the Dodd-Frank, the addition of
entities such as municipal advisors, securities-based swap
entities, and hedge fund and other private fund advisers to the
Commission's jurisdiction has resulted in an increase in the
number of referrals to the Enforcement program.
The sheer number of persons and entities falling within the
Commission's jurisdiction reflects only part of the challenge.
These registrants offer ever-changing products in the market,
from traditional bonds and stocks to structured financial
instruments to derivatives, such as credit default swaps, that
require expertise in understanding of the products, the trading
methods, and the inherent risks. In addition, markets and
companies also are becoming increasingly global, creating a new
set of complexities, including the comparability of information
from different countries and cross-border enforcement. As
product offerings and fraudsters become more sophisticated, the
complexity of enforcement cases increases and requires more
resources dedicated to achieving a successful resolution.
Furthermore, the Enforcement program must confront the
risks to a fair securities marketplace posed by increasingly
complex and fragmented market structures, alternative trading
systems, and high-speed electronic trading. These innovations,
fueled by technological advances, have resulted in a
fundamental shift in market process and behavior. We must
ensure that these innovations do not outpace our efforts to
guard against illegal behavior masked by opaque trading
platforms or the millions of bids, offers, buys, or sells that
can be generated in milliseconds by automated computer
algorithms.
Amidst these challenges, we are under-resourced and lack
sufficient human capital, expertise, and technology to address
the ever more multifaceted and difficult-to-detect misconduct
that threatens investors and the markets. In both FY2013 and
FY2014, the SEC is requesting funds to hire additional
attorneys, trial lawyers, industry experts, forensic
accountants, and paraprofessionals for the Enforcement program,
to maintain the momentum of our recent enforcement activities
and strive to keep pace with markets of growing size and
complexity. Our inability to hire additional staff and augment
our capabilities will weaken the our investigative and
litigation functions; reduce our ability to obtain, process,
and analyze critical market intelligence; inhibit the adoption
of valuable information technology and state-of-the-art
investigative tools; and further reduce our ability to collect
on ordered disgorgement and penalties, and distribute monies
back to harmed investors. Further, our ability to proactively
identify hidden or emerging threats to the markets to halt
misconduct and minimize investor harm, adequately address
complex financial products and transactions, handle the
increasing size and complexity of the securities markets,
identify emerging threats and take prompt action to halt
violations, and recover funds for the benefit of harmed
investors would be severely hindered.
Q.2. Has the SEC conducted any internal research or analysis on
trade-offs to the public between settling an enforcement action
without admission of guilt and going forward with litigation as
necessary to obtain such admission?
If so, can you provide that analysis to the Committee?
A.2. The Commission is rigorous and methodical in analyzing
each offer to settle an enforcement action. While we have not
conducted a macro-analysis of the trade-offs to the public
between settling an enforcement action without an admission of
guilt or wrongdoing and going forward with litigation, every
settlement offer is analyzed on a case-by-case basis in light
of the unique facts and circumstances of that specific case.
Recently, we reviewed our approach to ensure we make full
and appropriate use of our leverage in the settlement process,
including a discussion of the neither-admit-nor-deny approach.
While the no admit/deny language is a powerful tool, there may
be situations where we determine that a different approach is
appropriate.
We currently do not enter no-admit-no-deny settlements in
cases in which the defendant admitted certain facts as part of
a guilty plea or other criminal or regulatory agreement. Beyond
this category of cases, there may be other situations that
justify requiring the defendant's admission of allegations in
our complaint or other acknowledgment of the alleged misconduct
as part of any settlement. In particular, there may be certain
cases where heightened accountability or acceptance of
responsibility through the defendant's admission of misconduct
may be appropriate, even if it does not allow us to achieve a
prompt resolution. Staff from the Division of Enforcement have
been in discussions with Chair White and each of the
Commissioners about the types of cases where requiring
admissions could be in the public interest. These may include
misconduct that harmed large numbers of investors or placed
investors or the market at risk of potentially serious harm;
where admissions might safeguard against risks posed by the
defendant to the investing public, particularly when the
defendant engaged in egregious intentional misconduct; or when
the defendant engaged in unlawful obstruction of the
Commission's investigative processes. In such cases, should we
determine that admissions or other acknowledgement of
misconduct are critical, we would require such admissions or
acknowledgement, or, if the defendants refuse, litigate the
case.
Of course, we recognize that insisting upon admissions in
certain cases could delay the resolution of cases, and that
many cases will not fit the criteria for admissions. For these
reasons, no-admit-no-deny settlements will continue to serve an
important role in our mission and most cases will continue to
be resolved on that basis. No-admit-no-deny settlements achieve
a significant measure of accountability and deterrence because
of the detailed factual allegations and findings contained in
our complaints, orders instituting proceedings, and settlement
documents--factual allegations or findings that present a
virtual road map of the wrongdoing that the Commission contends
violated the Federal securities laws. In addition, the very
public nature of our settlements enhances their deterrent
impact--our settlements frequently are accompanied by press
releases, dissected by the media, analyzed in detail by the
financial industry and the defense bar in various public
forums, and are the subject of speeches and other public
statements by the Chair, the Commissioners, and other SEC
officials.
There is, in fact, economic research that indicates that
SEC settlements have consequences for firms as well as
management and directors. For instance, a group of economists
found that the reputational penalties to a firm of an SEC
enforcement action for financial fraud are highly significant:
for each dollar that a firm misleadingly inflates its market
value, on average, it loses both this dollar plus an additional
$3.08 when its misconducts is revealed (Jonathan M. Karpoff, D.
Scott Lee, and Gerald S. Martin, ``The Cost to Firms of Cooking
the Books'', 43 Journal of Financial and Quantitative Analysis,
2008). The same economists studied 2,206 individuals identified
as responsible parties for 788 SEC and Department of Justice
enforcement actions for financial misrepresentation from 1978
through mid-2006. They found that 93 percent of the individuals
lose their jobs by the end of the regulatory enforcement
period, with the majority being explicitly fired (Karpoff, Lee,
and Martin, ``The Consequences to Managers for Financial
Misrepresentation'', 88 Journal of Financial Economics, 2008).
In addition, economists have found that when the SEC settles a
case, outside directors experience a decline in the number of
other board positions held (Eliezer Fich and Anil Shivdasani,
``Financial Fraud, Director Reputation, and Shareholder
Wealth'', 86 Journal of Financial Economics, 2007, and Eric
Helland, ``Reputational Penalties and the Merits of Class-
Action Securities Litigation'', 49 Journal of Law and
Economics, 2006).
Q.3. In Section 953(b) of the Dodd-Frank Act, Congress required
the SEC to issue a regulation mandating that companies disclose
the ratio of pay between the company's CEO and the company's
median employee. This disclosure requirement is intended to
help investors evaluate total levels of CEO pay relative to
other company employees. Many investors want to know about
these pay ratios because high pay disparities between the CEO
and other employees--particularly in a time of economic belt
tightening--can result in lower employee morale, reduced
productivity, and higher turnover, thereby signaling economic
trouble for the company. It has now been more than 2 years
since the SEC issued its rule implementing the Dodd-Frank
``say-on-pay'' vote requirement, but the SEC has not yet issued
a rule implementing Section 953(b).
Why hasn't the SEC issued rules implementing Section
953(b)?
When will these rules be issued?
A.3. As I noted in my testimony, the Commission has made
substantial progress in writing the huge volume of new rules
the Dodd-Frank Act directs, but I recognize there is more work
to do. The Commission and the staff are continuing to work
diligently to implement the provisions of the Dodd-Frank Act,
including Section 953(b), while balancing that work our other
responsibilities, including the implementation of the
provisions of the JOBS Act. The staff is actively working on
developing recommendations for the Commission concerning the
implementation of Section 953(b), which requires the Commission
to implement rules requiring disclosure of the CEO's annual
total compensation, the median of the annual total compensation
paid to all employees other than the CEO and the ratio between
the two numbers.
This rulemaking raises a number of new issues for the
Commission and registrants that require careful consideration.
As evidenced in the public comment file on the Commission's Web
site, which includes more than 20,000 comment letters relating
to this rulemaking, the comments reflect a wide range of views
concerning the implementation of the provision and the
potential costs and benefits associated with the requirements.
The staff is carefully reviewing and analyzing these comments
as it develops recommendations for the Commission.
Q.4. [Response to question during the hearing from Senator
Warren]: ``When was the last time you took a big Wall Street
bank to trial?''
A.4. We are fully prepared to go to trial every time we bring
an enforcement action, but we believe there is no reason to
delay justice and relief for investors when we can obtain
through a settlement the relief that we could reasonably expect
to receive at trial, without the delay of a lengthy and
protracted litigation. We also believe that SEC settlements
achieve a significant measure of accountability and deterrence
because of the detailed factual allegations contained in our
complaints and settlement documents--factual allegations that
present a virtual road map of the wrongdoing that we contend
violated the Federal securities laws. In addition, the very
public nature of our settlements enhances their deterrent
impact--our settlements often are accompanied by press
releases, dissected by the media, analyzed in detail by the
financial industry and the defense bar in various public
forums, and are the subject of speeches and other public
statements by the Chairman, the Commissioners, and other SEC
officials.
The reality is, as trial-ready as we may be, Wall Street
banks and other large public companies often weigh the risks of
litigating to trial against the SEC--including the risk of
loss, litigation costs, reputational damage and other factors--
and choose instead to offer a proposed settlement. On the other
hand, individuals may weigh the risks of litigating against the
SEC differently than do large banks and public companies,
particularly given that our settlements often include remedies
such as industry bars that restrict an individual's ability to
earn a living in the financial industry.
While the SEC will continue to settle many of the cases
that it files, the calculus for whether we settle or litigate a
case will change under a new shift in approach to our
traditional settlement policy. Recently, the Enforcement
Division, in consultation with the Chair White and the other
Commissioners, reviewed the SEC's settlement policy and
provided guidance to Enforcement staff about the types of cases
where requiring a defendant, as part of a settlement, to admit
the SEC's allegations could be in the public interest. These
cases may include those where the misconduct harmed large
numbers of investors or placed investors or the market at risk
of potentially serious harm; where admissions might safeguard
against risks posed by the defendant to the investing public,
particularly when the defendant engaged in egregious
intentional misconduct; or when the defendant engaged in
unlawful obstruction of the Commission's investigative
processes. In such cases, should we determine that admissions
or other acknowledgement of misconduct are critical, we would
require such admissions or acknowledgement, or, if the
defendant refuses, litigate the case. Even under this shift in
approach, many cases will not fit the criteria for admissions.
Accordingly, no-admit-no-deny settlements will continue to
serve an important role in the SEC's mission and most cases
will continue to be resolved on that basis.
Regarding your particular question about litigating with
large financial institutions, we have filed a significant
number of litigated actions--actions where we stood ready to go
to trial--in our financial crisis-related cases against
individuals, many of whom were CEOs, CFOs, or other senior
executives at major Wall Street banks or financial
institutions. In total, we have filed crisis-related actions
against 105 individuals--70 percent of which were filed as
contested actions--employed by Goldman Sachs, J.P. Morgan,
Citigroup, Wells Fargo, Bear Stearns, Bank of America, Fannie
Mae, Freddie Mac, Countrywide, New Century, and other large
financial firms.
As to actions against particular Wall Street banks, our
April 2012 financial crisis-related case against Goldman Sachs
arising from the Abacus CDO transaction was a contested
litigated action before resolving in a landmark $550 million
settlement that also required Goldman Sachs to make various
compliance reforms. We continue to actively litigate towards an
upcoming trial against Fabrice Tourre, the Goldman Sachs Vice
President primarily responsible for structuring and marketing
the transaction.
A major firm, if not a major bank, we litigated to trial
against the Reserve Fund Management Co., the investment firm
running the $62 billion Reserve Primary Fund money-market fund
that fell below $1 per share--breaking the buck, in Wall Street
vernacular--when its $785 million in Lehman debt was rendered
worthless in bankruptcy. We also litigated to trial against
Bruce Bent, Sr., and his son, Bruce Bent II, for their conduct
in allegedly deceiving investors about the risks facing the
Reserve Fund after Lehman's September 2008 collapse. The jury
found that Reserve Management and a related brokerage
operation, Resrv Partners Inc., violated antifraud provisions
of the Federal securities laws and also found Bruce Bent II
liable for one negligence claim.
We also engaged in extended litigation against Brookstreet
Securities Corporation, a California-based broker-dealer, along
with its CEO, and several registered representatives for
systemically selling risky mortgage-backed securities to
retirees and other customers with conservative investment goals
as the housing market was collapsing during the financial
crisis. After nearly 3 years of litigation first initiated in
December 2009, we won summary judgment--just before trial--
against Brookstreet Securities and its CEO and both were
ordered to pay a maximum penalty of $10 million, plus
disgorgement. The Brookstreet registered representatives went
to trial and we are still awaiting a final decision.
In sum, we think that our policy of obtaining settlements
where they reasonably approximate what we could achieve at
trial is an effective way to hold accountable those entities
and individuals whom we believe to have violated the Federal
securities laws far sooner than through protracted litigation.
Although we believe our settlement policy is in the public
interest we certainly stand ready and able to litigate to
trial--a willingness that only strengthens our negotiation
position when crafting a settlement that benefits and protects
investors.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM ELISSE B. WALTER
Q.1. Section 120 of the Dodd-Frank Act states that ``[t]he
Council shall consult with the primary financial regulatory
agencies [ . . . ] for any proposed recommendation that the
primary financial regulatory agencies apply new or heightened
standards and safeguards for a financial activity or
practice.'' In its November 2012 release on money market fund
regulatory proposals, FSOC states that ``in accordance with
Section 120 of the Dodd-Frank Act, the Council has consulted
with the SEC staff.'' It is my understanding that FSOC did not
consult with any of the SEC Commissioners serving at the time.
Given that the SEC is solely governed by the commissioners,
and especially considering that SEC staff serves at the will of
the SEC Chairman rather than all Commissioners, how would such
consultations with staff fulfill this statutory obligation
going forward?
A.1. The Dodd-Frank Act contains numerous consultation
requirements applicable to the SEC, including requirements for
the SEC to consult with other agencies, or for other agencies
to consult with the SEC, in connection with rulemaking and
other actions. These consultations typically involve
discussions and coordination with staff, including senior
staff, of the relevant agencies, which is consistent with the
traditional way that agencies Government-wide have performed
interagency consultations under numerous statutes. In
developing its proposed recommendations for money market mutual
fund reform, and consistent with the traditional manner of
consultation, the FSOC consulted with the SEC staff.
Q.2. What research has FSOC done to determine the reduction in
assets held in money market funds that could result from the
proposed section 120 recommendations?
Have you done anything to quantify the economic effect of a
substantial shift in assets from prime money market funds to
Treasury money market funds, banks, or unregulated investment
funds?
A.2. I cannot speak to what research the FSOC did prior to
issuing its Section 120 report, beyond what may be in those
recommendations. The SEC's recent rule proposal addressing
potential money market fund reform generally tackled the
difficult questions regarding the potential economic impacts of
various reform alternatives and specifically addressed the
question of whether there will be a reduction in assets held by
money market funds and if so, where those assets may go. The
proposing release explicitly acknowledges that investors may
withdraw some of their assets from affected money market funds.
At the same time, however, the proposal makes clear that the
SEC cannot make reliable estimates of the amount of dollars
that will leave the industry or where those dollars will likely
go.
The release provides information regarding the holdings of
money market funds, including the fraction of various types of
securities that have been held by the money market fund
industry (for example, Treasury securities, commercial paper,
and certificates of deposit). This information demonstrates
that money market funds are important players in certain asset
classes. The release does not, however, directly estimate what
might happen were money market funds to withdraw from certain
asset classes. Quantifying the effects of movements from money
market funds to other investment alternatives is challenging
because the SEC is unable to estimate how the investment
alternatives would invest the new monies. For example, if
institutional investors moved their monies from prime money
market funds to unregulated investment funds, it is possible
that the unregulated investment funds would ultimately choose
to invest in the same assets that were held previously by the
prime money market funds. If this were to happen, the effects
on issuers and the short-term financing markets would be
negligible. However, there could be substantive effects if the
unregulated investment funds invested in substantively
different assets. Given the uncertainty, it is difficult to
quantify those effects.
The release contains questions on this issue and we look
forward to receiving comments from the public. Moreover, the
SEC's proposal includes an expansion of the data required to be
filed with the SEC regarding unregistered investment funds,
known as ``liquidity funds,'' that potentially could serve as
an alternative to registered money market funds. Such data
would enable the SEC and the FSOC to monitor any growth in such
funds as well as identify the asset classes in which those
funds invest.
Q.3. Under Title V--Private Company Flexibility and Growth,
Section 501 Threshold for Registration will the Securities and
Exchange Commission provide guidance as to the process for
determining whether a shareholder meets the ``accredited
investor'' definition for purposes of the JOBS Act?
A.3. As you know, under Title V of the JOBS Act, an issuer that
is not a bank or bank holding company is required to register a
class of equity securities within 120 days after its fiscal
year end, if on the last day of its fiscal year it has total
assets of more than $10 million and a class of equity
securities, other than an exempted security, held of record by
either 2,000 persons or 500 persons who are not accredited
investors.
I understand that companies are uncertain about how to
establish and track which shareholders qualify as accredited
investors in order to be able to comply with this provision,
particularly because investors, especially investors in
secondary market transactions, do not have current or ongoing
obligations to provide information to the issuer or the
issuer's agent as to whether or not they are accredited
investors. Although the changes to Section 12(g) of the
Exchange Act were effective upon enactment, the Commission will
need to amend certain rules to reflect these statutory changes.
The issue of how a company would determine whether a
shareholder qualifies as an accredited investor for purposes of
determining the number of holders of record is one that the
Commission's staff is aware of and is carefully considering as
it prepares recommendations for the Commission.
Q.4. Under Title V--Private Company Flexibility and Growth,
Section 502 Employees are family members (including heirs of
the employee and trusts established by the employee) included
in the definition of persons for purposes of the following:
``securities held by persons who received the securities
pursuant to an employee compensation plan in transactions
exempted from the registration requirements of section 5 of the
Securities Act of 1933''?
A.4. In addition to raising the total assets and shareholder
thresholds that require registration of a class of security by
companies other than banks and bank holding companies, Title V
of the JOBS Act excludes shares held by those who received them
pursuant to employee compensation plans from inclusion in the
number of holders of record. Title V also requires the
Commission to adopt a safe harbor for the determination of
whether such a holder received the securities pursuant to an
employee compensation plan that was exempt from the
registration requirements of Securities Act Section 5. The
issue of transfers among family members as it applies to the
exclusion of employee compensation plan securities under
Section 12(g) is one that the Commission's staff is aware of
and is carefully considering as it prepares its recommendations
for the Commission.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM GARY GENSLER
Q.1. Given how complex it is to determine whether a trade is a
hedge or a proprietary trade, it appears the real issue is
whether a trade threatens the safety and soundness of the bank.
What benchmark does your agency use to determine whether a
particular activity is or is not ``hedging''? How does your
agency determine whether the trade presents risks to the safety
and soundness of a financial institution?
A.1. The Dodd-Frank Act requires that the CFTC, the Federal
Reserve Board, the Securities and Exchange Commission, the
Office of the Comptroller Currency, and the Federal Deposit
Insurance Corporation write regulations that implement the
Volcker Rule. The CFTC's related Proposed Rule was published on
February 14, 2012, along with request for public comment. The
Proposed Rule describes seven criteria that a banking entity
must meet in order to rely on the hedging exemption. Included
is a condition that the transaction in question hedge or
otherwise mitigate one or more specific risks, that the
transaction be reasonably correlated to the risk or risks the
transaction is intended to hedge, that the hedging transaction
not give rise to significant exposures that are not themselves
hedged in a contemporaneous transaction, and other related
conditions. The CFTC and the other agencies are in the process
of evaluating and reviewing each of the comments that were
received on the proposed Volcker Rule and will address those
comments in a Final Rule.
Q.2. Last year the CFTC issued proposed interpretive guidance
on cross-border application of the swaps provisions of Dodd-
Frank, the so-called extraterritoriality guidance. This
guidance received widespread criticism from foreign regulators
across the globe for, among other things, not conforming to a
G20 agreement, being too expansive in scope and confusing in
application. Recently, the CFTC approved an exemptive order
delaying the effective date for some of the provisions and
issued further cross-border guidance in an attempt to clarify
the scope and definition of ``U.S. person.'' However, at least
one foreign regulator (The Financial Services Agency of the
Government of Japan) sent you a letter stating that the further
guidance made the definition even less clear. What steps is the
CFTC taking to address those concerns?
A.2. The Commission is reviewing, summarizing, and considering
all comments received as it works toward finalizing the cross-
border guidance. We are also working bilaterally with domestic
and foreign regulators, including the Japanese Financial
Services Authority (JFSA), to answer any questions and discuss
any issues they have regarding the CFTC's proposals.
Additional Material Supplied for the Record
HIGHLIGHTS OF GAO-13-180: FINANCIAL CRISIS LOSSES AND POTENTIAL IMPACTS
OF THE DODD-FRANK ACT, JANUARY 2013
SUBMITTED WRITTEN TESTIMONY OF CHRISTY ROMERO, SPECIAL INSPECTOR
GENERAL FOR THE TROUBLED ASSET RELIEF PROGRAM (SIGTARP)
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, I want to thank you for holding today's hearing on Wall
Street reform and an oversight of our Nation's financial stability. The
Office of the Special Inspector General for the Troubled Asset Relief
Program (SIGTARP) serves as the watchdog over the Troubled Asset Relief
Program (TARP), the Federal bailout resulting from the financial
crisis. SIGTARP protects the interests of those who funded TARP
programs--American taxpayers. Our mission is to promote economic
stability through transparency, robust enforcement, and coordinated
oversight.
In order to determine where our Nation stands today in terms of
Wall Street reforms and financial stability oversight, we must
understand how our Nation found itself in a financial crisis and a
bailout in 2008. SIGTARP has examined the past actions by Wall Street
institutions that made them ``too big to fail'' and led to the TARP
bailout. The issues that arose in the wake of the financial crisis, and
our Government's response, have implications for the future. Indeed,
the Congressional hearings on the Dodd-Frank Wall Street Reform and
Consumer Protection Act are largely focused on the reasons why Treasury
and the Federal banking regulators believed that these institutions
were ``too big to fail'' requiring a TARP bailout, and the reforms that
were needed to prevent future bailouts. Only by examining the past, can
we take advantage of lessons learned to protect taxpayers better in the
future.
Four years after the passage of the TARP bailout, critical
questions remain prevalent about financial stability and Wall Street
reform. Does moral hazard still exist? Is our financial system still
vulnerable to companies that were considered ``too big to fail?'' Do
taxpayers have a stronger, more stable financial system that is less
prone to crisis--one in which the U.S. Government need not intervene to
rescue a failing institution--as an owner or a shareholder--or else
risk financial collapse? Taxpayers need and deserve lasting change
arising out of the 2008 financial crisis.
While there have been significant reforms to our financial system
over the past 4 years, more change is needed to address the root causes
of the financial crisis and the resulting bailout, including
vulnerabilities to highly interconnected institutions, and past
failures in risk management. Financial institutions, regulators, and
Treasury have a benefit that was missing during the financial crisis:
the benefit of time . . . time to shore up existing strengths and to
minimize vulnerabilities.
There are lessons to be learned from the 2008 financial crisis and
TARP. And as history has a way of repeating itself, we must take those
lessons learned and put into place the changes that will bring a safer
tomorrow--a future in which the flaws and excesses of corporate America
do not create an undertow for families and small businesses.
Too Interconnected To Fail
One of the most important lessons of TARP and the financial crisis
is that our financial system remains vulnerable to companies that can
be deemed ``too interconnected to fail.'' In 2008, we learned that our
financial system was akin to a house of cards, with a foundation built
on businesses that were ``too big to fail.'' But these businesses were
not only too big to fail, in and of themselves, they also were highly
interconnected. If one were to fall, the house of cards could collapse.
When the crisis hit, regulators were ill-prepared to protect
taxpayers because they had failed to appreciate the interconnected
nature of our financial system, and the resulting threats to American
jobs, retirement plans, mortgages, and loans. Thus, Treasury and
regulators turned to TARP.
These same financial institutions continue to form the foundation
of our economy. They continue to be dangerously interconnected. And, in
fact, they have only gotten bigger in the past 4 years. \1\ In 2012,
the Federal Reserve Bank of Dallas reported that the biggest banks have
grown larger still because of artificial advantages, particularly the
widespread belief that the Government will step in to rescue the
creditors of the biggest institutions if necessary--a belief
underscored by TARP.
---------------------------------------------------------------------------
\1\ According to Federal Reserve data, as of September 30, 2012,
the top five banking institutions (all TARP recipients) held $8.7
trillion in assets, equal to approximately 55 percent of our Nation's
gross domestic product. By comparison, before the financial crisis,
these institutions held $6.1 trillion in assets, equal to 43 percent of
GDP.
---------------------------------------------------------------------------
Whether Dodd-Frank's newly created resolution authority will
ultimately be successful in ending ``too big to fail'' will depend on
the actions taken by regulators and Treasury. Notwithstanding the
passage of Dodd-Frank, the FRB Dallas reports that the sheer size of
these institutions--and the presumed guarantee of Government support in
time of crisis--have provided a ``significant edge--perhaps a
percentage point or more--in the cost of raising funds.'' In other
words, cheaper credit translates into greater profit.
After Dodd-Frank, credit rating agencies began including the
prospect of Government support in determining credit ratings. In 2011,
Moody's downgraded three institutions citing a decrease in the
probability that the Government would support them, while stating that
the probability of support for highly interconnected institutions was
very high. Recently, a Moody's official stated that Government support
was receding.
It is too early to tell whether full implementation of Dodd-Frank
will ameliorate the need for taxpayers to bail out companies if there
is a future crisis. Even without the failure of any one of these
institutions, we have learned that their near failure or significant
distress could cause ripple effects for families and businesses.
Despite TARP and other Federal efforts preventing the failure of these
institutions, much of Americans' household wealth evaporated. Treasury
Secretary Timothy F. Geithner testified before Congress in a hearing on
Dodd-Frank that there was a ``threat of contagion'' caused by the
interconnectedness of major firms. Given this continued ``threat of
contagion'' to our financial system, Treasury and regulators should
take this opportunity to protect taxpayers from the possibility of any
future financial crisis.
Through Dodd-Frank, Congress significantly reformed the regulators'
authority to hold ``systemically important'' institutions to higher
standards. However, it remains unclear how regulators will use that
authority, and to what degree. The determination of which nonbank
institutions are considered systemic also remains unclear. In addition,
companies previously described as systemic, such as AIG, have gone
without financial regulation for years. Despite the fact that the
identity of banks that will be subject to higher standards has been
known for 2 years, the standards for these companies are far from
final. Regulators have moved more slowly than expected, due in part to
strong lobbying efforts against change.
Treasury and regulators must provide incentives to the largest,
most interconnected institutions to minimize both their complexity and
their interconnectedness. Treasury and regulators should send clear
signals to the financial industry about levels of complexity and
interconnectedness that will not be accepted. Treasury and regulators
must set the standards through increased capital and liquidity
requirements to absorb losses, as well as tighter margin standards.
Treasury and regulators should limit risk through constraints on
leverage. And companies, in turn, must do their part.
Risk Management
Companies must engage in effective risk management, and regulators
must supervise this risk management. According to Treasury Secretary
Geithner's Congressional testimony in support of Dodd-Frank, the
biggest failure in our financial system was that it allowed large
institutions to take on leverage without constraint. Leverage--debt or
derivatives used to increase return--has risk because it can multiply
gains and losses. Large interconnected financial institutions had
woefully inadequate risk management policies, which allowed problems to
intensify. \2\ Financial institutions made risky subprime mortgages,
which they then sliced, diced, and repackaged into complex mortgage
derivatives to be sold to each other and to other investors. These
companies and investors were heavily dependent on inflated credit
ratings. Institutions bought these long-term illiquid securities with
short-term funding that froze in 2008, causing severe liquidity crises.
Treasury asked Congress to approve TARP because these illiquid mortgage
assets had, in essence, choked off credit.
---------------------------------------------------------------------------
\2\ Testimony of Treasury Secretary Henry Paulson, Financial
Crisis Inquiry Commission, May 6, 2010.
---------------------------------------------------------------------------
Insufficient attention was placed on counterparty risk, with many
of the companies believing they were ``fully hedged'' with zero risk
exposure. Companies developed elaborate methods of hedging, including
buying insurance-like protection against the default of these
investments (called credit default swaps). Companies hedged through
offsetting trades that bet on the increase and decrease in the value of
the security. These hedges, many of which did not fully protect against
exposure, provided a false sense of protection that led to decreased
risk management and decreased market discipline.
The financial system was opaque, impeding an understanding of the
true exposure to risk by institutions, rating agencies, investors,
creditors, and regulators. Products such as credit default swaps went
unregulated. Offsetting trades occurred on the over-the-counter
market--a market that, unlike the New York Stock Exchange or other
exchanges, has no transparency. With no effective curbs on risk,
executives often ignored risk, with many receiving extraordinary pay
based on how many mortgages they created, while at the same time
transferring their risk in the ultimate success of the mortgages. In
short, Wall Street cared more about dollars than sense. And yet, we
must ask ourselves: Has anything changed?
In 2008, the U.S. Government assured the world that it would use
TARP and access to the Federal Reserve's discount window to prevent the
failure of any major financial institution. But in so doing, it
encouraged future high-risk behavior by insulating the risk-takers from
the consequences of failure. This concept--known as moral hazard--is
alive and well. A 2012 study by Federal Reserve economists found that
large TARP banks have actually increased the number of loans that could
be considered ``risky,'' which ``may reflect the conflicting influences
of Government ownership on bank behavior.'' Fannie Mae and Freddie Mac
also operated with an implicit Government guarantee, which led to lower
borrowing costs that enabled them to take on significant leverage.
According to Treasury, these entities ``were a core part of what went
wrong with our system.'' \3\ Dodd-Frank did not address Fannie Mae and
Freddie Mac.
---------------------------------------------------------------------------
\3\ Testimony of Treasury Secretary Timothy F. Geithner, Senate
Banking Committee, June 18, 2009.
---------------------------------------------------------------------------
Financial institutions must practice discipline and responsibility
by reforming risk management and corporate governance. Companies cannot
write off risk management believing that their exposure is removed by
hedging. Companies must understand their exposure to risk, including
conducting heightened reviews of counterparty risk.
Recent scandals such as JPMorgan's ``London whale'' and LIBOR
manipulation have shown that excessive risk-taking continues unchecked
by executives and boards of directors. Companies should make a deeper
assessment of their assets. Assets carry different amounts of risk;
collateral for some loans may be stronger than others. In determining
the amount of TARP funds to invest in a bank, Treasury used the total
risk-weighted assets, rather than total assets. Executives and boards
must better understand, monitor, and manage risk.
We learned from the crisis that we cannot expect companies to
constrain excess risk-taking on their own initiative. Regulators
therefore must protect hardworking Americans by setting constraints on
leverage. Given their interconnectedness, risk at one institution
(Lehman Brothers, for example) can shock our entire system. Our
regulators must require ``strong shock absorbers,'' as described by
Treasury Secretary Geithner.
Bank examiners must increase their supervision of risk management
at all banks, and the supervision of companies that pose a risk to our
financial system must be even stronger. Regulators can use information
from on-site examiners, Federal Reserve stress tests, and plans called
``living wills'' (submitted by these companies) to determine areas of
risk. While regulators are still going through the process to write
rules establishing these standards, other rules have not yet been
written.
Treasury and regulators should set strong capital requirements and
liquidity cushions to absorb shock; longer-term funding to prevent a
liquidity crisis; strong rules regarding leverage; and constraints on
specific products or lines of business that hide true exposure to risk.
In the wake of the 2008 financial crisis, we realized that change
was necessary. There has been meaningful change to our financial
system. But there is much more to be done. Americans need and deserve a
financial system with regulation that encourages growth, but that
minimizes susceptibility to current risks--and one that is flexible
enough to protect against emerging risks. Treasury and regulators must
have courage and steely resolve to enact change as they are up against
Wall Street executives who simply wish to return to ``business as
usual,'' with no public memory of the bailout or the lasting impact to
the American taxpayer. Enduring progress will not be easy, but it can,
and must, be achieved.