[Senate Hearing 113-566]
[From the U.S. Government Publishing Office]
S. Hrg. 113-566
WALL STREET REFORM: ASSESSING AND ENHANCING THE FINANCIAL REGULATORY
SYSTEM
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE PROGRESS FINANCIAL REGULATORY AGENCIES ARE MAKING TOWARD
COMPLETING RULES THAT IMPLEMENT THE DODD-FRANK WALL STREET REFORM AND
CONSUMER PROTECTION ACT
__________
SEPTEMBER 9, 2014
__________
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
Glen Sears, Deputy Policy Director
Greg Dean, Republican Chief Counsel
Jelena McWilliams, Republican Senior Counsel
Dawn Ratliff, Chief Clerk
Troy Cornell, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
----------
TUESDAY, SEPTEMBER 9, 2014
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Crapo................................................ 2
WITNESSES
Daniel K. Tarullo, Governor, Board of Governors of the Federal
Reserve System................................................. 4
Prepared statement........................................... 41
Responses to written questions of:
Chairman Johnson......................................... 101
Senator Crapo............................................ 101
Senator Merkley.......................................... 104
Senator Toomey........................................... 110
Senator Kirk............................................. 117
Martin J. Gruenberg, Chairman, Federal Deposit Insurance
Corporation.................................................... 5
Prepared statement........................................... 47
Thomas J. Curry, Comptroller of the Currency, Office of the
Comptroller of the Currency.................................... 7
Prepared statement........................................... 60
Responses to written questions of:
Senator Crapo............................................ 119
Senator Merkley.......................................... 121
Senator Hagan............................................ 126
Senator Toomey........................................... 127
Senator Kirk............................................. 129
Senator Heller........................................... 131
Richard Cordray, Director, Consumer Financial Protection Bureau.. 8
Prepared statement........................................... 69
Responses to written questions of:
Chairman Johnson......................................... 132
Senator Crapo............................................ 134
Senator Toomey........................................... 137
Senator Kirk............................................. 139
Senator Heller........................................... 141
Mary Jo White, Chair, Securities and Exchange Commission......... 10
Prepared statement........................................... 72
Responses to written questions of:
Senator Crapo............................................ 141
Senator Tester........................................... 146
Senator Merkley.......................................... 147
Senator Warren........................................... 155
Senator Kirk............................................. 162
Senator Heller........................................... 164
Timothy G. Massad, Chairman, U.S. Commodity Futures Trading
Commission..................................................... 12
Prepared statement........................................... 95
Responses to written questions of:
Senator Crapo............................................ 164
Senator Merkley.......................................... 168
Senator Kirk............................................. 170
Senator Moran............................................ 171
Senator Heller........................................... 172
(iii)
WALL STREET REFORM: ASSESSING AND ENHANCING THE FINANCIAL REGULATORY
SYSTEM
----------
TUESDAY, SEPTEMBER 9, 2014
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:01 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. I call this hearing to order.
Today, I welcome back the financial regulators for another
one of our many Wall Street Reform oversight hearings in this
Committee since the enactment of the law. You all have been
busy over August as you continue to make progress in completing
rulemakings to implement Wall Street Reform. I thank you and
your staffs for your hard work.
I strongly believe today, as I did in 2010, that Wall
Street Reform was the appropriate response at the time to the
financial crisis. We can already see the benefits. We have an
enhanced system of regulation for our largest banks and nonbank
financial companies. We have greater transparency and oversight
for derivatives. We have a dedicated and accountable watchdog
focused on better protecting consumers. We have strengthened
coordination between regulators. And, we have new ways to
monitor threats to financial stability.
As we all know, the road to implementing Wall Street Reform
has been long and it has not always been easy. This is
especially true for regulators trying to work together to write
effective rules for an increasingly complex and global
financial system. For some, this work has been done while
Congress has not provided adequate funding. Proposed rules have
not always been met with open arms from Congress, industry, or
consumer groups. However, through robust and constant
oversight, Members of this Committee have had the opportunity
to express their views, and each of you and your agencies have
listened. Because of it, the finalized rules are stronger.
Going forward, as we get farther away from the crisis and
calls to water down Wall Street Reform grow louder,
policymakers cannot forget the lessons from the crisis and how
costly a weak regulatory system can be. Our financial system is
strongest when we have tough, but fair, oversight to provide a
level playing field for all financial firms to better serve
their clients.
Today, I look forward to hearing from the witnesses their
next steps to complete the remaining Wall Street Reform
rulemakings. Because of your diligent work, our financial
institutions are stronger, our economy is more stable, and the
rest of the world is looking to us when it comes to strong
financial regulation. This is a vast improvement from where our
country was before and during the financial crisis.
I now turn to Senator Crapo for his opening statement.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you, Mr. Chairman.
Dodd-Frank requires about 400 new rules to be written and
approved by the Federal financial regulators, and to date,
slightly more than 50 percent of these rules have been
finalized, and nearly 25 percent are still in the proposed
stage. The remaining 25 percent are yet to be written.
With some 220 rulemakings finalized, we still have no idea
what the cumulative cost of Dodd-Frank is or will be. The
Volcker Rule and the conflict minerals rule alone will add
approximately 4.6 million paperwork burden hours and over one
billion for services of outside professionals, according to the
regulators' own Paperwork Reduction Act estimates, and that is
just for 2 of the 220 rules finalized.
We cannot pretend that these additional costs are not
passed on to consumers. Without a cumulative analysis of the
true costs and burdens of the rules, we cannot understand their
overall impact on the regulated entities, consumers, and the
markets.
For example, while Dodd-Frank was intended to exempt small
institutions from some regulations, what I hear back in Idaho
is that regulatory demands are trickling down even to the
smaller banks and entities. Community banks are
disproportionately affected because they are less able to
absorb additional costs. Out of concern about what new
regulations may be imposed next, financial institutions keep
money for compliance costs set aside rather than investing it
in local communities.
We can and should make commonsense changes to lessen the
regulatory burden. In past hearings, the regulators have
supported several Dodd-Frank fixes, including the end-user fix,
the swaps push-out rule, and giving the Fed flexibility to
tailor the capital standards it places on insurance companies.
Regarding the latter, the Senate passed by unanimous consent a
fix so that insurance companies are not subject to bank-like
capital requirements contrary to their business model.
I look forward to hearing from the witnesses what specific
fixes should be made so that traditional banking services do
not become so complicated or expensive that banks like those in
Idaho and other rural communities can no longer offer such
services.
I appreciate that some of your agencies have commenced the
statutorily mandated interagency review of existing regulations
to identify outdated, unnecessary, or unduly burdensome
regulations. A similar review led to the 2006 Regulatory Relief
law, and I encourage the remaining agencies to join in this
effort. I urge all of you to make this review a priority, to
set up outreach meetings and with community banks and others,
and to provide a list of recommendations to Congress. For
example, several of our witnesses have discussed eliminating a
paper version of the Annual Privacy Notice, a measure that has
passed the House by a voice vote and currently has more than 70
cosponsors in the Senate.
In addition to Dodd-Frank regulatory mandates, the law also
established the Financial Stability Oversight Council. At the
July FSOC hearing, I reiterated my concerns to Secretary Lew
about the lack of transparency of FSOC's designation process.
Last week's action by FSOC on Met Life only reinforces those
concerns and threatens to disrupt a carefully forged regulatory
balance for an industry that has been traditionally under the
purview of State regulators. The U.S. financial system and
capital markets cannot remain the preferred destination for
investors throughout the world if our regulators operate under
a cloak of secrecy.
Secretary Lew stated that each of the designated nonbank
SIFIs was given detailed explanations as to why they were
designated, but this information was provided only after the
designations were made. This is not how our regulatory
framework should operate. I urge you to publish indicator-based
SIFI designation criteria in the Federal Register for public
comment, and I urge you to impose a moratorium on new
designations until there are objective metrics and increased
transparency. Only then can we restore accountability to the
FSOC designation process. All of your agencies should recognize
the benefit in having an open and transparent regulatory
process. Transparency does not weaken rulemakings, it gives
them much-needed legitimacy.
Mr. Chairman, the issues we are discussing today are very
important, especially as they relate to our smaller financial
institutions. I know that the Committee will be looking at the
small business issues in the near future, and I thank you for
that.
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. Daniel
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.
Rich Cordray is the Director of the Consumer Financial
Protection Bureau.
Mary Jo White is the Chair of the Securities and Exchange
Commission.
Tim Massad is Chairman of the Commodities Futures Trading
Commission. Tim, welcome back to the Committee.
Mr. Massad. Thank you.
Chairman Johnson. I thank you all 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.
Governor Tarullo, you may begin your testimony.
STATEMENT OF DANIEL K. TARULLO, GOVERNOR, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Tarullo. Thank you, Mr. Chairman and Senator Crapo and
other Members of the Committee.
Senator Johnson, I understand that this may be the last
time that this group of six appears before you in your time as
Chairman of the Committee, and I just want to say before I
begin that I think everybody appreciates the care and even-
handedness with which you have approached the substance of
these important issues of financial regulation. And, speaking
as one who has testified before you over the years, I also want
to thank you for the patience and courtesy that you have
extended to all witnesses in your time as Chair. I think it is
something that we have all appreciated and that people have
broadly admired, and we obviously will miss your presence on
this Committee.
In appearing before this Committee in February, I noted my
hope and expectation that this year would be the beginning of
the end of our implementation of the major provisions of the
Dodd-Frank Act. Seven years later, we are on track to fulfill
that expectation, as detailed in my written testimony. To be
clear, though, this is the beginning of the end, not the end
itself. The agencies still have some work to do in adopting
some regulations specifically required by Dodd-Frank. Moreover,
the Fed has some additional work to do in filling out a regime
of additional prudential requirements for systemically
important financial firms.
Let me mention here two priorities. First, we will be
proposing capital surcharges for the eight U.S. banks that have
been identified as of global systemic importance. By increasing
above Basel III levels the amount of common equity required to
be held by these firms, we look to improve their resiliency to
take account of the impact their failure would have on the
financial system. While we will use the risk-based capital
surcharge framework developed by the Basel Committee as a
starting point, we will strengthen that framework in two
respects.
First, the surcharge levels for the U.S. institutions will
extend higher than the Basel Committee range, which will mean
higher applicable surcharges for most U.S. firms--most of the
eight U.S. firms, noticeably so in some cases.
Second, the surcharge formula will directly take into
account each U.S. G-SIB's reliance on short-term wholesale
funding, which we believe to be a very important indicator of
systemic importance because of the potential for funding runs
and contagion under stress.
I would note that while some other countries have also
applied higher surcharges on their G-SIBs than required by the
Basel Committee, none has explicitly taken account of short-
term wholesale funding vulnerabilities.
Second, we are developing a proposal for these same eight
banks to maintain a minimum amount of long-term unsecured debt.
Should one of these firms ever go into resolution or
bankruptcy, this structurally subordinated debt would have been
previously identified as available for conversion into loss
absorbing equity. The presence of a substantial tranche of such
long-term unsecured debt should reduce run risk by clarifying
the position of other creditors in an orderly liquidation or
bankruptcy process. It should also have the benefit of
improving market discipline, since the holders of that debt
would know they face the prospect of loss should the firm
become insolvent.
You will note I mentioned short-term wholesale funding a
couple of times in connection with the most systemically
important institutions. We are also mindful of the risks that
runnable funding can pose more generally. We have been working
with our international counterparts on a proposal for minimum
margins for security financing transactions, such as repos,
that would extend to lending of this sort to all market actors.
While there is more to be done with respect to the largest
institutions and vulnerable wholesale funding markets, I would
close by suggesting it may be time to consider raising some
thresholds or eliminating altogether the application of some
Dodd-Frank provisions to other banks. The three banking
agencies before you today have all been working on ways to
reduce regulatory and supervisory burdens on smaller- and mid-
sized banks. There would also be benefit, I think, from some
statutory changes. One would be to raise the current $50
billion asset threshold that determines which banks are in the
systemic category.
A second would be to exempt community banks entirely from
provisions such as the Volcker Rule and the incentive
compensation provision of Dodd-Frank, which are really both
directed at practices in larger institutions.
Thank you for your attention. I would be pleased to answer
any questions you may have.
Chairman Johnson. Thank you.
Chairman Gruenberg, please proceed.
STATEMENT OF MARTIN J. GRUENBERG, CHAIRMAN, FEDERAL DEPOSIT
INSURANCE CORPORATION
Mr. Gruenberg. Thank you, Chairman Johnson, Ranking Member
Crapo, and Members of the Committee, for the opportunity to
testify today on the FDIC's implementation of the Dodd-Frank
Act.
If I may, like Governor Tarullo, I would like to begin by
thanking Chairman Johnson for his strong personal support and
encouragement to me, both during my service on the staff of
this Committee as well as since I have been at the FDIC. I am
very grateful for the support and encouragement you have given
me and will greatly miss your steady, thoughtful leadership of
this Committee.
The recent actions by the banking agencies to adopt a
supplementary leverage capital ratio, a final rule on the
liquidity coverage ratio, and a proposed rule on margin
requirements for derivatives address three key areas of
systemic risk that, taken together, are an important step
forward in addressing the risks posed, particularly by the
largest, most systemically important financial institutions.
In April of this year, the banking agencies finalized an
enhanced supplementary leverage ratio final rule for the eight
largest and most systemically important bank holding companies
and their insured banks. This rule strengthens the
supplementary leverage capital requirements well beyond the
levels required in the Basel III Accord. The enhanced
supplementary leverage standards will help achieve one of the
most important objectives of capital reforms, addressing the
buildup of excessive leverage that contributes to systemic
risk.
Just last week, the Federal banking agencies issued a joint
interagency final rule implementing a liquidity coverage ratio.
During the recent financial crisis, many banks had insufficient
liquid assets and could not borrow to meet their liquidity
needs, which greatly exacerbated the depth of the crisis. The
liquidity coverage ratio standard will be the first
quantitative liquidity requirement in the United States and is
an important step toward bolstering the liquidity position of
large internationally active banking organizations.
And, finally, establishing margin requirements for over-
the-counter derivatives is one of the most important reforms of
the Dodd-Frank Act. Before the crisis, some institutions
entered into large OTC derivative positions without the prudent
exchange of collateral, or margin, to support those positions.
The margin requirements required by the proposed rule should
promote financial stability by reducing systemic leverage in
the derivatives marketplace.
The FDIC and the Federal Reserve have completed their
reviews of the 2013 Resolution Plans submitted to the agencies
by the 11 largest, most complex bank holding companies as
required by Title I of the Dodd-Frank Act. On August 5, the
agencies issued letters to each of these firms detailing the
specific shortcomings of each firm's plan and the requirements
for the 2015 submission. While the shortcomings of the plans
varied across the firms, the agencies identified several common
features of the plans' shortcomings, including unrealistic or
inadequately supported assumptions and the failure to make or
even to identify the necessary changes in firm structure and
practices to enhance the prospects for orderly resolution.
The agencies will work closely with the companies to
implement required improvements in the resolution plans,
including simplifying their legal structures, amending
derivative contracts to provide for a stay of early termination
rights, ensuring continuity of critical operations during
bankruptcy, and demonstrating operational capabilities to
produce reliable information in a timely manner. The agencies
are also committed to finding an appropriate balance between
transparency and confidentiality for proprietary and
supervisory information in the resolution plans.
Finally, in its role as supervisor of the majority of the
community banks in the United States, the FDIC has been engaged
in a sustained effort to better understand the issues related
to community banks, those institutions that provide traditional
relationship-based banking services in their local communities.
Since the beginning of this year, FDIC analysts have published
new papers dealing with consolidation among community banks,
the effects of long-term rural depopulation on community banks,
and the efforts of minority depository institutions to provide
essential banking services in the communities they serve. We
have also instituted a new section of the Quarterly Banking
Profile that focuses specifically on community banks and are
providing technical assistance to them, including assisting
with critical cyber risks.
Mr. Chairman, that concludes my remarks. I would be glad to
respond to your questions.
Chairman Johnson. Thank you.
Comptroller Curry, please proceed.
STATEMENT OF THOMAS J. CURRY, COMPTROLLER OF THE CURRENCY,
OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. Curry. Chairman Johnson, Ranking Member Crapo, and
Members of the Committee, I am pleased to appear here today to
provide an update on the steps the OCC has recently taken to
further enhance the effectiveness of our bank supervision and
to provide a status report on the completed and current
projects required by the Dodd-Frank Act.
Like my colleagues, I, too, however, would like to first
thank Chairman Johnson for his guidance and steady leadership
over the years. I have been in public service for a long time
and learned early on that when Congressman Johnson or Senator
Johnson had something to say on a financial matter, it was
worth listening to. I thank you for your years of service and
wisdom and wish you well in your retirement.
In the 4 years since passage of the Dodd-Frank Act, new
tools have been developed and new rules have been put in place
to address regulatory gaps and to create a stronger financial
system. For our part, we at the OCC have completed all of the
Dodd-Frank rulemakings for which we have sole responsibility.
For those interagency rulemakings that remain to be completed,
I believe we have made good progress to date and anticipate
finalizing many of them in the near term.
Since the crisis, we have also seen steady improvements in
the overall financial condition of the banking system. Despite
the improving strength and health of banks, however, I am
keenly aware of the need for supervisors to remain vigilant.
Last week, I was pleased to sign a new rule that not only
memorializes the heightened standards we have applied to large,
complex banks since 2010, but provides also an enforcement
mechanism to compel compliance when necessary. Requiring higher
supervisory standards for the largest and most complex banks we
oversee is consistent with the Dodd-Frank Act's broad objective
of strengthening the stability of the financial system. These
heightened standards address the need for comprehensive and
effective risk management, an engaged board of directors that
exercises independent judgment, a more robust audit function,
talent management recruitment and succession planning, and a
compensation structure that does not encourage inappropriate
risk taking.
Consistent with the heightened standards we are requiring
of the largest banks, we are holding ourselves accountable to
supervisory improvements, as well. Last year, I asked a team of
international regulators to provide a broad, candid, and
independent assessment of our supervision of mid-sized and
large banks. The review identified a number of areas where we
performed really well, but also highlighted areas where we need
to improve. The OCC has embraced the team's findings and taken
steps to execute recommendations that include transformational
improvements.
One key improvement includes expanding our Lead Expert
Program, which will allow us to better compare the operations
of the institutions we regulate to identify trends, best
practices, and weaknesses. Another change will improve our
ability to identify systemic risk by enhancing our risk
monitoring processes and reporting, and that fits squarely with
the semi-annual public reports by our National Risk Committee.
Those reports highlight emerging industry trends and identify
those risk areas where we will focus our resources.
While the OCC has taken many steps to improve our
supervision of large banks, we also recognize the impact of our
activities on community banks. While we are focused on strong
and effective supervision, we are always mindful of the need to
avoid unnecessary burden on community banks. We have responded
by tailoring our supervisory programs to the risks and
complexity of a bank's activities. In each rulemaking, the OCC
has sought and listened to the concerns of community banks. As
an example, the lending limits rule provides a simpler option
for small banks to use for measuring credit exposures, and the
final domestic capital rules address concerns of small banks
with respect to the treatment of TruPS, accumulated other
comprehensive income, and residential mortgages.
My written statement includes a full status report on the
many Dodd-Frank Act rulemakings the OCC has been involved in
and our efforts to better coordinate with other domestic and
international regulators. My statement concludes with an update
of our activities to shore up the industry's defenses against
cyberthreats, which I regard as one of the most significant
emerging issues facing the industry.
Thank you again, and I would be happy to answer the
Committee's questions.
Chairman Johnson. Thank you.
Director Cordray, please proceed.
STATEMENT OF RICHARD CORDRAY, DIRECTOR, CONSUMER FINANCIAL
PROTECTION BUREAU
Mr. Cordray. Chairman Johnson, Ranking Member Crapo,
Members of the Committee, thank you for the opportunity to
testify today about implementation of the Dodd-Frank Act.
It will surprise nobody to learn that I will join my
colleagues in expressing our respect and admiration for your
leadership on financial reform and in this body. Your obvious
commitment to fair consumer financial markets set an example
for this Bureau in our work that, I think, is improving the
lives of so many people across your State and this country.
And, I will always remember your personal kindness and your
family in welcoming me to South Dakota and having me hear from
your constituents about these issues, and your personal
kindness, in particular, in advising me that if I pronounced
the State capital as ``Pierre'' rather than ``Pier,'' that
would make me a dude.
[Laughter.]
Mr. Cordray. The Consumer Financial Protection Bureau, as
you know, is the Nation's first financial agency whose sole
focus is on protecting consumers in the financial marketplace,
and over the past 3 years, we have made considerable progress
in fulfilling our rulemaking, supervisory, and enforcement
responsibilities to protect people across this country.
Our initial focus, as directed by Congress, by all of you,
was to address deep problems in the mortgage market that helped
precipitate the financial crisis. We began by issuing a series
of mortgage rules that took effect early this year. They
require creditors to make reasonable good faith assessments
that borrowers are able to repay their loans, address pervasive
problems in mortgage servicing that caused so many homeowners
to end up in foreclosure, and regulate compensation practices
for loan originators, among others. We have worked closely with
industry housing counselors and other stakeholders to ensure
the rules are implemented smoothly and timely.
Last fall, we also issued another mortgage rule to
accompany a goal long urged in the Congress, which was to
consolidate and streamline Federal mortgage disclosures under
various laws. The new ``Know Before You Owe'' mortgage forms
are streamlined and simplified to help consumers understand
their options, choose the deal that is best for them, and avoid
costly surprises at the closing table.
This summer, we also issued a proposed rule required by
Congress to implement changes made to the Home Mortgage
Disclosure Act. As with the redesign of the mortgage disclosure
forms, we believe this rulemaking presents an opportunity to
reduce unwarranted regulatory burdens.
As each of these initiatives proceeds, we are working
diligently to monitor the effects of our rules on the mortgage
market and make clarifications and adjustments to our rules
where warranted. Right now, for instance, we are pursuing
further research to determine how best to define the scope of
statutory provisions for small creditors that operate
predominately in rural or underserved areas in order to promote
access to credit in those areas.
We are also addressing pressing issues in nonmortgage
markets, including the first consumer protections ever for
remittance transfers--international money transfers, that is--
and a series of larger participant rules to supervise
operations and activities in other markets. And, we are
currently in the process of developing proposed rules on
prepaid cards, debt collection, and payday lending.
Another key task for the Bureau has been to build effective
supervision and enforcement programs to ensure compliance with
Federal consumer financial laws. For the first time ever, we
have the authority to supervise not only the larger banks, but
also a broad range of nonbank financial companies, including
mortgage lenders and servicers, payday lenders, student loan
originators and servicers, debt collectors, and credit
reporting companies.
We made it a priority to coordinate the timing and
substance of examination activities with our Federal and State
regulatory partners. Our supervision program is helping to
drive cultural change within financial institutions that places
more emphasis on treating customers fairly. Our work has
strengthened compliance management at the large banks and
caused many large nonbank firms to implement such systems for
the first time.
Consistent enforcement of the laws under our jurisdiction
benefits consumers, honest businesses, and the economy as a
whole. To date, our enforcement actions have resulted in $4.7
billion in relief for 15 million consumers who were harmed by
illegal practices.
For example, with officials in 49 States, we took action
against the Nation's largest nonbank mortgage loan servicer for
misconduct at every stage in the mortgage servicing process.
With 13 State Attorneys General, we obtained $92 million in
debt relief for 17,000 servicemembers and others harmed by a
company's predatory lending scheme that inflated prices for
electronics.
We worked with the Department of Justice to order a large
auto lender to pay $80 million in damages to 235,000 Hispanic,
African American, and Asian and Pacific Islander borrowers
because of discriminatory practices, the largest amount the
Federal Government has ever secured in an auto lending
discrimination case. And, we took action against two of the
Nation's largest payday lenders for various violations of the
law, including the Military Lending Act.
The core of our mission is to stand on the side of
consumers and make sure they are treated fairly in the
financial marketplace. We have now handled 440,000 consumer
complaints and counting and secured monetary and nonmonetary
relief on their behalf, including many people in each of your
States. We are working on other resources for consumers to help
them better understand the choices they make in the
marketplace.
I would like to say that my outstanding colleagues at the
Bureau, as well as the leaders of our Federal agencies
represented on this panel, are strongly dedicated to a shared
vision of a healthy financial marketplace and we are working
together well to achieve this goal.
Thank you, and I look forward to your questions.
Chairman Johnson. Thank you.
Chair White, please proceed.
STATEMENT OF MARY JO WHITE, CHAIR, SECURITIES AND EXCHANGE
COMMISSION
Ms. White. Thank you. Chairman Johnson, Ranking Member
Crapo, and Members of the Committee, thank you for inviting me
to testify about the SEC's ongoing implementation of the Dodd-
Frank Act and our efforts to reduce systemic risk, close
regulatory gaps, and better protect investors.
Chairman Johnson, I am a relative newcomer to this
Committee, but I certainly want to add my admiration for you,
your professionalism, your leadership of this Committee, and
your support, really, for all of our efforts. So, thank you
very much.
As you know, the Dodd-Frank Act gave the SEC significant
new responsibilities and included some 90 provisions that
require complex SEC rulemaking. The SEC has made quite
substantial progress implementing our Congressionally mandated
rulemaking agenda as we have simultaneously continued our
broader core responsibilities of pursuing securities
violations, important discretionary rulemaking, reviewing
public company disclosures, inspecting the activities of
regulated entities, and maintaining fair and efficient markets,
which has included a continuing review and initiatives to
enhance the quality of our equity and fixed income markets.
Since I became Chair in April of last year, we have focused
on eight key areas of SEC responsibility mandated by the Dodd-
Frank Act: Credit rating agencies, asset-backed securities,
municipal advisors, asset management including regulation of
private fund advisers, over-the-counter derivatives, clearance
and settlement, proprietary activities by financial
institutions, and executive compensation.
Specifically, in furtherance of these regulatory
objectives, the Commission has to date created a new regulatory
framework for municipal advisors, advanced significant new
standards for the clearing agencies that stand at the center of
our financial system, along with our fellow regulators
implemented new restrictions on the proprietary activities of
financial institutions through the Volcker Rule, finalized
rules intended to strengthen the integrity of credit ratings by
reducing conflicts of interest in ratings and improving their
transparency. These rules were adopted on August 27 and
implemented actually 14 credit rating agency rulemakings.
We have adopted significantly enhanced disclosures of
asset-backed securitizations, also adopted last month. We
completed reforms in July to address risks of investor runs in
money market funds, a systemic vulnerability in the financial
crisis, pushed forward new rules for previously unregulated
derivatives, begun implementing additional executive
compensation disclosures, put in place strong new controls on
broker-dealers that hold customer assets, reduced reliance on
credit ratings, and barred bad actors from private securities
offerings.
Since April 2013, the SEC has proposed or adopted nearly 20
significant Dodd-Frank Act rules and thus far has proposed or
adopted in total rules to address about 90 percent of all the
provisions of the Dodd-Frank Act that mandate Commission
rulemaking.
In the eight categories of mandated rulemaking that I have
identified, the bulk of our work is completed or nearing
completion. Our focus now is on finishing our Title VII and
executive compensation rules as required by Dodd-Frank.
We have also worked closely with our fellow financial
regulators to ensure that our financial regulatory system works
overall to protect against risks, both by promoting financial
stability and supporting a sensible and integrated financial
regulatory framework that works effectively for market
participants. The Financial Stability Oversight Council
established by the Dodd-Frank Act, on which I participate as a
member, serves a critical role in that effort.
While the SEC has made significant progress on both our
Dodd-Frank and JOBS Act rulemakings, more remains to be done,
and we must continue our work with intensity. As we do so, we
must be deliberate as we consider and prioritize our remaining
mandates and deploy our broadened regulatory authority,
supported by robust economic analysis. Progress ultimately will
be measured based on whether we have implemented rules that
create a strong and effective regulatory framework and stand
the test of time under intense scrutiny in rapidly changing
financial markets. We must be focused on fundamental and
lasting reform that will protect investors and our markets and
safeguard our financial system.
Thank you again for the opportunity to testify today. I
would be happy to answer any questions.
Chairman Johnson. Thank you.
Chairman Massad, please proceed.
STATEMENT OF TIMOTHY G. MASSAD, CHAIRMAN, U.S. COMMODITY
FUTURES TRADING COMMISSION
Mr. Massad. Thank you, Chairman Johnson and Ranking Member
Crapo and Members of the Committee. I am pleased to testify
before you today on behalf of the Commission.
While this is my first appearance as CFTC Chair, I also
want to add my thanks to you, Chairman Johnson, particularly
with respect to my prior role at Treasury overseeing the TARP
program. It was very unfortunate, of course, that we ever had
to implement TARP, but I appreciate your support for all of our
efforts to stabilize the system.
Before I begin, I would also like to note that my fellow
Commissioner, Chris Giancarlo, is here. He, like me, is a new
member of the Commission and I am pleased that he is here
today.
I would like to review our progress in implementing the
Dodd-Frank Act, Congress's response to the worst financial
crisis since the Great Depression. We must never forget that
this crisis imposed terrible costs on all Americans--millions
of jobs lost, homes foreclosed, many businesses shuttered, and
many retirements and college educations deferred. And, that is
why implementation is so important.
In Dodd-Frank, Congress enacted four basic reforms of the
swap market: Increased oversight of major market players;
clearing of standardized transactions on central
clearinghouses; transparent trading of standardized
transactions on regulated platforms; and regular reporting for
increased market transparency.
The CFTC has made substantial progress in implementing
these reforms. First, we have put in place a framework for the
oversight of swap dealers and major swap participants. Today,
104 swap dealers and 2 major swap participants are
provisionally registered, and we require them to observe strong
risk management practices and business conduct standards.
Second, standardized swaps must now be cleared with a
registered clearinghouse so that risk can be better monitored
and mitigated. In December 2007, only 16 percent of outstanding
transactions measured by notional value were cleared, according
to industry estimates. Last month, 60 percent were cleared. In
addition, last month, an estimated 85 percent of index credit
default swaps were cleared.
Third, standardized swaps must also be traded on a
regulated platform. There are currently 22 swap execution
facilities temporarily registered and volumes are growing.
And, fourth, rules for data reporting are in place. All
swaps, whether cleared or uncleared, must be reported to swap
data repositories. We have four SDRs provisionally registered
and operating.
And, in getting us where we are today, no group deserves
more credit than the hard working staff of the agency, and I
want to publicly thank them for their extraordinary
contributions.
But, much work remains to be done. Let me highlight a few
priorities. First, as we gain experience with new regulations,
we will likely make adjustments to the rules. With reforms as
significant as these, this is to be expected. And, in
particular, we want to make sure the new rules do not place
undue burdens on commercial end users that were not responsible
for the crisis and that depend on these markets to hedge risk.
We will also be mindful of their interest as we complete the
small number of remaining rules required by Dodd-Frank.
To that end, I have scheduled a public meeting on September
17 where we will consider a rule governing special entities,
like public power companies. The Commission will also consider
at that time a proposed rule on margin for uncleared swaps
similar to the rules put forward last week by my banking
regulator colleagues here today.
Second, for reforms to succeed, global regulators must work
together to harmonize rules as much as possible. I have been
very focused on this effort since the day I took office.
Third, we must make sure that market participants comply
with the rules. Strong enforcement and compliance efforts are
vital to maintaining public confidence and participation in our
markets.
And, fourth, technology and data management are priorities.
The CFTC is leading an international effort to establish
consistent standards for reporting, and we will also make sure
the SDRs and market participants report data accurately and
promptly, as this is critical to effective market oversight and
transparency.
All of these tasks require resources. While the agency
staff is excellent and we will do all we can with what we have,
I believe the CFTC's current financial resources are
insufficient to fulfill our increased responsibilities. I hope
to work with Congress to address this need.
The United States has the best financial markets in the
world, the most dynamic, innovative, competitive, and
transparent, and they have been an engine of our economic
growth and prosperity. Effective oversight is vital to
maintaining those strong financial markets.
Thank you again for inviting me today and I look forward to
your questions.
Chairman Johnson. Thank you all.
I will now ask the Clerk to put 5 minutes on the clock for
each Member's questions.
My first question is for each of the panelists. What Wall
Street Reform rules will be finalized before the end of the
year by your agency? For example, should we expect a final risk
retention rule or rule on long-term debt to facilitate an
orderly resolution? Governor Tarullo, let us begin with you and
go down the line.
Mr. Tarullo. Senator, I would expect that we will finalize
the financial sector concentration rule. And, with respect to
risk retention, I am interested, actually, to hear what some of
my colleagues say. I do not know whether I would say by the end
of the year, but I think we are definitely in the home stretch.
Mr. Gruenberg. Mr. Chairman, the agencies have been working
hard on the risk retention rule and I think we are in the end
game. And, I would hope, without making predictions, that we
could complete that rulemaking by the end of the year.
And, you mentioned the long-term debt rule. As you know,
the FDIC has been working cooperatively with the Fed on that
rule and I am hopeful the Fed will be able to move forward on
that area, as well.
Mr. Curry. I, too, would hope to complete the risk
retention rule by the end of the year. The OCC is certainly
committed to devoting the appropriate resources to get it done,
and I hope to be able to work cooperatively with both the
Federal banking agencies and the housing-related agencies, as
well.
Mr. Cordray. Mr. Chairman, we are not directly involved in
the risk retention rule, but we take an interest in it as it
overlaps with our qualified mortgage rule to some significant
degree.
We continue to work on the HMDA implementation and the
mortgage rules implementation, generally. We will have other
larger participant rules that allow us to supervise other
financial markets before the end of the year. And, we continue
to work, as I said, on a number of other issues that are not
mandated by Dodd-Frank but are an important part of
implementing its goals.
Ms. White. With respect to the Dodd-Frank Act, as I
mentioned in my oral testimony, we expect to focus on Title VII
and the executive compensation rules. I do not say they will be
finished by year end, but we will be focusing on those. I do
expect to work with our fellow regulators in completing the
credit risk retention rule.
Outside of Dodd-Frank, we expect to pursue by the end of
the year Regulation SCI, which is Systems Compliance and
Integrity, as well as other initiatives in the equity market
structure area.
Mr. Massad. Mr. Chairman, we are not part of the risk
retention rule, but we will, as I noted, be acting on a rule
for special entities next week which addresses some of the
smaller end-user concerns. We will also be acting on a
reproposal of the margin rule. Of course, with the public
comment period, we may not quite get that finalized by the end
of the year.
Most of our rules are done, so, again, we are very focused
on looking at them and making sure we have addressed some of
the end-user concerns.
Chairman Johnson. Thank you.
Governor Tarullo, your staff has indicated that the Fed is
taking a two-track approach with capital rules for insurance
companies, including one approach the Fed could use if Congress
enacts legislation that the Senate passed unanimously months
ago to provide the Fed with more flexibility to tailor rules
for insurance companies. Is it important for Congress to enact
that law soon to provide for more appropriate rules for
insurance companies?
Mr. Tarullo. Senator, it would be very welcome if the House
would follow your lead and enact that to give us the kind of
flexibility in making an assessment on liability
vulnerabilities of insurance companies that are unique to
insurance companies. We will continue with our two tracks of
planning. We are going to conduct a quantitative impact study
to try to develop some more information on insurance industry
specific products, but it would be very helpful. Thank you.
Chairman Johnson. Chairman Gruenberg, in August, you
announced that the living wills for the 11 largest banking
organizations contain important shortcomings. You have given
each of these banking organizations until July 1 of 2015 to
submit a resolution plan that addresses the shortcomings. What
will your agency be doing in the next year to monitor these
banks and their efforts to address their living will
shortcomings?
Mr. Gruenberg. Mr. Chairman, as I indicated in my opening
statement, we have, in effect, now given each of the 11 firms a
detailed road map of changes they need to make to improve the
resolvability of their firms. We anticipate--by ``we,'' I mean
the FDIC and the Federal Reserve, which worked together jointly
on these letters--to give the firms direction and guidance to
follow through on compliance and implementation of the
directions contained in those 11 letters.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman.
I, too, in my first question, want to talk to each of the
agencies, but I am going to do it in segments. I am focusing in
this question on EGRPRA, the Economic Growth and Regulatory
Paperwork Reduction Act, which, as you know, has requirements
in it for reviews that are statutorily mandated to evaluate
existing regulations to identify outdated, unnecessary, or
unduly burdensome regulations. It was actually this Act that we
used some years back when we made some very good progress
working with many of you to pass a significant Regulatory
Relief Act.
I understand that the Federal Reserve, the FDIC, and the
OCC are already well into and have been going--well underway
and are going down the road of doing this, and so my first
question is to the three of you, which is, will you commit that
your agencies will provide us with a list of--or a table of
regulations that fit this category that we could evaluate for
regulatory reform purposes, and specifically with focus on
community banks?
Mr. Curry. Mr. Chairman, I am currently the Chairman of the
FFIEC, which is overseeing the EGRPRA process, and I think our
objectives are totally in tune with your objectives that you
stated today. The focus of our review of unnecessary or
burdensome rules is really focused on community banks.
Senator Crapo. Good.
Mr. Curry. We are also looking to make sure that we get
adequate input from community bankers directly, so we will be
holding a series of outreach sessions throughout the country to
take in that information. And then, ultimately, we do intend to
do two things: One, to make changes that we have complete
control over in terms of regulations and policy statements, but
also to file a report with Congress in which we would make
recommendations for appropriate statutory changes.
Senator Crapo. Thank you.
Mr. Gruenberg. I would simply add that I agree with
everything the Comptroller said. The EGRPRA process actually
offers the agencies a nice opportunity to take an overview of
the regulatory compliance issue and identify opportunities both
for addressing unneeded regulatory requirements, as well as
opportunities for any statutory change. This has been a focus
of attention and priority, certainly for our three agencies. As
the Comptroller indicated, we are planning a series of public
hearings around the country. We will be participating directly
in some of those hearings and we view it as a good opportunity
to take a broad overview of this.
Senator Crapo. Thank you.
Governor Tarullo.
Mr. Tarullo. Tom gave a good summary, Senator, I think, of
where the three banking agencies are and I agree with him.
Senator Crapo. All right. Thank you very much.
And then to the other three, as I understand it, the CFPB
is covered by this law, also, but the timing is not necessarily
kicking in at the same timeframe for the CFPB, and the CFTC and
SEC are not technically under the law. But, my question to the
three of you is that, regardless of that, will you pursue the
same process and help to provide us with your evaluation of the
kind of unnecessary or unduly regulatory burdensome regulations
that we have, and in particular with regard to community banks?
Mr. Cordray. I will simply say, I am part of the FFIEC. We
are following, as the Comptroller indicated as Chairman of that
body, his lead on regulatory burden review. We have our own
statutory provision that requires a 5-year look-back on all
rules that the CFPB promulgates. We have been actively involved
with industry looking at the mortgage rules to see if there are
tweaks that are needed as we go, and we have made a number of
those to assist compliance. We also have had our own
streamlining initiative, which led to work on the ATM sticker
issue, which Congress ultimately resolved, and we provided
technical assistance on that, and relief on the Annual Privacy
Notices, which is coming very soon in final form.
Senator Crapo. Thank you.
Ms. White. And, I think, Senator Crapo, you are correct. I
do not think the statute applies to us, but I am very much
committed to reviewing our rules in that fashion. We also are
obviously in constant contact with those who our rules impact.
Our rules do not generally have as much impact on community
banks.
One of the other things that I have tried to do since I
became Chair is also to review our major rules, both JOBS Act
and Dodd-Frank and others, as they come out the door so that we
are making changes, making them more efficient, stronger, as we
go.
Senator Crapo. Thank you.
And, Mr. Massad, could you be real fast, because I have got
to get one more question in here.
Mr. Massad. Certainly. We agree with the goal, Senator, and
will be happy to work with your office on it.
Senator Crapo. Thank you. I appreciate that.
My next question is for Governor Tarullo, and, Governor, in
your testimony and in your speech at the Federal Reserve Bank
of Chicago's Annual Bank Structure Conference, you called for
raising the trigger when a bank is systemically important from
$50 billion. I would like you, if you would for us, please, to
just expand on your thinking there, because I agree with you
very strongly and I hope we can make progress in this area.
Mr. Tarullo. Senator, I think we have had the benefit now
of several years of stress testing under both Dodd-Frank and
also our capital requirements assessment process, and I think
we have just concluded that, given the intensity and the
complexity of the work around the really good stress testing
which we believe is necessary for the largest firms, we have
not felt that the additional safety and soundness benefits of
that really aren't substantial enough to warrant the kinds of
expenditures that banks above $50 billion but well below the
largest systemically important institutions have to expend.
Their balance sheets are pretty easily investigated by us, and
their lending falls in a fairly discrete number of forms. So,
in thinking about it, we just thought that having some
experience put us in a better position to make that judgment,
and that is why I mentioned it in the Chicago speech.
Senator Crapo. Well, thank you. I think your observation is
very well taken and is one of those examples of what I am
talking about here today, as well, where we need to find places
where we can resolve some of these unnecessary burdens that are
causing difficulty. Thank you.
Chairman Johnson. Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman. I thank the
witnesses.
Now, as we speak, the Treasury Secretary and Secretary of
Transportation are holding a summit with leaders across the
country to encourage greater investment in infrastructure
projects. But, unfortunately, the Administration's effort to
promote greater investment in infrastructure fly in the face of
rulemaking finalized last week by the Fed, the OCC, and the
FDIC. By excluding municipal bonds from being considered as
high-quality liquid assets, Federal regulators have run the
risk of limiting the scope of financial institutions willing to
take on investment-grade municipal securities, which we know
are the lifeblood of development in this country.
My city and State, New York City and State, rely on this
financing to pave roads, bridges, and start construction in new
schools, but it is not just New York. Any city or State that
have made tough decisions to protect their credit ratings--
Chicago, Philadelphia, California--are susceptible to the
impact of this rule. Investment-grade municipal bonds not only
serve as the mechanism through which we are able to create
bonds and finance critical infrastructure, but the securities
service high-quality assets that adequately cover liquidity
outflows in periods of stress.
I certainly support regulatory efforts to ensure the
banking section is able to absorb shocks in times of financial
and economic stress, as well as enhanced liquidity, but I have
not yet heard a convincing argument why, for instance,
corporate debt can be considered a high-quality asset but
investment-grade municipal securities cannot. Investment-grade
municipal bonds have comparable, if not better, trade, volume,
and price volatility, and they performed well through the
financial crisis. In fact, in 2008 and 2009, price declines on
AAA corporate bonds were greater than the price declines on
both AA municipal general bonds and revenue bonds. And, this
does not even touch on the fact the new rule permits foreign
sovereign debt to be qualified as HQLA while these municipal
bonds are not.
And, the exclusion of this type of debt from counting
toward liquidity coverage for banking institutions has the
potential for States and municipalities to both increase the
cost of interest payments and decrease investment by the
largest banking institutions in infrastructure. Now, more than
ever, we should be wary of blunt policies that have the
potential to negatively impact the municipal bond market and,
ultimately jobs.
The debt issuances from certain States and local
municipalities are considered high-quality liquid assets by
markets and should be treated as such by the rule. Developing
criteria to assess liquidity and performance of various
municipal bond offerings is a more narrowly tailored approach
that was absent from the rule finalized last Wednesday. I hope
all three agencies will reassess the finalized rule and issue
supplemental rules that appropriately account for these
instruments.
So, here are my questions. First, Governor Tarullo, I know
this rule is something you have looked at closely. I was
particularly struck by your comments last week in which you
acknowledged that, quote, ``Staff analysis suggests that the
liquidity of some State and municipal bonds is comparable to
that of the very liquidity of corporate bonds that can qualify
as HQLA,'' and indicated the staff has been working on some
idea for determining criteria for such bonds which might be
considered for inclusion. Would you mind discussing what types
of ideas do you believe are appropriate, and specifically,
whether these ideas would allow for greater flexibility so that
certain investment-grade municipal bonds could be considered
high-quality liquid assets.
And, then, after you opine, I would like to ask Chairman
Gruenberg and Comptroller Curry if they think a rule that
provides greater flexibility in this area would be something
that is important to look into.
Governor Tarullo.
Mr. Tarullo. Thank you, Senator. As you noted, we, the
Board, asked the staff to prepare a proposal that would allow
for recognition as high-quality liquid assets those State and
municipal bonds which are in the same league with very liquid
corporates, and what we have asked the staff to do is an
analysis of the liquidity characteristics of State and munis,
taking into account daily trading volumes. There are some
differences in those markets, but our analysis during the
course of the comment period suggested that there ought to be a
way of identifying the more liquid State and munis, because if
they are really liquid, we really do want banks to be able to
take that into account in thinking about their maturity
lengths.
Senator Schumer. Right. So, you want some comparability
here and you do not want to lump all municipal bonds in one
pot.
Mr. Tarullo. That is correct, Senator.
Senator Schumer. OK. Chairman Gruenberg.
Mr. Gruenberg. Senator, I----
Senator Schumer. The question to you is, would you consider
revising this rule if the analysis shows that the liquidity
levels are similar.
Mr. Gruenberg. The short answer is yes, Senator----
Senator Schumer. Good.
Mr. Gruenberg. ----and I indicated in my remarks at our
Board meeting that we would monitor carefully the impact on the
market, and if there was reason to make adjustments, we would
consider adjustments.
Senator Schumer. Yes. We have loads of our mayors and our
finance directors, as well as Governors, are howling about
this, and so they really think it will impact their markets and
they are experienced to know.
How about Comptroller Curry.
Mr. Curry. Senator, we are certainly looking forward to
discussing with the Fed any additional research or thoughts
that they may have in this area. If there is a possibility to
calibrate a standard that differentiates certain municipal
securities from the broader characteristics, we would look
forward to talking to the Fed about it.
Senator Schumer. Would you be open to changing--to
modifying the rule----
Mr. Curry. Based on----
Senator Schumer. ----as Mr. Gruenberg and Mr. Tarullo have
said they would be?
Mr. Curry. Certainly, based on supporting research or
thoughts from the Fed.
Senator Schumer. What does that mean?
Mr. Curry. I----
Senator Schumer. Would you be open to revising the rule?
Mr. Curry. We are open, but we need to talk with our
colleagues.
Senator Schumer. OK. Thank you, Mr. Chairman, and I thank
you. If all three of you are open to it, and two of you seemed
pretty favorable toward it, I hope you will go ahead and do it,
because it is really important.
Chairman Johnson. Senator Corker.
Senator Corker. Thank you, Mr. Chairman. I appreciate it. I
appreciate all of you being here and the job that you do.
Back when Dodd-Frank was being created, each of us were
assigned certain areas to work on, and our friend Mark Warner
and I worked on Title I and II, and Amy Friend changed it a
little bit, but still pretty good. And, I want to focus on
those two areas. I actually think it was some of the strongest
pieces of the Dodd-Frank bill. And, I noticed that the FDIC and
the Fed had a joint letter relative to the living wills. I will
say, in fairness, Senator Warner was far more focused on the
living wills, and I appreciate his efforts in that regard.
But, I noticed that you had a joint statement, and then
what happened after that is the Fed backed away from that and
wrote something separate from the joint letter that really
watered down, if you will, your concern about living wills,
which created a concern for me, because I know that there is a
process that gets put in place if both of you agree that they
are inadequate, and, therefore, by stepping away, that has been
watered down to a big degree. And, I am just curious as to why
that took place, and both of you might want to respond to that.
Mr. Tarullo. Senator, I did not see any watering down of
the impact of the letters that we agreed on and jointly sent
out. What we jointly agreed on were the measures that we
actually want the banks to take in order to become more
resolvable, which, I think, is the object of this entire
exercise. And, so far as I could determine, there was
substantial convergence, certainly at the staff and principal
levels, on those areas where we expect to see progress.
I think the difference was that the FDIC made a
determination of noncredibility of the letters that had been
submitted already. The feeling at the Board was that there are
obviously shortcomings--that is why we wanted to get these
specifics out--but, we also thought that it was important to go
through another stage of the iterative process that had been
laid out in our reg, and I think is contemplated by the
statute, because that, after all, is the object here, to get us
to the point where the firms are resolvable in bankruptcy as
well as under Title II. And, as you will note in our statement,
the Fed statement and also in the letters, if the firms are not
able to take the steps that we have jointly indicated they need
to take by next July, the agencies will be prepared to take
action under Dodd-Frank in order to enforce those provisions.
And, so, I think by doing that, by being as specific as we
were, I think we should put to rest any complaints that there
was not enough guidance from the agencies along the way. I
think the guidance is out there now and it is actually quite
explicit.
Senator Corker. But, it does have the effect, does it not,
of really slowing down and putting off the institutions taking
the steps they need to take to simplify--there is an iterative
process, as you mentioned, and, I think, by doing what the Fed
did, you added a step to that, did you not?
Mr. Tarullo. Well, I think, actually, what we did was we
focused on what we actually want them to change, and we made it
pretty clear we want a change in the next year. So, I hope
there is no slow-down here. We are certainly not expecting a
slow-down. On the contrary. We are expecting acceleration in
their planning and them to do it with more realistic
assumptions than they did in their prior submissions.
Senator Corker. One of the things that I think there have
been concerns about is you have been--the FSOC has been given
tremendous powers to deal with these entities if you feel like
there, in fact, is any possibility that because of their size
or complexity, they could create a risk to the system. I just
want to ask the two of you, I know we have asked in letter
form, several of us, we have gotten back, as we might expect,
semi-nebulous responses. But, is it a fact or is it not that
will you use the powers that are given to you if these firms--
if you find themselves after this year process not in a place
to be resolved appropriately through bankruptcy, will you take
the measures that you have--many people are trying to pass
legislation, but you already have powers within the
organizations to take steps and force them to be less complex.
Will you do that?
Mr. Tarullo. Sure, Senator. That is, I think, again, the
object of the process, is to try to get them to the point of
resolvability, but as we indicated, we are prepared to use the
powers granted in Dodd-Frank if, in fact, they do not get
there.
I might also add that the things I mentioned this morning--
the higher level of surcharges for the most systemically
important institutions, the attention to the short-term
wholesale funding vulnerabilities, and the requirement for a
substantial amount of subdebt that could be convertible--are
all measures that are actually intended in the same direction,
which is to ensure both the resiliency and the resolvability of
these institutions.
Mr. Gruenberg. Senator, if I could just add, I think the
answer to your question is yes, we will be prepared to use the
authorities of the statute. We have laid down a clear marker at
the Fed and the FDIC for these firms in terms of the kinds of
changes that need to be made.
And, if I may, I would underscore the agreement between the
two agencies on the substance of the letters, which, I think,
was really very solid and meaningful. Think the firms are
clearly on notice that there is an expectation of compliance
with the directions in the letters, and there is a joint
commitment by the two agencies to follow through on that.
Senator Corker. Well, I thank you, and Mr. Chairman, I
appreciate the time. I will say that a big part of the concerns
that were expressed during that time in the passage of the bill
was about the extraordinary actions that we and the American
people had to take during that time. And, unless you,
especially the two of you, are willing to take the steps that
are necessary to ensure that these organizations are not too
complex to be resolved through bankruptcy, then all is for
naught. So, I hope you will. I thank you for your work, and I
appreciate the time, Mr. Chairman.
And, by the way, thank you for creating a bipartisan
atmosphere on the Committee, too, since everybody is apparently
thinking you are going to be Chairman of the Universe after
this----
[Laughter.]
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Madam Chair, you and I have on previous occasions discussed
the CEO pay ratio provision I offered in the Wall Street Reform
law, which requires companies to disclose the ratio of
compensation of their chief executive with the pay of median
workers. This measure focuses investors' attention on the
relative value a CEO creates in order to facilitate better
checks and balances against insiders paying themselves runaway
compensation packages.
And, while CEOs undoubtedly can create value for companies,
so can ordinary workers across an organization. So, when a CEO
asks for a raise while giving other employees a pay cut,
investors should have this information so they can ask whether
this is a value creation or simply value capture by insiders,
especially in an environment in which incomes for the top 1
percent have grown by more than 86 percent over the last 20
years, while incomes for everyone else has grown by less than 7
percent.
As you know from my letters of support, I was pleased to
see the SEC's proposed rule last year to implement this
provision, which, in my view, accurately reflects the
legislative intent that I and others intended. Can you please
give us an update on the status of this rulemaking, and when
does the SEC expect to finalize it?
Ms. White. Essentially, as I think I said in my oral
testimony, we are focused for the balance of this year in terms
of our Dodd-Frank mandated rulemakings on Title VII and
executive compensation. Pay ratio is one of those that has been
proposed, but not adopted. It is certainly a priority to
complete it this year.
Senator Menendez. So, it is your expectation that you would
complete it this year?
Ms. White. It is my hope and expectation to complete it
this year. The staff is still going through the comments, which
were extensive, and formulating a final recommendation, but
that is my expectation.
Senator Menendez. OK. I hope there will be more expectation
and less hope.
Now, let me turn to, Chair White, this summer, the SEC
received its record one-millionth public comment supporting a
rule to require public issuer companies to disclose their
political campaign spending to investors. Supporters include
leading academics in the field of corporate governance,
Vanguard founder John Bogle, investment managers and advisors,
and the investing public. Without disclosure, corporate
insiders may be spending company funds to support candidates or
causes that are directly adverse to shareholders' interests
without shareholders having any knowledge of it. The amounts
being spent may be small or large, but shareholders have no way
of knowing. And, even where the amounts are small relative to
the overall size of the company, the impact on an election,
and, therefore, on shareholders, can still be very large.
If corporate political spending is material to investors,
as the leading experts in the field and over one million
members and the investing public believe it is, why is not the
SEC requiring public issuer companies to disclose this
information? Do you have any plans to engage in a rulemaking on
this issue any time soon?
Ms. White. As you know, we have two petitions actually
still pending before the SEC to require such disclosure. If, in
fact, in a particular company the political spending is
material under the law, that would be required to be disclosed
now. The petition is broader than that.
Again, as, I believe, the Senator and others are aware, we
are very focused on our mandated rulemakings under Dodd-Frank
and the JOBS Act and the staff is currently not working on a
proposal in that area. I do note that a number of companies
have voluntarily made those disclosures and that subject can
also be, and often is, a subject of a proxy proposal.
Senator Menendez. Well, I appreciate where you said your
focus is, but when one million--I think it is very rare that
you get one million public comments in support of a proposal.
And, even if you look at Justice Kennedy's majority opinion in
Citizens United, which opened the floodgates for corporate
election spending and that presumed that shareholders should
have transparency--it presumed, in his opinion, that
shareholders would have transparency in order to enforce
accountability over executives. So, how is it that investors
have control, have that transparency, if they cannot even get
basic information about what is being spent?
Ms. White. I appreciate the intense interest of investors
and others in this issue. The comment letters, of which there
have been many, have been on both sides. And, it is an area
that I am quite sensitive to. It is of high interest. But, as I
said earlier, at this point in time, it is not part of our
current regulatory agenda. We are focused on the mandated
rulemakings.
Senator Menendez. Well, I appreciate that, as someone who
was here and helped not only devise Dodd-Frank, but also
supported it. I will just close on this comment. You know, I
would hope that--this is true across the spectrum--that all of
you realize that while you may ultimately deal with significant
corporations in this country, that at the end of the day, it is
the public who we collectively seek to serve. And, that is best
served by transparency and openness and an opportunity to
understand what companies are doing, whether that is CEO pay to
worker pay, or whether that is using potentially millions of
dollars of corporate funds to maybe the disadvantage of the
very investors who are investing in that company.
And, so, I hope that the hallmark of what we can expect
from all of you, but certainly in this case where you have some
particular unique jurisdiction, is a push toward greater
transparency so that investors really understand what choices
they are making and whether the company is best serving them.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Johanns.
Senator Johanns. Thank you, Mr. Chairman.
Governor Tarullo, let me go back to the question that the
Chairman asked you about capital standards relative to
insurance companies. I fear we have kind of left you folks in a
difficult position. This bill, as you know, has moved through
the Senate by unanimous consent, and I thank my colleague,
Senator Brown, for his help on this bill. So, I think, on the
Senate side, we are in pretty good shape. It is even kind of
rarer that things would move by unanimous consent, but this
did.
On the House side, it has not happened yet. We hope it
will. In fact, my sincere desire is that that will happen very
quickly, certainly by the end of the year, but we do not know
if that is going to happen, and there you are. You are caught
in this kind of limbo situation of what do you do here.
So, let me ask you, how are you folks handling this? Is
there a track for this law passing and a separate track for
this law not passing and you having to cobble something
together that, hopefully, complies with Dodd-Frank? How are you
dealing with this in this interim period of time?
Mr. Tarullo. Senator, you have intuited correctly. We are
trying to think about it under both alternatives. Under one
alternative, we would be able to take account of the different
liability structure of core insurance kinds of activities, and
that would allow us to shape capital requirements at the
consolidated holding company level in a way that fully took
account of those differences in business models.
In the absence of the legislation, we will still be able to
do some things, because there are insurance products that do
not resemble existing bank products. And, so, in some cases, we
can, and we are already planning to, assign different risk
weights to those based upon our assessment of the actual risk
associated with those assets. But, that is where the two-
tracking is actually taking place.
I mentioned a little while back the quantitative impact
study that we are doing. By getting more information from the
insurance companies, we hope to actually find a few other areas
where, consistent with existing statutory requirements, we
could still make some adjustments.
But in the end, Senator, it does all come down to core
insurance activities and the different kind of liability risks
that are associated with them. The assets are often the same.
It is really on that liability side of the balance sheet that
you feel a difference in what a property and casualty insurer
does as opposed to what a bank does, and that is what we would
like to be able to take into account.
Senator Johanns. Your comments lead me to another kind of
whole other area of inquiry that we are not going to be able to
get too far into with the limited time, but let me just throw
out a question, and this probably impacts other panel members,
too. There is so much about the insurance industry that you are
telling us you want more information on. You want--you have got
the quantitative impact study, and there are probably some
other areas where you are seeking additional information. And,
yet, we have three insurance companies--Met Life, AIG,
Prudential--who have been designated systemically risky or
whatever. How do you do that? How do you get so far down the
road and identify these folks as being that when, by your own
testimony, you acknowledge that there are things about the
insurance industry that you want more information on?
Mr. Tarullo. So, Senator, I guess I would draw a
distinction between the creation of capital standards for
traditional or current insurance activities, on the one hand,
and an assessment of systemic risk on the other. My own reading
of the FSOC process with respect to Prudential and AIG is that
there is not a lot of concern about the core insurance
activities of those companies. The concerns were with respect
to some nontraditional insurance activities where runnability
is more of a concern, and also with respect to things that are
not insurance activities of any sort. I think that is where the
analysis would allow one to conclude there is systemic
importance.
I personally do not think that the issue of whether there
is systemic importance in traditional insurance activities has
really been broached, and I am personally not sure we need to
broach it. I mean, my pretty strong presumption would be that
there is not.
Senator Johanns. OK. Thank you, Mr. Chairman.
Chairman Johnson. Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Chair White, I sent you a letter on the SEC's waiver
policies. I appreciate your response. We received it yesterday,
and we will follow up with you. Thank you for that.
Governor Tarullo, I appreciate especially your comments and
your discussion, and Mr. Gruenberg's, with Senator Corker. I
thought that was helpful. You say that capital surcharges to
the largest banks could be a good deal higher than the 2.5
percent Basel rules. An unnamed Fed official told the Wall
Street Journal they could be as high as 4.5 percent. Not
surprisingly, the industry tells us that those additional
requirements would be costly, would put them at a competitive
disadvantage. Tell the Committee why they are important for
financial stability.
Mr. Tarullo. Senator, I would say several things. First, as
some of you may recall, a few years ago, when we were beginning
this exercise on capital surcharges, we did quite a bit of
analysis. And, while we did not think that we could come up
with a point estimate of exactly, precisely what was an
appropriate surcharge given the additional risks to the system
and the impact on the system of the failure of one of these
firms, we did come up with a range. And, in all honesty, the
one to 2.5 percent that the Basel Committee concluded, while an
important step forward, was at the low end of that range. And,
I think we will feel more comfortable to be somewhat closer to
the middle of the range of estimates of the kind of additional
resiliency that is needed.
The second point I would make is that a few other countries
have already come to similar conclusions. Switzerland has on
its own applied higher surcharges than the Basel approach calls
for for its two large globally active institutions. Sweden and
the Netherlands--each has one globally systemically important
institution--they have done the same, and I think at least one
or two other countries are thinking of it. I think we are all
trying to come to grips with what we really need in order to
provide more assurance that these firms do not threaten the
financial system.
And, the third point I would make, which I alluded to in
the written testimony, is the whole idea of these being
increasingly strict surcharges, higher surcharges as the
systemic importance of the entity increases, is grounded in,
the very sound principle embodied in Dodd-Frank that the
stringency of these additional prudential standards should
increase as the systemic importance of the firm increases.
Now, why is that important? Well, it is important because
of the potential harm to society if the firm gets in trouble.
But, it also provides the firm with a kind of tradeoff. You
know, if the firm really thinks that it has to be this big and
this complicated to engage in a certain set of activities or to
have a certain size balance sheet, then it can do so, but it
has to have very high levels of capital. If, on the other hand,
those highest levels of capital appear to not be worth it, then
it has the option of changing what people have called its
systemic footprint.
So, I think, for all of those reasons, this is really a
quite important step forward globally, for everybody to do
surcharges, but, for us and some other countries to recognize
that we need to go a little further than the minimums that have
been provided in Basel.
Senator Brown. Thank you, and I would note that under these
estimates, it could take the largest banks to a 14 percent
requirement. There is a great deal of support in this Committee
and, I think, throughout the House and Senate on stronger
capital standards like that.
Comptroller Curry, thank you for your--the OCC finalizing
rules for heightened expectations for--just because of lack of
time, I will not ask you a question, but thank you for that. I
think that you have taken major steps toward changing the
culture in board rooms. I think we are obviously not there
yet--I know you think that, too--changing the culture in terms
of risk management and elevating risk management to a
particularly important part of large banks' and holding
companies' decision-making process. Thank you.
For my final question, Chair White, at your confirmation
hearing, I asked you about Industry Guide 3, the SEC's
disclosure rules for bank holding companies. You responded that
you agreed that a review of these rules, which an SEC staff
report says have not been updated since 1986, that a review was
warranted. When can we expect the SEC to update its Guide 3
disclosures to help make the largest banks that have increased
measurably and dramatically in both size and complexity in this
three-decade time period, when can we expect you to come
forward to make them more transparent?
Ms. White. As part of our disclosure effectiveness review,
the Industry Guide 3 is currently under review by the staff.
The staff is in the process of actually preparing
recommendations to update Guide 3, including whether to bring
the requirements as they ultimately end up into Regulation SK.
If we change our disclosure requirements, they would also be
put out for notice and comment. We have opened a window in
connection with this initiative where we have also been
receiving some public comments on that. And, so, it is moving
along.
In terms of the ``when'' question, I mean, I cannot answer
it precisely, but it is something that we are actively engaged
on now. I actually reached out, I think, in August to Governor
Tarullo to invite the Fed's input into that, too, because,
obviously, of their role over bank holding companies.
Senator Brown. Thank you. Thanks, Mr. Chairman.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
You know, we have wrestled with this right here with most
of you for years. Capital--what is adequate capital? What is
good capital? What is liquidity, which, I guess, goes to the
basis of what we are talking about.
In the insurance field, have you shared with the Committee,
the Chairman or the Ranking Member, the methodology of how you
designated some of these big insurance companies, like Met Life
and Prudential and others, as systemically risky? Do you
furnish any of the information to the Committee, or would you
be willing to do that, because this is a topic of more than
passing interest right now. Governor Tarullo?
Mr. Tarullo. So, I have to confess, Senator, that I do not
know the answer to that question. Treasury, as you know, chairs
the FSOC----
Senator Shelby. OK.
Mr. Tarullo. I do not know whether any of my colleagues
know whether there is a formal submission process to the
Committee.
Mr. Gruenberg. Senator----
Senator Shelby. Chairman.
Mr. Gruenberg. ----I do not know if there is a specific
submission for the Committee. After a final decision is
reached, I believe there is a public document that is released
laying out the basis for the action in some detail, not
disclosing proprietary information. But, I do not know that
there has been a specific communication to the Committee apart
from that.
Senator Shelby. I know a lot of the people, participants
and CEOs and board members in the insurance company, are really
concerned, because they do not know what direction. I think
they see the direction, but do not know what is happening next
in the field. Is there any way you can give them some certainty
there, or is it just a work in progress as far as you are
concerned? You have designated, what, three big insurance
companies? How many? As systemically risky.
Mr. Tarullo. Oh, there have been final determinations on
two----
Senator Shelby. Two.
Mr. Tarullo. ----Senator. There has been a news report on a
third.
Senator Shelby. News.
Mr. Tarullo. But, that is not a complete administrative
determination yet. The third already designated is GE Capital,
which is not insurance.
Senator Shelby. OK.
Mr. Curry. Senator----
Senator Shelby. Yes, sir.
Mr. Curry. The FSOC has adopted procedures to outline how
we approach our determinations. I do believe, to answer your
question, that we could probably do a better job in explaining
and informing affected institutions as to how that process
works and making sure that we get the most relevant information
possible to make our decision.
Senator Shelby. Let me get into the surcharge a minute.
Some of our large foreign banks that do business here, will
they be subject to the surcharge, too, above three, what, 3
percent or whatever, 2.5--three percent, 3.5--above Basel III?
Governor.
Mr. Tarullo. Senator, that is not our current intention,
although as I mentioned a moment ago, a number of the home
authorities of countries have already at a consolidated level
imposed higher than Basel levels on their own institutions.
Senator Shelby. As high as what you are doing here?
Mr. Tarullo. I am not sure anybody would go as high, but
that is probably because those three countries do not have
anybody who is currently in the so-called top buckets.
Senator Shelby. OK. Well, but do you basically believe, as
a matter of public policy, that large foreign banks doing
business in the U.S. should be subject to--they are--to our
regulatory authority and also capital standards?
Mr. Tarullo. Well, yes. That, is, of course, why we----
Senator Shelby. That is what we did----
Mr. Tarullo. ----adopted the intermediate holding company
regulatory requirement and made sure that all the operations of
the big foreign banks are brought under one umbrella and they
are subject to capital standards, liquidity standard, and, if
need be, resolution standards here in the U.S.
Senator Shelby. Chairman Gruenberg, do you agree with that?
Mr. Gruenberg. I do, Senator.
Senator Shelby. Comptroller?
Mr. Curry. Yes, Senator.
Senator Shelby. OK. That is all. Thank you, Mr. Chairman.
Chairman Johnson. Senator Warner.
Senator Warner. Thank you, Mr. Chairman.
I am going to make a couple quick editorial comments before
I get to a question, actually, for Chairman White. First of
all, I want to follow up on what Senator Corker said. We did
struggle through on Title I and II, and the living wills
concept or funeral plans, it was a new idea. There were others,
Senator Brown and others, who had a more clearly defined cap on
too big to fail. A fair debate took place. I think that debate
continues to be revisited. And, I would simply say that--or
urge, again, I understand this iterative process, but we really
need to keep a fire lit underneath this, and if at some point
the FSOC does not act to start using some of these tools that
were given, then I really do question whether we, as well
intentioned as we were, whether we got it right in Title I and
Title II in terms of ending the too big to fail.
So, my editorial comment would be, let us speed up this
iterative process. The fact that we are now going into many,
many years of getting these plans right, we have got to get it
right, but I would also like to see it come to a conclusion,
and, I think, some evidence that some of these tools that were
broad in grant would actually be used.
Second, and Governor Tarullo, I was pleased to hear your
comments at the outset. I would like to follow up with you
both, one, on looking at the asset cap size of $50 billion may
not be the right number. I think we need to acknowledge, again,
that historically, Congress never gets it 100 percent right.
You have got to come back and do fix-it bills, and I think it
is time for a fix-it bill around Dodd-Frank.
I also hope, echoing what Senator Crapo emphasized, that we
tried to put in restrictions on smaller enterprises, community
banks. One part that Senator Crapo raised which I would love to
echo, as well, is the regulatory creep. But, we tried to be
explicit on community banks not falling into some of the more
burdensome regulatory requirements of Dodd-Frank. My fear is
that while we put that in as a legislated exclusion under, I
believe $10 billion cap, that kind of best practices creep has
kind of come into that, and I find repeatedly from smaller
institutions enormous additional marginal cost added. So, I
hope you will come back with some specific suggestions there on
how we might look at that.
Chairman White, I cannot get in front of a public session
without echoing once again, urging you to continue to move
forward on JOBS Act. I sent you another letter last Friday. I
am again looking at what is happening, or not happening, for
that matter, around the country on equity fundraising. I still
think it is a tool we may not, again, get 100 percent right,
but we have got to try to use that tool, the sooner the better.
I would like to get to a question. I have been spending
some time looking at the excess complexity in equity trading
that, I think, sometimes allows entrenched firms advantages
over smaller firms. For example, Direct Edge, EDGX, as just one
example, has a hundred different ways a share stock can be
billed. They have 12 different tiers, seven of which pay
customers to trade. And, for some certain select customers, the
rebate per share fee is greater than the take fee. I know we
have talked about maker taker and some of these areas. This is
a level of complexity further down.
Do you have any specific plans to address complexity in the
marketplace? For example, would the SEC support ensuring
transparency for market participants by providing them the
ability to audit the fees or rebates, or even looking at
potentially banning some of these practices? How far down the
trail are you at looking at this issue?
Ms. White. We have a number of initiatives, as actually
discussed publicly in June, with respect to enhancing the
transparency of the equity markets, and particularly on the
fees. Also we are talking about initiatives on the conflicts of
interest in terms of complexity of order types. I mean, that is
of concern on a number of fronts. One of the things that I
mentioned in that speech, and then followed up on, is to have
the exchanges basically do an audit of all of those and report
back to the SEC. I expect that to be completed in the fall. It
is underway.
We are also looking at, really, across the board a number
of other near-term initiatives and then a broader review of the
structural issues, as well. Our markets are very strong and
very reliable, but that does not mean that enhancements and
more level playing field initiatives cannot and should not be
undertaken.
Senator Warner. I would be very interested in continuing to
work with you on that.
And then, finally--and you may not get a chance to address
it since my time is running out--I am concerned about the
increased leverage ratios among some of the broker-dealers. My
understanding from your own data, that firms like Barclays are
up toward 30-to-1 on their leverage ratios. That is getting
close to where Lehman and Bear Stearns and others were. I hope
this is a subject of some concerns----
Ms. White. Yes, and I probably should get back to you in
the interest of time, but certainly, that is an area that is
monitored by us, and FINRA, as well. We can talk about what our
net capital rule does, as well as some initiatives we have to
enhance some of our financial responsibility oversight of
broker-dealers, including a possible rulemaking on leverage.
Senator Warner. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Well, thank you, Mr. Chairman.
Thank you for this excellent testimony. We have all been
sort of thinking back to some of the challenges of Dodd-Frank.
One of the challenges on derivatives was to have a regime which
would be able to be effective, given that there were two
different agencies that had jurisdiction over derivatives,
dictated more by history than logic. And, my understanding--
and, what we did is we insisted upon some joint rulemaking in
critical areas, and I understand that this joint rulemaking has
been completed. Is that the case, Chair White, Chairman Massad?
Mr. Massad. Yes, that is generally true, and I would just
say on the point of making sure that we work together well, I
think that is certainly a priority of mine. I believe Chair
White shares that feeling, and we have been in touch on a
number of issues already and our staffs are working together.
Senator Reed. Well, let me commend you on that, because as
you understood--as we understood--trying to sort out the lines
and create different agencies, to do different things--what we
tried to do is basically take the existing structure and make
it cooperate and work more congruently, for want of a better
term.
But, let me shift to the SEC. Throughout the course of the
testimony, you have pointed out the huge issues that you still
have to face. My calculation is roughly 18 rules left the SEC
has to complete with respect to the swaps, including
securities-based swaps, execution facilities, rules governing
registered security-based swap repositories, to rules regarding
conflict of interest. And, you have pointed out that you are
prioritizing Dodd-Frank rules. Can you give us the assurance
that these derivatives rules are at the very top of your list
to get done very quickly?
Ms. White. I can assure you of that. We have a number to
complete, as you have pointed out. It is a very high priority
of mine to get them done as quickly as we can, but also as well
as we can. And, one of the areas which you also touched on is
making sure that they are workable for this global market as
well as strong and robust, working not only with Chairman
Massad on these--I have the benefit of his rulemaking in a
number of those areas--but also our international counterparts.
But, totally committed to getting them done.
Senator Reed. And, Chairman Massad made the point that the
resources are getting pretty thin. Is that the same case in the
SEC, Madam Chair?
Ms. White. It is absolutely the case, Senator.
Senator Reed. So, we can talk the talk here about how you
have got to get things done, how it is important and so
critical, et cetera, but if we do not--the Congress--provide
you the resources, you cannot get it done.
Ms. White. I very much appreciate that. And also, I think
we all have to be focused on, the fact that once these rules
are finished, we have to implement them and enforce them, and
that takes resources.
Senator Reed. Thank you. Let me just quickly shift gears
because we have been talking about what is already on the table
that you have to get done. Some of my colleagues have suggested
other things that you should be interested in. One of the
issues, really, is cybersecurity, Madam Chair. You have public
companies that have been reporting significant problems, which
leads me to believe that they are not alone and that the SEC
has to start thinking seriously about routine disclosure for
two reasons.
One is the investing public should know very quickly that
there is something amiss, but also it is like that old line in
the Army. What people inspect and evaluate, they tend to do
more of, and I think this would be an action-forcing device for
companies now that either feel they are free riders or they are
too small, et cetera, to really begin to think and take
seriously their responsibilities to their shareholders,
ultimately, in this area. Are you thinking along these lines?
Ms. White. Certainly, in terms of the priority of cyber-
and the long-term risk it is to not only investors, but the
country. No question about that. As you know, Senator, we
issued guidance, disclosure guidance, in 2011. We also, in our
Division of Corporation Finance, continued to review the
filings of the companies under that guidance and get comments
on that. I have recently also formed an interdivisional cyber
working group within the SEC to bring all of the expertise and
information together, and that is one of the things that we
will look at, among others. I mean, we also, obviously, have
cyber responsibilities for our registrants----
Senator Reed. Right----
Ms. White. ----systems and so forth.
Senator Reed. You are moving fast. I suggest we all have to
move faster.
Chairman Cordray, thank you for extraordinary work,
particularly with the Military Lending Act. Can you explain why
it is important to finalize some of the rules that are pending,
and update the rules to protect these servicemen and women.
Mr. Cordray. I think it is obvious on its face, and
Congress, of course, intervened very helpfully about a year and
a half ago to require a review and revision of the rules that
did not implement that law as intended by Congress. The
statute, as you know, indicated that the CFPB was to consult
with the Department of Defense. We have worked closely with
them, and organized a larger group that included colleagues
from the other agencies. Department of Treasury took a lead
role. These rules are well along. They are at OMB at this
point, and my understanding is that they are now moving. I
think that your efforts to prod that along have been helpful,
fruitful, and I believe that we will see action very quickly at
this point, and I am pleased to be able to say that.
Senator Reed. Well, thank you very much, Mr. Chairman. I
had the opportunity to mention that to Secretary of Defense
Hagel, who gets it from the E5 level, which he was in Vietnam,
to the SECDEF level, and we talked, again, a lot about what we
owe to our servicemen and women. We certainly owe, as a
minimum, fair dealing in the marketplace.
Mr. Cordray. Thank you for that, and I think this will go a
long way to getting us where we should be.
Senator Reed. Thank you, Mr. Chairman. Thank you.
Chairman Johnson. Senator Manchin.
Senator Manchin. Thank you, Mr. Chairman, and I thank all
of you for being here today.
I would like to first say that my little State of West
Virginia depends an awful lot on community banks, so I am going
to be talking about cybersecurity here and the need for reform
with cybersecurity. We just learned about Home Depot's data
breach, which might be the largest retailer breach and is just
on the heels of the Target breach.
According to one report, U.S. banks had to reissue 8
percent of all debit cards and 4 percent of all credit cards,
on average. For small community banks, reissuing those cards
cost just over $11 per debit card and $12.75 per credit card,
including production, mailing, and staff time. That is what the
report said. This is not simply a drop in the bucket for these
community banks, as I am sure you all know. These hacks could
prove the difference between being in the black and bleeding
red for the bottom lines and make all of them very vulnerable.
So, even if your agency is not directly responsible--which
I know it is not--for cybersecurity, it has an effect on the
banks you regulate. What is your opinion about the need for the
reform and how it is affecting the financial markets today? Mr.
Tarullo, I will start with you, over at that end.
Mr. Tarullo. Senator, you are raising an issue that we have
discussed in this Committee--I think, somewhat ironically, the
last hearing was right after the Target breach, I believe. And,
I think, again, you have just noted that even though there is
work to do in the banking sector--and there surely is, and I
think Tom, in a moment, will probably explain some of what we
have been trying to do together in the FFIEC. I do think, for
all of us as bank regulators, when we see the asymmetry in the
requirements of nonbank companies, or the absence of
requirements for nonbank companies to take measures to protect
personal information, it is frustrating, particularly for the
smaller banks, but to be honest, for banks of all sizes, and I
think we feel, to some degree, we have all got one hand tied
behind our back.
So, among the many other things that need to be done in
this area one is to get a set of expectations as to what
nonfinancial companies that are not subject to the regulation
of those of us sitting at this table are expected to do in
protecting the very same kinds of information that our
institutions hold.
Senator Manchin. I think what I am trying to get to is the
cost that, basically, small community banks are incurring,
especially in States such as West Virginia, that depends on
them, basically, for our banking community, if you will. And,
you add anything else to that from Dodd-Frank that trickles
down to the community banks, you are just adding more on their
vulnerability. So, if you would like to----
Mr. Curry. Yes. I would like to add, as Governor Tarullo
mentioned, this has been an issue that we are coordinating
through the FFIEC in terms of making sure that community banks,
in particular, are appropriately responding to cyberthreats,
and we see this as actually a much larger issue----
Senator Manchin. Sure.
Mr. Curry. ----than just the financial costs of reissuing
cards, because it really goes to the trust between a customer
and the security of their deposit or other banking
relationship.
But, as Governor Tarullo mentioned, it is really an issue
of leveling the playing field in terms of the regulatory
requirements between banks and nonbanks, and in this case,
retailers. Banks really have, clearly, longstanding over a
decade, expectations in terms of maintaining the security of
account information, including electronic access to it. We
actually assess, as part of our regulatory function, their
capabilities from an IT standpoint. And, we have clear rules on
customer notification and notification to law enforcement and
regulatory authorities. I think it is important that Governor
Tarullo mentioned, that similar requirements need to be in
place for the nonbank participants in our payment system.
Senator Manchin. OK. Thank you. If I could--I have one more
question, sir, and I am so sorry, but I wanted to get to Ms.
White.
Chairman White, the Wall Street Journal recently reported
that two firms are working to create a fund for Bitcoin to
allow investors to speculate on Bitcoin's worth. As you know, I
wrote a letter describing my concern that the regulators have
not yet issued rules on Bitcoin. And, this is especially
troubling since Bitcoin is wildly speculative, as you know, and
is especially subject to electronic theft and scams.
I know your agency is taking a particularly long period of
time to approve a Bitcoin exchange traded fund and I would
applaud your caution. However, I want to convey my concern with
this virtual currency again and hope that the other regulators
will help you to fill in the gaps so that you can protect all
of our American consumers. So, if you can just give me a quick
update--I know my time is running out here--on----
Ms. White. I will be quick. Basically, this is an evolving
area for all the regulators----
Senator Manchin. Yes.
Ms. White. ----as you know. We have taken enforcement
actions, actually, in Bitcoin-involved Ponzi schemes some time
ago. We have issued, I think, two separate investor alerts, and
as you mentioned, we are also reviewing a filing very
carefully----
Senator Manchin. Yes.
Ms. White. ----that is key to Bitcoin. At this point, there
is not a conclusion by our staff that the currency itself is a
security, so there is not that kind of regulation that flows at
this point, but we continue to look at it very, very carefully
and work with our fellow regulators on it, as well.
Senator Manchin. Do you think you will be having a rule----
Ms. White. Well, I think, at this stage, there is not a
planned rulemaking. As I say, at this stage, we have not
concluded that it is a security that would be subject to that
kind of regulation by us. But, it is something we are still
very focused on.
Senator Manchin. Thank you.
Chairman Johnson. Senator Heitkamp.
Senator Heitkamp. Mr. Chairman, first, let me thank my good
friend, Senator Warren from Massachusetts, for letting me bump
in line. I have to go preside at noon.
But, I want to make the point, in case you guys have not
figured that out from my letters and my discussions with you, I
really care about small community banks. They are the
lifeblood, the capital lifeblood for the many, many people in
the great State of North Dakota. I know we consistently talk
about the need for reform, the need for look-back, the need to
have a very directed discussion about the regulatory
responsibilities and how that is affecting community banks.
I would like to be able to go back to my independent
community banks and tell them when there is going to be
regulatory relief enacted, and I know there is always a lot of
swirl and a lot of talk, but I share Senator Crapo's
discussion, and so I am curious about timeframe, because they
are making decisions today. And, what started out to be too big
to fail has become for many of these community banks too small
to succeed. They are moving out of lending in certain areas as
a result of what they perceive to be massive regulatory burden.
And, so, if we are going to stem the tide of dissolution of
that portion of their business because of compliance burdens,
we need to offer a timeframe, and so I am curious to anyone who
can tell me when we will actually get an answer to small
community banks on regulatory relief.
Mr. Curry. Senator, from an FFIEC perspective, where we are
coordinating the Federal banking agencies' EGRPRA process, that
is already underway. We have put out for comment a series of
rules and regulations. That comment period closed. There will
be two more. So, we are programmatically reviewing the
regulations that are under our authority to make those
judgments that you are asking us to do to recommend or to
eliminate those rules and regulations under our control.
An important part of this process, as I mentioned earlier,
we are going to have direct input from community bankers. We
have asked them to identify those areas where they are most
pressing in need of a change and how we can go about doing
that.
Senator Heitkamp. That does not answer the question about
time. Maybe----
Mr. Curry. The statute requires a fairly lengthy review
process, but we intend to do it as quickly as possible and to
have either action taken under our own independent rulemaking
or to make recommendations to Congress.
Senator Heitkamp. Mr. Tarullo.
Mr. Tarullo. Senator, I would just comment. Sometimes,
people, when they talk about regulatory burden, they lump
together two sets of things. One is actual legislative or
regulatory requirements, called the Federal Register type
requirements.
The second thing, which Senator Manchin and maybe Senator
Warner, several of you have referred to already today, is the--
somebody called it, quite aptly, the trickle down effect of
supervisory practices, and we do not have to wait for a formal
process to do something about that. I think Tom met with the
same group yesterday of small bankers. They were a very good
group, and the reason I thought they were a particularly good
group is they came in with specifics. They came in with
specifics and they said, look, here is a way in which some
articulated supervisory expectation is, we think, not
appropriate for us, creating a problem for us, and we think it
is trickling down. In some cases, I think they were right. It
was good for our staff to be there to hear it, as we have done
with groups of small community bankers in the past. We got a
list of action items to follow up on.
So, although the EGRPRA process is kind of formalized, I
think--and I suspect the same thing is going on at the OCC and
the FDIC--that we can be constantly in a process of trying to
change current practices, and, you know, if you do it even at
the request of a small number of smaller banks, the benefits of
that can proliferate.
I do think, in the end, we have this problem of we have got
thousands of examiners and it is hard to get them all
coordinated without bringing all the decisions to Washington,
which none of us wants to do.
Senator Heitkamp. And, I am running out of time. I have a
couple more questions I will submit for the record, with the
agreement of the Chairman.
But, just back to this, there is nothing like certainty. I
mean, there can be promises that this is how supervise--you
know, what is going to happen in a bank audit, and do not worry
about this, but they will worry about it, and they will worry
about compliance burdens because the cost of not being in
compliance is so high that just the risk will cause those banks
to retreat from the market. And, I do not think that is in the
best interest of this country, and it certainly is not in the
best interest of my State.
And, so, thank you for elevating this to one of your top
concerns. I understand all of the great burdens that you all
have in making sure that we do not have systemic failure, but,
again, what was too big to fail has become too small to succeed
and we need to fix that problem.
Chairman Johnson. Senator Warren.
Senator Warren. Thank you, Mr. Chairman.
In the past year, the three largest banks in this country--
JPMorgan Chase, Citigroup, and Bank of America--have admitted
to breaking the law and have settled with the Government for a
combined $35 billion. Now, as Judge Rakoff of the Southern
District of New York has noted, the law on this is clear. No
corporation can break the law unless an individual within that
corporation broke the law. Yet, despite the misconduct at these
banks that generated tens of billions of dollars in settlement
payments by the companies, not a single senior executive at
these banks has been criminally prosecuted.
Now, I know that your agencies cannot bring prosecutions
directly, but you are supposed to refer cases to the Justice
Department when you think individuals should be prosecuted. So,
can you tell me how many senior executives at these three banks
you have referred to the Justice Department for prosecution?
Mr. Tarullo. Well, Senator, I do not know the answer to
that question, but I want to pick up on something you just
said, because I think it is actually quite important, that
although failures of the sort that have resulted in these big
fines, criminal and civil, almost always result from problems
in organizations, because there are many ways to catch these--
--
Senator Warren. Governor Tarullo----
Mr. Tarullo. Hold on, Senator, if I could. There often are
individuals who can clearly be identified as responsible, and
although, as you know, we do not have criminal prosecutorial
power, what we do have is the power to insist that firms either
discharge current employees who have been implicated in this,
even if they have not been criminally prosecuted--which we have
done in the past couple of cases--or, as we are doing now,
conducting investigations under the authorities that are
already in the law that would allow us to ban these people from
working for----
Senator Warren. So, I take it what you are saying, Governor
Tarullo, is that you do not know of any criminal prosecutions
in these three banks that the Fed has recommended.
Mr. Tarullo. Well, we have----
Senator Warren. You have investigated enough to know that--
--
Mr. Tarullo. We shared all----
Senator Warren. ----that these banks are responsible. They
have given--they have admitted to wrongdoing. They have signed
up for $35 billion in a settlement. And no one has been
referred?
Mr. Tarullo. Well, Senator, we have shared all the
information that the Department of Justice needed, and I think
the Justice Department has probably made its own assessment on
both sets of criminal and civil----
Senator Warren. So, you are saying you have referred people
for criminal prosecution?
Mr. Tarullo. No. We have provided information to----
Senator Warren. But, you have not actually referred someone
for criminal prosecution. You know, I just----
Mr. Tarullo. Well, we----
Senator Warren. I want to be clear about the contrast here.
After the savings and loan crisis in the 1970s and the 1980s,
the Government brought over a thousand criminal prosecutions
and got over 800 convictions. The FBI opened nearly 5,500
criminal investigations because of referrals from banking
investigators and regulators.
So, if we did not even limit it to these three banks, how
many prosecutions have you all regulated [sic]? What we have to
remember here is the main reason that we punish illegal
behavior is for deterrence, you know, to make sure that the
next banker who is thinking about breaking the law remembers
that a guy down the hall was hauled out of here in handcuffs
when he did that. These civil settlements do not provide
deterrence. The shareholders for the companies pay the
settlement. Senior management does not pay a dime.
And, in fact, if you are like Jamie Dimon, the CEO of
JPMorgan Chase, you might even get an $8.5 million raise for
the settlement of negotiating such a great settlement when your
company breaks the law. So, without criminal prosecutions, the
message to every Wall Street banker is loud and clear. If you
break the law, you are not going to jail, but you might end up
with a much bigger paycheck.
So, no one should be above the law. If you steal a hundred
bucks on Main Street, you are probably going to jail. If you
steal a billion bucks on Wall Street, you darn well better go
to jail, too.
So, I have another question I want to ask about, and that
is about living wills, that is, the plans that big banks are
supposed to submit now so that if they start to fail, they
could be liquidated without bringing down the economy or
needing a taxpayer bailout. Last month, the FDIC and the Fed,
as we talked about earlier, sent letters to 11 of the country's
biggest banks, telling them that their living wills did not cut
it. You said that if these banks failed, either they would need
a Government bailout or they would bring down the economy.
These letters confirmed quite literally that 6 years after the
financial crisis, all of our biggest banks remain too big to
fail.
Now, in your joint statement, you said--and I want to get
this right--that by next July, the 11 banks must demonstrate,
quote, ``significant progress to address all the shortcomings
identified in the letter,'' and if the banks do not address
significant progress, you told Senator Corker earlier in this
hearing, you have tools to force the banks to make changes, and
I just want to underline that means higher capital standards,
higher liquidity standards, restrict bank growth, limit bank
operations. But, these actions take place only if there is not
significant progress on the part of the banks.
So, I just would like the two of you, FDIC and the Fed,
just to speak briefly to the question--because I realize I am
out of time here, Mr. Chairman--what constitutes
``significant'' in this case? What is it you want to see the
too big to fail banks do, and if they do not do it, the action
you are going to take? Chairman Gruenberg, maybe we could start
with you, and then Governor Tarullo.
Mr. Gruenberg. Senator, we laid out in these letters a
pretty specific set of markers for the institutions to meet
that goes to some of the key obstacles to orderly resolution of
these firms. We directed them in the letters to simplify their
legal structures so that they put their business lines in line
with their legal entity so that in resolution, you can sort the
firm out and figure out how to manage the failure.
A critical issue is their derivatives contracts. Those
contracts provide for automatic termination in the event at the
beginning of an insolvency proceeding. Those contracts need to
be changed in order to avoid the contagion consequences that we
saw in 2008 from a disorderly termination of those contracts.
We direct in the letters the firms to change those contracts.
Critical operations--a firm has got to be able, during the
course of a resolution process, to maintain its IT and other
critical operations so the whole operation does not fall apart.
You may have an IT operation in a foreign jurisdiction that
could get taken out or not made available as a result of
problems by the institution. The institution has to develop
back-up capabilities to sustain its critical operations.
Otherwise, the public ends up having to pick up the slack.
Information--the institutions have to be able to produce
critical, timely information that is essential to managing a
resolution process. The firms right now do not have that
capability.
These are specific, measurable actions that we have
directed the firms to take, and we are going to be looking for
these firms to take specific, measurable actions to address
these. And, they have got a year now. They are on notice. We
are going to be working closely with these firms so there is
clarity of guidance, and we are going to be expecting action,
and that is really the whole purpose of this effort.
Senator Warren. Thank you, Chairman.
Mr. Tarullo. If I could just underscore that last point
that Marty made, Senator. None of us wants to be in the
situation where, next July or August, there is this issue of,
well, we made this progress. Is this significant or is this not
significant?
Senator Warren. Right.
Mr. Tarullo. And, so, what Marty just alluded to is the
point I was going to make and I will now underscore, that we
have our supervisors from the Fed and the FDIC in the
institutions right now and this will be a process of what are
you going to do about this and wanting to hear in very tangible
terms what it is they are doing. And, I know at the Fed, I
suspect at the FDIC, the boards will be regularly briefed on
this so that we will be in a position to be giving indications
that this is what we expected or you guys are already falling
short, because I think what lay behind your question was the
concern that, next July, we get into this palaver of whether
progress has been significant or not.
Senator Warren. So, we are not going to be back here a year
from now having this same conversation again. You are prepared
to demand that they take these measurable steps, and if they
fail to do so, you are going to use your tools to take them for
them----
Mr. Tarullo. Correct.
Senator Warren. ----is that right? Good. Thank you.
Thank you for your indulgence, Mr. Chairman.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
I want to follow up on Senator Warren's observations
regarding the Justice Department and criminal activity in
financial institutions or whatever. I realize that you are
regulators. You are not prosecutors. But, if there is $35
billion, more or less, in fines or settlements because of
criminal conduct, and there is no justice--justice is important
for the big and the well-being and also small--something is
wrong with the Justice Department. People should not be able,
whoever they are, not just financial institutions, should be
able to buy their way out of culpability, especially when it is
so strong, it defies rationality. You know, I agree with her on
that.
But, I think, Senator Warren, that it goes to the Justice
Department, because I am not defending my regulators, because I
call them to task at times, but they can make recommendations,
they can send things over, but, ultimately, it seems like the
Justice Department seems bent on money rather than justice, you
know, and that is a mistake and the American people pick up on
that.
Having said that, Governor, I want to get back on the
insurance regulation, if I could. Have you or others, have you
consulted with any of the State regulators in making the SIFI
designations for the insurers, and if you have, what did they
say? For years, we all know this, the States have regulated
insurance. We know the story of AIG. We have hashed it out here
many times. But, AIG was not running an insurance company. They
had visions. But, they got out of their basic stuff and it
caused them great harm, as we all know, and caused headaches
right here in this Committee and with you guys.
But, Met Life and Prudential, to my knowledge, they have
not been involved in credit default swaps and everything, other
than managing their own risk. I do not know. You might have a
better feel for this. But, have you consulted or dealt, had a
dialog with some of the State regulators before you make these
designations, and if you have, what have they said, and if you
have not, why have you not?
Mr. Tarullo. I would say first, Senator, as I am sure you
know, that on the FSOC, there is a slot reserved for a
representative of the National Association of Insurance
Commissioners----
Senator Shelby. I know. We know.
Mr. Tarullo. ----and there is also, by statute, the
independent insurance person, who also brings to bear expertise
and experience----
Senator Shelby. Sure.
Mr. Tarullo. ----and they, obviously, have both been fully
involved. I certainly would be a little reluctant to speak for
them here, but they are fully involved and other commissioners
in the NAIC have been, as well.
Senator Shelby. Is this--you know, the States have
regulated these insurance companies for years, and this is new
for the Federal Government and for you. Is this the beginning
of a preemption of the Federal over the State in the regulation
of insurance? Some people would argue that.
Mr. Tarullo. Yes. Certainly not from the Fed's point of
view.
Senator Shelby. Uh-huh.
Mr. Tarullo. There are two ways that we get supervision of
entities that are either owned by or include insurance firms.
One, if the entity also owns a depository institution, because
that is when the Holding Company Act requirements come in.
Senator Shelby. Uh-huh.
Mr. Tarullo. Or, two, if they are designated by the FSOC.
When they are designated by the FSOC, it is because of their
systemic importance, and our supervision and oversight and
regulation of those institutions is directed toward the
containment of systemic risk, not their insurance business. As
I said earlier, I, at least, do not regard generally
traditional insurance activities as posing systemic risk.
It is the nontraditional, the more runnable things, the new
things where we see similarities that are more toward contagion
and runnable assets and the like, the sort of thing that we are
regulating in the banking arena, but we do not want to be in
the business of regulating insurance companies the way State
insurance commissioners do, which is trying to preserve the
franchise for the benefit of the policy holders. Our purpose is
a different one, which is assuring on a consolidated basis the
safety and soundness of a----
Senator Shelby. Sure.
Mr. Tarullo. ----large financial institution.
Senator Shelby. Let me ask you a question, if I could----
Chairman Johnson. One more question.
Senator Shelby. I have to ask a long question, then----
[Laughter.]
Senator Shelby. Would a big insurance company--we will just
use Met Life or Prudential or anybody--that was managing their
own risk through derivatives and so forth, would they be
considered, for the most part, an end user?
Mr. Massad. Well, generally, our consideration of end users
applies to companies that are not primarily financial in
nature.
Senator Shelby. Uh-huh, like steel and all this?
Mr. Massad. Exactly. Exactly.
Senator Shelby. Hard commodities.
Mr. Massad. So, large insurance companies who have a lot of
swap activity, we would not consider----
Senator Shelby. OK.
Mr. Massad. ----as end users.
Senator Shelby. Thank you. Thank you, Mr. Chairman.
Chairman Johnson. I want to thank today's witnesses, again,
for their testimony.
This hearing is adjourned.
[Whereupon, at 12:10 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF DANIEL K. TARULLO
Governor, Board of Governors of the Federal Reserve System
September 9, 2014
Chairman Johnson, Ranking Member Crapo, and other Members of the
Committee, thank you for the opportunity to testify on the Federal
Reserve's activities in mitigating systemic risk and implementing the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act). In testifying before this Committee in February, I noted my hope
and expectation that this year would be the beginning of the end of our
implementation of the major provisions of the Dodd-Frank Act. Seven
months later, we are on track to fulfill that expectation. The Federal
Reserve and other banking supervisors have continued to make progress
in implementing the congressional mandates in the Dodd-Frank Act,
promoting a stable financial system, and strengthening the resilience
of banking organizations. In today's testimony, I will provide an
update on the Federal Reserve's implementation of the Dodd-Frank Act
and describe key upcoming regulatory and supervisory priorities to
address the problems of ``too big to fail'' and systemic risk. The
Federal Reserve is committed to continuing to work with our fellow
banking agencies and with the market regulators to help ensure that the
organizations we supervise operate in a safe and sound manner and are
able to support activity in other sectors of the economy.
As we complete our revisions to the financial regulatory
architecture, we are cognizant that regulatory compliance can impose a
disproportionate burden on smaller financial institutions. In addition
to overseeing large banking firms, the Federal Reserve supervises
approximately 800 State-chartered community banks that are members of
the Federal Reserve System, as well as several thousand small bank
holding companies. In my testimony, I also will describe how the
Federal Reserve is seeking to ensure that its regulations and
supervisory framework are not unnecessarily burdensome for community
banking organizations so they can continue their important function of
safe and sound lending to local communities.
Recent Dodd-Frank Act Implementation Milestones
Since the passage of the Dodd-Frank Act more than 4 years ago, the
Federal Reserve and the other agencies represented at this hearing have
completed wide-ranging financial regulatory reforms that have remade
the regulatory landscape for financial firms and markets.
Internationally, at the Basel Committee on Banking Supervision (BCBS),
we have helped develop new standards for global banks on risk-based
capital, leverage, liquidity, single-counterparty credit limits, and
margin requirements for over-the-counter derivatives. We have also
worked with the Financial Stability Board (FSB) to reach global
agreements on resolution regimes for systemic financial firms and on a
set of shadow banking regulatory reforms.
Domestically, we have completed many important measures. We
approved final rules implementing the Basel III capital framework,
which help ensure that U.S. banking organizations maintain strong
capital positions and are able to continue lending to creditworthy
households and businesses even during economic downturns. We
implemented the Dodd-Frank Act's stress testing requirements, which are
complemented by the Federal Reserve's annual Comprehensive Capital
Analysis and Review. Together, these supervisory exercises provide a
forward-looking assessment of the capital adequacy of the largest U.S.
banking firms. Pursuant to section 165 of the Dodd-Frank Act, we
established a set of enhanced standards for large U.S. banking
organizations to help increase the resiliency of their operations and
thus promote financial stability. In addition, the Federal Reserve
implemented a rule requiring foreign banking organizations with a
significant U.S. presence to establish U.S. intermediate holding
companies over their U.S. subsidiaries and subjecting such companies to
substantially the same prudential standards applicable to U.S. bank
holding companies. We finalized the Volcker rule to implement section
619 of the Dodd-Frank Act and prohibit banking organizations from
engaging in short-term proprietary trading of certain securities and
derivatives. These and other measures have already created a financial
regulatory architecture that is much stronger and much more focused on
financial stability than the framework in existence at the advent of
the financial crisis.
More recently, the Federal Reserve, often in tandem with some or
all of the other agencies represented at this hearing, has made
progress on a number of other important regulatory reforms. I will
discuss those steps in more detail.
Liquidity Rules for Large Banking Firms
Last week, the Federal Reserve and the other U.S. banking agencies
approved a final rule, consistent with the enhanced prudential
standards requirements in section 165 of the Dodd-Frank Act, which
implements the first broadly applicable quantitative liquidity
requirement for U.S. banking firms. Liquidity standards for large U.S.
banking firms are a key contributor to financial stability, as they
work in concert with capital standards, stress testing, and other
enhanced prudential standards to help ensure that large banking firms
manage liquidity in a manner that mitigates the risk of creditor and
counterparty runs.
The rule's liquidity coverage ratio, or LCR, requires covered
banking firms to hold minimum amounts of high-quality liquid assets--
such as central bank reserves and high-quality Government and corporate
debt--that can be converted quickly and easily into cash sufficient to
meet expected net cash outflows over a short-term stress period. The
LCR applies to bank holding companies and savings and loan holding
companies with $250 billion or more in total consolidated assets or $10
billion or more in on-balance-sheet foreign exposures. The rule also
applies a less stringent, modified LCR to bank holding companies and
savings and loan holding companies that are below these thresholds but
with more than $50 billion in total assets. The rule does not apply to
bank holding companies or savings and loan holding companies with less
than $50 billion in total assets, nor to nonbank financial companies
designated by the Financial Stability Oversight Council (FSOC). The
Federal Reserve will apply enhanced liquidity standards to designated
nonbank financial companies through a subsequently issued order or rule
following an evaluation of each of their business models, capital
structures, and risk profiles.
The rule's LCR is based on a liquidity standard agreed to by the
BCBS but is more stringent than the BCBS standard in several areas,
including the range of assets that qualify as high-quality liquid
assets and the assumed rate of outflows for certain kinds of funding.
In addition, the rule's transition period is shorter than that in the
BCBS standard. The accelerated phase-in of the U.S. LCR reflects our
objective that large U.S. banking firms maintain the improved liquidity
positions they have already built following the financial crisis, in
part because of our supervisory oversight. We believe the LCR will help
ensure that these improved liquidity positions will not weaken as
memories of the financial crisis fade.
The final rule is largely identical to the proposed rule, with a
few key adjustments made in response to comments from the public. Those
adjustments include changing the scope of corporate debt securities and
publicly traded equities qualifying as high-quality liquid assets,
phasing in reporting requirements, and modifying the stress period and
reporting frequency for firms subject to the modified LCR.
Swap Margin Reproposal
Sections 731 and 764 of the Dodd-Frank Act require the
establishment of initial and variation margin requirements for swap
dealers and major swap participants (swap entities) on swaps that are
not centrally cleared. These requirements are intended to ensure that
the counterparty risks inherent in swaps are prudently limited and not
allowed to build to unsustainable levels that could pose risks to the
financial system. In addition, requiring all uncleared swaps to be
subject to robust margin requirements will remove economic incentives
for market participants to shift activity away from contracts that are
centrally cleared.
The Federal Reserve and four other U.S. agencies originally issued
a proposed rule to implement these provisions of the Dodd-Frank Act in
April 2011. Following the release of the original proposal, the BCBS
and the International Organization of Securities Commissions began
working to establish a consistent global framework for imposing margin
requirements on uncleared swaps. This global framework was finalized
last September. After considering the comments that were received on
the April 2011 U.S. proposal and the recently established global
standards, the agencies issued a reproposal last week. Under the
reproposal, swap entities would be required to collect and post initial
and variation margin on uncleared swaps with another swap entity and
other financial end-user counterparties. The requirements are intended
to result in higher initial margin requirements than would be required
for cleared swaps, which is meant to reflect the more complex and less
liquid nature of uncleared swaps.
In accordance with the statutory requirement to establish margin
requirements regardless of counterparty type, the reproposal would
require swap entities to collect and post margin in connection with any
uncleared swaps they have with nonfinancial end users. These
requirements, however, are quantitatively and qualitatively different
from the margin requirements for swaps with financial end users.
Specifically, swaps with nonfinancial end users would not be subject to
specific, numerical margin requirements but would only be subject to
initial and variation margin requirements at such times, in such forms,
and in such amounts, if any, that the swap entity determines is
necessary to address the credit risk posed by the counterparty and the
transaction. There are currently cases where a swap entity does not
collect initial or variation margin from nonfinancial end users because
it has determined that margin is not needed to address the credit risk
posed by the counterparty or the transaction. In such cases, the
reproposal would not require a change in current practice. The agencies
believe that these requirements are consistent with the Dodd-Frank Act
and appropriately reflect the low level of risk presented by most
nonfinancial end users.
The agencies in the reproposal have taken several steps to help
mitigate any impact to the liquidity of the financial system that could
result from the swap margin requirements. These steps include
incorporating an initial margin requirement threshold below which
exchanges of initial margin are not required, allowing for a wider
range of assets to serve as eligible collateral, and providing smaller
swap entities with an extended timeline to come into compliance. We
look forward to receiving comments on the reproposal.
Modifications to the Supplementary Leverage Ratio and Adoption of the
Enhanced Supplementary Leverage Ratio
Also last week, the Federal Reserve and the other U.S. banking
agencies approved a final rule that modifies the denominator
calculation of the supplementary leverage ratio in a manner consistent
with the changes agreed to earlier this year by the BCBS. The revised
supplementary leverage ratio will apply to all banking organizations
subject to the advanced approaches risk-based capital rule starting in
2018. These modifications to the supplementary leverage ratio will
result in a more appropriately measured set of leverage capital
requirements and, in the aggregate, are expected to modestly increase
the stringency of these requirements across the covered banking
organizations.
This rule complements the agencies' adoption in April of a rule
that strengthens the internationally agreed-upon Basel III leverage
ratio as applied to U.S.-based global systemically important banks (G-
SIBs). This enhanced supplementary leverage ratio, which will be
effective in January 2018, requires U.S. G-SIBs to maintain a tier 1
capital buffer of at least 2 percent above the minimum Basel III
supplementary leverage ratio of 3 percent, for a total of 5 percent, to
avoid restrictions on capital distributions and discretionary bonus
payments. In light of the significantly higher risk-based capital rules
for G-SIBs under Basel III, imposing a stricter leverage requirement on
these firms is appropriate to help ensure that the leverage ratio
remains a relevant backstop for these firms.
Key Regulatory Priorities
As we near the completion of the implementation of the major
provisions of the Dodd-Frank Act, some key regulatory reforms remain
unfinished. To that end, the Federal Reserve contemplates near- to
medium-term measures to enhance the resiliency and resolvability of
U.S. G-SIBs and address the risks posed to financial stability from
reliance by financial firms on short-term wholesale funding.
The financial crisis made clear that policymakers must devote
significant attention to the potential threat to financial stability
posed by our most systemic financial firms. Accordingly, the Federal
Reserve has been working to develop regulations that are designed to
reduce the probability of failure of a G-SIB to levels that are
meaningfully below those for less systemically important firms and to
materially reduce the potential adverse impact on the broader financial
system and economy in the event of a failure of a G-SIB.
G-SIB Risk-Based Capital Surcharges
An important remaining Federal Reserve initiative to improve G-SIB
resiliency is our forthcoming proposal to impose graduated common
equity risk-based capital surcharges on U.S. G-SIBs. The proposal will
be consistent with the standard in section 165 of the Dodd-Frank Act
that capital requirements be progressively more stringent as the
systemic importance of a firm increases. It will build on the G-SIB
capital surcharge framework developed by the BCBS, under which the size
of the surcharge for an individual G-SIB is a function of the firm's
systemic importance. By further increasing the amount of the most loss-
absorbing form of capital that is required to be held by firms that
potentially pose the greatest risk to financial stability, we intend to
improve the resiliency of these firms. This measure might also create
incentives for them to reduce their systemic footprint and risk
profile.
While our proposal will use the G-SIB risk-based capital surcharge
framework developed by the BCBS as a starting point, it will strengthen
the BCBS framework in two important respects. First, the surcharge
levels for U.S. G-SIBs will be higher than the levels required by the
BCBS, noticeably so for some firms. Second, the surcharge formula will
directly take into account each U.S. G-SIB's reliance on short-term
wholesale funding. We believe the case for including short-term
wholesale funding in the surcharge calculation is compelling, given
that reliance on this type of funding can leave firms vulnerable to
runs that threaten the firm's solvency and impose externalities on the
broader financial system.
Resolvability of G-SIBs
Our enhanced regulation of G-SIBs also includes efforts to improve
their resolvability. Most recently, in August, the Federal Reserve and
the Federal Deposit Insurance Corporation (FDIC) completed reviews of
the second round of resolution plans submitted to the agencies in
October 2013 by 11 U.S. bank holding companies and foreign banks.
Section 165(d) of the Dodd-Frank Act requires banking organizations
with total consolidated assets of $50 billion or more and nonbank
financial companies designated by the FSOC to submit resolution plans
to the Federal Reserve and the FDIC. Each plan must describe the
organization's strategy for rapid and orderly resolution in the event
of material financial distress or failure. In completing the second
round reviews of these banking organizations' resolution plans, the
FDIC and the Federal Reserve noted certain shortcomings in the
resolution plans that the firms must address to improve their
resolvability in bankruptcy. Both agencies also indicated the
expectation that the firms make significant progress in addressing
these issues in their 2015 resolution plans.
In addition, the Federal Reserve has been working with the FDIC to
develop a proposal that would require the U.S. G-SIBs to maintain a
minimum amount of long-term unsecured debt at the parent holding
company level. While minimum capital requirements are designed to cover
losses up to a certain statistical probability, in the even less likely
event that the equity of a financial firm is wiped out, successful
resolution without taxpayer assistance would be most effectively
accomplished if a firm has sufficient long-term unsecured debt to
absorb additional losses and to recapitalize the business transferred
to a bridge operating company. The presence of a substantial tranche of
long-term unsecured debt that is subject to bail-in during a resolution
and is structurally subordinated to the firm's other creditors should
reduce run risk by clarifying the position of those other creditors in
an orderly liquidation process. A requirement for long-term debt also
should have the benefit of improving market discipline, since the
holders of that debt would know they faced the prospect of loss should
the firm enter resolution.
The Federal Reserve is working with global regulators, under the
auspices of the FSB, to develop a proposal that would require the
largest, most complex global banking firms to maintain a minimum amount
of loss absorbency capacity beyond the levels mandated in the Basel III
capital requirements.
Another element of our efforts to promote resolvability of large
banking organizations involves the early termination rights of
derivative counterparties to G-SIBs. Some of the material operating
subsidiaries of G-SIBs are counterparties to large volumes of over-the-
counter derivatives and other qualifying financial contracts that
provide for an event of default based solely on the insolvency or
receivership of the parent holding company. Although the Dodd-Frank Act
created an orderly liquidation authority (OLA) to better enable the
Government to resolve a failed systemically important financial firm--
and the OLA's stay and transfer provisions can prevent exercise of such
contractual rights by counterparties to contracts under U.S. law--the
OLA provisions may not apply to contracts under foreign law.
Accordingly, counterparties of the foreign subsidiaries and branches of
G-SIBs may have contractual rights and substantial economic incentives
to accelerate or terminate those contracts as soon as the U.S. parent
G-SIB enters OLA. This could render a resolution unworkable by
resulting in the disorderly unwind of an otherwise viable foreign
subsidiary and the disruption of critical intra-affiliate activities
that rely on the failing subsidiary. The challenge would be compounded
in a bankruptcy resolution because derivatives and other qualifying
financial contracts are exempt from the automatic stay under bankruptcy
law, regardless of whether the contracts are governed by U.S. or
foreign law.
The international regulatory community is working to mitigate this
risk as well. The Federal Reserve is working with the FDIC and global
regulators, financial firms, and other financial market actors to
develop a protocol to the International Swaps and Derivatives
Association (ISDA) Master Agreement to address the impediments to
resolvability generated by these early termination rights. The FSB will
be reporting progress on this effort in the fall.
Short-Term Wholesale Funding
As I have noted in prior testimony before this Committee, short-
term wholesale funding plays a critical role in the financial system.
During normal times, it helps to satisfy investor demand for safe and
liquid investments, lowers funding costs for borrowers, and supports
the functioning of important markets, including those in which monetary
policy is executed. During periods of stress, however, runs by
providers of short-term wholesale funding and associated asset
liquidations can result in large fire sale externalities and otherwise
undermine financial stability. A dynamic of this type engulfed the
financial system in 2008.
Since the crisis, the Federal Reserve has taken several steps to
address short-term wholesale funding risks. The Basel III capital
framework and the Federal Reserve's stress testing regime have
significantly increased the quantity and quality of required capital in
the banking system, particularly for those banking organizations that
are the most active participants in short-term wholesale funding
markets. Similarly, the implementation of liquidity regulations such as
the LCR, together with related efforts by bank supervisors, will help
to limit the amount of liquidity risk in the banking system.
We have also taken steps to reduce risks posed by the use of short-
term wholesale funding by actors outside the banking system. These
include leading an effort to reduce reliance by borrowers in the
triparty repo market on intraday credit from clearing banks and
increasing the regulatory charges on key forms of credit and liquidity
support that banks provide to shadow banks. In part because of these
actions and in part because of market adjustments, there is less risk
embedded in short-term wholesale funding markets today than in the
period immediately preceding the financial crisis. The short-term
wholesale funding markets are generally smaller, the average maturity
of short-term funding arrangements is moderately greater, and
collateral haircuts are more conservative. In addition, the banking
organizations that are the major intermediaries in short-term wholesale
funding markets are much more resilient based on the measures I
discussed earlier.
Nevertheless, we believe that more needs to be done to guard
against short-term wholesale funding risks. While the total amount of
short-term wholesale funding is lower today than immediately before the
crisis, volumes are still large relative to the size of the financial
system. Furthermore, some of the factors that account for the reduction
in short-term wholesale funding volumes, such as the unusually flat
yield curve environment and lingering risk aversion from the crisis,
are likely to prove transitory.
Federal Reserve staff is currently working on three sets of
initiatives to address residual short-term wholesale funding risks. As
discussed above, the first is a proposal to incorporate the use of
short-term wholesale funding into the risk-based capital surcharge
applicable to U.S. G-SIBs. The second involves proposed modifications
to the BCBS's net stable funding ratio (NSFR) standard to strengthen
liquidity requirements that apply when a bank acts as a provider of
short-term funding to other market participants. The third is numerical
floors for collateral haircuts in securities financing transactions
(SFTs)--including repos and reverse repos, securities lending and
borrowing, and securities margin lending.
Modifications to the NSFR could be designed to help address the
types of concerns described in my previous testimony regarding SFT
matched book activity. In the classic fact pattern, a matched book
dealer uses SFTs to borrow on a short-term basis from a cash investor,
such as a money market mutual fund, to finance a short-term SFT loan to
a client, such as a leveraged investment fund. The regulatory
requirements on SFT matched books are generally low despite the fact
that matched books can pose significant microprudential and
macroprudential risks. Neither the BCBS LCR nor the NSFR originally
finalized by the Basel Committee would have imposed a material charge
on matched book activity.
In January, the BCBS proposed a revised NSFR that would require
banks to hold a material amount of stable funding against short-term
SFT loans, as well as other short-term credit extensions, to nonbank
financial entities. By requiring banks that make short-term loans to
hold stable funding, such a charge would help limit the liquidity risk
that a dealer would face if it experiences a run on its SFT liabilities
but is unable to liquidate corresponding SFT assets. In addition, by
making it more expensive for the dealer to provide short-term credit,
the charge could help lean against excessive short-term borrowing by
the dealer's clients.
Turning to numerical floors for SFT haircuts, the appeal of this
policy measure is that it would help address the risk that post-crisis
reforms targeted at banking organizations will drive systemically risky
activity toward places in the financial system where prudential
standards do not apply. In its universal form, a system of numerical
haircut floors for SFTs would require any entity that wants to borrow
against a security to post a minimum amount of excess margin to its
lender that would vary depending on the asset class of the collateral.
Like minimum margin requirements for derivatives, numerical floors for
SFT haircuts would serve as a mechanism for limiting the build-up of
leverage at the transaction level and could mitigate the risk of
procyclical margin calls.
Last August, the FSB issued a consultative document that
represented an initial step toward the development of a framework of
numerical floors. However, the FSB's proposal contained some
significant limitations, including that its scope was limited to
transactions in which a bank or broker-dealer extends credit to an
unregulated entity and that the calibration of the numerical floor
levels was relatively low. Since then, the FSB has been actively
considering whether to strengthen the proposal along both of these
dimensions.
Financial Sector Concentration Limits
In May, the Federal Reserve proposed a rule to implement section
622 of the Dodd-Frank Act, which prohibits a financial company from
combining with another company if the resulting financial company's
liabilities exceed 10 percent of the aggregate consolidated liabilities
of all financial companies. Under the proposal, financial companies
subject to the concentration limit would include insured depository
institutions, bank holding companies, savings and loan holding
companies, foreign banking organizations, companies that control
insured depository institutions, and nonbank financial companies
designated by the FSOC for Federal Reserve supervision. Consistent with
section 622, the proposal generally defines liabilities of a financial
company as the difference between its risk-weighted assets, as adjusted
to reflect exposures deducted from regulatory capital, and its total
regulatory capital. Firms not subject to consolidated risk-based
capital rules would measure liabilities using generally accepted
accounting standards. We anticipate finalizing this rule in the near
term.
Credit Risk Retention
Section 941 of the Dodd-Frank Act requires firms generally to
retain credit risk in securitization transactions they sponsor.
Retaining credit risk creates incentives for securitizers to monitor
closely the quality of the assets underlying a securitization
transaction and discourages unsafe and unsound underwriting practices
by originators. In August 2013, the Federal Reserve, along with several
other agencies, revised a proposal from 2011 to implement section 941.
The Federal Reserve is working with the other agencies charged by the
Dodd-Frank Act with implementing this rule to complete it in the coming
months.
Rationalizing the Regulatory Framework for Community Banks
Before closing, I would like to discuss the Federal Reserve's
ongoing efforts to minimize regulatory burden consistent with the
effective implementation of our statutory responsibilities for
community banks, given the important role they play within our
communities. Over the past few decades, community banks have
substantially reduced their presence in lines of businesses such as
consumer lending in the face of competition from larger banks
benefiting from economies of scale. Today, as a group, their most
important forms of lending are to small- and medium-sized businesses.
Smaller community banks--those with less than $1 billion in assets--
account for nearly one-fourth of commercial and industrial lending, and
nearly 40 percent of commercial real estate lending, to small- and
medium-sized businesses, despite their having less than 10 percent of
total commercial banking assets. These figures reveal the importance of
community banks to local economies and the damage that could result if
these banks were unable to continue operating within their communities.
Banking regulators have taken many steps to try to avoid
unnecessary regulatory costs for community banks, such as fashioning
more basic supervisory expectations for smaller, less complex banks and
identifying which provisions of new regulations are relevant to smaller
banks. In this regard, the Federal Reserve has worked to communicate
clearly the extent to which new rules and policies apply to smaller
banks and to tailor them as appropriate. We also work closely with our
colleagues at the Federal and State banking regulatory agencies to
ensure that supervisory approaches and methodologies are consistently
applied to community banks.
But several new statutory provisions apply explicitly to some
smaller banks or, by failing to exclude any bank from coverage, apply
to all banks. The Federal Reserve is supportive of considering areas
where the exclusion of community banks from statutory provisions that
are less relevant to community bank practice may be appropriate. For
example, we believe it would be worthwhile to consider whether
community banks should be excluded from the scope of the Volcker rule
and from the incentive compensation requirements of section 956 of the
Dodd-Frank Act. The concerns addressed by statutory provisions like
these are substantially greater at larger institutions and, even where
a practice at a smaller bank might raise concerns, the supervisory
process remains available to address what would likely be unusual
circumstances.
Another area in which the Federal Reserve has made efforts to
right-size our supervisory approach with regard to community banks is
to improve our off-site monitoring processes so that we can better
target higher risk institutions and activities. Research conducted for
a 2013 conference sponsored by the Federal Reserve System and the
Conference of State Bank Supervisors addressed the resilience of the
community bank model and showed how some banks performed better than
others during the recent crisis. Building on this research, we are
updating our off-site monitoring screens to reflect experience gained
during the crisis and recalibrating our examination scoping process for
community banks to focus our testing on higher-risk banks and
activities, and whenever possible reduce procedures for banks of lower
risk.
Recognizing the burden that the on-site presence of many examiners
can place on the day-to-day business of a community bank, we are also
working to increase our level of off-site supervisory activities.
Responding to on-site examinations and inspections is of course a cost
for community banks, but this cost must be weighed against the
supervisory benefit of face-to-face interactions with bank examiners to
explore and resolve institution-specific concerns. The Federal Reserve
aims to strike the appropriate balance of off-site and on-site
supervisory activities to ensure that the quality of community bank
supervision is maintained without creating an overly burdensome
process. To that end, last year we completed a pilot on conducting
parts of the labor-intensive loan review off-site using electronic
records from banks. Based on good results with the pilot, we are
planning to continue using this approach in future reviews at banks
where bank management is supportive of the process and where electronic
records are available. We are also exploring whether other examination
procedures can be conducted off-site without compromising the ability
of examiners to accurately assess the safety and soundness of
supervised banks.
Conclusion
The Federal Reserve has made significant progress in implementing
the Dodd-Frank Act and other measures designed to improve the
resiliency of banking organizations and reduce systemic risk. We are
committed to working with the other U.S. financial regulatory agencies
to promote a stable financial system in a manner that does not impose a
disproportionate burden on smaller institutions. To help us achieve
these goals, we will continue to seek the views of the institutions we
supervise and the public as we further develop regulatory and
supervisory programs to preserve financial stability at the least cost
to credit availability and economic growth.
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
September 9, 2014
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) actions to implement the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act).
My written testimony will address several key topics. First, I will
discuss capital and liquidity rules that the bank regulatory agencies
recently finalized, as well as a recently proposed margin rule on
derivatives. Second, I will provide an update on our progress in
implementing the authorities provided the FDIC relating to the
resolution of systemically important financial institutions (SIFIs). I
will then discuss an updated proposed risk retention rule for
securitizations and implementation of the Volcker Rule. Finally, I will
discuss our supervision of community banks, including the FDIC's
efforts to address emerging cybersecurity and technology issues.
Capital, Liquidity, and Derivative Margin Requirements
The new regulatory framework established under the Dodd-Frank Act
augments and complements the banking agencies' existing authorities to
require banking organizations to maintain capital and liquidity well
above the minimum requirements for safety and soundness purposes, as
well as to establish margin requirements on derivatives. The recent
actions by the agencies to adopt a final rule on the leverage capital
ratio, a final rule on the liquidity coverage ratio, and a proposed
rule on margin requirements for derivatives address three key areas of
systemic risk and, taken together, are an important step forward in
addressing the risks posed particularly by the largest, most
systemically important financial institutions.
Supplementary Leverage Ratio
In April 2014, the FDIC published a final rule that, in part,
revises minimum capital requirements and, for advanced approaches
banks, \1\ introduces the supplementary leverage ratio requirement. The
Office of the Comptroller of the Currency (OCC) and the Federal Reserve
adopted a final rule in October 2013 that is substantially identical to
the FDIC's final rule. Collectively, these rules are referred to as the
Basel III capital rules.
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\1\ An advanced approaches bank is an insured depository
institution (IDI) that is an advanced approaches national bank or
Federal savings association under 12 CFR 3.100(b)(1), an advanced
approaches Board-regulated institution under 12 CFR 217.100(b)(1), or
an advanced approaches FDIC-supervised institution under 12 CFR
324.100(b)(1). In general, an IDI is an advanced approaches bank if it
has total consolidated assets of $250 billion or more, has total
consolidated on-balance sheet foreign exposures of $10 billion or more,
or elects to use or is a subsidiary of an IDI, bank holding company, or
savings and loan holding company that uses the advanced approaches to
calculate risk-weighted assets.
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The Basel III rulemaking includes a new supplementary leverage
ratio requirement--an important enhancement to the international
capital framework. Prior to this rule, there was no international
leverage ratio requirement. For the first time, the Basel III accord
included an international minimum leverage ratio, and consistent with
the agreement, the Basel III rulemaking includes a 3 percent minimum
supplementary leverage ratio. This ratio, which takes effect in 2018,
applies to large, internationally active banking organizations, and
requires them to maintain a minimum supplementary leverage ratio of 3
percent (in addition to meeting other capital ratio requirements,
including the agencies' long-standing Tier 1 leverage ratio).
In April 2014, the FDIC, the OCC and the Federal Reserve also
finalized an Enhanced Supplementary Leverage Ratio final rule for the
largest and most systemically important bank holding companies (BHCs)
and their insured banks. This rule strengthens the supplementary
leverage capital requirements beyond the levels required in the Basel
III accord. Eight banking organizations are covered by these Enhanced
Supplementary Leverage standards based on the thresholds in the final
rule.
The agencies' analysis suggests that the 3 percent minimum
supplementary leverage ratio contained in the international Basel III
accord would not have appreciably mitigated the growth in leverage
among SIFIs in the years leading up to the crisis. Accordingly, the
Enhanced Supplementary Leverage standards that the agencies finalized
in April will help achieve one of the most important objectives of the
capital reforms: addressing the buildup of excessive leverage that
contributes to systemic risk.
Under the Enhanced Supplementary Leverage standards, covered
insured depository institutions (IDIs) will need to satisfy a 6 percent
supplementary leverage ratio to be considered well capitalized for
prompt corrective action (PCA) purposes. The supplementary leverage
ratio includes off-balance sheet exposures in its denominator, unlike
the longstanding U.S. leverage ratio which requires capital only for
balance sheet assets. This means that more capital is needed to satisfy
the supplementary leverage ratio than to satisfy the U.S. leverage
ratio if both ratios were set at the same level. For example, based on
recent supervisory estimates of the off-balance sheet exposures of
these banks, a 6 percent supplementary leverage ratio would correspond
to roughly an 8.6 percent U.S. leverage requirement. Covered BHCs will
need to maintain a supplementary leverage ratio of at least 5 percent
(a 3 percent minimum plus a 2 percent buffer) to avoid restrictions on
capital distributions and executive compensation. This corresponds to
roughly a 7.2 percent U.S. leverage ratio.
An important consideration in calibrating the Enhanced
Supplementary Leverage ratio was the idea that the increase in
stringency of the leverage requirements and the risk-based requirements
should be balanced. Leverage capital requirements and risk-based
capital requirements are complementary, with each type of requirement
offsetting potential weaknesses of the other. In this regard, the Basel
III rules strengthened risk-based capital requirements to a much
greater extent than they strengthened leverage requirements. The
Enhanced Supplementary Leverage ratio standard will ensure that the
leverage requirement continues to serve as an effective complement to
the risk-based capital requirements of the largest, most systemically
important banking organizations, thereby strengthening the capital base
and the stability of the U.S. banking system.
Maintaining a strong capital base at the largest, most systemically
important financial institutions (SIFIs) is particularly important
because capital shortfalls at these institutions can contribute to
systemic distress and lead to material adverse economic effects. These
higher capital requirements will also put additional private capital at
risk before the Deposit Insurance Fund (DIF) and the Federal
Government's resolution mechanisms would be called upon. The final
Enhanced Supplementary Leverage ratio rule is one of the most important
steps the banking agencies have taken to strengthen the safety and
soundness of the U.S. banking and financial systems.
On September 3, 2014, the FDIC Board also finalized a rule
originally proposed in April 2014 that revises the denominator measure
for the supplementary leverage ratio and introduced related public
disclosure requirements. The changes in this rule apply to all advanced
approaches banking organizations, including the eight covered companies
that would be subject to the Enhanced Supplementary Leverage standards.
The denominator changes are consistent with those agreed upon by the
Basel Committee on Banking Supervision and would, in the aggregate,
result in a modest further strengthening of the supplementary leverage
ratio requirement as compared to the capital rules finalized in April.
Liquidity Coverage Ratio
On September 3, 2014, the FDIC issued a joint interagency final
rule with the Federal Reserve Board and the OCC implementing a
liquidity coverage ratio (LCR). During the recent financial crisis,
many banks had insufficient liquid assets and could not borrow to meet
their liquidity needs. The LCR final rule is designed to strengthen the
liquidity positon of our largest financial institutions, thereby
promoting safety and soundness and the stability of the U.S. financial
system.
This final rule applies to the largest, internationally active
banking organizations: U.S. banking organizations with $250 billion or
more in total consolidated assets or $10 billion or more in on-balance
sheet foreign exposure and their subsidiary depository institutions
with $10 billion or more in total assets. The Federal Reserve also
finalized a separate rule that would apply a modified LCR requirement
to BHCs with between $50 billion and $250 billion in total consolidated
assets. Other insured banks are not subject to the rule.
The LCR final rule establishes a quantitative minimum liquidity
coverage ratio that builds upon approaches already used by a number of
large banking organizations to manage liquidity risk. It requires a
covered company to maintain an amount of unencumbered high-quality
liquid assets (HQLA) sufficient to meet the total stressed net cash
outflows over a prospective 30 calendar-day period. A covered company's
total net cash outflow amount is determined by applying outflow and
inflow rates described in the rule, which reflect certain stressed
assumptions, against the balances of a covered company's funding
sources, obligations, and assets over a 30 calendar-day period.
A number of commenters have expressed concern about the exclusion
of municipal securities from HQLA in the final rule. It is our
understanding that banks do not generally hold municipal securities for
liquidity purposes, but rather for longer term investment and other
objectives. We will monitor closely the impact of the rule on municipal
securities and consider adjustments if necessary.
Margin Rule for Derivatives
Before the passage of the Dodd-Frank Act, the derivatives
activities of financial institutions were largely unregulated. One of
the issues observed in the crisis was that some financial institutions
had entered into large over-the-counter (OTC) derivatives positions
with other institutions without the prudent initial exchange of
collateral--a basic safety-and-soundness practice known as margin--in
support of the positions. Title VII addressed this situation in part by
requiring the use of central clearinghouses for certain standardized
derivatives contracts, and by requiring the exchange of collateral,
i.e., margin, for derivatives that are not centrally cleared.
Central clearinghouses for derivatives routinely manage their risks
by requiring counterparties to post collateral at the inception of a
trade. This practice is known as initial margin, in effect a type of
security deposit or performance bond. Moreover, central clearinghouses
routinely require a counterparty to post additional collateral if the
market value of the position moves against that counterparty, greatly
reducing the likelihood the clearinghouse will be unable to collect
amounts due from counterparties. This type of collateral is known as
variation margin.
Sections 731 and 764 of the Dodd Frank Act requires the large
dealers in swaps to adopt certain prudent margining practices for their
OTC derivatives activities that clearinghouses use, namely the posting
and collecting of initial and variation margin. The exchange of margin
between parties to a trade on OTC derivatives is an important check on
the buildup of counterparty risk that can occur with OTC derivatives
without margin. More generally, the appropriate exchange of margin
promotes financial stability by reducing systemic leverage in the
derivatives marketplace and promotes the safety and soundness of banks
by discouraging the excessive growth of risky OTC derivatives
positions.
The FDIC recently approved an interagency proposed rule to
establish minimum margin requirements for the swaps of an insured
depository institution or other entity that: (1) is supervised by the
FDIC, Federal Reserve, OCC, Federal Housing Finance Administration
(FHFA), or Farm Credit Administration (FCA); and (2) is also registered
with the Commodity Futures Trading Commission (CFTC) or the Securities
and Exchange Commission (SEC) as a dealer or major participant in
swaps. The proposed rule will be published in the Federal Register with
a 60-day public comment period.
In developing this proposal, the FDIC, along with the other banking
agencies, worked closely with the Basel Committee on Banking
Supervision (BCBS) and the International Organization of Securities
Commissions (IOSCO) to develop a proposed framework for margin
requirements on noncleared swaps (the ``international margin
framework'') with the goal of creating an international standard for
margin requirements on noncleared swaps. After considering numerous
comments, BCBS and IOSCO issued a final international margin framework
in September 2013. The agencies' 2014 proposed rule is closely aligned
with the principles and standards from the 2013 international
framework. The E.U. and other jurisdictions also have issued similar
proposals.
The proposed rule would require a covered swap entity (a swap
dealer, major swap participant, security-based swap dealer, or major
security-based swap participant) to exchange initial margin with
counterparties that are: (1) registered with the CFTC or SEC as swap
entities; or (2) financial end users with material swaps exposure--that
is, with more than $3 billion in notional exposure of OTC derivatives
that are not cleared. The rule would not require a covered swap entity
to collect initial margin from commercial end users. The agencies
intend to maintain the status quo with respect to the way that banks
interact with commercial end users.
The proposed rule would also require a covered swap entity to
exchange variation margin on swaps with all counterparties that are:
(1) swap entities; or (2) financial end users (regardless of whether
the financial end user has a material swaps exposure). There is no
requirement that a covered swap entity must collect or post variation
margin with commercial end users.
Because community banks typically do not have more than $3 billion
in notional exposure of OTC derivatives that are not cleared, the
agencies expect that the proposed rule will not result in community
banks being required to post initial margin. Community banks that do
engage in OTC derivatives that are not cleared are likely already
posting variation margin in the normal course of business, or in
amounts too small to fall within the scope of the rule. As a result,
the margin rule likely will have little, if any, impact on the vast
majority of community banks.
Resolution of Systemically Important Financial Institutions
Resolution Plans--``Living Wills''
Under the framework of the Dodd-Frank Act, bankruptcy is the
preferred option in the event of a SIFI's failure. To make this
objective achievable, Title I of the Dodd-Frank Act requires that all
BHCs with total consolidated assets of $50 billion or more, and nonbank
financial companies that the Financial Stability Oversight Council
(FSOC) determines could pose a threat to the financial stability of the
United States, prepare resolution plans, or ``living wills,'' to
demonstrate how the company could be resolved in a rapid and orderly
manner under the Bankruptcy Code in the event of the company's
financial distress or failure. The living will process is an important
new tool to enhance the resolvability of large financial institutions
through the bankruptcy process.
In 2011, the FDIC and the FRB jointly issued a final rule (the
165(d) rule) implementing the resolution plan requirements of Section
165(d) of the Dodd-Frank Act. The 165(d) rule provided for staggered
annual submission deadlines for resolution plans based on the size and
complexity of the companies. Eleven of the largest, most complex
institutions (collectively referred to as ``first wave filers'')
submitted initial plans in 2012 and revised plans in 2013.
During 2013, the remaining 120 institutions submitted their initial
resolution plans under the 165(d) rule. The FSOC also designated three
nonbank financial institutions for Federal Reserve supervision that
year. In July 2014, 13 firms that previously had submitted at least one
resolution plan submitted revised resolution plans, and the 3 nonbank
financial companies designated by the FSOC submitted their initial
resolution plans. The Federal Reserve and the FDIC granted requests for
extensions to two firms whose second resolution plan submissions would
have been due July 1. Those plans are now due to the agencies by
October 1, 2014. The remaining 116 firms are expected to submit their
second submission revised resolution plans in December 2014.
Following the review of the initial resolution plans submitted in
2012, the Federal Reserve and the FDIC issued joint guidance in April
2013 to provide clarification and direction for developing 2013
resolution plan submissions. The Federal Reserve and the FDIC
identified an initial set of obstacles to a rapid and orderly
resolution that covered companies were expected to address in the
plans. The five obstacles identified in the guidance--multiple
competing insolvencies, potential lack of global cooperation,
operational interconnectedness, counterparty actions, and funding and
liquidity--represent the key impediments to an orderly resolution. The
2013 plans should have included the actions or steps the companies have
taken or propose to take to remediate or otherwise mitigate each
obstacle and a timeline for any proposed actions. The agencies also
extended the deadline for submitting revised plans from July 1, 2013,
to October 1, 2013, to give the firms additional time to develop
resolution plan submissions that addressed the agencies' instructions.
Section 165(d) of the Dodd-Frank Act and the jointly issued
implementing regulation \2\ require the FDIC and the Federal Reserve to
review the 165(d) plans. If the agencies jointly determine that a plan
is not credible or would not facilitate an orderly resolution under the
U.S. Bankruptcy Code, the FDIC and the Federal Reserve must notify the
filer of the areas in which the plan is deficient. The filer must
resubmit a revised plan that addresses the deficiencies within 90 days
(or other specified timeframe).
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\2\ 12 CFR Part 243 and 12 CFR Part 381.
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The FDIC and the Federal Reserve have completed their reviews of
the 2013 resolution plans submitted to the agencies by the 11 bank
holding companies that submitted their revised resolution plans in
October 2013. On August 5, 2014, the agencies issued letters to each of
these first wave filers detailing the specific shortcomings of each
firm's plan and the requirements for the 2015 submission.
While the shortcomings of the plans varied across the first wave
firms, the agencies have identified several common features of the
plans' shortcomings, including: (1) assumptions that the agencies
regard as unrealistic or inadequately supported, such as assumptions
about the likely behavior of customers, counterparties, investors,
central clearing facilities, and regulators; and (2) the failure to
make, or even to identify, the kinds of changes in firm structure and
practices that would be necessary to enhance the prospects for orderly
resolution. The agencies will require that the annual plans submitted
by the first wave filers on July 1, 2015, demonstrate that those firms
are making significant progress to address all the shortcomings
identified in the letters, and are taking actions to improve their
resolvability under the U.S. Bankruptcy Code. These actions include:
establishing a rational and less complex legal structure
which would take into account the best alignment of legal
entities and business lines to improve the firm's
resolvability;
developing a holding company structure that supports
resolvability, including maintaining sufficient longer term
debt;
amending, on an industrywide and firm-specific basis,
financial contracts to provide for a stay of certain early
termination rights of counterparties triggered by insolvency
proceedings;
ensuring the continuity of shared services that support
critical operations and core business lines throughout the
resolution process; and
demonstrating operational capabilities for resolution
preparedness, such as the ability to produce reliable
information in a timely manner.
Agency staff will work with each of the first wave filers to
discuss required improvements in its resolution plan and the efforts,
both proposed and in progress, to facilitate each firm's preferred
resolution strategy. The agencies are also committed to finding an
appropriate balance between transparency and confidentiality of
proprietary and supervisory information in the resolution plans. As
such, the agencies will be working with these firms to explore ways to
enhance public transparency of future plan submissions.
Based upon its review of submissions by first wave filers, the FDIC
Board of Directors determined, pursuant to section 165(d) of the Dodd-
Frank Act, that the plans submitted by the first wave filers are not
credible and do not facilitate an orderly resolution under the U.S.
Bankruptcy Code. The FDIC and the Federal Reserve agreed that in the
event that a first wave filer has not, by July 1, 2015, submitted a
plan responsive to the shortcomings identified in the letter sent to
that firm, the agencies expect to use their authority under section
165(d) to determine that a resolution plan does not meet the
requirements of the Dodd-Frank Act.
Improvements to Bankruptcy
At the December 2013 meeting of the FDIC's Systemic Resolution
Advisory Committee, the FDIC heard how the existing bankruptcy process
could be improved to better apply to SIFIs. The current provisions of
the U.S. Bankruptcy Code do not expressly take into account certain
features of SIFIs that distinguish these firms from other entities that
are typically resolvable under bankruptcy without posing risk to the
U.S. financial system. Issues such as the authority to impose a stay on
qualified financial contracts and the ability to move part of a
bankrupt firm into a bridge entity in an expeditious and efficient
fashion are left unaddressed in current law. It also is unclear whether
traditional debtor-in-possession financing, which is available under
bankruptcy, would be sufficient to address the significant liquidity
needs arising from the failure of a SIFI. A further challenge in a U.S.
bankruptcy proceeding would be how it could foster global cooperation
with foreign authorities, courts, creditors, or other pertinent
parties, including U.S. financial regulatory officials, to ensure that
their interests will be protected.
Additionally, a number of scholars, policy analysts, and public
officials have made helpful proposals for changes to the U.S.
Bankruptcy Code that would facilitate the resolution of a SIFI in
bankruptcy. The FDIC has been reaching out to those in the bankruptcy
community to discuss ways to enhance the U.S. Bankruptcy Code to
facilitate an orderly failure of a SIFI. In addition, the FDIC has been
working with foreign authorities to encourage the International Swaps
and Derivatives Association (ISDA) to modify its standard-form
contracts to facilitate resolution in bankruptcy. The FDIC supports
these efforts and is prepared to work with Congress on modifications to
the U.S. Bankruptcy Code for the treatment of SIFIs in bankruptcy.
Implementation of Title II
Congress also recognized that there may be circumstances in which
the resolution of a SIFI under the U.S. Bankruptcy Code would have
serious adverse effects on financial stability in the U.S. Accordingly,
in Title II of the Dodd-Frank Act, Congress provided the FDIC with
orderly liquidation authority to resolve a failing SIFI as a last
resort in the event that resolution under the U.S. Bankruptcy Code
would result in systemic disruption of the financial system. This
Orderly Liquidation Authority serves as a backstop to protect against
the risk of systemic disruption to the U.S. financial system and allows
for resolution in a manner that results in shareholders losing their
investment, creditors taking a loss and management responsible for the
failure being replaced, resulting in an orderly unwinding of the firm
without cost to U.S. taxpayers.
In my February testimony before this Committee, I described how the
FDIC is developing a strategic approach, referred to as Single Point of
Entry (SPOE) strategy, to carry out its Orderly Liquidation Authority
for resolving a SIFI in the event it is determined that a firm cannot
be resolved under bankruptcy without posing a risk to the U.S.
financial system. Under the SPOE strategy, the FDIC would be appointed
receiver of the top-tier parent holding company of the financial group
following the company's failure and the completion of the
recommendation, determination, and expedited judicial review process
set forth in Title II of the Act. For the SPOE strategy to be
successful, it is critical that the top-tier holding company maintain a
sufficient amount of unsecured debt that would be available to provide
capital to manage the orderly unwinding of the failed firm. In a
resolution, the holding company's debt would be used to absorb losses
and keep the operating subsidiaries open and operating until an orderly
wind-down could be achieved.
In support of the SPOE strategy, the Federal Reserve, in
consultation with the FDIC, is considering the merits of a regulatory
requirement that the largest, most complex U.S. banking firms maintain
a minimum amount of unsecured debt at the holding company level, in
addition to the regulatory capital those companies already are required
to maintain. Such a requirement would ensure that there is sufficient
debt at the holding company level to absorb losses at the failed firm.
Cross-Border Issues
Advance planning and cross-border coordination for the resolution
of globally active SIFIs (G-SIFIs) will be essential to minimizing
disruptions to global financial markets. Recognizing that G-SIFIs
create complex international legal and operational concerns, the FDIC
continues to reach out to foreign regulators to establish frameworks
for effective cross-border cooperation.
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 developing contingency plans for the failure
of a G-SIFI that has operations in the United States and the United
Kingdom. Of the 28 G-SIFIs identified by the Financial Stability Board
(FSB) in the G20 countries, four are headquartered in the United
Kingdom, and eight in the United States. Moreover, more than 70 percent
of the reported foreign activities of the eight U.S. G-SIFIs originate
in the United Kingdom. The magnitude of the cross-border financial
relationships and local activity of G-SIFIs in the United States and
the United Kingdom makes the U.S.-UK bilateral relationship by far the
most significant with regard to the resolution of G-SIFIs. Therefore,
our two countries have a strong mutual interest in ensuring that the
failure of such an institution could be resolved at no cost to
taxpayers and without placing the financial system at risk.
The FDIC and UK authorities are continuing to work together to
address the cross-border issues raised in the December 2012 joint paper
on resolution strategies and the December 2013 tabletop exercise
between staffs at the FDIC, the Bank of England (including the
Prudential Regulation Authority), the Federal Reserve, and the Federal
Reserve Bank of New York. This work is intended to identify actions
that could be taken by each regulator to implement the SPOE resolution
strategy in the event of a resolution.
The FDIC also has continued to coordinate with representatives from
other European authorities to discuss issues of mutual interest,
including the resolution of European G-SIFIs and ways in which we can
harmonize receivership actions. The FDIC and the European Commission
(E.C.) continue to work collaboratively through a joint Working Group
composed of senior executives from the FDIC and the E.C., focusing on
both resolution and deposit insurance issues. The Working Group meets
twice a year, in addition to less formal meetings and exchanges of
detailees. In 2014, the Working Group convened in May, and there has
been ongoing collaboration at the staff level. The FDIC and the E.C.
have had in-depth discussions regarding the FDIC's experience with
resolution as well as the FDIC's SPOE strategy.
The E.U. recently adopted important legislation related to the
resolution of global SIFIs, such as the E.U.-wide Credit Institution
and Investment Firm Recovery and Resolution Directive, amendments that
further harmonize deposit guarantee schemes E.U.-wide, and a Single
Resolution Mechanism for Euro-area Member States and others that opt-
in. The E.U. is now working to implement that legislation through
secondary legislation, in the form of guidelines and standards, and by
establishing the organizational capacity necessary to support the work
of the Single Resolution Board under the Single Resolution Mechanism.
FDIC and E.C. staffs continue to collaborate in exchanging information
related to this implementation work. In June 2014, at the request of
the E.C., the FDIC conducted a 2-day seminar on resolutions for
resolution authorities and a broad audience of E.C. staff involved in
resolutions-related matters.
The FDIC continues to foster relationships with other jurisdictions
that regulate G-SIFIs, including Switzerland, Germany, France and
Japan. So far in 2014, the FDIC has had significant principal and
staff-level engagements with these countries to discuss cross-border
issues and potential impediments that would affect the resolution of a
G-SIFI. We will continue this work during the remainder of 2014 and in
2015 and plan to host tabletop exercises with staff from these
authorities. We also held preliminary discussions on developing joint
resolution strategy papers, similar to the one with the United Kingdom,
as well as possible exchanges of detailees.
In a significant demonstration of cross-border cooperation on
resolution issues, the FDIC signed a November 2013 joint letter with
the Bank of England, the Swiss Financial Market Supervisory Authority
and the German Federal Financial Supervisory Authority to ISDA. This
letter encouraged ISDA to develop provisions in derivatives contracts
that would provide for short-term suspension of early termination
rights and other remedies in the event of a G-SIFI resolution. The
authorities are now providing comments on proposed draft ISDA protocols
that would contractually implement these provisions during a resolution
under bankruptcy or under a special resolution regime. The adoption of
the provisions would allow derivatives contracts to remain in effect
throughout the resolution process under a number of potential
resolution strategies. The FDIC believes that the development of a
contractual solution has the potential to remove a key impediment to
cross-border resolution.
We anticipate continuation of our international coordination and
outreach and will continue to work to resolve impediments to an orderly
resolution of a G-SIFI.
Risk Retention
On August 28, 2013, the FDIC approved an NPR issued jointly with
five other Federal agencies to implement the credit risk retention
requirement in Section 941 of the Dodd-Frank Act. The proposed rule
seeks to ensure that securitization sponsors have appropriate
incentives to monitor and ensure the underwriting and quality of assets
being securitized. The proposed rule generally requires that the
sponsor of any asset-backed security (ABS) retain an economic interest
equal to at least 5 percent of the aggregate credit risk of the
collateral. This was the second proposal under Section 941; the first
was issued in April 2011.
The FDIC reviewed approximately 240 comments on the August 2013
NPR. Many comments addressed the proposed definition of a ``qualified
residential mortgage'' (QRM), which is a mortgage that is statutorily
exempt from risk retention requirements under the Dodd-Frank Act. The
NPR proposed to align the definition of QRM with the definition of
``qualified mortgage'' (QM) adopted by the Consumer Financial
Protection Bureau (CFPB) in 2013. The NPR also included a request for
public comment on an alternative QRM definition that would add certain
underwriting standards to the existing QM definition. The August 2013
proposal also sets forth criteria for securitizations of commercial
real estate loans, commercial loans, and automobile loans that meet
specific conservative credit quality standards to be exempt from risk
retention requirements.
The issuing agencies have reviewed the comments, met with
interested groups to discuss their concerns and have given careful
consideration to all the issues raised. The agencies have made
significant progress toward finalizing the rule and expect to complete
the rule in the near term.
Volcker Rule Implementation
In adopting the Volcker Rule, the agencies recognized that clear
and consistent application of the final rule across all banking
entities would be extremely important. To help ensure this consistency,
the five agencies formed an interagency Volcker Rule Implementation
Working Group. The Working Group has been meeting on a weekly basis and
has been able to make meaningful progress on coordinating
implementation. The Working Group has been able to agree on a number of
interpretive issues and has published several Frequently Asked
Questions. In addition, the Working Group has been able to successfully
develop a standardized metrics reporting template, which has been
provided to and tested by the industry. In addition, the Working Group
is developing a collaborative supervisory approach by the agencies.
Community Banks
Focus of Research
Since 2011, the FDIC has been engaged in a sustained research
effort to better understand the issues related to community banks--
those institutions that provide traditional, relationship-based banking
services in their local communities. Our initial findings were
presented in a comprehensive study published in December 2012. The
study covered topics such as structural change, geography, financial
performance, lending strategies and capital formation, and it
highlighted the critical importance of community banks to our economy
and our banking system. While the study found that community banks
account for about 14 percent of the banking assets in the U.S., they
also account for around 45 percent of all the small loans to businesses
and farms made by all banks in the U.S. In addition, the study found
that, of the more than 3,100 U.S. counties, nearly 20 percent (more
than 600 counties)--including small towns, rural communities and urban
neighborhoods--would have no physical banking presence if not for the
community banks operating there.
The study also showed that community banks' core business model--
defined around careful relationship lending, funded by stable core
deposits, and focused on the local geographic community that the bank
knows well--performed comparatively well during the recent banking
crisis. Among the more than 500 banks that have failed since 2007, the
highest rates of failure were observed among noncommunity banks and
among community banks that departed from the traditional model and
tried to grow with risky assets often funded by volatile brokered
deposits.
Our community bank research agenda remains active. Since the
beginning of the year, FDIC analysts have published new papers dealing
with consolidation among community banks, the effects of long-term
rural depopulation on community banks, and the efforts of Minority
Depository Institutions to provide essential banking services in the
communities they serve.
We have also instituted a new section in the FDIC Quarterly Banking
Profile, or QBP, that focuses specifically on community banks. Although
some 93 percent of FDIC-insured institutions met our community bank
definition in the first quarter, they hold a relatively small portion
of industry assets; as a result, larger bank trends tend to obscure
community bank trends. This new quarterly report on the structure,
activities and performance of community banks should help smaller
institutions compare their results with those of other community banks
as well as those of larger institutions. Introducing this regular
quarterly report is one example of the FDICs commitment to maintain an
active program of research and analysis on community banking issues in
the years to come.
Subchapter S
The Basel III capital rules introduce a capital conservation buffer
for all banks (separate from the supplementary leverage ratio buffer
applicable to the largest and most systemically important BHCs and
their insured banks). If a bank's risk-based capital ratios fall below
specified thresholds, dividends and discretionary bonus payments become
subject to limits. The buffer is meant to conserve capital in banks
whose capital ratios are close to the minimums and encourage banks to
remain well-capitalized.
In July 2014, the FDIC issued guidance clarifying how it will
evaluate requests by S corporation banks to make dividend payments that
would otherwise be prohibited under the capital conservation buffer. S
corporation banks have expressed concern about the capital conservation
buffer because of a unique tax issue their shareholders face. Federal
income taxes of S corporation banks are paid by their investors. If an
S corporation bank has income, but is limited or prohibited from paying
dividends, its shareholders may have to pay taxes on their pass-through
share of the S corporation's income from their own resources.
Relatively few S corporation banks are likely to be affected by this
issue, and in any case not for several years. The buffer is phased-in
starting in 2016 and is not fully in place until 2019.
As described in the guidance, if an S corporation bank faces this
tax issue, the Basel III capital rules allow it (like any other bank)
to request an exception from the dividend restriction that the buffer
would otherwise impose. The primary regulator can approve such a
request if consistent with safety and soundness. Absent significant
safety and soundness concerns about the requesting bank, the FDIC
expects to approve on a timely basis exception requests by well-rated S
corporations to pay dividends of up to 40 percent of net income to
shareholders to cover taxes on their pass-through share of the bank's
earnings.
Cybersecurity
In its role as supervisor of State-chartered financial institutions
that are not members of the Federal Reserve System, the FDIC works with
other bank regulators to analyze emerging cyberthreats, bank security
breaches, and other technology incidents. An important initiative of
the FFIEC is a project to assess the level of cybersecurity readiness
at banks, technology service providers and our own supervisory
policies. The agencies plan to review any identified gaps to enhance
supervisory policies to address cyberthreats.
Recognizing that addressing cyber risks can be especially
challenging for community banks, the FDIC has taken a number of actions
in addition to those taken by the FFIEC to further improve awareness of
cyber risks and encourage practices to protect against threats. In
April, the FDIC issued a press release urging financial institutions to
utilize available cyber resources to identify and help mitigate
potential threats. During the first quarter of 2014, the FDIC
distributed a package to all FDIC supervised banks that included a
variety of tools to assist them in developing cyber readiness. As part
of this kit, the FDIC developed a ``Cyber Challenge'' resource for
community banks to use in assessing their preparedness for a cyber-
related incident, and videos and simulation exercises were made
available on www.FDIC.gov and mailed to all FDIC-supervised banks. The
Cyber Challenge is intended to assist banks in beginning a discussion
of the potential impact of IT disruptions on important banking
functions. In April, the FDIC also reissued three documents on
technology outsourcing that contain practical ideas for community banks
to consider when they engage in technology outsourcing. The documents
are: Effective Practices for Selecting a Service Provider; Tools To
Manage Technology Providers' Performance Risk: Service Level
Agreements; and Techniques for Managing Multiple Service Providers.
In addition to the FDIC's operations and technology examination
program, the FDIC monitors cybersecurity issues in the banking industry
on a regular basis through on-site examinations, regulatory reports,
and intelligence reports. The FDIC also works with a number of groups,
including the Finance and Banking Information Infrastructure Committee,
the Financial Services Sector Coordinating Council for Critical
Infrastructure Protection and Homeland Security, the Financial Services
Information Sharing and Analysis Center, other regulatory agencies and
law enforcement to share information on emerging issues.
Conclusion
Thank you for the opportunity to share with the Committee the work
that the FDIC has been doing to address systemic risk in the aftermath
of the financial crisis. I would be glad to respond to your questions.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF THOMAS J. CURRY
Comptroller of the Currency, Office of the Comptroller of the Currency
September 9, 2014
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for the opportunity to update you on steps the
Office of the Comptroller of the Currency (OCC) has taken to enhance
the effectiveness of our supervision and the status of our efforts to
implement the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act or Act).* The OCC is the primary regulator of nearly
1,650 national banks and Federal savings associations with
approximately $10.5 trillion in assets, which represents 68 percent of
all bank and thrift assets insured by the Federal Deposit Insurance
Corporation (FDIC). \1\ OCC-supervised banks and thrifts hold the
majority of FDIC-insured deposits and range from small, community banks
with assets of less than $100 million to some of the largest and most
complex financial institutions.
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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.
\1\ All data are as of June 30, 2014.
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Our Nation's economic and financial condition has steadily improved
since the financial crisis, and the strength and health of our Federal
banking system reflect this progress. As a bank supervisor, I take
comfort in these improvements. I am keenly aware, however, that we need
to remain vigilant, and I am instituting new measures to ensure we do
so. Specifically, the OCC is recalibrating the way we supervise large,
complex financial institutions based on the lessons we have learned
since the financial crisis. Importantly, we are strengthening our
capacity to take a broad, horizontal view across the institutions we
regulate to identify emerging trends and red flags, while enhancing our
traditional hands-on supervision of individual institutions. In
addition, we are requiring our largest institutions to improve risk
management and corporate governance.
In my testimony today, I will address recent OCC initiatives that
are central to the effective and vigilant oversight of national banks
and Federal savings associations. Additionally, in response to the
Committee's letter of invitation, I will discuss the OCC's progress in
issuing and implementing the rules required by the Dodd-Frank Act, as
well as the OCC's efforts to coordinate our supervision with other
domestic and international regulators. Finally, my testimony will touch
on emerging issues related to cybersecurity.
I. State of the National Banking and Federal Thrift System
The condition of the national banks and Federal savings
associations that the OCC supervises (collectively referred to here as
``banks'') has steadily improved over the past 4 years, as the economy
has slowly recovered from the severe 2008-2009 credit crisis and
recession. Banks have increased their total lending volume during this
period, although this increase is at a pace below the long-term average
rate of growth. Total credit growth has been subdued, primarily due to
an extended contraction in residential mortgage activity, with only
recent signs of emerging loan growth in this area. Private residential
mortgage securitization has yet to recover.
Although housing credit has continued to struggle, other areas of
loan growth have shown more resilience. For example, commercial and
industrial loan growth has averaged 10 percent per year during the past
4 years, triple its average pace in the decade before the financial
crisis. Auto sales and lending also have rebounded from the lows of the
recession and are fast approaching precrisis levels. Credit quality has
significantly improved. Charge-off rates for all major loan categories
are at or below the 25-year average and, as a result, the Federal
banking system's total loan charge-off rate is now 0.6 percent, 40
percent below the 25-year average of 1 percent. The ratio of loan loss
reserves to total loans, a measure of a bank's expectation of future
loan losses, has returned to its 1984-2006 average of below 2 percent,
after peaking at 4 percent in 2010. That said, concerns have begun to
emerge related to subprime auto lending outside the banking system and
to loan terms more generally. Leveraged lending also has grown rapidly,
and the OCC, along with the other Federal banking agencies, issued
guidance aimed at preventing overheating in this area.
Given the gradual recovery in lending and improved credit
performance, the profitability of the Federal banking system has
steadily improved, from a 7 percent return on equity in 2010 to
approximately 10 percent today. However, the return on assets is
approximately 1.1 percent, and profitability levels remain subdued
relative to the precrisis period. This is due in part to a continued
low level of loans to total assets and the narrow lending margins that
result from persistently low interest rates, as well as elevated
expenses tied to enhanced compliance and ongoing litigation costs. Even
so, the proportion of unprofitable banks is at 8.9 percent, just above
the 8 percent average in the decade prior to the crisis and well down
from a peak of nearly one-in-three at the height of the crisis.
The number of troubled institutions supervised by the OCC (CAMELS 4
or 5 rated) has decreased significantly, from a high of 196 in December
2010, to 77 in June of this year. Bank balance sheets also reflect
stronger capital and improved liquidity. Tier 1 common equity stands at
nearly 13 percent of risk-weighted assets, up from a low of 9 percent
in the fall of 2008. The current capital leverage ratio is now at 9.3
percent, 40 percent above the ratio in 2008. Liquid assets have
achieved a 30-year high of 15 percent of total assets.
II. Enhancing Supervision
The financial crisis underscored the critical role of supervision
in ensuring a safe and sound global banking system as well as the need
to change supervisory approaches that may not have kept pace with
developments in the industry. Key lessons from both the crisis and the
international supervisory peer review study that we commissioned
prompted the OCC to reassess and revise our supervisory approach for
all banks, particularly larger banks. Below, I describe OCC initiatives
in this area that will transform how we supervise both larger
institutions and the small institutions whose vitality is critical to
so many communities across our country.
A. New Supervisory Initiatives
In 2013, I asked a team of international regulators (referred to
here as the ``peer review team'') to provide the OCC with a candid and
independent assessment of our supervision of midsize and large banks.
The scope of the assessment was broad: it included how we go about the
business of supervision; our agency culture and approach to risk
identification; and any gaps in our supervisory approach or systems.
While the peer review team complimented many areas of OCC
supervision, it also identified areas where the OCC can improve:
enhancing systemic risk monitoring and the processes that support
supervisory responses; improving the consistency of supervisory
practices within and across business lines; and strengthening the
standards we use to supervise. In the months since the peer review
team's report, \2\ the OCC has taken steps to improve our supervisory
processes and execute plans based on the report's findings that include
a number of transformational improvements, which I describe below.
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\2\ http://www.occ.gov/news-issuances/news-releases/2013/nr-occ-
2013-184.html
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Remaking the Large Bank Lead Expert Program
We are expanding and restructuring the organization, functions, and
responsibilities of our Large Bank Lead Expert Program in which an
expert, independent of the dedicated examination staff, is assigned to
each key risk area. This expansion will allow us to compare the
operations of the institutions we regulate and improve our ability to
identify systemic risk. It will also enhance the quality control of our
exam processes and enable us to allocate our resources more
effectively. In addition, we are making a number of changes to our
dedicated examiner program and implementing a rotation policy to
enhance the skills and broaden the perspectives of our examination
teams.
Enhancing Risk Monitoring
The OCC's supervisory program includes our National Risk Committee
(NRC), which monitors the condition of the Federal banking system and
emerging threats to the system's safety and soundness. The NRC meets
quarterly and issues guidance to examiners providing important
perspectives on industry trends and highlighting issues requiring
supervisory attention. This information allows the OCC to react more
quickly to emerging risks and trends and to allocate our resources in a
manner that matches the challenges we are likely to face going forward.
In addition, using midyear and year-end data, the NRC publishes the
Semiannual Risk Perspective report, which informs the development of
our supervisory strategies and processes. We make this report available
to the public. The broad dissemination of this information is part of
our continuing efforts to provide greater transparency to both the
public and industry regarding the issues to which we are devoting
increased supervisory attention. In June 2014, the report also began
outlining our key supervisory priorities for the next twelve months
both for large bank supervision and for midsize and community bank
supervision.
Other analytical groups that focus on specific risk areas, such as
retail and commercial credit and conditions across our districts,
support the work of the NRC. We recently augmented the existing risk
committees with a Large Bank Supervision Risk Committee (LBSRC). The
LBSRC will further enhance our ability to identify and respond quickly
to emerging risk issues across large, complex institutions, ensure
consistency in our supervisory activities, and assist the NRC in its
risk monitoring activities.
Improving Management Information Systems and Data Analytics
The OCC has unique and secure access to substantial and
comprehensive banking system data, and it is imperative that we have
strong data analytics. Our goal is to transition to a shared services
environment across functions within the agency to improve the ability
of our supervisory staff to use this data and enhance the integrity and
consistency of our data analytics. These changes will improve the
consistency, reliability, and efficiency of our supervision of the
institutions that we oversee.
Formalizing an Enterprise Risk Management Framework
The OCC sets a high bar for the institutions we supervise, and we
must ask no less of ourselves. To this end, we are developing and
formalizing an enterprise risk management framework for the OCC,
including a risk appetite statement, to better define, measure, and
control the risks that we accept in pursuit of our mission, vision, and
strategic goals. A working group will soon conduct an initial
enterprisewide risk assessment and inventory existing risk management
practices.
B. Heightened Standards for Large Banks
Due to their size, activities, and implications for the U.S.
financial system, large institutions require more rigorous regulation
and supervision than less systemically significant institutions. Since
the crisis, we have applied heightened standards to large institutions.
These standards address comprehensive and effective risk management;
the need for an engaged board of directors that exercises independent
judgment; the need for a robust audit function; the importance of
talent development, recruitment, and succession planning; and a
compensation structure that does not encourage inappropriate risk
taking.
Last week, we issued final guidelines refining and formalizing
these standards and making them enforceable. These standards provide
important additional supervisory tools to examiners and focus bank
management and boards of directors on strengthening their institutions'
risk management practices and governance. The standards are generally
applicable to insured national banks, insured Federal savings
associations, and insured Federal branches of foreign banks with
average total consolidated assets of $50 billion or greater (referred
to in this subsection as ``banks'').
The final guidelines set forth minimum standards for the design and
implementation of a bank's risk governance framework and provide
minimum standards for the board's oversight of the framework. The
standards make clear that the framework should address all risks to a
bank's earnings, capital, and liquidity that arise from the bank's
activities.
The standards also set out roles and responsibilities for the
organizational units that are fundamental to the design and
implementation of the risk governance framework. These units, often
referred to as a bank's three lines of defense, are front line business
units, independent risk management, and internal audit. The standards
state that, together, these units should establish an appropriate
system to control risk taking. The standards also provide that banks
should develop a risk appetite statement that articulates the aggregate
level and types of risk a bank is willing to assume to achieve its
strategic objectives, consistent with applicable capital, liquidity,
and other regulatory requirements.
In addition, the final guidelines contain standards for boards of
directors regarding oversight of the design and implementation of a
bank's risk governance framework. They note that it is vitally
important for each director to be engaged in order to understand the
risks that his or her institution is taking and to ensure that those
risks are well-managed. Directors should be in a position to present a
credible challenge to bank management with the goal of preserving the
sanctity of the bank's charter. That is, a bank should not be treated
merely as a booking entity for a holding company. The Federal bank
charter is a special corporate franchise that provides a gateway to
Federal deposit insurance and access to the discount window.
Accordingly, management and independent directors must see that the
bank operates in a safe and sound manner.
We issued the final standards as a new appendix to Part 30 of our
regulations. Part 30 codifies an enforcement process set out in the
Federal Deposit Insurance Act that authorizes the OCC to prescribe
operational and managerial standards. If a bank fails to satisfy a
standard, the OCC may require it to submit a compliance plan detailing
how it will correct the deficiencies and how long it will take. The OCC
can issue an enforceable order if the bank fails to submit an
acceptable compliance plan or fails in any material way to implement an
OCC-approved plan.
Higher supervisory standards for the large banks we oversee, such
as those in the final guidelines, along with bank management's
implementation of these standards, are consistent with the Dodd-Frank
Act's broad objective of strengthening the stability of the financial
system. We believe that this increased focus on strong risk management
and corporate governance will help banks maintain the balance sheet
improvements achieved since the financial crisis and make them better
able to withstand the impact of future crises.
C. Supervision of Community Banks
The OCC is the supervisor of approximately 1,400 institutions with
assets under $1 billion, of which approximately 870 have less than $250
million in assets. These small institutions play a vital role in our
country's financial system by providing essential products and services
to our communities and businesses, including credit that is critical to
economic growth and job creation.
The OCC is a resource to these community banks through our more
than 60 offices throughout the United States. Our examiners are part of
the communities in which they work and are empowered to make most
supervisory decisions at the local level. In addition, the entire
agency works to support these examiners and small banks and provides
them with easy access to licensing specialists, lawyers, compliance and
information technology specialists, and a variety of other subject
matter experts.
Small banks face unique challenges, and the OCC has been sensitive
to this in our implementation of the Dodd-Frank Act and in our approach
to supervising these institutions. Throughout the rulemaking process,
the agency has sought and listened to comments and concerns from
community banks. We have heard--and we agree--that a one-size-fits-all
approach to bank supervision is not appropriate. Accordingly, we tailor
our supervisory programs to the risk and complexity of a bank's
activities and have separate lines of business for community and
midsize banks and large banks. When developing regulations, the OCC
works to avoid unnecessary regulatory and compliance burden on small
banks.
Our commitment to this principle is evident in many of the rules we
have issued. For example, the lending limits rule we issued under the
Dodd-Frank Act provides a simpler option that small banks may use for
measuring the credit exposure of derivative and securities financing
transactions. The final domestic capital rules, issued on an
interagency basis, also accommodate concerns of small banks with
respect to the treatment of trust preferred securities (TruPS),
accumulated other comprehensive income, and residential mortgages.
Finally, with our interagency counterparts, we revised the treatment of
certain collateralized debt obligations (CDOs) backed primarily by
TruPS under the Volcker Rule largely to address concerns raised by
community banks.
The OCC, along with the other Federal banking agencies, is also
engaged in a review of regulatory burden pursuant to the Economic
Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA). This
statute requires the OCC, as well as the FDIC and Board of Governors of
the Federal Reserve System (FRB), to seek public comment at least once
every 10 years to identify outdated, unnecessary, or unduly burdensome
regulations. The EGRPRA review provides the public with an opportunity
to recommend to the agencies how to reduce burden through targeted
regulatory changes.
In connection with the EGRPRA process, the agencies published a
Federal Register notice this past June asking for comment on three
categories of rules. The comment period on this first notice ended 1
week ago, and the agencies are reviewing the comments received. Over
the next 2 years, the agencies will issue three more Federal Register
notices that will invite public comment on the remaining rules. In each
notice, we will specifically ask the public, including small
institutions, to identify ways to reduce unnecessary burden associated
with our regulations.
The OCC also has taken steps to communicate more effectively with
the small banks we supervise. Certain provisions of the Dodd-Frank Act
apply to institutions of all sizes, but many apply only to larger
banks. Therefore, in each bulletin transmitting a new regulation or
supervisory guidance to our banks, we include both a ``highlights
section'' that succinctly summarizes the major provisions of the
issuance and an easy-to-see box written in plain English that allows
community banks to assess quickly whether the issuance applies to them.
We have also developed other methods for distilling complex
requirements, such as summaries and guides that highlight aspects of
rules that are relevant to small institutions. We have received
positive feedback on these communication tools, and we will continue to
work to make the regulatory process manageable for small banks.
III. Dodd-Frank Act: Regulatory Milestones Achieved
Congress enacted the Dodd-Frank Act to address regulatory gaps,
create a stronger financial system, and address systemic issues that
contributed to, or that accentuated and amplified the effects of, the
financial crisis. To achieve these objectives, the Act provided the
Federal financial regulators, including the OCC, with new tools to
address risk and to mitigate future financial crises.
The implementation of the Dodd-Frank Act presented challenges on an
unprecedented scale, as many of these new tools required, among other
things, the Federal financial regulators to write or revise a number of
highly complex regulations. In the 4 years since the Act became law,
the OCC has worked tirelessly to fulfill this mandate. I am pleased to
report that the OCC has completed all rules that we have independent
authority to issue. Furthermore, the OCC has finalized many of the
regulations that the Dodd-Frank Act required the OCC to issue jointly
or on a coordinated basis with other Federal financial regulators. For
those rulemakings that remain, we have made good progress and, in many
cases, we have seen meaningful improvements in industry practices in
anticipation of the finalized rules. Below, I will discuss the
completed rulemakings followed by a description of the rulemakings that
are in-process.
A. Finalized Rules
OCC/OTS Integration
The Dodd-Frank Act transferred to the OCC all the functions of the
Office of Thrift Supervision (OTS) relating to Federal savings
associations, as well as the responsibility for the examination,
supervision, and regulation of Federal savings associations. We have
previously reported on the successful transfer of these functions,
including the integration into the OCC of former OTS employees and
systems and the development of an aggressive cross-credentialing
program that qualifies examiners to lead examinations of both national
banks and Federal savings associations.
We are committed to continuing to improve and refine our new
responsibilities. For example, we are undertaking a comprehensive,
multiphase review of our regulations and those of the former OTS to
reduce regulatory burden and duplication, promote fairness in
supervision, and create efficiencies for both types of institutions. We
have begun this process and, in June of this year, we issued a proposal
to integrate national bank and Federal saving association rules
relating to corporate activities and transactions.
In addition, as we have gained experience in our supervision of
Federal savings associations, I have come to recognize that the current
legal framework limits the ability of these institutions to adapt their
business strategies to changing economic and business environments
unless they change their charter or business plans. More specifically,
Federal savings associations that want to move from a mortgage lending
business model to providing a mix of business loans and consumer credit
would need to change charters. I believe that the thrift charter should
be flexible enough to accommodate either strategy.
When I was a regulator in Massachusetts, we made State bank and
thrift powers and investment authorities, as well as supervisory
requirements, the same or comparable regardless of charters, and we
allowed the institutions to exercise those powers while retaining their
own corporate structure. Congress may wish to consider authorizing a
similar system at the Federal level. This flexibility will improve the
ability of thrifts to meet the financial needs of their communities.
The ``Volcker Rule''
On December 10, 2013, the OCC, jointly with the FDIC, FRB, and the
Securities and Exchange Commission (SEC), adopted final regulations
implementing the requirements of section 619, also known as the
``Volcker Rule''. \3\ Section 619 prohibits a banking entity from
engaging in short-term proprietary trading of financial instruments and
from owning, sponsoring, or having certain relationships with hedge
funds or private equity funds (referred to here and in the final
regulations as ``covered funds''). Notwithstanding these prohibitions,
section 619 permits certain financial activities, including market
making, underwriting, risk-mitigating hedging, trading in Government
obligations, and organizing and offering a covered fund.
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\3\ The Commodity Futures Trading Commission (CFTC) issued a
separate rule adopting the same common rule text and a substantially
similar preamble.
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In accordance with the statute, the final regulations prohibit
banking entities from engaging in impermissible proprietary trading and
strictly limit their ability to invest in covered funds. At the same
time, the regulations are designed to preserve market liquidity and
allow banks to continue to provide important client-oriented services.
As discussed later in this testimony, the OCC and the other agencies
are currently working together to implement this rulemaking.
The agencies followed this rulemaking with an interagency interim
final rule to permit banking entities to retain interests in certain
CDOs backed primarily by TruPS. We issued this interim rule because of,
and in response to, concerns expressed primarily by small institutions
that they would otherwise have to divest instruments that the Dodd-
Frank Act expressly allows for capital-raising purposes.
Annual Stress Tests
This OCC-only rule, issued on October 9, 2012, implements section
165(i)(2) of the Act by requiring banks with average total consolidated
assets of $10 billion or greater to conduct annual ``stress tests.''
The rule, which is consistent with and comparable to the stress test
rules issued by the other Federal banking agencies, establishes methods
for conducting stress tests, requiring that the tests be based on at
least three different economic scenarios (baseline, adverse, and
severely adverse). The rule also sets forth the form and content for
reporting the test results and requires banks to publish a summary of
the results. In addition, the rule divides banks into two categories,
based on asset size, so that those with total consolidated assets
between $10 and $50 billion and those with assets over $50 billion are
subject to different test requirements, as well as reporting and
disclosure deadlines.
Lending Limits
The OCC issued a final rule on June 25, 2013, implementing section
610 of the Act, which amended the national bank statutory lending limit
at 12 U.S.C. 84. The rule revises the lending limits applicable to
banks to include credit exposures arising from derivative transactions,
as well as repurchase agreements, reverse repurchase agreements,
securities lending transactions, and securities borrowing transactions.
Appraisals for Higher-Priced Mortgage Loans
On January 18, 2013, the OCC participated in the issuance of an
interagency rule concerning appraisals for ``higher-priced mortgage
loans,'' which are loans secured by a consumer's home with interest
rates above certain thresholds. The rule requires that creditors for
higher-priced loans obtain appraisals that meet certain standards,
notify loan applicants of the purpose of the appraisal, and give
applicants for certain higher-priced mortgages a copy of the appraisal
before advancing credit. In addition, if the seller acquired the
property for a lower price during the 6 months before the sale and the
price difference exceeds a certain threshold, a creditor must obtain a
second appraisal at no cost to the consumer. This requirement for
higher-priced home-purchase mortgage loans seeks to address fraudulent
property flipping by ensuring that the property value increase was
legitimate.
Collins Amendment
The OCC participated with the FDIC and FRB in issuing an
interagency rule on June 11, 2011, that established a floor for the
risk-based capital requirements applicable to the largest,
internationally active banking organizations. This rule amended the
advanced risk-based capital adequacy standards (the ``advanced
approaches rules'') consistent with section 171(b) of the Act, known as
the ``Collins Amendment''. Under the rule, a banking organization that
has received approval to use the advanced approaches rules is required
to meet the higher of the minimum requirements under the general risk-
based capital rules or the minimum requirements under the advanced
approaches rules.
Alternatives to External Credit Ratings
On June 13, 2012, the OCC published a rule implementing sections
939 and 939A of the Act. This rule removes references to external
credit ratings from the OCC's noncapital regulations, including its
regulation that sets forth the types of investment securities that
banks may purchase, sell, deal in, underwrite, and hold. Banks must
conduct their own analysis of whether a security is investment grade.
In addition, the OCC, together with the other Federal banking agencies,
removed all references to external credit ratings from their risk-based
capital rules when we finalized the enhanced capital rule on October
11, 2013 (discussed below). For example, for securitization positions,
the enhanced capital rule replaced a ratings-based approach with a non-
ratings-based supervisory formula for determining risk-based capital
requirements.
B. Rules In-Process
Swaps Margin Rule
The OCC, jointly with the FDIC, FRB, Federal Housing Finance Agency
(FHFA), and Farm Credit Administration, published a proposal in 2011 to
implement sections 731 and 764 of the Act by requiring covered swap
entities to collect margin for their noncleared swaps and noncleared
security-based swaps. Subsequently, the OCC, FDIC, and FRB participated
in international efforts to coordinate the implementation of margin
requirements among the G20 Nations. Following extensive public review
and comment, the Basel Committee on Bank Supervision (Basel Committee)
and the International Organization of Securities Commissions finalized
an international framework in September of last year.
After considering the international framework and the comments we
received on the U.S. proposal, the agencies decided to repropose the
U.S. swaps margin rule. I am happy to report that last week I signed an
interagency reproposal that imposes minimum initial margin and
variation requirements for certain noncleared swaps and security-based
swaps. The reproposal specifically seeks to avoid unnecessarily
burdening both nonfinancial entities that use swap contracts to hedge
commercial costs and smaller financial companies whose activities do
not pose a risk to the financial system. The rule would reduce risk,
increase transparency, and promote market integrity within the
financial system by addressing the weaknesses in the regulation and
structure of the swaps markets that the financial crisis revealed. The
comment period on this reproposal is open for 60 days but, as
previously noted in the OCC's Quarterly Report on Bank Trading and
Derivatives Activities, we have already seen improvements in the
overall collateralization rates for industry derivative exposures.
Credit Risk Retention
The OCC participated in the issuance of an interagency proposal in
2011 that established asset-backed securities requirements designed to
motivate sponsors of securitization transactions to exercise due
diligence regarding the quality of the loans they securitize. Under
this proposal, a securitizer would have to retain a material economic
interest in the credit risk of any asset that it transferred, sold, or
conveyed to a third party. The agencies received over 10,000 comments
on the proposal and concluded that the rulemaking would benefit from a
second round of public review and comment.
In September 2013, the interagency group issued a reproposal.
Although the reproposal includes significant changes from the original,
its focus is the same--to ensure that sponsors are held accountable for
the performance of the assets they securitize. The OCC and the other
participating agencies expect to approve the final rule in the near
future.
Incentive-Based Compensation Arrangements
The OCC, together with the FRB, FDIC, OTS, National Credit Union
Administration, SEC, and FHFA, published a proposal on April 14, 2011,
designed to ensure that certain financial institutions with more than
$1 billion in assets structure their incentive compensation
arrangements: (1) to balance risk and financial rewards; (2) to be
compatible with effective controls and risk management; and (3) to be
supported by strong corporate governance. Specifically, the proposal,
which would implement section 956 of the Act, would require these
institutions to report incentive-based compensation arrangements and
prohibit arrangements that either provide excessive compensation or
could expose an institution to inappropriate risks that could lead to
material financial loss. In light of the thousands of comments that the
agencies received on the proposal, as well as significant industry and
international developments related to incentive-based compensation, the
agencies continue to work on the rule. The completion of this rule is
an OCC priority because of the impact that poorly structured incentive
compensation can have on risk-taking behaviors and the overall safety
and soundness of an institution. Finalizing this rule will reinforce
and complement the risk management principles and heightened standards
that we are implementing.
Retail Foreign Exchange Transactions
On July 14, 2011, the OCC issued a final retail foreign exchange
transactions rule for OCC-regulated entities that engage in off-
exchange transactions in foreign currency with retail customers,
implementing section 742(c)(2) of the Act. The rule contains a variety
of consumer protections, including margin requirements, required
disclosures, and business conduct standards, on foreign exchange
options, futures, and futures-like transactions with certain retail
customers. To promote regulatory comparability, the OCC worked closely
with the CFTC, SEC, FDIC, and FRB in developing this rule. On October
12, 2012, the OCC issued a proposal to amend this final rule in light
of related CFTC and SEC rules, and we continue to work on finalizing
this proposal.
Appraisal Management Companies
In April 2014, the OCC joined in the issuance of an interagency
proposal to implement section 1473 of the Act, which sets forth minimum
requirements for State registration and supervision of appraisal
management companies (AMCs). (AMCs serve as intermediaries between
appraisers and lenders and provide appraisal management services). The
proposal: (1) provides that AMC-coordinated appraisals must adhere to
applicable quality control standards; (2) facilitates State oversight
of AMCs; and (3) ensures that States report to the Federal Financial
Institutions Examination Council's (FFIEC) Appraisal Subcommittee the
information needed to administer a national AMC registry. The agencies
plan to issue a final rule in the near term.
Source of Strength
The OCC, FRB, and FDIC continue to work on an interagency basis to
draft a proposal to implement section 616(d) of the Act to require bank
and savings and loan holding companies, as well as other companies that
control depository institutions, to serve as a ``source of strength''
for their subsidiary depository institutions. As we saw during the
crisis, too often banks served as a source of strength for nonbank
subsidiaries of their holding companies. This rulemaking will
complement actions we have taken elsewhere to preserve the federally
insured bank's financial health.
IV. Other Significant OCC Rulemaking Projects
The OCC, together with the FRB and FDIC, has proposed or finalized
a number of other significant rules over the past 4 years. Many of
these rules, although not mandated by the Dodd-Frank Act, share the
same broad objectives and address many of the same concerns as the Act.
Several of these rules result from international initiatives by groups
such as the Basel Committee and, consistent with the Dodd-Frank Act,
are intended to strengthen global capital and liquidity requirements
and promote a more resilient banking sector. I describe these rules
below.
Enhanced Liquidity Standards
On September 3, 2014, the OCC, FDIC, and FRB approved a final rule
to implement the Basel Committee's liquidity coverage ratio in the
United States. These standards address banking organizations'
maintenance of sufficient liquidity during periods of acute short-term
financial distress. Under the rule, large, internationally active
banking organizations \4\ are required to hold an amount of high
quality liquid assets to cover 100 percent of their total net cash
outflows over a prospective 30 calendar-day period.
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\4\ This category of institutions is defined as those with $250
billion or more in total consolidated assets or $10 billion or more in
foreign financial exposure.
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The agencies are also working with the Basel Committee to develop a
net stable funding ratio, which is intended to complement the liquidity
funding ratio by enhancing long-term structural funding. It is expected
that these liquidity standards, once fully implemented, will accompany
the existing liquidity risk guidance and enhanced liquidity standards
(issued by the FRB in consultation with the OCC and the FDIC) that are
part of the heightened prudential standards required by section 165 of
the Dodd-Frank Act.
Enhanced Capital Rule
Last year, the OCC, FDIC, and FRB issued a rule that
comprehensively revises U.S. capital standards. Most revisions,
including the narrowing of instruments that count as regulatory
capital, will be phased in over several years. For large,
internationally active banking organizations, this phase-in has already
begun. For all other banks, the phase-in will begin in 2015.
The Basel Committee's efforts to revise the international capital
framework shared many of the goals of the Dodd-Frank Act and addressed
many of the same issues. For example, both the agencies' enhanced
capital rule and the Dodd-Frank Act focus increased attention on
efforts to address the excessive interconnectedness of financial sector
exposures and to create incentives for the use of central clearing
houses for over-the-counter derivatives. This capital rule and the
Dodd-Frank Act require an improvement in the quality and consistency of
regulatory capital by narrowing the instruments that count as
regulatory capital. Furthermore, the enhanced capital rule establishes
conservative, stringent capital standards, especially for large banking
organizations, by increasing overall risk-based capital requirements
and refining the methodologies for determining risk-weighted assets to
better capture risk.
Supplementary Leverage Ratio
Regulatory capital standards in the U.S. have long included both
risk-based capital and leverage ratio requirements. The Basel
Committee's revisions to the international capital framework introduced
a new leverage ratio requirement for large, internationally active
banking organizations. The Federal banking agencies' supplementary
leverage ratio implements this additional and stricter leverage
requirement. Unlike the more broadly applicable leverage ratio, this
supplementary leverage ratio adds off-balance sheet exposures into the
measure of total leverage exposure (the denominator of the leverage
ratio). The supplementary leverage ratio is a more demanding standard
because large banking organizations often have significant off-balance
sheet exposures arising from different types of commitments,
derivatives, and other activities.
Earlier this year, to further strengthen the resilience of the
banking sector, the Federal banking agencies finalized a rule that
enhances the supplementary leverage ratio requirement for the largest,
most systemically important U.S. banking organizations (those with $700
billion or more in total consolidated assets or $10 trillion or more in
assets under custody). Under this rule, these banking organizations
will be required to maintain even more Tier 1 capital for every dollar
of exposure in order to be deemed ``well capitalized.''
Last week, the OCC and other Federal banking agencies approved a
final rule that further strengthens the supplementary leverage ratio by
more appropriately capturing a banking organization's potential
exposures. In particular, the revisions contained in this final rule
will better capture leverage embedded in a bank's buying and selling of
credit protection through credit derivatives. This should further
improve our assessment of leverage at the largest banks that are the
most involved in the credit derivatives business.
V. Coordination With Domestic and International Regulators
The Committee has also asked us to report on the OCC's efforts to
better coordinate with other domestic and international regulators. The
OCC, FDIC, and FRB have a long history of cooperative and productive
relationships, through a combination of formal agreements, informal
working groups, and the FFIEC. For example, although the OCC, FDIC, and
FRB each has its own infrastructure, focus, and responsibilities, we
work together to foster a coordinated and cohesive supervisory approach
that minimizes overlaps and avoids supervisory gaps. This allows each
agency to deploy its resources effectively and leverage supervisory
work products. It also allows for the timely communication of
supervisory risks, concerns, priorities, and systemic information,
while reducing the supervisory burden on our institutions and the
agencies. In addition, I am very pleased to report that the OCC and SEC
recently signed a Memorandum of Understanding to facilitate sharing and
coordination between our two agencies.
We have extended this network to include collaboration with the
Bureau of Consumer Financial Protection (CFPB) and State banking
regulators. For example, we have protocols in place to share
information with the CFPB, and we work together to schedule exams and
coordinate other supervisory activities. In addition, the OCC is
engaged in the Financial Stability Oversight Council, which the Dodd-
Frank Act established to help identify and respond to emerging risks
across the financial system. Together, these relationships allow
agencies to share and compare insights and expertise and to reduce
duplication.
Implementation of the Volcker Rule is another important area where
we are working together with other agencies to coordinate our
supervisory strategies and our interpretive approaches. An informal,
interagency staff-level working group meets regularly to discuss
interpretive issues common to all of the agencies with a goal of
developing and publishing uniform answers to frequently asked
questions. The agencies published the first set of ``Frequently Asked
Questions'' on their respective Web sites on June 10, 2014. In
addition, the agencies are discussing how the collaborative approach to
supervision in use among the banking agencies could be expanded to
include the SEC and the CFTC for purposes of Volcker compliance
supervision. I strongly support a supervisory approach that promotes
orderly, coherent supervision by the agencies involved in implementing
the Volcker Rule, and I look forward to our ongoing cooperation toward
that end.
The interconnectedness of the global financial system has also
increased the importance of effective international supervisory
coordination and collaboration. As members of the Basel Committee, the
OCC and the other U.S. Federal banking agencies played a critical role
in developing international standards incorporating many lessons
learned since the financial crisis, such as those reflected in the
agencies' enhanced capital rule. In addition, OCC staff serves on
numerous Basel Committee working groups and chairs its Supervision and
Implementation Group (SIG). The SIG has overseen the Basel Committee's
recent work disseminating good practices on stress testing and business
model analysis, as well as updating principles for bank governance,
risk data aggregation, and the management of supervisory colleges.
The OCC, along with the FDIC and FRB, also regularly enters into
arrangements with foreign regulators that broadly govern information
access and sharing. The purpose of these arrangements, which include
Memoranda of Understanding, statements of cooperation, and exchanges of
letters, is to assist each regulator in obtaining the information
necessary to carry out its respective supervisory responsibilities.
They address issues including cooperation during the licensing process,
the supervision of ongoing activities, and the handling of problem
banks.
The OCC also plays an important role in international discussions
concerning cross-border resolutions including through the Financial
Stability Board's Cross-Border Crisis Management Group and the Legal
Experts Group of the Resolutions Steering Group. In addition, the OCC
participates in such discussions in firm-specific Crisis Management
Groups and Supervisory Colleges and on a bilateral basis with
prudential supervisors. For example, we have been working with the
FDIC, FRB, SEC, and numerous foreign jurisdictions to develop
agreements to facilitate coordination in future crises that affect
significant, cross-border financial institutions.
VI. Emerging Issues: Cybersecurity
While it is essential that we learn lessons from history, it is
unlikely that the challenges of tomorrow will take the same form as
those of the past. The now regular and wide-scale reports of
cyberattacks underscore the importance of cybersecurity and
preparedness. It is clear that some of these attacks use increasingly
sophisticated malware and tactics. With this in mind, I want to share
with you what the OCC and our colleagues in the banking regulatory
community are doing to address one of the most pressing concerns facing
the financial services industry today--the operational risks posed by
cyberattacks. There are few issues more important to me, to the OCC,
and to our country's economic and national security than shoring up the
industry's and our own defenses against cyberthreats.
In June 2013, the FFIEC, which I currently chair, announced the
creation of the Cybersecurity and Critical Infrastructure Working Group
(CCIWG). This group coordinates with intelligence, law enforcement, the
Department of Homeland Security, and industry officials to provide
member agencies with accurate and timely threat information. Within its
first year, this working group released joint statements on the risks
associated with ``distributed denial of service'' attacks, automated
teller machine ``cash-outs,'' and the wide-scale ``Heartbleed''
vulnerability. They held an industry webinar for over 5,000 community
bankers and conducted a cybersecurity assessment of over 500 community
institutions. The information from this assessment will help FFIEC
members identify and prioritize actions that can enhance the
effectiveness of cybersecurity-related guidance to community financial
institutions.
The CCIWG is also working to identify gaps in the regulators'
examination procedures and examiner training to further strengthen the
banking industry's cybersecurity readiness and its ability to address
the evolving and increasing cybersecurity threats. The OCC will
continue to work with the institutions we supervise, our Federal
financial regulatory colleagues, and others within Federal, State, and
local governments as we address this ongoing threat to our financial
system.
Conclusion
Thank you again for the opportunity to appear before you and to
update the Committee on the OCC's continued efforts to implement the
Dodd-Frank Act and other initiatives at the agency.
______
PREPARED STATEMENT OF RICHARD CORDRAY
ADirector, Consumer Financial Protection Bureau
September 9, 2014
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for the opportunity to testify today about the
implementation of the Dodd-Frank Act. We appreciate your oversight and
leadership as we all work to strengthen our financial system and to
ensure that it serves both consumers and the long-term foundations of
the American economy.
As you know, the Consumer Financial Protection Bureau is the
Nation's first Federal agency whose sole focus is protecting consumers
in the financial marketplace. The effects of the financial crisis--with
millions of lost jobs, millions of lost homes, and tremendous declines
in household wealth amounting to trillions of dollars--remain vivid in
our collective experience. Although the damage done to individuals and
communities was substantial, our country is finally recovering.
In passing the Dodd-Frank Act, Congress vested in this new Bureau
the responsibility to stand on the side of consumers and to help
restore their trust in the financial marketplace. Over the past 3
years, we have made considerable progress in fulfilling our rulemaking,
supervisory, and enforcement responsibilities to protect people all
across this country.
Our initial focus, as directed by Congress, was to address deep
problems in the mortgage market that helped precipitate the financial
crisis. We began by issuing a series of mortgage rules that took effect
earlier this year. They require creditors to make reasonable, good
faith assessments that borrowers are able to repay their loans; address
pervasive problems in mortgage servicing that caused many homeowners to
end up in foreclosure; regulate compensation practices for loan
originators; and address various other practices that contributed to
the housing crisis and ensuing financial meltdown. We have spent much
of the last 20 months working intensively with industry, housing
counselors, and other stakeholders to ensure that these rules are
implemented smoothly according to the timelines established by
Congress.
Last fall, we also issued another mortgage rule to accomplish a
goal long urged in the Congress, which was to consolidate Federal
mortgage disclosures under various laws. The new ``Know Before You
Owe'' mortgage forms are streamlined and simplified to help consumers
understand their options, choose the deal that is best for them, and
avoid costly surprises at the closing table. We conducted extensive
testing of the new forms before issuing a proposal and later to
validate the results. The testing showed that consumers at very
different levels of experience were able to understand the new forms
better than the current forms. This rule takes effect about a year from
now, and we again are working intensively to help industry implement
the rule and to prepare educational materials that help consumers
understand and use the new forms.
This summer, we also issued a proposed rule to implement changes
Congress made to the Home Mortgage Disclosure Act. The point is to
improve the quality of data available to monitor compliance with fair
lending laws, public and private investment to meet housing needs, and
general developments in the mortgage market. As with the redesign of
the mortgage disclosure forms, we believe this rulemaking presents an
opportunity to reduce unwarranted regulatory burdens. So we are looking
closely at how to clarify existing requirements and streamline the
processes and infrastructure for reporting this data. We have conducted
detailed discussions with a group of small creditors to focus on their
particular concerns, and we are now seeking broad public comment from
all stakeholders on the proposed rule through the end of October.
As each of these initiatives proceeds, we are working diligently to
monitor the effects of our rules on the mortgage market; make
clarifications and adjustments to our rules where warranted; provide
compliance guides, webinars, and other tools to facilitate the
implementation process; and work closely with our fellow agencies to
support their own regulatory initiatives. We are intent on making sure
that these statutory and regulatory provisions achieve their intended
goals. Right now, for instance, we are pursuing further research to
determine how best to define the scope of statutory provisions for
small creditors that operate predominantly in ``rural or underserved''
areas in order to promote access to credit in those areas.
We are also intensifying our focus on nonmortgage markets to
address other pressing consumer financial protection issues. For
example, we adopted a rule specified by Congress that fashioned the
first comprehensive Federal consumer protections for international
money transfers, often called remittances. We have also issued a series
of rules defining the parameters of the Bureau's supervision authority
over larger participants in certain financial markets, which enables us
to impose supervisory oversight over their operations and activities.
More of those rules are on their way. We are well into the process of
developing proposed rules in several other areas, including prepaid
cards, debt collection, and payday lending. And we are conducting
intensive research on overdraft services and various other topics to
determine what kind of rulemaking activity may be warranted in those
areas.
Another key task for the Bureau has been to build effective
supervision and enforcement programs to ensure compliance with Federal
consumer financial laws. This work is critical to protect consumers,
yet at the same time it is designed to create fair markets through
evenhanded oversight. For the first time ever, this new Federal agency
has authority to supervise not only the larger banks but also a broad
range of nonbank financial companies, including mortgage lenders and
servicers, payday lenders, student loan originators and servicers, debt
collectors, and credit reporting companies. As we have built and
refined our supervision program, we have devised a system of risk-based
prioritization to make the best use of our examination resources. This
prioritization includes an assessment of potential consumer risk along
with factors such as product market size, the entity's market share,
the potential for consumer harm, and field and market intelligence that
includes other factors such as management quality, prior regulatory
history, and consumer complaints.
We strive to conduct effective examinations while minimizing
unnecessary burden on supervised entities. Examinations typically
involve work done both off site and on site, scoped to focus on areas
posing the highest potential risks to consumers. We have made it a
priority to coordinate the timing and substance of examination
activities with our Federal and State regulatory partners. By these
methods, our supervision program is helping to drive a cultural change
within financial institutions that places more emphasis on compliance
with the law and treating customers fairly. When examinations reveal
legal violations, we require appropriate corrective action, including
financial restitution to consumers. We are also insistent that
institutions must have compliance management systems to prevent
violations and ensure appropriate self-monitoring, correction, and
remediation where violations have occurred. This work has strengthened
compliance management at the large banks and caused many large nonbank
firms to implement compliance management systems for the first time.
Reinforcement of these expectations is helping to level the playing
field for competitors across entire markets, regardless of charter or
corporate form.
Our enforcement team is responsible for investigating possible
violations of Federal consumer financial laws and enforcing the law
through administrative and judicial proceedings. Consistent enforcement
of the laws under our jurisdiction benefits consumers, honest
businesses, and the economy as a whole. To date, our enforcement
actions amount to $4.7 billion in relief for roughly 15 million
consumers who were harmed by illegal practices.
Let me give just a few recent examples. Along with officials in 49
States, we took action against the Nation's largest nonbank mortgage
loan servicer for misconduct at every stage of the mortgage servicing
process. A Federal court consent order requires the company to provide
$2 billion in principal reduction to underwater borrowers and to refund
$125 million to nearly 185,000 borrowers who had already been
foreclosed upon. We also partnered with 13 State attorneys general to
obtain $92 million in debt relief for about 17,000 servicemembers and
others harmed by a company's predatory lending scheme involving
inflated prices for electronics where the actual annual percentage rate
charged exceeded 100 percent more than six times the rate that was
disclosed to servicemembers and other consumers.
We worked with the Department of Justice on two significant
matters. First, we secured an order from a Federal district court in
Pennsylvania requiring a bank to pay $35 million to African American
and Hispanic borrowers who were charged higher prices on mortgage loans
than nonminority borrowers. Second, we ordered one of the largest
indirect auto lenders to pay $80 million in damages to 235,000
Hispanic, African American, and Asian and Pacific Islander borrowers
because of discriminatory practices in ``marking up'' interest rates on
auto loans to rates higher than those charged to similarly situated
white borrowers. The $80 million refund to consumers and $18 million
civil penalty stand as the largest amount of relief that the Federal
Government has ever secured in a case of auto loan discrimination.
We also took action against two of the Nation's largest payday
lenders for violations of the law. In one of the actions, we secured
complete consumer refunds of up to $14 million and a $5 million civil
penalty from a company for robo-signing court documents related to debt
collection lawsuits, illegally overcharging servicemembers in violation
of the Military Lending Act, and destroying records in advance of our
examination. In the other matter, we determined after an investigation
that the company used illegal debt collection tactics--including
harassment and false threats of lawsuits or criminal prosecution--to
bully overdue borrowers into taking out new payday loans with expensive
fees despite their demonstrated inability to repay their existing
loans. The company will pay $10 million in restitution and penalties.
In both matters, injunctive relief has been imposed to prevent such
misconduct from recurring in the future.
At the heart of our mission is the premise that consumers deserve
to have someone stand on their side and make sure they are treated
fairly in the financial marketplace. Since the day we opened our doors
and received our first few hundred consumer complaints, we have now
handled nearly 440,000 complaints and secured both monetary and
nonmonetary relief on behalf of tens of thousands of individual
consumers, including many people in each of your States.
Consumers should also have the tools and information they need to
navigate financial choices. We have developed consumer resources such
as the ``Ask CFPB'' feature on our Web site, which allows consumers to
find answers to more than a thousand common financial questions and has
been visited by more than 3.3 million unique visitors. We developed
``Know Before You Owe'' tools to make the costs and risk of financial
products more clear. We also worked with the Department of Education to
develop the ``Financial Aid Shopping Sheet'', which has now been
adopted by more than 2,000 colleges and universities to help students
make apples-to-apples comparisons of college costs. We constantly
engage in extensive outreach efforts, and our Office of Servicemember
Affairs, led by Holly Petraeus, has visited 91 military installations
and units to hear concerns and share information with servicemembers.
All of our work has benefited by the engagement of millions of
Americans, and our constructive dialogue with financial institutions,
including community banks and credit unions in regular meetings all
around the country. My outstanding colleagues at the Consumer Bureau,
as well as the leaders of our fellow agencies represented on this
panel, are strongly dedicated to a shared vision of a healthy consumer
financial marketplace and we continue to work very well together in
pursuit of that goal.
Thank you and I look forward to your questions.
______
PREPARED STATEMENT OF MARY JO WHITE
Chair, Securities and Exchange Commission
September 9, 2014
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for inviting me to testify about the Securities
and Exchange Commission's (``SEC'' or ``Commission'') ongoing
implementation of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'' or ``Act'') to reduce systemic
risks, enhance transparency and better protect investors, as well as
other steps taken to improve financial stability, close regulatory
gaps, and better coordinate with domestic and international regulators.
\1\
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\1\ The views expressed in this testimony are those of the Chair
of the Securities and Exchange Commission and do not necessarily
represent the views of the full Commission.
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The Dodd-Frank Act gave the SEC significant new responsibilities,
requiring the agency to undertake the largest and most complex
rulemaking agenda in its history. The Act includes some 90 provisions
that require SEC rulemaking and more than 20 other provisions that
require studies or reports. In addition, the Act and the financial
crisis focused the SEC's efforts more directly on enhancing financial
stability and the reduction of systemic risk.
The SEC has made substantial progress implementing this agenda,
even as we have continued our core responsibilities of pursuing
securities violations, reviewing public company disclosures and
financial statements, inspecting the activities of regulated entities,
and maintaining fair and efficient markets, including enhancements to
our equity market structure.
Since I became SEC Chair in April of 2013, the Commission has
focused on eight key areas addressed by the Dodd-Frank Act: credit
rating agencies; asset-backed securities; municipal advisors; asset
management, including regulation of private fund advisers; over-the-
counter derivatives; clearance and settlement; proprietary activities
by financial institutions; and executive compensation. In furtherance
of those regulatory objectives, the Commission has, to date,
implemented new restrictions on the proprietary activities of financial
institutions through the Volcker Rule, created a wholly new regulatory
framework for municipal advisors, and advanced significant new
standards for the clearing agencies that stand at the center of our
financial system. We also have finalized critical Dodd-Frank Act rules
intended to strengthen the integrity of credit ratings, reducing
conflicts of interest in ratings and improving their transparency. We
have adopted significantly enhanced disclosures for asset-backed
securitizations and completed structural and operational reforms to
address risks of investor runs in money market funds. We have pushed
forward new rules for previously unregulated derivatives and begun
implementing additional executive compensation disclosures. And we have
put in place strong new controls on broker-dealers that hold customer
assets, reduced reliance on credit ratings, and barred bad actors from
private securities offerings. Since April 2013, the SEC has proposed or
adopted nearly 20 significant Dodd-Frank Act rules, in addition to
adopting structural reforms for money market funds, which were
highlighted as a systemic vulnerability in the financial crisis.
Attached as Appendix A is a detailed summary of the agency's required
Dodd-Frank Act rulemaking, which reflects that the Commission has
proposed or adopted rules with respect to approximately 90 percent of
all of the provisions of the Dodd-Frank Act that mandate Commission
rulemaking.
We have worked closely with our fellow financial regulators to
ensure that our financial regulatory system works together to protect
against risks, both by promoting financial stability and supporting a
sensible and integrated financial regulatory framework that works
effectively for market participants. The Financial Stability Oversight
Council (FSOC) established by the Dodd-Frank Act, in which I
participate as a member, also serves an important role in this effort.
While the SEC has made significant progress, more remains to be
done on both our Dodd-Frank Act and Jumpstart Our Business Startups
(JOBS) Act rulemakings, and we must continue our work with intensity.
As we do so, we must be deliberate as we consider and prioritize our
remaining mandates and deploy our broadened regulatory authority,
supported by robust economic analysis. Progress will ultimately be
measured based on whether we have implemented rules that create a
strong and effective regulatory framework and stand the test of time
under intense scrutiny in rapidly changing financial markets. Our
responsibility is much greater than simply ``checking the box'' and
declaring the job done. We must be focused on fundamental and lasting
reform.
As requested by the Committee, my testimony today will provide an
overview of the Commission's Dodd-Frank Act implementation and discuss
those rules that are yet to be completed.
Credit Ratings
The Dodd-Frank Act requires the Commission to undertake a number of
rulemakings related to nationally recognized statistical rating
organizations (NRSROs). The Commission began the process of
implementing these mandates with the adoption of a rule in January 2011
\2\ requiring NRSROs to provide a description of the representations,
warranties, and enforcement mechanisms available to investors in an
offering of asset-backed securities, including how they differ from
those of similar offerings. Last month, the Commission completed its
required rulemaking for NRSROs by adopting rules requiring NRSROs to,
among other things: (1) report on internal controls; (2) protect
against potential conflicts of interest; (3) establish professional
standards for credit analysts; (4) publicly provide--along with the
publication of a credit rating--disclosure about the credit rating and
the methodology used to determine it; and (5) enhance their public
disclosures about the performance of their credit ratings. \3\ These
rules create an extensive framework of robust reforms and will
significantly strengthen the governance of NRSROs. The reforms will
also significantly enhance the transparency of NRSRO activities and
thereby promote greater scrutiny and accountability of NRSROs.
Together, this package of reforms should improve the overall quality of
NRSRO credit ratings and protect against the reemergence of practices
that contributed to the recent financial crisis.
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\2\ 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, pursuant to Section 939B of
the Act, the Commission issued an amendment to 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.
\3\ See Release No. 34-72936, ``Nationally Recognized Statistical
Rating Organizations'' (August 27, 2014), http://www.sec.gov/rules/
final/2014/34-72936.pdf.
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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; \4\ (2) a study on alternative compensation models for
rating structured finance products, which was published in December
2012; \5\ and (3) a study on NRSRO independence, which was published in
November 2013. \6\ In response to the study on alternative compensation
models for rating structured finance products, the Commission held a
public roundtable in May 2013 to invite discussion regarding, among
other things, the courses of action discussed in the report. The staff
has considered the various viewpoints presented during discussion at
the roundtable, as well as in the related public comment letters, and
is discussing potential approaches with the Commission.
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\4\ Credit Rating Standardization Study (September 2012), http://
www.sec.gov/news/studies/2012/939h_credit_rating_standardization.pdf.
\5\ Report to Congress on Assigned Credit Ratings (December 2012),
http://www.sec.gov/news/studies/2012/assigned-credit-ratings-study.pdf.
\6\ Report to Congress on Credit Rating Agency Independence Study
(November 2013), http://www.sec.gov/news/studies/2013/credit-rating-
agency-independence-study-2013.pdf.
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As required by the Dodd-Frank Act, the Commission established an
Office of Credit Ratings (OCR) charged with administering the rules of
the Commission with respect to NRSROs, promoting accuracy in credit
ratings issued by NRSROs, and helping to ensure that credit ratings are
not unduly influenced by conflicts of interest and that NRSROs provide
greater disclosure to investors. As required by the Dodd-Frank Act, OCR
conducts examinations of each NRSRO at least annually and the
Commission makes available to the public an annual report summarizing
the essential exam findings. The third annual report of the staff's
examinations was published in December 2013. \7\
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\7\ 2013 Summary Report of Commission Staff's Examinations of Each
Nationally Recognized Statistical Rating Organization (December 2013),
http://www.sec.gov/news/studies/2013/nrsro-summary-report-2013.pdf.
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The Dodd-Frank Act also requires the SEC, to the extent applicable,
to review its regulations that require use of credit ratings as an
assessment of the creditworthiness of a security, remove these
references, and replace them with appropriate standards of
creditworthiness. The Commission has adopted final amendments that
remove references to credit ratings from most of its rules and forms
that contained such references, including rules adopted in December
2013 removing references to credit ratings in certain provisions
applicable to investment companies and broker-dealers, \8\ and in
August 2014 new requirements to replace the credit rating references in
shelf eligibility criteria for asset-backed security offerings with new
shelf eligibility criteria. \9\
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\8\ See Release No. 34-60789, ``References to Ratings of
Nationally Recognized Statistical Rating Organizations'', (October 5,
2009) (pre- Dodd-Frank Act adopting amendments to remove references to
credit ratings in certain Commission rules) http://www.sec.gov/rules/
final/2009/34-60789.pdf; Release No. 33-9245, ``Security Ratings'',
(July 27, 2011) (post- Dodd-Frank Act adopting amendments to remove
references to credit ratings in certain Commission rules) http://
www.sec.gov/rules/final/2011/33-9245.pdf; Release No. 33-9506,
``Removal of Certain References to Credit Ratings Under the Investment
Company Act'', (December 27, 2013) (post- Dodd-Frank Act adopting
amendments to remove references to credit ratings in certain Commission
rules), http://www.sec.gov/rules/final/2013/33-9506.pdf; Release No.
34-71194, ``Removal of Certain References to Credit Ratings Under the
Securities Exchange Act of 1934'', (December 27, 2013) (post- Dodd-
Frank Act adopting amendments to remove references to credit ratings in
certain Commission rules), http://www.sec.gov/rules/final/2013/34-
71194.pdf.
\9\ See Release No. 34-72936, ``Nationally Recognized Statistical
Rating Organizations'' (August 27, 2014), http://www.sec.gov/rules/
final/2014/34-72936.pdf.
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Asset-Backed Securities
The Commission has completed implementing several significant
provisions of the Dodd-Frank Act related to asset-backed securities
(ABS), and I have focused the staff and Commission on finalizing the
remaining mandates. Within a year of the enactment of the Act, the
Commission adopted rules to implement Sections 943 and 945 of the Act.
The rules implementing Section 943 require ABS issuers to disclose the
history of repurchase requests received and repurchases made relating
to their outstanding ABS. \10\ The rules implementing Section 945
require an asset-backed issuer in offerings registered under the
Securities Act of 1933 (Securities Act) to perform a review of the
assets underlying the ABS that must be designed and effected to provide
reasonable assurance that the prospectus disclosure about the assets is
accurate in all material respects and disclose the nature of such
review. \11\ Shortly after the 1-year anniversary of the Act, 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 ABS issuers and granted the
Commission authority to issue rules providing for the suspension or
termination of this duty to file reports. \12\
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\10\ 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.
\11\ 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.
\12\ 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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Just last month, the Commission adopted expansive new requirements
for enhanced disclosures for ABS, including requiring standardized
asset-level data for certain asset classes. \13\ For those asset
classes, the new requirements implement Section 942(b) of the Act,
which directed the Commission to adopt regulations to require asset-
level information to the extent necessary for investors to
independently perform due diligence. The final rules require that
prospectuses and ongoing reports of securities backed by assets related
to real estate or automobiles, or backed by debt securities, contain
detailed asset-level information about each of the assets in the pool.
The Commission continues to consider whether asset-level disclosure
would be useful to investors across other asset classes. The rules also
provide investors with more time to consider transaction-specific
information, including information about the pool assets. These
measures should better protect investors in these markets by providing
important data and other information that will allow investors to
conduct diligence on asset-backed securities that is independent of a
credit rating agency. Although not mandated by the Dodd-Frank Act, the
staff continues to monitor the private placement securitization markets
to determine whether they should recommend advancing similar measures
for those markets.
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\13\ See Release No. 33-9638, ``Asset-Backed Securities Disclosure
and Registration'' (August 27, 2014), http://www.sec.gov/rules/final/
2014/33-9638.pdf.
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In addition, the Commission is working with other Federal
regulators to jointly develop risk retention rules, as required by
Section 941 of the Act. These rules will address the appropriate
amount, form, and duration of required risk retention for securitizers
of ABS. In March 2011, the Commission joined its fellow regulators in
proposing rules to implement Section 941 \14\ and, after careful
consideration of the many comments received, in August 2013 reproposed
these rules with several significant modifications. \15\ Together with
the other agencies, we have made significant progress toward developing
a final rule and we are nearing the final stages of that rulemaking.
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\14\ See Release No. 34-64148, ``Credit Risk Retention'' (March
30, 2011), http://www.sec.gov/rules/proposed/2011/34-64148.pdf. Section
941 of the Act generally requires the Commission, the Federal Reserve
Board, the Federal Deposit Insurance Corporation, the 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 ABS, transfers, sells, or conveys to a third party.
It 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 15 U.S.C. 78o-11(c)(1)(A).
\15\ See Release No. 33-34-70277, ``Credit Risk Retention''
(August 28, 2013), http://www.sec.gov/rules/proposed/2013/34-70277.pdf.
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In September 2011, the Commission proposed a rule to implement
Section 621 of the Act, which prohibits 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. \16\ The proposed rule would prohibit underwriters and other
``securitization participants'' from engaging in such transactions with
respect to both nonsynthetic and synthetic asset-backed securities,
whether in a registered or unregistered offering. The proposal is not
intended to prohibit legitimate securitization activities, and the
Commission asked questions in the release to help strike an appropriate
balance. The proposal generated substantial comment that included
requests for significant alterations to the proposed rule, which the
staff is carefully considering in preparing its recommendation for
consideration by the Commission.
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\16\ 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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Municipal Securities
The Dodd-Frank Act imposed a new requirement that ``municipal
advisors'' register with the SEC. This registration requirement applies
to persons who provide advice to municipal entities or obligated
persons on municipal financial products or the issuance of municipal
securities, or who solicit municipal entities or obligated persons.
\17\ In September 2013, the Commission adopted final rules for
municipal advisor registration. \18\ The new registration requirements
and regulatory standards aim to address problems observed with the
conduct of some municipal advisors, including failure to place the duty
of loyalty to their municipal entity client ahead of their own
interests, undisclosed conflicts of interest, advice rendered by
financial advisors without adequate training or qualifications, and
``pay to play'' practices.
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\17\ 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. See Release
No. 34-62824, ``Temporary Registration of Municipal Advisors'',
(September 1, 2010), http://www.sec.gov/rules/interim/2010/34-
62824.pdf. The Commission received over 1,200 confirmed registrations
of municipal advisors pursuant to this temporary rule.
\18\ See ``Registration of Municipal Advisors'', Release No. 34-
70462 (September 20, 2013), http://www.sec.gov/rules/final/2013/34-
70462.pdf. See also ``Registration of Municipal Advisors Frequently
Asked Questions'' (issued on January 10, 2014, and last updated on May
19, 2014), http://www.sec.gov/info/municipal/mun-advisors-faqs.pdf. The
staff in the Office of Municipal Securities provided this interpretive
guidance to address certain questions that arose from municipal market
participants relating to the implementation of the final rules.
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Municipal advisors were required to comply with the final rules as
of July 1, 2014, \19\ and to register with the SEC using the final
registration forms during a 4-month phased-in compliance period, which
began on July 1, 2014. \20\ Except for certain personally identifiable
information, the SEC municipal advisor registration information is
available to the public through the SEC's Electronic Data Gathering,
Analysis, and Retrieval (EDGAR) system Web site. \21\
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\19\ See Release No. 34-71288, ``Registration of Municipal
Advisors''; Temporary Stay of Final Rule, (January 13, 2014), http://
www.sec.gov/rules/final/2014/34-71288.pdf.
\20\ The final rules require municipal advisors to register with
the SEC by completing a Form MA and to provide information regarding
natural persons associated with the municipal advisor and engaged in
municipal advisory activities on such municipal advisor's behalf by
completing a Form MA-I for each such natural person.
\21\ To search by a municipal advisor company's name, see http://
www.sec.gov/edgar/searchedgar/companysearch.html.
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In addition, Commission staff in August of this year launched an
examination initiative to conduct focused, risk-based examinations of
municipal advisors. \22\ These examinations will be specifically
focused and shorter in duration than typical examinations. The
initiative is designed both to provide targeted outreach to inform new
municipal advisor registrants of their obligations as registered
entities and to permit the Commission to examine a significant
percentage of new municipal advisor registrants. Additionally,
Commission staff will oversee the Financial Industry Regulatory
Authority (FINRA) staff in its examinations of municipal advisors that
are also FINRA members.
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\22\ See ``Industry Letter for the Municipal Advisor Examination
Initiative'' (August 19, 2014), available at: http://www.sec.gov/about/
offices/ocie/muni-advisor-letter-081914.pdf.
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The Dodd-Frank Act also required the Commission to establish an
Office of Municipal Securities (OMS), reporting directly to the Chair,
to administer the rules pertaining to broker-dealers, municipal
advisors, investors and issuers of municipal securities, and to
coordinate with the Municipal Securities Rulemaking Board (MSRB) on
rulemaking and enforcement actions. \23\ During its first 2 years of
operations, OMS devoted its attention primarily to finalizing and
implementing the municipal advisor registration rules, including
providing interpretive guidance to market participants and
participating in the review of municipal advisor registrations. Over
the next year, OMS expects to continue to devote significant attention
to implementing these final rules, to review a considerable number of
rule filings by the MSRB related to municipal advisor regulation, and
to coordinate with SEC examination staff in their examinations of
municipal advisors. In addition, OMS also continues to monitor current
issues in the municipal securities market (such as pension disclosure,
accounting, and municipal bankruptcy issues) and to assist in
considering further recommendations to the Commision with respect to
disclosure, market structure, and price transparency in the municipal
securities markets. \24\
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\23\ See Section 979 of the Dodd-Frank Act.
\24\ See recommendations in the ``Commission's Report on the
Municipal Securities Market'' (July 31, 2012), http://www.sec.gov/news/
studies/2012/munireport073112.pdf.
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Private Fund Adviser Registration and Reporting
Title IV of the Dodd-Frank Act directed the Commission to implement
a number of provisions designed to enhance the oversight of private
fund advisers, including registration of advisers to hedge funds and
other private funds that were previously exempt from SEC registration.
These provisions enable regulators to have a more comprehensive view of
private funds and the investment advisers managing those assets.
The SEC's implementation of required rulemaking under Title IV is
complete. In June 2011, the Commission adopted rules requiring advisers
to hedge funds and other private funds to register by March 2012,
addressing what had once been a sizable gap in regulators' ability to
monitor for systemic risk and potential misconduct. \25\ As a result of
the Dodd-Frank Act and the SEC's new rules, the number of SEC-
registered private fund advisers has increased by more than 50 percent
to 4,322 advisers. Even after accounting for the shift of mid-sized
advisers to State registration pursuant to the Dodd-Frank Act, \26\ the
total amount of assets managed by SEC-registered advisers has increased
significantly from $43.8 trillion in April 2011 to $62.3 trillion in
August 2014, while the total number of SEC-registered advisers has
remained relatively unchanged from 11,505 to 11,405.
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\25\ See Release No. IA-3221, ``Rules Implementing Amendments to
the Investment Advisers Act of 1940'' (June 22, 2011), http://
www.sec.gov/rules/final/2011/ia-3221.pdf.
\26\ Id.
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For private fund advisers required to be registered with the
Commission, pursuant to the Dodd-Frank Act the Commission adopted
confidential systemic risk reporting requirements on Form PF in October
2011 to assist the FSOC in systemic risk oversight. \27\ As required by
the Act, Form PF was designed in consultation with FSOC, and the data
filed on Form PF has been made available to the Office of Financial
Research within the Department of the Treasury.
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\27\ See Release No. IA-3308, ``Reporting by Investment Advisers
to Private Funds and Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF''; Joint Final Rule (October 21, 2011),
http://www.sec.gov/rules/final/2011/ia-3308.pdf.
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To date, approximately 2,700 investment advisers have filed Form PF
reporting information on approximately 8,000 hedge funds, 70 liquidity
funds, and 7,000 private equity funds. During the past year, the
Commission's staff has focused its efforts on utilizing Form PF data in
examinations and investigations of private fund advisers, using Form PF
data in the Commission's risk monitoring activities, providing
additional guidance to filers, and working with other Federal
regulators and international organizations regarding issues relating to
private fund advisers. As required by the Dodd-Frank Act, Commission
staff transmitted an annual report to Congress this past August on
these uses. \28\
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\28\ See ``Annual Staff Report Regarding the Use of Data Collected
from Private Fund Systemic Risk Reports'' (August 15, 2014), http://
www.sec.gov/reportspubs/special-studies/im-private-fund-annual-report-
081514.pdf.
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During the past 2 years, Commission staff reviewed the Advisers Act
and its rules and provided guidance regarding their application to
private fund advisers, including guidance to clarify: the application
of the custody rule when advisers to audited private funds utilize
special purpose vehicles; \29\ how the custody rule applies to escrows
utilized by private fund advisers upon the sale of a portfolio company;
\30\ when an adviser to an audited private fund may itself maintain
custody of private stock certificates instead of holding them at a
third-party custodian; \31\ the definition of ``knowledgeable
employees'' for purposes of the Investment Company Act; \32\ when
certain private fund investors are ``qualified clients'' under the
Advisers Act; \33\ and the application of the venture capital exemption
in certain common scenarios. \34\
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\29\ See ``IM Guidance Update 2014-08, Private Funds and the
Application of the Custody Rule to Special Purpose Vehicles and
Escrows'' (June 2014), http://www.sec.gov/investment/im-guidance-2014-
07.pdf.
\30\ Id.
\31\ See ``IM Guidance Update 2013-04, Privately Offered
Securities under the Investment Advisers Act Custody Rule'' (August
2013), http://www.sec.gov/divisions/investment/guidance/im-guidance-
2013-04.pdf.
\32\ See ``SEC No-Action Letter, Managed Funds Association''
(February 6, 2014), http://www.sec.gov/divisions/investment/noaction/
2014/managed-funds-association-020614.htm.
\33\ See ``IM Guidance Update 2013-10, Status of Certain Private
Fund Investors as Qualified Clients'' (November 2013), http://
www.sec.gov/divisions/investment/guidance/im-guidance-2013-10.pdf.
\34\ See ``IM Guidance Update, Guidance on the Exemption for
Advisers to Venture Capital Funds'' (December 2013), http://
www.sec.gov/divisions/investment/guidance/im-guidance-2013-13.pdf.
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In addition, I anticipate that in October 2014, Commission staff
will conclude a 2-year initiative to conduct focused, risk-based exams
of newly registered private fund advisers. These ``presence''
examinations have been shorter in duration and more streamlined than
typical examinations, and have been designed both to engage with the
new registrants to inform them of their obligations as registered
entities and to permit the Commission to examine a higher percentage of
new registrants. The initiative has included outreach, as well as
examinations that have focused on five critical areas: (1) marketing;
(2) portfolio management; (3) conflicts of interest; (4) safety of
client assets; and (5) valuation. As of early September 2014, staff had
completed approximately 340 examinations of newly registered private
fund advisers, and over 40 additional examinations are underway.
Over-the-Counter Derivatives
The Dodd-Frank Act established a new oversight regime for the over-
the-counter 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 and the end-user
exemption; trade reporting and trade execution; the operation of
clearing agencies, trade data repositories, and trade execution
facilities; capital, margin, and segregation requirements and business
conduct standards for dealers and major market participants; and public
transparency for transactional information. Such rules are intended to
achieve a number of goals, including:
Facilitating the centralized clearing of security-based
swaps, whenever possible and appropriate, with the intent of
reducing counterparty and systemic risk;
Increasing transparency for market participants and
regulators in their efforts to monitor the market and, as
appropriate, address risks to financial stability;
Increasing security-based swap transaction disclosure;
Reducing counterparty and systemic risk through capital,
margin and segregation requirements for nonbank dealers and
major market participants; and
Addressing potential conflict of interest issues relating
to security-based swaps.
Since I testified before this Committee last February, the
Commission has proposed rules relating to books and records \35\ and
proposed rules to enhance the oversight of clearing agencies deemed to
be systemically important or that are involved in complex transactions,
such as security-based swaps. \36\ With these steps, the Commission has
now proposed all the core rules required by Title VII of the Dodd-Frank
Act.
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\35\ See ``Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and Broker-
Dealers; Capital Rule for Certain Security-Based Swap Dealers'',
Release No. 34-71958 (April 17, 2014), http://www.sec.gov/rules/
proposed/2014/34-71958.pdf.
\36\ See ``Standards for Covered Clearing Agencies'', Release No.
34-71699 (March 12, 2014), http://www.sec.gov/rules/proposed/2014/34-
71699.pdf.
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Most recently, in June of this year, the Commission adopted the
critical, initial set of cross-border rules and guidance, focusing on
the swap dealer and major swap participant definitions. \37\ The rules
and guidance explain when a cross-border transaction must be counted
toward the requirement to register as a security-based swap dealer or
major security-based swap participant. The rules also address the scope
of the SEC's cross-border antifraud authority. In addition, the
Commission adopted a procedural rule regarding the submission of
``substituted compliance'' requests. This rule represents a major step
in the Commission's efforts to establish a framework to address
circumstances in which market participants may be subject to more than
one set of comparable regulations across different jurisdictions.
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\37\ See Release No. 34-72474, ``Application of `Security-Based
Swap Dealer' and `Major Security-Based Swap Participant' Definitions to
Cross-Border Security-Based Swap Activities'' (June 25, 2014), http://
www.sec.gov/rules/final/2014/34-72472.pdf.
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These rules and guidance focus on a central aspect of the
Commission's May 2013 comprehensive proposal regarding the application
of Title VII to cross-border security-based swap transactions. \38\ The
cross-border application of other substantive requirements of Title VII
will be addressed in subsequent releases, resulting in final rules in a
particular substantive area that apply to the full range of security-
based swap transactions, not just purely domestic ones. I believe that
this integrated approach will reduce undue costs and provide a more
orderly implementation process for both regulators and market
participants. In addition, the Commission previously adopted a number
of key definitional and procedural rules, provided a ``roadmap'' for
the further implementation of its Title VII rulemaking, and took other
actions to provide legal certainty to market participants during the
implementation process.
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\38\ See Release No. 34-69490, ``Cross-Border Security-Based Swap
Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms
Relating to the Registration of Security-Based Swap Dealers and Major
Security-Based Swap Participants'' (May 1, 2013), http://sec.gov/rules/
proposed/2012/34-68071.pdf.
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Commission staff also continues to work intensively on
recommendations for final rules required by Title VII that have been
proposed but not yet adopted. These final rules will address regulatory
reporting and post-trade public transparency; \39\ security-based swap
dealer and major security-based swap participant requirements,
including business conduct and financial responsibility requirements;
\40\ mandatory clearing, the end-user exemption and trade execution,
and the regulation of clearing agencies and security-based swap
execution facilities; \41\ and enforcement and market integrity,
including swap-specific antifraud measures. \42\ In addition, I expect
that the Commission will soon 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.
---------------------------------------------------------------------------
\39\ 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. In 2013, the Commission reproposed
Regulation SBSR. See Release No. 34-69490, ``Cross-Border Security-
Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules
and Forms Relating to the Registration of Security-Based Swap Dealers
and Major Security-Based Swap Participants'' (May 1, 2013), http://
www.sec.gov/rules/proposed/2013/34-69490.pdf; and Release No. 34-69491.
\40\ 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 Dealers 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.
\41\ 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.
\42\ 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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In March 2012, the Commission adopted rules providing exemptions
under the Securities Act of 1933, the Securities Exchange Act of 1934,
and the Trust Indenture Act of 1939 for security-based swaps
transactions involving certain clearing agencies satisfying certain
conditions. 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.
Clearing Agencies
Title VIII of the Dodd-Frank Act provides for increased regulation
of financial market utilities \43\ (FMUs) and financial institutions
that engage in payment, clearing, and settlement activities 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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\43\ 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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Registration of Security-Based Swap Clearing Agencies
There are now three clearing agencies registered with the
Commission to clear security-based swaps, and Commission staff
maintains regular channels of communication with those clearing
agencies regarding their operations. In 2013, the Commission also
amended its established rule filing procedures to accommodate the
special circumstances of clearing agencies registered with both the
Commission and the Commodity Futures Trading Commission (CFTC) to help
ensure that the new regulatory regime for security-based swaps operates
as intended and without undue burdens on dually registered security-
based swap clearing agencies. \44\
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\44\ See Release No. 34-69284, ``Amendment to Rule Filing
Requirements for Dually-Registered Clearing Agencies'' (April 3, 2013),
http://www.sec.gov/rules/final/2014/34-69284.pdf.
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Clearing Agency Standards
To further the objectives of Title VIII and promote the integrity
of clearing agency operations and governance, the Commission adopted
rules in October 2012 requiring all registered clearing agencies to
maintain certain standards with respect to risk management and certain
operational matters. \45\ The rules also contain specific requirements
for clearing agencies that perform central counterparty services, such
as provisions governing credit exposures and the financial resources of
the clearing agency, and establish record keeping and financial
disclosure requirements for all registered clearing agencies.
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\45\ 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 March of this year, the Commission proposed a series of
additional clearing agency standards. \46\ The proposed rules would
establish a new category of ``covered clearing agency'' subject to
enhanced standards. The comment period on the proposal closed in May
2014, and Commission staff is preparing a recommendation to the
Commission for final rules.
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\46\ See Release No. 34-71699, ``Standards for Covered Clearing
Agencies'' (March 12, 2014), http://www.sec.gov/rules/proposed/2014/34-
71699.pdf.
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The proposed rules benefited from consultations between the
Commission staff and staffs of the CFTC and the Board of Governors of
the Federal Reserve System (the ``Board''), and are designed to further
strengthen the Commission's oversight of securities clearing agencies
and promote consistency in the regulation of clearing organizations
generally, thereby helping to ensure that clearing agency regulation
reduces systemic risk in the financial markets.
Systemically Important Clearing Agencies
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. SEC staff participates in the interagency committee established
by FSOC to develop a framework for the designation of systemically
important FMUs. In July 2012, FSOC designated six clearing agencies
registered with the Commission as systemically important FMUs under
Title VIII. \47\
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\47\ 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.
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Title VIII also provides a framework for an enhanced supervisory
regime for designated FMUs, including oversight in consultation with
the Board and FSOC. The Commission is expected to consider regulations
containing risk management standards for the designated FMUs it
supervises, taking into consideration relevant international standards
and existing prudential requirements for such FMUs. \48\ The Commission
also is required to examine such FMUs annually, and to consider certain
advance notices identifying changes to its rules, procedures, or
operations that could materially affect the nature or level of risks
presented by the FMU in consultation with the Board. \49\
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\48\ See Section 805(a)(2) of the Dodd-Frank Act. Commission staff
also worked jointly with the staffs of the CFTC and the Board to submit
a report required under the Dodd-Frank Act to Congress in July 2011
discussing recommendations regarding risk management supervision of
clearing entities that are DFMUs. See also ``Risk Management
Supervision of Designated Clearing Entities'', Report by the
Commission, Board and CFTC to the Senate Committees on Banking,
Housing, and Urban Affairs and Agriculture pursuant to Section 813 of
Title VIII of the Dodd-Frank Act (July 2011), http://www.sec.gov/news/
studies/2011/813study.pdf.
\49\ See Section 806(e)(4) of the Dodd-Frank Act.
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In June 2012, the Commission adopted rules that establish
procedures for how it will address advance notices of significant rule
filings from the FMUs, \50\ and it has since considered a significant
number of such notices. \51\ Commission staff also has completed the
second series of annual examinations of the designated FMUs for which
it acts as supervisory agency and recently initiated the third series
of annual examinations.
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\50\ 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.
\51\ Advance notices are published on the Commission Web site at
http://www.sec.gov/rules/sro.shtml.
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Volcker Rule
On December 10, 2013, the Commission joined the Board, the Federal
Deposit Insurance Corporation (FDIC), the Office of the Comptroller of
the Currency (OCC) (collectively, the ``Federal banking agencies''),
and the CFTC in adopting the same rule under the Bank Holding Company
Act to implement Section 619 of the Dodd-Frank Act, known as the
``Volcker Rule''. \52\
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\52\ See Release No. BHCA-1, ``Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships With,
Hedge Funds and Private Equity Funds'' (December 10, 2013), http://
www.sec.gov/rules/final/2013/bhca-1.pdf. The CFTC (CFTC) adopted the
same rule on the same date. See http://www.cftc.gov/ucm/groups/public/
@newsroom/documents/file/federalregister121013.pdf. On January 14,
2014, the Commission, together with the Federal banking agencies and
the CFTC, approved a companion interim final rule that permits banking
entities to retain interests in certain collateralized debt obligations
backed primarily by trust preferred securities. See Release No. BHCA-2,
``Treatment of Certain Collateralized Debt Obligations Backed Primarily
by Trust Preferred Securities With Regard to Prohibitions and
Restrictions on Certain Interests in, and Relationships With, Hedge
Funds and Private Equity Funds'' (January 17, 2014), http://
www.sec.gov/rules/interim/2014/bhca-2.pdf.
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Consistent with Section 619, the final rule generally restricts
``banking entities''--including bank-affiliated, SEC-registered broker-
dealers, security-based swap dealers, and investment advisers--from
engaging in proprietary trading, sponsoring hedge funds and private
equity funds, or investing in such funds.
As with any regulatory initiative of this scope and complexity, the
final rule demands close attention to the nature and pace of
implementation, particularly with respect to smaller banking entities.
The Dodd-Frank Act provides a period for banking entities to bring
their activities and investments into conformance with Section 619 that
is scheduled to end on July 21, 2015. During the conformance period,
the largest trading firms must begin to record and report certain
quantitative measurements. The first of these data submissions were
received on September 2. Staged implementation of metrics reporting and
enhanced compliance standards will continue after the end of the
conformance period based on size and activity thresholds. Among other
benefits, this incremental approach will allow the agencies to review
the data collection and revise or tailor its application, as
appropriate.
Currently, the regulatory agencies and banking entities are closely
focused on implementation of the final rule. The collaborative
relationships among the agencies that developed during the rulemaking
process are carrying forward and are supporting closely coordinated
staff guidance and action. The interagency working group meets
regularly to discuss implementation issues including, among other
things, coordinated responses to interpretive questions, technical
issues related to the collection of metrics data, and approaches to
supervising and examining banking entities. In response to banking
entities' interpretive questions on the final rule, the staffs of the
agencies have published coordinated responses to frequently asked
questions on various aspects of the rule. As banking entities seek to
comply with the final rule and request additional guidance, I expect
the interagency group to continue working together in this manner, as
well as in the coordination of examinations for compliance with the
final rule.
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
shareholder advisory say-on-pay, say-on-frequency and ``golden
parachute'' votes on executive compensation. \53\ The
Commission also proposed rules to implement the Section 951
requirement that institutional investment managers report their
votes on these matters at least annually. \54\ Staff is working
on draft final rules for this remaining part of Section 951 for
the Commission's consideration in the near term.
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\53\ 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.
\54\ 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, by rule, to 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. \55\ To conform their
rules to the new requirements, national securities exchanges
that have rules providing for the listing of equity securities
filed proposed rule changes with the Commission. \56\ The
Commission issued final orders approving the proposed rule
changes in January 2013. \57\
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\55\ See Release No. 33-9330, ``Listing Standards for Compensation
Committees'' (June 20, 2012), http://www.sec.gov/rules/final/2012/33-
9330.pdf.
\56\ 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).
\57\ 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).
Pay Ratio Disclosure. As required by Section 953(b) of the
Act, in September 2013, the Commission proposed rules that
would amend existing executive compensation rules to require
public companies to disclose the ratio of the compensation of a
company's chief executive officer to the median compensation of
its employees. \58\ The Commission has received over 128,000
comment letters on the proposal, including more than 1,000
unique comment letters. The staff is carefully considering
those comments and is preparing recommendations for the
Commission for a final rule.
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\58\ See Release No. 33-9452, ``Pay Ratio Disclosure'' (September
18, 2013), http://www.sec.gov/rules/proposed/2013/33-9452.pdf.
Incentive-Based Compensation Arrangements. Section 956 of
the Dodd-Frank Act requires the Commission, along with multiple
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. \59\ The Commission has
received a significant number of comment letters on the
proposed rule, and I have asked the Commission staff to work
with their fellow regulators to develop a recommendation to
finalize rules to implement this provision.
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\59\ See Release No. 34-64140, ``Incentive-Based Compensation
Arrangements'', (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, and these rules are all
now effective. \60\
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\60\ See Release No. 34-64140, ``Incentive-Based Compensation
Arrangements'', (March 29, 2011), http://www.sec.gov/rules/proposed/
2011/34-64140.pdf.
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 ``clawback'' policies, \61\ and new disclosure
requirements about executive compensation and company performance, \62\
and employee and director hedging. \63\ The staff currently is
developing recommendations for the Commission concerning the
implementation of these provisions of the Act, which I expect to be
taken up by the Commission in the near future.
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\61\ See Section 954 of the Dodd-Frank Act.
\62\ See Section 953(a) of the Dodd-Frank Act.
\63\ See Section 955 of the Dodd-Frank Act.
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Broker-Dealer Audit Requirements
The Dodd-Frank Act provided the Public Company Accounting Oversight
Board (PCAOB) with explicit authority, among other things, to
establish, subject to Commission approval, auditing standards for
broker-dealer audits filed with the Commission. In August 2013, the
Commission amended the broker-dealer financial reporting rule to
require that broker-dealer audits be conducted in accordance with PCAOB
standards and to more broadly provide additional safeguards with
respect to broker-dealer custody of customer securities and funds. \64\
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\64\ See Release No. 43-0073, ``Broker-Dealer Reports'' (August
21, 2013), http://www.gpo.gov/fdsys/pkg/FR-2013-08-21/pdf/2013-
18738.pdf.
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Whistleblower Program
Pursuant to Section 922 of the Dodd-Frank Act, the SEC established
a whistleblower program to pay awards to eligible whistleblowers who
voluntarily provide the agency with original information about a
violation of the Federal securities laws that leads to a successful SEC
enforcement action in which over $1 million in sanctions is ordered. As
detailed in the SEC's Office of the Whistleblower third annual report
to Congress, \65\ during FY2013 the Commission received 3,238 tips from
whistleblowers in the United States and 55 other countries. The high
quality information we have received from whistleblowers has allowed
our investigative staff to work more efficiently and better utilize
agency resources. Last fall, the Commission made its largest
whistleblower award to date, awarding over $14 million to a
whistleblower whose information led to an SEC enforcement action that
recovered substantial investor funds, \66\ and this July we awarded
more than $400,000 to a whistleblower who reported a fraud to the SEC
after the company failed to address the issue internally. \67\ We
expect future awards to further increase the visibility and
effectiveness of this important enforcement initiative.
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\65\ Annual Report on the Dodd-Frank Whistleblower Program Fiscal
Year 2013 (November 2013), http://www.sec.gov/about/offices/owb/annual-
report-2013.pdf.
\66\ See ``In the Matter of Claim for Award'', SEC Release No. 34-
70554 (September 30, 2013), http://www.sec.gov/rules/other/2013/34-
70554.pdf, and ``SEC Awards More Than $14 Million to Whistleblower'',
SEC Release No. 2013-209 (October 1, 2013), http://www.sec.gov/News/
PressRelease/Detail/PressRelease/1370539854258.
\67\ See ``In the Matter of Claim for Award'', SEC Release No. 34-
72727 (July 31, 2014), http://www.sec.gov/rules/other/2014/34-
72727.pdf, and ``SEC Announces Award for Whistleblower Who Reported
Fraud to SEC After Company Failed To Address Issue Internally'', SEC
Release No. 2014-154 (July 31, 2014), http://www.sec.gov/News/
PressRelease/Detail/PressRelease/1370542578457.
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In addition, the Dodd-Frank Act expanded whistleblower protections
by empowering the Commission to bring enforcement actions against
employers that retaliate against whistleblowers. Earlier this year, we
exercised this authority for the first time when we penalized a firm
and its principal for retaliating against a whistleblower who reported
potential securities violations to the SEC. \68\
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\68\ See ``SEC Charges Hedge Fund With Conducting Conflicted
Transactions and Retaliating Against Whistleblower'', SEC Release No.
2014-118 (June 16, 2014), http://www.sec.gov/News/PressRelease/Detail/
PressRelease/1370542096307.
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Investment Advisers and Broker-Dealers' Standards of Conduct
Section 913 of the Dodd-Frank Act granted the Commission broad
authority to impose a uniform standard of conduct for broker-dealers
and investment advisers when providing personalized investment advice
about securities to retail customers. The question of whether and, if
so, how to use this authority is very important to investors and the
Commission.
In January 2011, the Commission submitted to Congress a staff study
required by Section 913 (the ``IA/BD Study''), which addressed the
obligations of investment advisers and broker-dealers when providing
personalized investment advice about securities to retail customers,
and recommended, among other things, that the Commission exercise the
discretionary rulemaking authority provided by Section 913. \69\ In
March 2013, the Commission issued a public Request for Data and Other
Information (Request) relating to the provision of retail investment
advice and regulatory alternatives, which sought data to assist the
Commission in determining whether to engage in rulemaking, and if so,
what the nature of that rulemaking ought to be. \70\
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\69\ 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.
\70\ See ``Request for Data and Other Information: Duties of
Brokers, Dealers, and Investment Advisers'' (March 1, 2013), http://
www.sec.gov/rules/other/2013/34-69013.pdf.
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In order to more fully inform the Commission's decision on this
matter, I directed the staff to evaluate all of the potential options
available to the Commission, including a uniform fiduciary standard for
broker-dealers and investment advisers when providing personalized
investment advice to retail customers. As part of its evaluation, the
staff has been giving serious consideration to, among other things, the
IA/BD Study's recommendations, the views of investors and other
interested market participants, potential economic and market impacts,
and the information we received in response to the Request. I have
asked the staff to make its evaluation of options a high priority.
In addition to considering the potential options available to the
Commission, Commission staff continues to provide regulatory expertise
to Department of Labor staff as they consider potential changes to the
definition of ``fiduciary'' under the Employee Retirement Income
Security Act (ERISA). The staff and I are committed to continuing these
conversations with the Department of Labor, both to provide technical
assistance and information with respect to the Commission's regulatory
approach and to discuss the practical effect on retail investors, and
investor choice, of their potential amendments to the definition of
``fiduciary'' for purposes of ERISA.
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.
In December 2011, the Commission adopted final rules for the mine
safety provision. \71\ In August 2012, the Commission adopted final
rules for the disclosures relating to conflict minerals and payments by
resource extraction issuers. \72\
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\71\ See Release No. 33-9286, ``Mine Safety Disclosure'' (December
21, 2011), http://www.sec.gov/rules/final/2011/33-9286.pdf.
\72\ 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.
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A lawsuit was filed challenging the resource extraction issuer
rules, and in July 2013, the U.S. District Court for the District of
Columbia vacated the rules. \73\ Since the court's decision, members of
the Commission and the staff have met with interested parties and are
considering comments submitted by stakeholders in order to formulate a
recommendation for revised rules for the Commission's consideration.
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\73\ See ``American Petroleum Institute, et al. v. Securities and
Exchange Commission and Oxfam America Inc.'', No. 12-1668 (D.D.C. July
2, 2013).
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A lawsuit (NAM vs. SEC) also was filed challenging the conflict
minerals rule, and in April 2014, the U.S. Court of Appeals for the
D.C. Circuit upheld the rule against all challenges made under the
Administrative Procedure Act and the Exchange Act, but held that a
portion of the rule violated the First Amendment. \74\ Following the
Court of Appeals decision in NAM, Commission staff issued a statement
on April 29, 2014, that provides detailed guidance regarding compliance
with those portions of the rule that were upheld, pending any further
action by the Commission or the courts. On May 2, 2014, the Commission
ordered a stay of the effective date for compliance with those portions
of Rule 13p-1 and Form SD subject to the constitutional holding of the
Court of Appeals. On May 29, 2014, the Commission filed a petition
asking the Court of Appeals to hold the case for potential panel
rehearing or rehearing en banc once the Court of Appeals issued a
decision in another First Amendment case then pending before the en
banc Court (American Meat Institute v. USDA). The intervenor in the NAM
case, Amnesty International, also filed a petition for rehearing or
rehearing en banc of the First Amendment portion of the panel opinion.
The Court issued its en banc decision in American Meat Institute on
July 29, 2014. On August 28, 2014, the Court ordered the appellants to
file a response to both the SEC's and Amnesty International's petitions
for rehearing en banc in NAM by September 12, 2014.
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\74\ See ``National Association of Manufacturers, et al. v.
Securities and Exchange Commission, et al.'', No. 13-5252 (D.C. Cir.
April 14, 2014).
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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. \75\ The staff also
currently is conducting a review of the accredited investor definition,
as mandated by Section 413(b)(2)(A) of the Act.
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\75\ 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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In July 2013, the Commission implemented Section 926 of the Act by
adopting final 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. \76\
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\76\ See Release No. 33-9214, ``Disqualification of Felons and
Other `Bad Actors' from Rule 506 Offerings'' (July 10, 2013), http://
www.sec.gov/rules/final/2013/33-9414.pdf.
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Office of Minority and Women Inclusion
In July 2011, pursuant to Section 342 of the Dodd Frank Act, the
SEC formally established its Office of Minority and Women Inclusion
(OMWI). OMWI is responsible for matters related to diversity in
management, employment, and business activities at the SEC. This
includes developing standards for equal employment opportunity and
diversity of the workforce and senior management of the SEC, the
increased participation of minority-owned and women-owned businesses in
the SEC's programs and contracts, and assessing the diversity policies
and practices of entities regulated by the SEC.
To improve diversity in our workforce and in SEC contracts, OMWI
has deployed an outreach strategy where the SEC participates in
minority- and women-focused career fairs, conferences, and business
matchmaking events to attract diverse suppliers and job seekers to the
SEC. As a result of its outreach efforts, as of FY2014 Q3, 31.9 percent
of the total contract dollars awarded by the SEC were awarded to
minority and women contractors, up from 28.7 percent awarded in FY2013.
As of FY2014 Q3, 35.8 percent of new hires were minorities and 40.7
percent were women, up from 33.5 percent minorities and 40.3 percent
women hired in FY2013. OMWI and the Commission are committed to
continuing to work proactively to increase the participation of
minority-owned and women-owned businesses in our programs and
contracting opportunities and to encourage diversity and inclusion in
our workforce.
OMWI also continues to make progress on the development of
standards and policies relating to regulated entities and contracting.
On October 23, 2013, pursuant to Section 342(b)(2)(C) of the Act, the
SEC, along with the OCC, the Board, the FDIC, the National Credit Union
Administration, and the Consumer Financial Protection Bureau, issued an
interagency policy statement proposing joint standards for assessing
the diversity policies and practices of the entities they regulate.
\77\ The standards are intended to promote transparency and awareness
of diversity policies and practices within federally regulated
financial institutions. The public comment period for the policy
statement ended on February 7, 2014, \78\ and after careful review and
consideration of the more than 200 comment letters received, the OMWI
Directors are currently drafting the final interagency policy
statement. I anticipate that the final interagency policy statement
will be circulated within the agencies for review and formal approval
over the next few months.
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\77\ See Release No. 34-70731, ``Proposed Interagency Policy
Statement Proposing Joint Standards for Assessing the Diversity
Policies and Practices of the Entities Regulated by the Agencies and
Request for Comment'' (October 23, 2013) https://www.sec.gov/rules/
policy/2013/34-70731.pdf.
\78\ See ``Public Comment on the Proposed Interagency Policy
Statement Establishing Joint Standards for Assessing the Diversity
Policies of Practices of Entities Regulated by the Agencies'',
(December 19, 2013) https://www.sec.gov/rules/policy/2013/comments-
joint-standards-diversity.shtml.
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Customer Data Protection--Identity Theft Red Flags and Financial
Privacy Rules
In April 2013, to implement Section 1088 of the Dodd-Frank Act, the
SEC and the CFTC jointly adopted Regulation S-ID. \79\ Regulation S-ID
requires certain regulated financial institutions such as broker-
dealers and registered investment advisers to adopt and implement
identity theft programs. Specifically, the regulation requires covered
firms to implement policies and procedures designed to:
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\79\ See Release No. 34-69359, ``Identity Theft Red Flags Rules''
(April 10, 2013), https://www.sec.gov/rules/final/2013/34-69359.pdf.
See also 17 CFR Part 248, Subpart C.
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identify relevant types of identity theft red flags;
detect the occurrence of those red flags;
respond appropriately to the detected red flags; and
periodically update the identity theft program.
Regulation S-ID's requirements complement the SEC's other rules for
protecting customer data. \80\
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\80\ Regulation S-P requires broker-dealers, investment companies,
and registered investment advisers to adopt and implement written
policies and procedures to safeguard customer records and information.
See Release 34-42974, ``Privacy of Consumer Financial Information''
(Regulation S-P) (June 22, 2000), https://www.sec.gov/rules/final/34-
42974.htm. See also 17 CFR Part 248, Subpart A.
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SEC Resources
The SEC collects transaction fees that offset the annual
appropriation to the SEC. Accordingly, regardless of the amount
appropriated to the SEC, our funding level will not take resources from
other agencies, nor will it have an impact on the Nation's budget
deficit. Yet, since FY2012, the SEC has not received a significant
increase in resources to permit the agency to bring on the additional
staff needed to adequately carry out our mission.
Our budgetary needs have, of course, been increased by the
responsibilities added by the Dodd-Frank and JOBS Acts, but our
significant budgetary gap and needs would remain had those extensive
additional responsibilities not been added. There is an immediate and
pressing need for significant additional resources to permit the SEC to
increase its examination coverage of registered investment advisers so
as to better protect investors and our markets. While the SEC makes
increasingly effective and efficient use of its limited resources, we
nevertheless were in a position to only examine 9 percent of registered
investment advisers in fiscal year 2013. In 2004, the SEC had 19
examiners per trillion dollars in investment adviser assets under
management. Today, we have only eight. Additional resources are vital
to increase exam coverage over investment advisers and other key areas,
and also to bolster our core investigative, litigation, and analytical
enforcement functions. It is also a high priority for us to continue
the agency's investments in the technologies needed to keep pace with
today's high-tech, high-speed markets.
With respect to our new responsibilities, we need additional staff
experts to focus on enforcement, examinations, and regulatory
oversight. We must strengthen our ability to take in, organize, and
analyze data on the new markets and entities under the agency's
jurisdiction. The new responsibilities cannot be handled appropriately
with the agency's existing resource levels without undermining the
agency's other core duties, particularly as we turn from rule writing
to implementation and enforcement of those rules.
Also critical will be the SEC's continued use of the Reserve Fund,
established under the Dodd-Frank Act. The SEC dedicated the Reserve
Fund to critical IT upgrades, and, if funding permits, plans to
continue investing in areas such as data analysis, EDGAR and sec.gov
modernization, enforcement and examinations support, and business
process improvements.
If the SEC does not receive sufficient additional resources, the
agency will be unable to fully build out its technology and hire the
industry experts and other staff needed to oversee and police our areas
of responsibility, especially in light of the expanding size and
complexity of our overall regulatory space. Our Nation's markets are
the safest and most dynamic in the world, but without sufficient
resources, it will become increasingly difficult for our talented
professionals to detect, pursue, and prosecute violations of our
securities laws as the size, speed, and complexity of the markets grow
around us.
Conclusion
The Commission has made tremendous progress implementing the
extensive rulemakings and other initiatives mandated by the Dodd-Frank
Act to strengthen regulation and our financial system. As the
Commission strives to complete the remaining work, I look forward to
working with this Committee and others in the financial marketplace to
adopt rules that protect investors, maintain fair, orderly and
efficient markets, and facilitate capital formation--as we also
undertake the necessary measures to enhance financial stability and
limit potential systemic risks. Thank you for your support of the SEC's
mission and for inviting me to share our progress with you. I look
forward to answering your questions.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF TIMOTHY G. MASSAD
Chair, Commodity Futures Trading Commission
September 9, 2014
Thank you Chairman Johnson, Ranking Member Crapo, and Members of
the Committee. I am pleased to testify before you today on behalf of
the Commission. This is my first official hearing as Chairman of the
CFTC. It is truly an honor to serve as Chairman at this important time.
I met and spoke with several Members of this Committee during the
confirmation process, and I appreciated hearing your thoughts and
suggestions during that time. I look forward to this Committee's input
going forward.
During the last 5 years, we have made substantial progress in
recovering from the worst financial crisis since the Great Depression.
The Dodd-Frank Act was a comprehensive response, and much has been
accomplished in implementing it. The CFTC has largely completed the
rulemaking stage of Dodd-Frank implementation. However, much work
remains to finish the job Congress has given us.
I look forward to working together with you, as well as my
colleagues at the CFTC and others around the globe to ensure that our
futures, swaps and options markets remain the most efficient and
competitive in the world, and to protect the integrity of the markets.
The Significance of Derivatives Market Oversight
Very few Americans participate directly in the derivatives markets.
Yet these markets profoundly affect the prices we all pay for food,
energy, and most other goods and services we buy each day. They enable
farmers to lock in a price for their crops, utility companies or
airlines to hedge the costs of fuel, and auto companies or soda
bottlers to know what aluminum will cost. They enable exporters to
manage fluctuations in foreign currencies, and businesses of all types
to lock in their borrowing costs. In the simplest terms, derivatives
enable market participants to manage risk.
In normal times, these markets create substantial, but largely
unseen, benefits for American families. During the financial crisis,
however, they created just the opposite. It was during the financial
crisis that many Americans first heard the word derivatives. That was
because over-the-counter swaps--a large, unregulated part of these
otherwise strong markets--accelerated and intensified the crisis like
gasoline poured on a fire. The Government was then required to take
actions that today still stagger the imagination: for example, largely
because of excessive swap risk, the Government committed $182 billion
to prevent the collapse of a single company--AIG--because its failure
at that time, in those circumstances, could have caused our economy to
fall into another Great Depression.
It is hard for most Americans to fathom how this could have
happened. While derivatives were just one of many things that caused or
contributed to the crisis, the structure of some of these products
created significant risk in an economic downturn. In addition, the
extensive, bilateral transactions between our largest banks and other
institutions meant that trouble at one institution could cascade
quickly through the financial system like a waterfall. And, the opaque
nature of this market meant that regulators did not know what was going
on or who was at risk.
Responding to the Crisis--Enactment and Implementation of the Dodd-
Frank Act
The lessons of this tragedy were not lost on the leaders of the
United States and the G20 Nations. They committed to bring the over-
the-counter swaps market out of the shadows. They agreed to do four
basic things: require regulatory oversight of the major market players;
require clearing of standardized transactions through regulated
clearinghouses known as central counterparties or CCPs; require more
transparent trading of standardized transactions; and require regular
reporting so that we have an accurate picture of what is going on in
this market.
In the United States, these commitments were set forth in Title VII
of the Dodd-Frank Act. Responsibility for implementing these
commitments was given primarily to the CFTC. I would like to review
where we stand in implementing the regulatory framework passed by
Congress to bring the over-the-counter swaps market out of the shadows.
Oversight
The first of the major directives Congress gave to the CFTC was to
create a framework for the registration and regulation of swap dealers
and major swap participants. The agency has done so. As of August 2014,
there are 104 swap dealers and two major swap participants
provisionally registered with the CFTC.
We have adopted rules requiring strong risk management. We will
also be making periodic examinations to assess risk and compliance. The
new framework requires registered swap dealers and major swap
participants to comply with various business conduct requirements.
These include strong standards for documentation and confirmation
of transactions, as well as dispute resolution processes. They include
requirements to reduce risk of multiple transactions through what is
known as portfolio reconciliation and portfolio compression. In
addition, swap dealers are required to make sure their counterparties
are eligible to enter into swaps, and to make appropriate disclosures
to those counterparties of risks and conflicts of interest.
As directed by Congress, we have worked with the SEC, other U.S.
regulators, and our international counterparts to establish this
framework. We will continue to work with them to achieve as much
consistency as possible. We will also look to make sure these rules
work to achieve their objectives, and fine-tune them as needed where
they do not.
Clearing
A second commitment of Dodd-Frank was to require clearing of
standardized transactions at central counterparties. The use of CCPs in
financial markets is commonplace and has been around for over 100
years. The idea is simple: if many participants are trading
standardized products on a regular basis, the tangled, hidden Web
created by thousands of private two-way trades can be replaced with a
more transparent and orderly structure, like the spokes of a wheel,
with the CCP at the center interacting with other market participants.
The CCP monitors the overall risk and positions of each participant.
Clearing does not eliminate the risk that a counterparty to a trade
will default, but it provides us various means to mitigate that risk.
As the value of positions change, margin can be collected efficiently
to ensure counterparties are able to fulfill their obligations to each
other. And if a counterparty does default, there are tools available to
transfer or unwind positions and protect other market participants. To
work well, active, ongoing oversight is critical. We must be vigilant
to ensure that CCPs are operated safely and deliver the benefits they
are designed to provide.
The CFTC was the first of the G20 Nations' regulators to implement
clearing mandates. We have required clearing for interest rate swaps
(IRS) denominated in U.S. dollars, Euros, Pounds and Yen, as well as
credit default swaps (CDS) on certain North American and European
indices. Based on CFTC analysis of data reported to swap data
repositories, as of August 2014, measured by notional value, 60 percent
of all outstanding transactions were cleared. This is compared to
estimates by the International Swaps and Derivatives Association (ISDA)
of only 16 percent in December 2007. With regard to index CDS, most new
transactions are being cleared--85 percent of notional value during the
month of August.
Our rules for clearing swaps were patterned after the successful
regulatory framework we have had in place for many years in the futures
market. We do not require that clearing take place in the United
States, even if the swap is in U.S. dollars and between U.S. persons.
But we do require that clearing occurs through registered CCPs that
meet certain standards--a comprehensive set of core principles that
ensures each clearinghouse is appropriately managing the risk of its
members, and monitoring its members for compliance with important
rules.
Fourteen CCPs are registered with the CFTC as derivatives clearing
organizations (DCOs) either for swaps, futures, or both. Five of those
are organized outside of the United States, including three in Europe
which have been registered since 2001 (LCH.Clearnet Ltd.); 2010 (ICE
Clear Europe Ltd); and 2013 (LCH.Clearnet SA). In some cases, a
majority of the trades cleared on these European-based DCOs are for
U.S. persons.
At the same time, the CFTC has specifically exempted most
commercial end users from the clearing mandate. We have been sensitive
to Congress's directive that these entities, which were not responsible
for the crisis and rely on derivatives primarily to hedge commercial
risks, should not bear undue burdens in accessing these markets to
hedge their risk.
Of course, central clearing by itself is not a panacea. CCPs do not
eliminate the risks inherent in the swaps market. We must therefore be
vigilant. We must do all we can to ensure that CCPs have financial
resources, risk management systems, settlement procedures, and all the
necessary standards and safeguards consistent with the core principles
to operate in a fair, transparent and efficient manner. We must also
make sure that CCP contingency planning is sufficient.
Trading
The third area for reform under Dodd-Frank was to require more
transparent trading of standardized products. In the Dodd-Frank Act,
Congress provided that certain swaps must be traded on a swap execution
facility (SEF) or another regulated exchange. The Dodd Frank Act
defined a SEF as ``a trading system or platform in which multiple
participants have the ability to execute or trade swaps by accepting
bids and offers made by multiple participants.'' The trading
requirement was designed to facilitate a more open, transparent and
competitive marketplace, benefiting commercial end users seeking to
lock in a price or hedge risk.
The CFTC finalized its rules for SEFs in June 2013. Twenty-two SEFs
have temporarily registered with the CFTC, and two applications are
pending. These SEFs are diverse, but each will be required to operate
in accordance with the same core principles. These core principles
provide a framework that includes obligations to establish and enforce
rules, as well as policies and procedures that enable transparent and
efficient trading. SEFs must make trading information publicly
available, put into place system safeguards, and maintain financial,
operational, and managerial resources to discharge their
responsibilities.
Trading on SEFs began in October of last year. Beginning February
2014, specified interest rate swaps and credit default swaps must be
traded on a SEF or another regulated exchange. Notional value executed
on SEFs has generally been in excess of $1.5 trillion weekly.
It is important to remember that trading of swaps on SEFs is still
in its infancy. SEFs are still developing best practices under the new
regulatory regime. The new technologies that SEF trading requires are
likewise being refined. Additionally, other jurisdictions have not yet
implemented trading mandates, which has slowed the development of
cross-border platforms. There will be issues as SEF trading continues
to mature. We will need to work through these to achieve fully the
goals of efficiency and transparency SEFs are meant to provide.
Data Reporting
The fourth Dodd-Frank reform commitment was to require ongoing
reporting of swap activity. Having rules that require oversight,
clearing, and transparent trading is not enough. We must have an
accurate, ongoing picture of what is going on in the marketplace to
achieve greater transparency and to address potential systemic risk.
Title VII of the Dodd-Frank Act assigns the responsibility for
collecting and maintaining swap data to swap data repositories (SDRs),
a new type of entity necessitated by these reforms. All swaps, whether
cleared or uncleared, must be reported to SDRs. There are currently
four SDRs that are provisionally registered with the CFTC.
The collection and public dissemination of swap data by SDRs helps
regulators and the public. It provides regulators with information that
can facilitate informed oversight and surveillance of the market and
implementation of our statutory responsibilities. Dissemination,
especially in real-time, also provides the public with information that
can contribute to price discovery and market efficiency.
While we have accomplished a lot, much work remains. The task of
collecting and analyzing data concerning this marketplace requires
intensely collaborative and technical work by industry and the agency's
staff. Going forward, it must continue to be one of our chief
priorities.
There are three general areas of activity. We must have data
reporting rules and standards that are specific and clear, and that are
harmonized as much as possible across jurisdictions. The CFTC is
leading the international effort in this area. It is an enormous task
that will take time. We must also make sure the SDRs collect, maintain,
and publicly disseminate data in the manner that supports effective
market oversight and transparency. Finally, market participants must
live up to their reporting obligations. Ultimately, they bear the
responsibility to make sure that the data is accurate and reported
promptly.
Our Agenda Going Forward
The progress I have outlined reflects the fact that the CFTC has
finished almost all of the rules required by Congress in the Dodd-Frank
Act to regulate the over-the-counter swaps market. This was a difficult
task, and required tremendous effort and commitment. My predecessor,
Gary Gensler, deserves substantial credit for leading the agency in
implementing these reforms so quickly. All of the Commissioners
contributed valuable insight and deserve our thanks. But no group
deserves more credit than the hardworking professional staff of the
agency. It was an extraordinary effort. I want to publicly acknowledge
and thank them for their contributions.
The next phase requires no less effort. I want to highlight several
areas going forward that are critical to realizing the benefits
Congress had in mind when it adopted this new framework and to
minimizing any unintended consequences.
Finishing and Fine-Tuning Dodd-Frank Regulations
First, as markets develop and we gain experience with the new Dodd-
Frank regulations, I anticipate we will, from time to time, make some
adjustments and changes. This is to be expected in the case of a reform
effort as significant as this one. These are markets that grew to be
global in nature without any regulation, and the effort to bring them
out of the shadows is a substantial change. It is particularly
difficult to anticipate with certainty how market participants will
respond and how markets will evolve. At this juncture, I do not believe
wholesale changes are needed, but some clarifications and improvements
are likely to be considered.
In fine-tuning existing rules, and in finishing the remaining rules
that Congress has required us to implement, we must make sure that
commercial businesses like farmers, ranchers, manufacturers, and other
companies can continue to use these markets effectively. Congress
rightly recognized that these entities stand in a different position
compared to financial firms. We must make sure the new rules do not
cause inappropriate burdens or unintended consequences for them. We
hope to act on a new proposed rule for margin for uncleared swaps in
the near future. On position limits, we have asked for and received
substantial public comment, including through roundtables and face-to-
face meetings. This input has been very helpful enabling us to
calibrate the rules to achieve the goals of reducing risk and improving
the market without imposing unnecessary burdens or causing unintended
consequences.
Cross-Border Regulation of the Swaps Market
A second key area is working with our international counterparts to
build a strong global regulatory framework. To succeed in accomplishing
the goals set out in the G20 commitments and embodied in the Dodd-Frank
Act, global regulators must work together to harmonize their rules and
supervision to the greatest extent possible. Fundamentally, this is
because the markets that the CFTC is charged to regulate are truly
global. What happens in New York, Chicago, or Kansas City is
inextricably interconnected with events in London, Hong Kong and Tokyo.
The lessons of the financial crisis remind us how easy it is for risks
embedded in overseas derivatives transactions to flow back into the
United States. And Congress directed us to address the fact that
activities abroad can result in importation of risk into the United
States.
This is a challenging task. Although the G20 Nations have agreed on
basic principles for regulating over-the-counter derivatives, there can
be many differences in the details. While many sectors of the financial
industry are global in nature, applicable laws and rules typically are
not. For example, no one would expect that the laws which govern the
selling of securities, or the securing of bank loans, should be exactly
the same in all the G20 Nations. While our goal should be
harmonization, we must remember that regulation occurs through
individual jurisdictions, each informed by its own legal traditions and
regulatory philosophies.
Our challenge is to achieve as consistent a framework as possible
while not lowering our standards simply to reach agreement, thus
triggering a ``race to the bottom.'' We must also minimize
opportunities for regulatory arbitrage, where business moves to locales
where the rules are weaker or not yet in place.
The CFTC's adoption of regulations for systemically important CCPs
is a useful model for success. Our rules were designed to meet the
international standards for the risk management of systemically
important CCPs, as evidenced by the Principles for Financial Market
Infrastructures (PFMIs) published by the Bank of International
Settlement's Committee on Payment and Settlement Systems and the
Technical Committee of the International Organization of Securities
Commissions, to which the Commission was a key contributor.
Since the day I joined the CFTC, I have been focused on cross-
border issues. In my first month in office I went to Europe twice to
meet with my fellow regulators, and I have been engaged in ongoing
dialogue with them.
Robust Compliance and Enforcement
A third major area is having robust compliance and enforcement
activities. It is not enough to have rules on the books. We must be
sure that market participants comply with the rules and fulfill their
obligations. That is why, for example, several weeks ago we fined a
large swap dealer for failing to abide by our data reporting rules.
A strong compliance and enforcement function is vital to
maintaining public confidence in our markets. This is critical to the
participation of the many Americans who depend on the futures and swaps
markets--whether they are farmers, oil producers or exporters. And even
though most Americans do not participate directly in the futures and
swaps markets, our enforcement efforts can help rebuild and maintain
public confidence and trust in our financial markets.
We must aggressively pursue wrongdoers, big or small, and
vigorously fulfill our responsibility to enforce the regulations
governing these markets. Our pursuit of those who have manipulated
benchmarks like LIBOR, a key global benchmark underlying a wide variety
of financial products and transactions, is a prime example of this
principle in practice. So is our successful litigation against Parnon
Energy and Arcadia, two energy companies that systematically
manipulated crude oil markets to realize illicit profits.
Dodd-Frank provided the Commission with a number of new statutory
tools to ensure the integrity of our markets, and we have moved
aggressively to incorporate these tools into our enforcement efforts.
Our new antimanipulation authority gives us enhanced ability to go
after fraud-based manipulation of our markets. We have put that
authority to good use in a host of cases and investigations, including
actions against Hunter Wise and a number of smaller firms for
perpetrating precious metals scams. Congress also gave us new authority
to attack specific practices that unscrupulous market participants use
to distort the markets, such as ``spoofing,'' where a party enters a
bid or offer with the intent to move the market price, but not to
consummate a transaction. We used this new antispoofing provision to
successfully prosecute Panther Energy for its spoofing practices in our
energy markets.
Going forward, protecting market integrity will continue to be one
of our key priorities. Market participants should understand that we
will use all the tools at our disposal to do so.
Information Technology and Data Management
It is also vital that the CFTC have up to date information
technology systems. Handling massive amounts of swaps data and
effective market oversight both depend on the agency having up-to-date
technology resources, and the staff--including analysts and economists,
as well as IT and data management professionals--to make use of them.
The financial markets today are driven by sophisticated use of
technology, and the CFTC cannot effectively oversee these markets
unless it can keep up.
Cybersecurity is a related area where we must remain vigilant. As
required by Congress, we have implemented new requirements related to
exchanges' cybersecurity and system safeguard programs. The CFTC
conducts periodic examinations that include review of cybersecurity
programs put in place by key market participants, and there is much
more we would like to do in this area. Going forward, the Commission's
examination expertise will need to be expanded to keep up with emerging
risks in information security, especially in the area of cybersecurity.
Resources and Budget
All of these tasks represent the significant increases in
responsibility that came with Dodd Frank. They require resources. But
the CFTC does not have the resources to fulfill these tasks as well as
all the responsibilities it had--and still has--prior to the passage of
Dodd Frank. The CFTC is lucky to have a dedicated and resourceful
professional staff. Although I have been at the agency a relatively
short time, I am already impressed by how much this small group is able
to accomplish. Still, as good as they are, the reality of our current
budget is evident.
I recognize that there are many important priorities that Congress
must consider in the budgeting process. I appreciate the importance of
being as efficient as possible. I have also encouraged our staff to be
creative in thinking about how we can best use our limited resources to
accomplish our responsibilities. We will keep the Teddy Roosevelt adage
in mind, that we will do what we can, with what we have, where we are.
But I hope to work with members of Congress to address our budget
constraints. Our current financial resources limit our ability to
fulfill our responsibilities in a way that most Americans would expect.
The simple fact is that Congress's mandate to oversee the swaps market
in addition to the futures and options markets requires significant
resources beyond those the agency has previously been allocated.
Without additional resources, our markets cannot be as well supervised;
participants cannot be as well protected; market transparency and
efficiency cannot be as fully achieved.
Specifically, in the absence of additional resources, the CFTC will
be limited in its ability to:
Perform adequate examinations of market intermediaries,
including systemically important DCOs and the approximately 100
swap dealers that have registered with the Commission under the
new regulatory framework required by Dodd-Frank.
Use swaps data to address risk in a marketplace that has
become largely automated, and to develop a meaningful
regulatory program that is required to promote price
transparency and market integrity.
Conduct effective daily surveillance to identify the
buildup of risks in the financial system, including for
example, review of CFTC registrant activity reports submitted
by Commodity Pool Operators and banking entities, as well as to
monitor compliance with rules regarding prohibitions and
restrictions on proprietary trading.
Investigate and prosecute major cases involving threats to
market integrity and customer harm and strengthen enforcement
activities targeted at disruptive trading practices and other
misconduct of registered entities such as precious metals
schemes and other forms of market manipulation.
Conclusion
A few core principles must motivate our work in implementing Dodd-
Frank. The first is that we must never forget the cost to American
families of the financial crisis, and we must do all we can to address
the causes of that crisis in a responsible way. The second is that the
United States has the best financial markets in the world. They are the
strongest, most dynamic, most innovative, most competitive and
transparent. They have been a significant engine of our economic growth
and prosperity. Our work should strengthen our markets and enhance
those qualities. We must be careful not to create unnecessary burdens
on the dynamic and innovative capacity of our markets. I believe the
CFTC's work can accomplish these objectives. We have made important
progress but there is still much to do. I look forward to working with
the Members of this Committee and my fellow regulators on these
challenges.
Thank you again for inviting me today. I look forward to your
questions.
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM DANIEL K. TARULLO
Q.1. Since the Volcker Rule was finalized last December, what
has the Fed done with other regulators to coordinate its
interpretation and enforcement, and how has the Interagency
Working Group facilitated these efforts?
A.1. In pursuit of our goals for a consistent application of
the Volcker Rule across banking entities, the Federal Reserve
continues to work with the Office of the Comptroller of the
Currency, Federal Deposit Insurance Corporation, Securities and
Exchange Commission, and Commodity Futures Trade Commission
(the Agencies). Staffs of the Agencies meet regularly to
address key implementation and supervisory issues as they
arise. An interagency group that includes staff from the
Agencies reviews and discusses all substantive questions
received. Two subcommittees of the interagency group have been
established. One is developing a framework for coordinating
examinations among the Agencies. The other addresses issues
related to the required submission of metrics which certain of
the largest firms began reporting in September.
External guidance will be handled through agency-issued
frequently asked questions (FAQs) and other forms of guidance
as needed. Nine FAQs have been published to date that clarify
particular provisions of the final rule, including the
submission of metrics, expectations during the conformance
period, the application of certain covered funds restrictions,
and clarification regarding the annual CEO attestation.
Staffs of the Agencies also continue to meet with and
collect questions from banking entities under their respective
jurisdictions, and banking entities may submit questions
regarding matters of interest raised by the Volcker Rule to the
Agencies. Staffs of the Agencies expect to continue to
coordinate responding to matters that are of common interest in
public statements, including through public responses to FAQs
and in public guidance.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM DANIEL K. TARULLO
Q.1. On September 3, the FRB, FDIC, and OCC issued final
liquidity rules for large banks that will require more than 30
U.S. banks to add a combined $100 billion more in liquid assets
than they currently hold. A Fed economist said that the rule
``will to some extent make credit a bit more costly.'' Has the
FRB conducted a detailed analysis to determine exactly how much
more costly credit will become as a consequence of this rule
for both small businesses and individual consumers? If yes,
please provide that analysis and the ensuing result. If not,
please explain why the FRB did not undertake such analysis.
A.1. The economist who provided the referenced quote explained
that the liquidity coverage ratio (LCR) could make lending
incrementally more costly in the sense that the LCR standard
would cause banks to hold more liquid balance sheets than
without the LCR requirement. He also noted, however, that the
increased liquidity will also make financial crises less likely
to occur and less severe if they do. As we saw in 2007 to 2009,
financial crises result in a sharp decline in credit
availability and an increase in its cost, and viewed over time
and on average, credit availability may increase and credit may
be less costly as a result of the LCR. Indeed, that was a
conclusion of the study on the likely impact of the LCR and new
capital requirements, which was conducted by the Bank for
International Settlements (with participation from Board
economists) and released in August, 2010. \1\
---------------------------------------------------------------------------
\1\ The protocol and additional information regarding the protocol
is available on ISDA's Web site at http://www2.isda.org/functional-
areas/protocol-management/protocol/20.
---------------------------------------------------------------------------
Over the past several years, Federal Reserve Board (Board)
staff has observed a material improvement in the liquidity
position of banks, with limited impact to the overall market
because banks tended to take low-cost measures to improve their
liquidity positions. For example, banks have improved
collateral management and decreased the size of commitments to
better reflect customer needs, two measures which incur minimal
cost. Banks have also taken other actions such as improving the
mix of liabilities to include more stable funding like retail
deposits, which also has had limited impact on their cost of
funding. We anticipate that banks will continue to take these
and similar low-cost measures to improve their liquidity
positions and eliminate the estimated shortfall.
Q.2. In your testimony you mention that global regulators are
working on an ISDA protocol resolving the insolvency of a SIFI.
Under such protocol, would U.S. market participants be
potentially asked to waive their rights to protections afforded
under U.S. law, such as netting and termination rights?
A.2. On November 12, 2014, the International Swaps and
Derivatives Association (ISDA) issued for adoption by companies
the ISDA 2014 Resolution Stay Protocol. \2\ The protocol amends
the ISDA Master Agreement between parties adhering to the
protocol to provide for a suspension of early termination
rights and other remedies upon the commencement of certain
resolution proceedings. These contractual amendments align with
the provisions of the Federal Deposit Insurance Act and Title
II of the Dodd-Frank Wall Street Reform and Consumer Protection
Act concerning stays of early termination rights in qualified
financial contracts, but would apply those provisions to
derivatives transaction counterparties that are not otherwise
subject to U.S. law. Thus, the ISDA protocol will better
effectuate U.S. law in the event of the resolution of a U.S.
company operating cross-borders. Furthermore, the protocol
amendments would create similar stays applicable to derivatives
transactions if the parent or other affiliate of the adhering
counterparty has entered into an orderly resolution proceeding
under the U.S. Bankruptcy Code. The protocol would not affect
the application of U.S. law to contracts in the United States
or those involving U.S. parties, nor would it impact the
jurisdiction of U.S. courts and Federal regulators.
---------------------------------------------------------------------------
\2\ Ibid.
Q.3. The issue of FSOC accountability and transparency is one
that I have raised numerous times. Given the magnitude of the
regulatory burden and other costs imposed by a SIFI
designation, it is imperative that the designation process be
as transparent and objective as possible.
Do you object to the public disclosure of your individual
votes, including an explanation of why you support or oppose
such designation?
A.3. I am not a member of the Financial Stability Oversight
Council (FSOC), so I do not have a vote in the body.
Q.4. Will you commit to pushing for greater accountability and
transparency reforms for FSOC? Specifically, will you commit to
push the FSOC to allow more interaction with companies involved
in the designation process, greater public disclosure of what
occurs in FSOC principal and deputy meetings, publish for
notice and comment any OFR report used for evaluating
industries and companies, and publish for notice and comment
data analysis used to determine SIFI designations? If you do
not agree with these proposed reforms, what transparency and
accountability reforms would you be willing to support?
A.4. On February 4, the FSOC approved a set of procedures for
the designation process that are intended to supplement its
rule and guidance. The changes are intended to bring more
transparency to the process and provide companies that have
passed the initial thresholds for consideration with the
opportunity to engage with FSOC staff and the staff of member
agencies at an early point in the process. As FSOC considers
other potential changes to the process, the FSOC will need to
balance the need for greater transparency with the need to
protect information that is supervisory, proprietary, or
otherwise confidential in nature. Public disclosure of such
information could harm firms. Accordingly, the FSOC is careful
to protect such information in providing a public basis
statement that makes clear the basis for designation. The FSOC
will also need to ensure that any changes to the process do not
impinge on a free and frank deliberation within the FSOC as
this is an important part of an effective designation process.
The publicly available basis for the FSOC's determination
contains an extensive explanation of the analysis the Council
took into account when considering whether to designate a
nonbank financial company for supervision by the Board.
Finally, while the Office of Financial Research did not
request comment on its asset manager study, the Securities and
Exchange Commission received and published comments on the
study that have been reviewed by staff at member agencies.
Q.5. In the July FSOC meeting, the Council directed staff to
undertake a more focused analysis of industrywide products and
activities to assess potential risks associated with the asset
management industry.
Does the decision to focus on ``products and activities''
mean that the FSOC is no longer pursuing designations of asset
management firms?
Did the FSOC vote on whether to advance the two asset
management companies to Stage 3? If so, why was this not
reported? If not, why was such a vote not taken in order to
provide clarity to the two entities as well as the industry?
A.5. At its July 2014 meeting, the FSOC discussed its ongoing
evaluation of the potential systemic threats posed by asset
management firms and their activities. At the conclusion of
that discussion, the FSOC directed staff to undertake a more
focused analysis of these issues and, at its December public
meeting, the FSOC issued a notice published in the Federal
Register seeking public comment on potential risks to U.S.
financial stability from asset management products and
activities. The FSOC's work in this area is ongoing but still
preliminary. The Board is committed to helping ensure that the
Council updates the public about its work in this important
area as it becomes possible to do so.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM DANIEL K. TARULLO
Q.1. With the Volcker Rule, we finally learned the lessons from
the bailout of Long-Term Capital Management and then the 2008
financial crisis that we simply cannot afford to have big,
systemically significant firms making big bets on the ups and
downs of the market. Casino banking is over--if you stick to
your guns and enforce the Rule.
I deeply appreciate the hard work you did to getting to a
final rule last December, and I recognize the hard work you are
doing now to implement it. However, we are still at the
beginning legs of the journey, and I believe in ``trust but
verify''--which requires full, continued cooperation by our
regulators and engagement with the public.
During the financial crisis, we all saw the horrific
results when different regulators saw only parts of the risks
to some firms. There were too many regulatory silos, which do
not work because firms do not function that way. You also need
a complete picture of what is going on in any one institution
and across different firms. Indeed, one of the least recognized
benefits of the Volcker Rule is to force the regulators to pay
attention, together, to trading activities, which have become
so important at so many banks. But critically, this means all
the regulators need full access to all collected data and
information.
In addition, accountability to the public through
disclosure provides another layer of outside oversight and
analysis, as well as equally importantly, public confidence
that Wall Street reform is real.
Based on the track record of various public disclosure
mechanisms out there already--including for example, the CFTC's
positions of traders--there is significant space for reasonably
delayed disclosures of metrics data to enhance Volcker Rule
accountability and public confidence. Now Treasury Deputy
Secretary and then-Federal Reserve Governor Sarah Bloom Raskin
highlighted disclosure in her statement on adoption of the
final rule, and financial markets expert Nick Dunbar has
similarly called for disclosure as a key tool. (See Nick
Dunbar, ``Volcker Sunlights Should Be the Best Disinfectant'',
July 25, 2014, http://www.nickdunbar.net/articles/volcker-
sunlight-should-be-the-best-disinfectant/.) The OCC's Quarterly
Trading Activity Report may be a perfect venue to engage in
this type of disclosure, provided it is expanded to cover the
entire banking group.
First, will each of you commit to working to ensure that
each of your agencies has a complete picture of an entire
firm's trading and compliance with the Volcker Rule, which can
best be accomplished by having all data in one place so that
all regulators have access to it?
A.1. Section 13 of the Bank Holding Company Act (BHC Act)
allocates authority among the Office of the Comptroller of the
Currency (OCC), Federal Deposit Insurance Corporation (FDIC),
Federal Reserve, Securities and Exchange Commission (SEC) and
Commodity Futures Trading Commission (CFTC) (the Agencies) with
respect to banking entities for which each Agency is the
primary Federal regulator. In light of how the statute
allocates authority among the Agencies, the final rule
implementing section 13 requires that each banking entity
provide periodic reports of certain quantitative measurements
to its primary Federal regulator. A frequently asked question
issued by the Agencies in June 2014, explained that a trading
desk that spans multiple legal entities must report the
quantitative measurements to each of the Agencies with
jurisdiction under section 13 of the BHC Act over any of the
entities. \1\ The Agencies have been and continue to cooperate
in reviewing the data submitted by firms.
---------------------------------------------------------------------------
\1\ See http://www.federalreserve.gov/bankinforeg/volcker-rule/
faq.htm#2.
---------------------------------------------------------------------------
While the Agencies do not currently have plans to have all
the data in one place, the Federal Reserve intends to work with
the other Agencies to coordinate supervision and enforcement of
section 13 and implementing regulations. This coordination
includes sharing the metrics data provided by banking entities
under the final rule as appropriate.
Q.2. Second, are you committed to using disclosure to help
advance compliance with and public trust from the Volcker Rule?
A.2. In the preamble of the final rule, the Agencies emphasized
that the purpose of the quantitative measurements is not as a
dispositive tool for determining compliance with the rule but
rather would be used to monitor patterns and identify activity
that may warrant further review. Banking entities that are
subject to metrics reporting as of September 2014, generally
have requested confidential treatment of the metrics data under
the Freedom of Information Act as trade secrets and commercial
or financial information obtained from a person that is
privileged or confidential.
The Agencies also indicated in the final rule that they
intended to revisit the quantitative measurements in September
2015, after having gained experience with the data. At that
time, the Federal Reserve will consult with the other Agencies
regarding the potential for release of aggregated data on a
delayed basis that would not identify the trading positions of
any individual firm.
Q.3. The success of the Volcker Rule over the long term will
depend upon the commitment of regulators to the vision of a
firewall between high risk, proprietary trading and private
fund activities, on the one hand, and traditional banking and
client-oriented investment services on the other hand. One of
the most important parts of ensuring that vision is
meaningfully implemented is the December 2013 final rule's
application of its provisions at the ``trading desk'' level,
defined as the ``smallest discrete unit of organization'' that
engages in trading.
Unfortunately, reports have emerged suggesting that banks
are already attempting to combine and reorganize what had been
separate trading desks into one ``trading desk'' for Volcker
Rule purposes, as a way to game the metrics-based reporting
essential to effective monitoring by regulators of each
institution's compliance with the Volcker Rule. The OCC has
already identified this risk in its Interim Examination
Procedures, and attempted to limit such actions to instances
where the desks were engaged in ``similar strategies,'' the
combination has a ``legitimate business purpose,'' and the
combination assists the firm to ``more accurately reflect the
positions and fluctuations'' of its trading. I feel that the
OCC's interim protections may not, however, be enough ensure
compliance with the final rule.
I am deeply concerned that combining or reorganizing
trading desks would undermine the strength of the metrics-based
oversight, particularly related to whether market-making is
truly to serve near-term customer demand and whether hedging is
truly that. To avoid obscuring evasion by changing the mixture
and volume of the ``flow'' of trading that is reported by the
``trading desk'' unit, I would suggest that examiners ought to
strictly apply the final rule's approach to ``trading desk''
and apply the guidance set out by the OCC extremely narrowly,
along with additional protections. For instance, ``similar
strategies'' would need to include both the type of the trading
(e.g., market-making) but also the same or nearly identical
products, as well as be serving the same customer base, among
other standards. As an example, if two desks traded in U.S.
technology stocks and technology stock index futures, combining
those into one desk might make sense, depending on other
factors, such as where the desks were located and what
customers they were serving. But combining, for example,
various industry-specific U.S. equities desks that today are
separate would not pass muster for complex dealer banks.
It is also important to remember that an important
supervisory benefit from implementing the Volcker Rule at a
genuine trading desk level is that regulators will gain a much
deeper, more granular understanding of the risks emanating the
large banks' many different trading desks--the kind of risks
that led one particular trading desk to become famous as the
London Whale.
When confronted with attempts to reorganize trading desks,
regulators should look carefully at whether submanagement
structures, bonus structures, or other indicia exist that would
suggest that the reorganized ``trading desk'' is not actually
the smallest discrete unit of organization contemplated by the
final rule and essential to the metrics-based oversight system
being developed.
Will you commit to scrutinizing, for the purposes of the
Volcker Rule, any reorganizations of trading desks as posing
risks of evasion and will you commit to working jointly to
clarify any guidance on the definition of trading desk for
market participants?
A.3. The final rule implementing section 13 of the BHC Act
applies various requirements to a trading desk of a banking
entity and requires banking entities subject to quantitative
measurements reporting under Appendix A of the final rule to
report the required metrics for each trading desk. As you note,
the final rule defines a ``trading desk'' to mean the smallest
discrete unit of organization of a banking entity that
purchases or sells financial instruments for the trading
account of the banking entity or an affiliate thereof. \2\ In
issuing the final rules, the Agencies explained that adopting
an approach focused on the trading desk level would allow
banking entities and the Agencies to better distinguish between
permitted market making-related activities and trading that is
prohibited by section 13 of the BHC Act and will thus prevent
evasion of the statutory requirements. \3\
---------------------------------------------------------------------------
\2\ See 12 CFR 248.3(e)(13).
\3\ See 76 FR 5536 at 5591.
---------------------------------------------------------------------------
As part of the supervisory process, the Federal Reserve
intends to monitor how banking entities define a trading desk
and to monitor any reorganizations of trading desks in order to
avoid evasion of the requirements of section 13 and the final
rule. The Federal Reserve will work with the other Agencies to
clarify any guidance on the definition of trading desk if
needed to address concerns about such reorganizations and
evasion.
Q.4. Ensuring speedy compliance with the provisions of the
Merkley-Levin Volcker Rule is a top priority for strong
implementation. It has already been 4 years since adoption, and
banks should be well on their way to conforming their trading
and fund operations.
However, as you know, we also provided for an additional 5
years of extended transition for investments in ``illiquid
funds,'' which were expected to include some types of private
equity funds. We did this because some private equity funds,
such as venture capital funds, do not usually permit investors
to enter or exit during the fund's lifetime (usually 10 years
or so) because of the illiquidity of those investments.
As you know, the Federal Reserve Board's rule on the
``illiquid funds'' extended transition interprets the statutory
provision of a ``contractual commitment'' to invest as
requiring a banking entity, where a contract permits divestment
from a fund, to seek a fund manager's and the limited partners'
consent to exit a fund. The rule, however, provides for the
Board to consider whether the banking entity used reasonable
best efforts to seek such consent but that an unaffiliated
third party general partner or investors made unreasonable
demands.
I strongly support the Board's desire to implement the
Volcker Rule in a speedy manner. In addition, the Board's
approach in the final conformance rule goes a long way to
ensuring that the illiquid funds extended transition only be
available for investments in truly illiquid funds, and not a
way to avoid divestment of hedge funds and private equity
funds.
At the same time, we designed the provision to provide for
a smooth wind-down for illiquid funds. Indeed, I am sensitive
to the legitimate business needs of firms seeking to comply
with the Volcker Rule while maintaining relationships with
important customers to whom they may seek to provide
traditional banking services.
Accordingly, I would urge the Board to clarify that a
banking entity's requirement to make ``reasonable efforts'' to
exercise its contractual rights to terminate its investment in
an illiquid fund could be satisfied, for example, by a
certification by the banking entity (a) that the banking
entity's exit from the fund would be extraordinary from the
perspective of how most investors enter or exit the fund (i.e.,
the investment contract does not routinely or ordinarily
contemplate entry or exit, and/or such other indicia as are
necessary to help distinguish between illiquid private equity
funds and other funds, like hedge funds, that ordinarily and
routinely permit investor redemptions), (b) that inquiring with
third-party fund managers and limited partners regarding
termination would result in a significant detriment to the
business of the banking entity and (c) that the banking entity
believes that the divestment would result in losses,
extraordinary costs, or otherwise raise unreasonable demands
from the third-party manager relating to divestment (or the de
facto equivalent thereto).
Such a certification from the banking entity, along with
the language of the relevant fund agreements and such other
requirements as the Board determines appropriate, would obviate
the need to seek consent from third-party fund managers. Have
you considered clarifying this in a FAQ?
A.4. A number of commenters have requested that the Federal
Reserve modify the meaning of what is ``necessary to fulfill a
contractual obligation'' of the banking entity under the
Board's 2011 conformance rule. The Federal Reserve is
considering these comments in light of the requirements of
section 13. The Federal Reserve will consider your comments
regarding a potential certification for illiquid funds in
determining what next steps to take on these matters.
Q.5. We've recently seen reports that the largest Wall Street
banks are nominally ``deguaranteeing'' their foreign affiliates
in order to avoid coverage under U.S. regulatory rules,
especially those related to derivatives. This
``deguaranteeing'' appears to be based on a fiction that U.S.
banks do not actually guarantee the trading conducted by
foreign subsidiaries, and hence would not be exposed to any
failure by the foreign subsidiary.
Can you comment on that, and specifically, whether you
believe that U.S. bank or bank holding company could be exposed
to losses from--or otherwise incur liability related to--a
foreign affiliate's trading even when no explicit guarantee to
third parties exists. Please specifically address whether an
arrangement, commonly known as a ``keepwell,'' provided by the
U.S. parent or affiliate to the foreign affiliate potentially
could create such exposure--and specifically, liability--for
the U.S. entity.
A.5. As a general matter, the Federal Reserve engages in
consolidated supervision and regulation of bank holding
companies (BHCs) and banks. Most of the Federal Reserve's BHC
regulations apply on a consolidated basis; accordingly, removal
of any BHC parent guarantees of, or keepwell arrangements with,
foreign subsidiaries have little or no effect on the BHC's
consolidated risk-based capital, leverage, and liquidity
requirements. In other words, for most of our key BHC
regulations, we generally treat the assets, liabilities, and
exposures of a BHC's foreign subsidiaries as owned by the BHC,
whether or not there is an explicit guarantee by the BHC parent
of the assets, liabilities, or exposures of the foreign
subsidiary. Our basic supervisory stance is to require a BHC to
manage its own risks as well as the risks of all of its
domestic and foreign consolidated subsidiaries.
With respect to rules related to derivatives transactions,
in September 2014, the prudential regulators (including the
OCC, the Federal Reserve, the FDIC, the Farm Credit
Administration, and the Federal Housing Finance Agency)
released a proposed rule for margin requirements for covered
swap entities. Covered swap entities are defined to mean
entities registered as swap dealers or major swap participants
with the CFTC, or registered as security-based swap dealers or
major security-based swap participants with the SEC and that
are regulated by one of the prudential regulators.
The proposed rule addressed the cross-border application of
the margin requirements, including the treatment of guarantees.
In particular, the proposal stated that the requirements would
not apply to any foreign noncleared swap of a foreign covered
swap entity. To qualify as a foreign noncleared swap eligible
for this exclusion, no guarantor of either party's obligations
under the swap could be a U.S. entity. Moreover, the proposed
rule also provided that certain covered swap entities may be
eligible for substituted compliance, whereby they could comply
with the swap margin rules of another jurisdiction instead of
the U.S. rule if the prudential regulators made a comparability
determination. The proposal explicitly provided that a covered
swap entity was eligible for substituted compliance only if the
covered swap entity's obligations under the swap were not
guaranteed by a U.S. entity.
Q.6. Moreover, please comment on whether the size and
importance to the U.S. parent or affiliate of the foreign
affiliate's activities could itself create an implied guarantee
such that the U.S. firm would have major reputational or
systemic risk reasons to prevent the foreign affiliate from
incurring significant losses or even failing--similar to
rescues that occurred during the financial crisis of entities
that were supposed to be bankruptcy remote.
A.6. Please see response to Question 5 above. As noted above,
the Federal Reserve generally takes a consolidated approach to
supervision regardless of the size or importance of the U.S.
entity.
Q.7. Finally, many of these foreign bank subsidiaries are so-
called ``Edge Act'' corporations, which I understand are
consolidated with the insured depository subsidiary for many
purposes. Please comment on whether there is any chance that
losses in these Edge Act corporations, particularly losses in
their derivatives operations, could impact the deposit
insurance fund.
A.7. The potential for losses at subsidiaries to affect the
operations of a parent BHC or bank, and in turn affect the
deposit insurance fund, is one of the important reasons why the
Federal Reserve takes a consolidated approach to supervision
and regulation of BHCs and banks. Elimination of guarantees and
keepwell arrangements between a bank and its Edge Act
subsidiary would not affect our supervision of the BHC, the
bank, or the Edge Act corporation, nor would it change the
bank's capital or liquidity requirements.
Q.8. There have been several recent stories in Reuters that
highlight how some large bank holding companies continue to be
engaged deeply in the investment and trading in physical
commodities--ownership of oil trains and natural gas plants
businesses.
Are you concerned about the continued expansion by some of
our largest bank holding companies into activities? Can you
provide an update on the status of your physical commodities
review, and whether you intend to at least ensure that short
term trading in physical commodities are covered by appropriate
limits, protections, and prohibitions against conflicts of
interest?
A.8. In January 2014, the Federal Reserve Board (Board) invited
public comment through an advance notice of proposed rulemaking
(ANPR) on a range of issues related to the commodities
activities of financial holding companies. The scope of our
ongoing review covers commodities activities and investments
under section 4(k) complementary authority, merchant banking
authority, and section 4(o) grandfather authority. Recently,
some of the financial holding companies engaged in physical
commodities activities have publicly indicated that they are
reducing or terminating some of these activities.
As the ANPR explains, we are exploring what further
prudential restrictions or limitations on the ability of
financial holding companies to engage in commodities-related
activities are warranted to mitigate the risks associated with
these activities. Such additional restrictions could include
reductions in the maximum amount of assets or revenue
attributable to such activities, increased capital or insurance
requirements on such activities, and prohibitions on holding
specific types of physical commodities that pose undue risk to
the company. We also are exploring what restrictions or
limitations on investments made through the merchant banking
authority would appropriately address those or similar risks.
In response to the notice, the Board received 184 unique
comments and more than 16,900 form letters. Commenters included
Members of Congress, individuals, public interest groups,
academics, end users, banks, and trade associations. The
comments present a range of views and suggested Board actions--
from no action to prohibiting trading or ownership of
commodities associated with catastrophic risk, strengthening
prudential safeguards (such as reducing caps on the amount of
permitted activities), strengthening risk-management practices,
enhancing public disclosure, requiring additional capital,
increasing regulatory coordination, and developing risk-
management best practices. The Board has been reviewing the
comments and considering what steps would be appropriate to
address the risks posed by physical commodities activities.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM DANIEL K. TARULLO
Q.1. In June 2013, the FSOC voted to designate AIG, GE Capital,
and Prudential as nonbank SIFIs. Shortly thereafter, in July
2013, the Financial Stability Board, of which the Federal
Reserve is an influential member, voted to designate AIG,
Prudential, and MetLife as systemically important. What
warranted the immediate designation of AIG and Prudential and
the substantial delay in designating MetLife?
A.1. Under the Dodd-Frank Wall Street and Consumer Protection
Act (Dodd-Frank Act), the Financial Stability Oversight Council
(FSOC) may only designate financial companies that are not bank
holding companies. MetLife was a U.S. bank holding company
until February 14, 2013. On that date, it received the required
approvals from both the Federal Deposit Insurance Corporation
and the Federal Reserve Board (Board) to deregister as a bank
holding company. These approvals followed the completed sale of
MetLife Bank's depository business to General Electric Capital
Corporation (GECC) on January 11, 2013.
Because MetLife--unlike AIG, GECC, and Prudential--was a
bank holding company until February 2013, FSOC's designation
process for MetLife trailed that of AIG, GECC, and Prudential.
Q.2. It makes logical sense for national Governments to conduct
their own reviews of potentially systemically important firms
within their countries before voting to designate them as such
at an international body. However, this was not the case with
MetLife. Why did the Fed vote first to designate MetLife as a
SIFI at the FSB before voting to designate MetLife as a
domestic nonbank SIFI?
A.2. As noted in the prior response, because MetLife was a bank
holding company until February 2013, the FSOC designation
process for MetLife was delayed. Moreover, it is important to
note that the Financial Stability Board's (FSB) process for
identifying global systemically important insurers (G-SIIs) is
independent from the FSOC's designation process. Among other
differences, the FSB and FSOC have different designation
frameworks and standards. In addition, any standards adopted by
the FSB, including designation of an entity as a global
systemically important financial institution (G-SIFI), are not
binding on the Board or any other agency of the U.S.
Government, or any U.S. companies. Thus, FSB designation of an
entity as a nonbank SIFI does not automatically result in the
Board becoming the entity's prudential regulator. Under the
Dodd-Frank Act, the FSOC is responsible for deciding whether a
nonbank financial company should be regulated and supervised by
the Board, based on its assessment of the extent to which the
failure, material distress, or ongoing activities of that
entity could pose a risk to the U.S. financial system.
Q.3. What analysis and review did the Federal Reserve conduct
prior to supporting the FSB's July 2013 designation of MetLife,
AIG, and Prudential?
A.3. The methodology for identifying G-SIIs was developed by
the International Association of Insurance Supervisors (IAIS).
The IAIS' assessment methodology identifies five categories to
measure relative systemic importance: (1) nontraditional
insurance and noninsurance activities, (2) interconnectedness,
(3) substitutability, (4) size, and (5) global activity. Within
these five categories, there are 20 indicators, including:
intrafinancial assets and liabilities, gross notional amount of
derivatives, Level 3 assets, nonpolicyholder liabilities and
noninsurance revenues, derivatives trading, short term funding
and variable insurance products with minimum guarantees. The
initial assessment methodology involved three steps: (1) the
collection of data, (2) a methodical assessment of that data,
and (3) a supervisory judgment and validation process.
Documents associated with the development of the methodology
were reviewed by Board staff.
Q.4. What analysis and review did the Federal Reserve conduct
on MetLife after July 2013 but before the recent FSOC vote on
designation?
A.4. The FSOC's analysis is based on a broad range of
quantitative and qualitative information available to the FSOC
through existing public and regulatory sources, and information
submitted by MetLife. The analysis is tailored, as appropriate,
to address company-specific risk factors, including but not
limited to, the nature, scope, size, scale, concentration,
interconnectedness, and mix of the activities of MetLife. Board
staff, along with the staffs other FSOC member agencies and
offices, contributed to this analysis.
Q.5. What kind of contact have you or your colleagues at the
Federal Reserve had with the FSB as it relates to reviewing
asset managers?
A.5. The FSB, in consultation with the International
Organization of Securities Commissions (IOSCO), is currently
developing methodologies to identify systemically important
nonbank noninsurer (NBNI) firms. The purpose of this exercise
is to fulfill a request by the G20 Leaders to identify threats
to global financial stability that could arise from the
material financial distress or failure of NBNI firms, mirroring
a process for identifying global systemically important banks
and insurers. \1\ The Board is participating in this process,
along with other U.S. agencies.
---------------------------------------------------------------------------
\1\ See paragraph 70 of the G20 Leaders' Declaration from the St.
Petersburg Summit, September 2013: https://www.g20.org/sites/default/
files/g20_resources/library/Saint_
Petersburg_Declaration_ENG_0.pdf.
---------------------------------------------------------------------------
Earlier this year, the FSB issued a consultative document
on ``Assessment Methodologies for Identifying Non-Bank Non-
Insurer (NBNI) Global Systemically Important Financial
Institutions.'' \2\ It proposed assessing the systemic
importance of NBNI firms with reference to a set of five
factors: size; interconnectedness; substitutability; complexity
and global activities. These factors are broadly consistent
with those that have been used in the identification of
globally significant banks and insurers. For practical reasons,
the FSB also proposed using a ``materiality threshold'' of $100
billion in net assets under management (AUM) to limit the set
of firms for which detailed data on these five factors would be
collected. (Hedge funds would be subject to an additional
threshold of $400 to $600 billion in gross notional exposure.)
NBNI firms that are considered potentially systemically
important by their national supervisors could be added to the
assessment pool, even when they fall below this threshold.
---------------------------------------------------------------------------
\2\ The consultation paper is available for download at: http://
www.financialstabilityboard.org/wp-content/uploads/r_140108.pdf.
---------------------------------------------------------------------------
In its consultation paper, the FSB sought comments on the
merits of the proposed threshold, and solicited proposals for
alternative practicable screening mechanisms. The comments
received, including those from many U.S. firms and industry
associations, will be an important input that will help refine
the assessment methodologies. \3\ Moreover, there will continue
to be significant input from U.S. agencies before an assessment
methodology is approved by the FSB. U.S. agencies are also
active participants in IOSCO. This work is ongoing and has yet
to reach any conclusions.
---------------------------------------------------------------------------
\3\ Responses to the consultation paper are available for download
at: http://www.iosco.org/library/
index.cfm?section=pubdocs&publicDocID=435.
---------------------------------------------------------------------------
It is important to note that any standards adopted by the
FSB, including designation of an entity as a G-SIFI, are not
binding on the Board or any other agency of the U.S.
Government, or any U.S. companies. Under the Dodd-Frank Act,
the FSOC is responsible for deciding whether a nonbank
financial company should be regulated and supervised by the
Board, based on its assessment of the extent to which the
failure, material distress, or ongoing activities of that
entity could pose a risk to the U.S. financial system.
Moreover, the Board would only adopt FSB regulatory standards
after following the well-established rulemaking protocols under
U.S. law, which include a transparent process for proposal
issuance, solicitation of public comments, and rule
finalization.
As stated above, the purpose of the FSB exercise is to
identify threats to global financial stability that could arise
from the material financial distress or failure of NBNI firms.
It is possible that the FSB may decide that, at present, none
of these firms poses such a threat. However, in the event that
financial stability risks are identified by the FSB, and U.S.
authorities agree with this identification, the FSOC has a
range of policies options at its disposal. These include
communicating such risks in its annual report to Congress;
recommending that existing primary regulators apply heightened
standards and safeguards; and designating individual firms as
``systemically important financial institutions,'' thereby
subjecting them to supervision and regulation by the Board. The
appropriate response will depend upon the nature of the risks
identified, and will seek to maximize net benefits to the
economy.
This past July, the FSOC directed staff to ``undertake a
more focused analysis of industrywide products and activities
to assess potential risks associated with the asset management
industry.'' The FSOC's work program is complementary to that of
the FSB--in both cases, the purpose is to identify metrics that
can be used across the industry to feed into an assessment of
financial stability risks generated by asset management funds
and activities. There is ample opportunity for mutually
beneficial information sharing in these processes.
Q.6. How does the FSOC's new approach with respect to asset
managers affect the United States' input into the same process
with respect to the FSB?
A.6. Please see the response to Question 5.
Q.7. The FSB has proposed a ``materiality threshold'' of $100
billion in assets under management (AUM), which would capture
only U.S. mutual funds, and no funds from other countries. Did
you and do you continue to support a $100 billion AUM test for
materiality?
A.7. Please see the response to Question 5.
Q.8. Because this test disproportionately affects U.S. funds,
doesn't it put them at a disadvantage vis-a-vis their
international competitors?
A.8. Please see the response to Question 5.
Q.9. Does it seem at all inconsistent to you that the FSOC went
ahead with designating nonbank firms as SIFIs before knowing
what regulatory framework would be applied once designated?
A.9. The Dodd-Frank Act authorizes the FSOC to make a
determination as to whether the material financial distress of
a nonbank financial company could pose a threat to U.S.
financial stability; the nature of the enhanced prudential
standards to be applied to a company if the FSOC determines
that the company could pose such a threat is a separate process
conducted by the Board. Under section 113 of the Dodd-Frank
Act, the FSOC is required to consider a specific set of factors
when determining whether a nonbank financial company should be
designated by the FSOC for supervision by the Board. There is
no requirement in section 113 or elsewhere for the FSOC to
consider the standards to be applied to nonbank financial
companies designated for supervision by the Board (designated
firms). The FSOC has not found that its conclusion of whether a
company's material financial risk could pose a threat to U.S.
financial stability required a determination beforehand as to
how enhanced prudential standards would apply to the company.
Section 165 of the Dodd-Frank Act establishes mandated
enhanced prudential standards that must be applied to any
nonbank financial company designated by the FSOC. Section
165(a)(2) requires the Board to tailor prudential standards for
a designated firm as appropriate in light of any predominant
line of business and activities of the firm, among other
factors. Consistent with section 165, the Board has chosen not
to adopt a universal, one-size-fits-all regulation governing
all designated firms. Instead, the Board has chosen to apply
enhanced prudential standards to designated firms individually
through an order or rule following an evaluation of the
business model, capital structure, and risk profile of each
designated firm. This individualized approach allows the Board
to tailor its supervision and adapt standards as appropriate to
each designated firm.
Q.10. How do we know if the systemic risks perceived by the
FSOC can be effectively addressed through designation, if the
Federal Reserve and the FSOC don't currently know how they plan
to regulate these entities?
A.10. The application of enhanced prudential standards by the
Board to designated firms will mean that these firms must meet
new capital and liquidity standards which aim to decrease the
risk they may pose to U.S. financial stability. As described in
response to Question 9 above, the Board is committed to
tailoring the application of such standards to designated firms
to best address the unique business model, capital structure,
risk profile, and systemic footprint of each designated firm
before crafting the applicable enhanced prudential standards.
We believe this individualized approach will allow us to best
address and ameliorate any risks they pose to the financial
system.
Q.11. Has the Federal Reserve already thought about how to
regulate nonbank SIFIs? If so, when will the Fed articulate
this framework to the public and the entities subject to
regulation?
A.11. As described in response to Questions 9 and 10 above, the
precise details of the frameworks for nonbank SIFIs will be
informed by analysis of the capital structures, financial
activities, riskiness, and complexity of these firms, along
with other relevant risk-related factors. For example, with
regard to the development of enhanced prudential standards for
designated firms that are insurance companies, the Board began
a quantitative impact study (QIS) to evaluate the potential
effects of its capital framework on designated firms that are
substantially engaged in insurance underwriting activities. We
will use the results of the QIS to inform the design of an
appropriate framework for these firms that respects the
realities of insurance activities.
With regard to GECC, the remaining designated firm, the
Board proposed for public comment in November 2014, a
comprehensive set of enhanced prudential standards for the
firm. The comment period closed in February, and staff is
analyzing comments received. We expect to have these frameworks
in place as soon as practicable.
Q.12. Given the recent decision by FSOC to take a new approach
with respect to asset managers, should Congress expect the FSOC
to take a similar approach with respect to insurance companies?
If so, what impact will this have on insurance companies
already designated by FSOC?
If not, doesn't this exemplify quite a bit of
methodological inconsistency, subjecting some nonbank firms to
certain kinds of reviews, while subjecting other firms to
different reviews?
A.12. Under the Dodd-Frank Act, the FSOC has a variety of
authorities to address risks to financial stability from the
nonbanking firms. These authorities include designating nonbank
financial companies for supervision by the Federal Reserve
Board as well as making recommendations to existing primary
regulators to apply new or heightened standards and safeguards
to the financial activities or practices of such firms.
In exercising this authority, the FSOC, to date, has
designated four nonbank financial companies based on a
consideration of the statutory factors as applied to each
individual company's unique business model as well as its
leverage, liabilities, activities, and interconnectedness to
the financial system, among other factors. In the event that
the material financial distress of a nonbank financial company
would pose a threat to U.S. financial stability, it is
appropriate for the FSOC to designate that firm as systemically
important, as FSOC has determined in the case of three
insurance companies--AIG, Prudential, and MetLife.
With regard to asset managers, the FSOC is currently
studying the relationship of the asset management industry
generally to U.S. financial stability, including analysis of
potential risks such as the transmission of the material
financial distress of an asset manager to the broader financial
system. At its December 2014 public meeting, the FSOC issued a
notice published in the Federal Register seeking public comment
on potential risks to U.S. financial stability from asset
management products and activities. The FSOC's work in this
area is ongoing and no determinations have been made at this
time.
Q.13. A number of ABS classes, including securitized auto and
credit card loans, were denied any HQLA status in the recently
finalized LCR rule. What was your reasoning for this?
A.13. The banking agencies that issued the liquidity coverage
ratio (LCR) rule analyzed and considered many asset classes for
treatment as high-quality liquid assets (HQLA) in the LCR.
Evidence from the 2007 to 2009 financial crisis and the period
following indicates that the market demand for securitization
issuances can decline rapidly during a period of stress and may
not rapidly recover. The ability to monetize these
securitization issuances through or in the repurchase market
may be limited in a period of stress. Ultimately, a number of
types of asset-backed securities (ABS), including securitized
auto and credit card loans, were not treated as HQLA under the
final rule because the banking agencies concluded that as an
asset class, they are not sufficiently liquid, particularly
during times of stress.
Q.14. Because many of the banks that need to comply with the
LCR comprise a significant number of the investors in these
ABS, will denying HQLA status to ABS increase borrowing costs
for consumers and small businesses? Was a cost-benefit analysis
conducted on this particular provision of the rule? Would you
be open to sharing that analysis, on this provision or on the
rule as a whole, with Congress?
A.14. We do not believe that demand for private label ABS will
be materially affected by the LCR; nor do we believe that the
borrowing costs to consumers and small businesses will be
materially affected by the non-HQ LA status of private label
ABS in the LCR. In this regard, it is important to note that
the LCR contains provisions that provide favorable treatment to
borrowings from retail and small business customers as compared
to borrowings from large businesses. In addition, the banking
agencies reviewed investments in ABS by banking organizations
subject to the LCR final rule and found that ABS holdings by
these firms comprise a limited amount of the total ABS market.
In developing and finalizing the LCR rule, the banking
agencies considered the various benefits and costs associated
with the LCR, including the potential economic impact of asset
classes being treated or not treated as HQLA and the potential
impact of the rule as a whole on mitigating systemic risk. We
also took into account a 2010 study by the Bank for
International Settlements, which was contributed to by the U.S.
banking agencies, on the long-term economic impact of stronger
liquidity and capital requirements for banks. The study
suggested that over time and on average, credit availability
would increase and credit would be less costly due to the
likelihood that such regulations will make future financial
crisis less likely and less severe.
Q.15. Additionally, the finalized LCR rule confers no HQLA
status to private-label mortgage-backed securities while
conferring GSE-guaranteed mortgage-backed securities Level 2A
HQLA status. Republicans and Democrats are committed to
attracting more private capital to housing finance. To what
extent did you consider the ramifications of this decision as
it relates to broader housing finance reform?
A.15. Data indicates that Government-sponsored enterprise (GSE)
guaranteed mortgage-backed securities (MBS) have been and
continue to be very liquid instruments, which is the basis for
their treatment as Level 2A HQLA (subject to operational and
other requirements) in the LCR issued by the banking agencies.
In contrast, evidence from the 2007 to 2009 financial crisis
and the period following indicates that the market demand for a
variety of private label securitization issuances can decline
rapidly during a period of stress, and that such demand may not
rapidly recover. The banking agencies determined that private-
label MBS do not exhibit the through-the-cycle liquidity
characteristics necessary to be included as HQLA under the
final rule, and as noted in response to Question 14 above, we
considered the costs and benefits of treating privatelabel MBS
as HQLA in developing and finalizing the LCR. Like other assets
not treated as HQLA that are nevertheless permissible
investments, we believe banking organizations will continue to
invest in these types of assets in order to meet the demands of
their customers and benefit from the yields these investments
offer.
Q.16. Doesn't the disparate treatment of PLMBS and GSE MBS
direct more funding into GSE-guaranteed mortgages and make it
harder for private capital (without Government guarantees from
the GSEs, FHA, VA, or USDA) to re-enter the market?
A.16. We recognize the importance of private capital as a
source of funding to the U.S. residential mortgage markets and
note that the LCR rule does not prohibit banking organizations
from continuing to invest in private label MBS. In recognition
of the fact that many types of permissible investments for
banking organizations may not be readily liquid during times of
financial stress, the LCR requires banking organizations to
meet the proposed liquidity requirements with assets that have
historically been a reliable source of liquidity in the United
States during times of stress. As discussed above, the banking
agencies determined that private label MBS did not meet this
standard. The agencies do not anticipate, however, that the
exclusion of this asset class from HQLA will significantly
deter investment by banking organizations in these assets.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
FROM DANIEL K. TARULLO
Q.1. The Federal Reserve's earliest regulatory proposals
setting requirements for Savings and Loan Holding Companies
recognized a difference between top-tier holding companies that
are insurance companies themselves and shell-holding companies
carrying out a broad range of financial activities outside of
the regulated insurance umbrella, such as AIG. This distinction
seems appropriate.
Do you see any compelling reason to change capital rules
for top-tier insurance SLHCs in the U.S. from those currently
utilized under State law?
A.1. Section 171 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the Dodd-Frank Act) requires, in part,
that the Federal Reserve Board (Board) establish consolidated
minimum risk-based and leverage requirements for depository
institution holding companies, which includes Savings and Loan
Holding Companies (SLHCs), and nonbank financial companies
supervised by the Board. Thus, section 171 of the Dodd-Frank
Act requires the Board to establish consolidated requirements
for these firms at the holding company level, in contrast to
the capital requirements that are imposed under individual
State insurance laws on insurance companies on a stand-alone,
legal entity basis.
In June 2012, the Board proposed changes to its regulatory
capital framework that would, in part, establish consolidated
capital requirements for savings and loan holding companies,
including those with substantial insurance underwriting
activity (insurance SLHCs). In finalizing the framework in July
2013, the Board excluded insurance SLHCs from application of
the revised capital rule pending further consideration of
whether and how the proposed requirements should be modified
for these companies. The Board has been working to develop a
revised regulatory capital framework for insurance SLHCs that
appropriately addresses the risks to capital adequacy on a
consolidated level, not just at the level covered by the State
insurance laws. In October 2014, the Federal Reserve began a
quantitative impact study (QIS) to evaluate the potential
effects of its revised regulatory capital framework on
insurance SLHCs and nonbank financial companies supervised by
the Board that engage substantially in insurance underwriting
activity. The Board is conducting the QIS to inform the design
of an appropriate capital framework for these firms.
Q.2. The Fed is tasked with developing capital rules for both
insurance-based SLHCs and SIFIs. What differences do you see
between SLHCs and SIFIs, and how will the capital rules reflect
these differences? Do your international efforts for globally
systemic firms have any influence on your development of
capital rules for insurance-based SLHCs?
A.2. While the capital standards applied to insurance-based
SLHCs and nonbank financial companies supervised by the Board
will respect the realities of insurance activities, the precise
details of the standards will be informed by analysis of the
capital structures, financial activities, riskiness, and
complexity of these two sets of firms, along with other
relevant risk-related factors. To the extent that there are
similarities in these areas between insurance-based SLHCs and
nonbank financial companies, elements of the capital standards
applied to them would likely be similar. Where differences
exist, the standards would be tailored to take into account the
unique characteristics of these firms' insurance operations.
The Board's understanding of these two sets of firms has
been informed by work in a number of different areas, including
what has been learned through the Board's supervision of
insurance-based SLHCs over the past 3 years, the Board's
membership in the International Association of Insurance
Supervisors, the Board's discussions with State insurance
commissioners, and the QIS described in response to Question 1.
We are committed to developing capital requirements that are
appropriate for the business mixes, risk profiles, and systemic
footprints of these two sets of firms.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM THOMAS J. CURRY
Q.1. The issue of FSOC accountability and transparency is one
that I have raised numerous times. Given the magnitude of the
regulatory burden and other costs imposed by a SIFI
designation, it is imperative that the designation process be
as transparent and objective as possible.
Do you object to the public disclosure of your individual
votes, including an explanation of why you support or oppose
such designation?
Will you commit to pushing for greater accountability and
transparency reforms for FSOC? Specifically, will you commit to
push the FSOC to allow more interaction with companies involved
in the designation process, greater public disclosure of what
occurs in FSOC principal and deputy meetings, publish for
notice and comment any OFR report used for evaluating
industries and companies, and publish for notice and comment
data analysis used to determine SIFI designations? If you do
not agree with these proposed reforms, what transparency and
accountability reforms would you be willing to support?
A.1. I am committed to a designation process that is fair, that
provides appropriate levels of transparency, and that is based
on an objective analysis and consideration of the statutory
factors set forth by Congress in the Dodd-Frank Act. The
current designations process, which the Council published for
notice and comment, includes various mechanisms to promote
accountability and to provide companies the ability to interact
and respond to a proposed designation prior to any final action
by the Council. In particular, the Stage 3 phase of the
designation process is iterative providing extensive
opportunities for the company to interact with staff conducting
the analysis and to present information and data that the
company believes is relevant for FSOC's analysis. For example,
for one of the companies that has been designated, the FSOC
spent almost a year conducting its analysis after beginning its
engagement with the company, and the Council considered more
than 200 data submissions from the company that totaled over
6,000 pages. Staff of FSOC members and member agencies had
contact with the company at least 20 times, including seven
meetings with senior management and numerous other telephone
meetings. The FSOC's evaluation, which considered the company's
views and information, culminated in a detailed and lengthy
analysis (over 200 pages) that the FSOC shared with the company
following the proposed designation and before a vote by the
Council on a final designation.
The Council's public basis document, which is part of the
record whenever the Council decides to designate a company,
provides a public record of the views of Council members.
Specifically, the public basis document, which is posted to the
Council's Web site, reflects the views by the assenting Council
members for the designation, with any dissenting views recorded
as part of the public record.
The FSOC recently issued responses to frequently asked
questions about the designation process to provide greater
clarity and transparency on the current process. The Council
has also discussed various changes proposed by stakeholders,
Members of Congress, and other interested parties that could
enhance the current process. Such changes could include, for
example, earlier notification of companies that they are under
review. At the Council's direction, the FSOC's Deputies
Committee has recently held meetings with various stakeholders
to solicit their views and feedback on steps that the Council
could take to provide additional transparency and engagement
during the various phases of the designation process. The
Council intends to have further discussions on this issue at
its upcoming meetings.
More broadly, the Council has taken steps to increase the
overall transparency of Council actions, including providing
more detail in Council minutes and publishing Council meeting
agendas a week in advance, except in exigent circumstances.
Q.2. In the July FSOC meeting, the Council directed staff to
undertake a more focused analysis of industrywide products and
activities to assess potential risks associated with the asset
management industry.
Does the decision to focus on ``products and activities''
mean that the FSOC is no longer pursuing designations of asset
management firms?
Did the FSOC vote on whether to advance the two asset
management companies to Stage 3? If so, why was this not
reported? If not, why was such a vote not taken in order to
provide clarity to the two entities as well as the industry?
A.2. At its recent meetings, the FSOC discussed the Council's
various work streams related to asset managers, including its
work related to analyzing industrywide and firm-specific risks.
Based on those discussions, the Council has agreed to undertake
a more focused analysis of industrywide products and
activities. The objective of this work is to inform the
Council, about what, if any, additional policy actions by FSOC
or its members may be appropriate. The Dodd-Frank Act provides
FSOC with a range of policy tools, including making
recommendations to regulators and the industry in the FSOC's
annual report, issuing formal recommendations to primary
financial regulatory agencies to apply new or heightened
standards or safeguards, designating a nonbank financial
company to be supervised by the Federal Reserve, or designating
payment, clearing, or settlement activities as systemically
important. It would be premature to determine which, if any, of
these policy tools may be most appropriate until the Council's
more in-depth analysis of the industry and its activities are
completed. In light of these decisions, and pending the
completion of these work streams, the Council has not voted on
any action with respect to specific asset management firms.
Q.3. There has been much attention surrounding Operation Choke
Point, a DOJ-led effort with your agencies participating.
Unfortunately, this Operation has resulted in numerous
legitimate small businesses losing access to basic banking
services. I appreciate that your agencies have issued new
guidance last month to address market uncertainty. It is my
understanding that your agencies, as part of this Operation,
refer cases to DOJ if you suspect a violation of the Financial
Institutions Reform, Recovery, and Enforcement Act (FIRREA).
Please provide the number of FIRREA referrals each of your
agencies has made to DOJ as a part of Operation Choke Point.
A.3. The OCC is not a part of Operation Choke Point and has not
made any referrals to DOJ as a part of Operation Choke Point.
Q.4. If your agency did not provide any FIRREA referrals to DOJ
directly in connection with Operation Choke Point, how many
FIRREA referrals has your agency provided to DOJ since DOJ
commenced its Operation Choke Point?
A.4. The OCC expects that potential criminal violations and
suspicious transactions that are indicative of money laundering
or terrorist financing would be referred to the DOJ through the
Suspicious Activity Reporting (SAR) system maintained by
FinCEN. Most SARs are filed by the institutions themselves,
although the OCC may also file SARs, e.g., where a bank fails
to file, or files an incomplete or inaccurate SAR. Since
December 2012, the OCC has filed nine SARs.
The OCC may also reach out directly to DOJ to bring
priority SARs to their attention. In addition, under the Equal
Credit Opportunity Act (ECOA), the OCC is also required to make
a referral to DOJ when it has a ``reason to believe'' that a
bank has engaged in a pattern or practice of discrimination on
a prohibited basis.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM THOMAS J. CURRY
Q.1. With the Volcker Rule, we finally learned the lessons from
the bailout of Long-Term Capital Management and then the 2008
financial crisis that we simply cannot afford to have big,
systemically significant firms making big bets on the ups and
downs of the market. Casino banking is over--if you stick to
your guns and enforce the Rule.
I deeply appreciate the hard work you did to getting to a
final rule last December, and I recognize the hard work you are
doing now to implement it. However, we are still at the
beginning legs of the journey, and I believe in ``trust but
verify''--which requires full, continued cooperation by our
regulators and engagement with the public.
During the financial crisis, we all saw the horrific
results when different regulators saw only parts of the risks
to some firms. There were too many regulatory silos, which do
not work because firms do not function that way. You also need
a complete picture of what is going on in any one institution
and across different firms. Indeed, one of the least recognized
benefits of the Volcker Rule is to force the regulators to pay
attention, together, to trading activities, which have become
so important at so many banks. But critically, this means all
the regulators need full access to all collected data and
information.
In addition, accountability to the public through
disclosure provides another layer of outside oversight and
analysis, as well as equally importantly, public confidence
that Wall Street reform is real.
Based on the track record of various public disclosure
mechanisms out there already--including for example, the CFTC's
positions of traders--there is significant space for reasonably
delayed disclosures of metrics data to enhance Volcker Rule
accountability and public confidence. Now Treasury Deputy
Secretary and then-Federal Reserve Governor Sarah Bloom Raskin
highlighted disclosure in her statement on adoption of the
final rule, and financial markets expert Nick Dunbar has
similarly called for disclosure as a key tool. (See Nick
Dunbar, ``Volcker Sunlights Should Be the Best Disinfectant'',
July 25, 2014, http://www.nickdunbar.net/articles/volcker-
sunlight-should-be-the-best-disinfectant/.) The OCC's Quarterly
Trading Activity Report may be a perfect venue to engage in
this type of disclosure, provided it is expanded to cover the
entire banking group.
First, will you commit to working to ensure that each of
your agencies has a complete picture of an entire firm's
trading and compliance with the Volcker Rule, which can best be
accomplished by having all data in one place so that all
regulators have access to it?
A.1. We agree that it is important for regulators to have a
complete picture of a firm's trading activities and Volcker
compliance efforts. Toward this end, we are working closely
with the other Volcker rulewriting agencies to coordinate our
oversight across multiple legal entities. Coordinated oversight
requires information sharing which in turn may require the
agencies to enter into memoranda of understanding that will
govern the sharing. We are currently working to put such
memoranda in place where needed.
Q.2. Second, are you committed to using disclosure to help
advance compliance with and public trust from the Volcker Rule?
A.2. We support appropriate public disclosures. For example,
the revised market risk capital rule requires banks to publish
data on their trading activities. We note that public
disclosure must be consistent with the Trade Secrets Act and
the Freedom of Information Act. Moreover, as we noted in the
final rule, the purpose of the metrics is to flag activity that
warrants further supervisory scrutiny. The metrics alone are
not necessarily indicative of proprietary trading. As a result,
the metrics data may not provide sufficient information to help
the public identify proprietary trading.
Q.3. The success of the Volcker Rule over the long term will
depend upon the commitment of regulators to the vision of a
firewall between high risk, proprietary trading and private
fund activities, on the one hand, and traditional banking and
client-oriented investment services on the other hand. One of
the most important parts of ensuring that vision is
meaningfully implemented is the December 2013 final rule's
application of its provisions at the ``trading desk'' level,
defined as the ``smallest discrete unit of organization'' that
engages in trading. Unfortunately, reports have emerged
suggesting that banks are already attempting to combine and
reorganize what had been separate trading desks into one
``trading desk'' for Volcker Rule purposes, as a way to game
the metrics-based reporting essential to effective monitoring
by regulators of each institution's compliance with the Volcker
Rule. The OCC has already identified this risk in its Interim
Examination Procedures, and attempted to limit such actions to
instances where the desks were engaged in ``similar
strategies,'' the combination has a ``legitimate business
purpose,'' and the combination assists the firm to ``more
accurately reflect the positions and fluctuations'' of its
trading. I feel the OCC's interim protections may not, however,
be enough to ensure compliance with the final rule. I am deeply
concerned that combining or reorganizing trading desks would
undermine the strength of the metrics-based oversight,
particularly related to whether market-making is truly to serve
near-term customer demand and whether hedging is truly that. To
avoid obscuring evasion by changing the mixture and volume of
the ``flow'' of trading that is reported by the ``trading
desk'' unit, I would suggest that examiners ought to strictly
apply the final rule's approach to ``trading desk'' and apply
the guidance set out by the OCC extremely narrowly, along with
additional protections. For instance, ``similar strategies''
would need to include both the type of the trading (e.g.,
market-making) but also the same or nearly identical products,
as well as by serving the same customer base, among other
standards. As an example, if two desks traded in U.S.
technology stocks and technology stock index futures, combining
those into one desk might make sense, depending on other
factors, such as where the desks were located and what
customers they were serving. But combining, for example,
various industry-specific U.S. equities desks that today are
separate would not pass muster for complex dealer banks.
It is also important to remember that an important
supervisory benefit from implementing the Volcker Rule at a
genuine trading desk level is that regulators will gain a much
deeper, more granular understanding of the risks emanating the
large banks' many different trading desks the kind of risks
that led one particular trading desk to become famous as the
London Whale. When confronted with attempts to reorganize
trading desks, regulators should look carefully at whether
submanagement structures, bonus structures, or other indicia
exist that would suggest that the reorganized ``trading desk''
is not actually the smallest discrete unit of organization
contemplated by the final rule and essential to the metrics-
based oversight system being developed.
Will you commit to scrutinizing, for the purposes of the
Volcker Rule, any reorganizations of trading desks as posing
risks of evasion and will you commit to working jointly to
clarify any guidance on the definition of trading desk for
market participants?
A.3. Yes. As you noted, the OCC has been proactive on this
issue, and we will continue to closely scrutinize any conduct
that could indicate an attempt to evade the requirements of the
Volcker Rule.
Q.4. Ensuring speedy compliance with the provisions of the
Merkley-Levin Volcker Rule is a top priority for strong
implementation. It has already been 4 years since adoption, and
banks should be well on their way to conforming their trading
and fund operations. However, as you know, we also provided for
an additional 5 years of extended transition for investments in
``illiquid funds,'' which were expected to include some types
of private equity funds. We did this because some private
equity funds, such as venture capital funds, do not usually
permit investors to enter or exit during the fund's lifetime
(usually 10 years or so) because of the illiquidity of those
investments.
As you know, the Federal Reserve Board's rule on the
``illiquid funds'' extended transition interprets the statutory
provision of a ``contractual commitment'' to invest as
requiring a banking entity, where a contract permits divestment
from a fund, to seek a fund manager's and the limited partners'
consent to exit a fund. The rule, however, provides for the
Board to consider whether the banking entity used reasonable
best efforts to seek such consent but that an unaffiliated
third party general partner or investors made unreasonable
demands. I strongly support the Board's desire to implement the
Volcker Rule in a speedy manner. In addition, the Board's
approach in the final conformance rule goes a long way to
ensuring that the illiquid funds extended transition only be
available for investments in truly illiquid funds, and not a
way to avoid divestment of hedge funds and private equity
funds.
At the same time, we designed the provision to provide for
a smooth wind-down for illiquid funds. Indeed, I am sensitive
to the legitimate business needs of firms seeking to comply
with the Volcker Rule while maintaining relationships with
important customers to whom they may seek to provide
traditional banking services.
Accordingly, I would urge the Board to clarify that a
banking entity's requirement to make ``reasonable efforts'' to
exercise its contractual rights to terminate its investment in
an illiquid fund could be satisfied, for example, by a
certification by the banking entity (a) that the banking
entity's exit from the fund would be extraordinary from the
perspective of how most investors enter or exit the fund (i.e.,
the investment contract does not routinely or ordinarily
contemplate entry or exit, and/or such other indicia as are
necessary to help distinguish between illiquid private equity
funds and other funds, like hedge funds, that ordinarily and
routinely permit investor redemptions), (b) that inquiring with
third-party fund managers and limited partners regarding
termination would result in a significant detriment to the
business of the banking entity and (c) that the banking entity
believes that the divestment would result in losses,
extraordinary costs, or otherwise raise unreasonable demands
from the third-party manager relating to divestment (or the de
facto equivalent thereto).
Such a certification from the banking entity, along with
the language of the relevant fund agreements and such other
requirements as the Board determines appropriate, would obviate
the need to seek consent from third-party fund managers.
Have you considered clarifying this in a FAQ?
A.4. By statute, the Board of Governors of the Federal Reserve
System has sole authority to grant the special conformance
period for illiquid funds, and, accordingly, we defer to the
Board on this issue.
Q.5. We've recently seen reports that the largest Wall Street
banks are nominally ``deguaranteeing'' their foreign affiliates
in order to avoid coverage under U.S. regulatory rules,
especially those related to derivatives. This
``deguaranteeing'' appears to be based on a fiction that U.S.
banks do not actually guarantee the trading conducted by
foreign subsidiaries, and hence would not be exposed to any
failure by the foreign subsidiary.
Can you comment on that, and specifically, whether you
believe that U.S. bank or bank holding company could be exposed
to losses from--or otherwise incur liability related to--a
foreign affiliate's trading even when no explicit guarantee to
third parties exists. Please specifically address whether an
arrangement, commonly known as a ``keepwell,'' provided by the
U.S. parent or affiliate to the foreign affiliate potentially
could create such exposure--and specifically, liability--for
the U.S. entity.
A.5. There are a number of transactions and arrangements that
could expose a U.S. bank or a bank holding company to losses
from a foreign affiliate's trading activities. For example, as
the OCC, the Federal Reserve Board, FDIC and Federal Housing
Finance Agency noted in the joint proposed swaps margin rule,
many swaps agreements contain cross-default provisions that
give swaps counterparties legal rights against certain
``specified entities,'' even when no explicit guarantee to a
third party exists. See ``Margin and Capital Requirements for
Covered Swaps Entities'', 79 FR 57348 (Sept. 24, 2014). In
these arrangements, a swaps counterparty of a foreign
subsidiary of a U.S. covered swap entity may have a contractual
right to close out and settle its swaps positions with the U.S.
entity if the foreign subsidiary of the U.S. entity defaults on
its own swaps positions with the counterparty. While not
technically a guarantee of the foreign subsidiary's swaps,
these provisions may be viewed as reassuring counterparties to
foreign subsidiaries that the U.S. bank stands behind its
foreign subsidiaries' swaps. Other similar arrangements may
include liquidity puts or keepwell agreements.
In a keepwell agreement between a bank and an affiliate, a
bank or holding company typically commits to maintain the
capital levels or solvency of the affiliate. To the extent a
foreign affiliate's trading activity reduces its capital or
threatens its solvency, a keepwell agreement issued by a U.S.
member bank could potentially expose the bank to losses.
In addition, the Federal Reserve generally views a keepwell
agreement between a member bank and its affiliate as similar in
terms of credit risk to issuing a guarantee on behalf of an
affiliate. See 67 Federal Register 76560, 76569 (Dec. 12,
2002). 23A does not hinge on credit risk. Such an agreement
would generally be subject to the quantitative and collateral
restrictions in section 23A of the Federal Reserve Act. Under
section 23A's quantitative limits, the maximum amount of
covered transactions that a member bank may enter into with an
affiliate, including guarantees issued on behalf of the
affiliate, is 10 percent of the bank's capital. Accordingly,
the quantitative limits would prohibit a keepwell agreement
that is unlimited in amount. Even if the bank's obligations
under the keepwell agreement is limited to less than 10 percent
of the bank's capital, the collateral requirements in section
23A, as amended by section 608 of Dodd-Frank, require that a
bank's guarantee be secured by eligible collateral at all times
the guarantee is in place.
Q.6. Moreover, please comment on whether the size and
importance to the U.S. parent or affiliate of the foreign
affiliate's activities could itself create an implied guarantee
such that the U.S. firm would have major reputational or
systemic risk reasons to prevent the foreign affiliate from
incurring significant losses or even failing--similar to
rescues that occurred during the financial crisis of entities
that were supposed to be bankruptcy remote.
A.6. In the absence of an explicit guarantee, a U.S. bank or
bank holding company ordinarily would not have a legal
obligation to step in. Moreover, a bank's ability to provide
assistance to a foreign affiliate would be limited under
various laws including sections 23A and 23B of the Federal
Reserve Act. For example, under section 23B, a member bank
could not provide assistance to a foreign affiliate unless that
assistance was provided to the affiliate on terms and under
circumstances, including credit standards, that are
substantially the same as a comparable transaction between a
bank and a nonaffiliate. In addition, the requirement under
section 23B also applies to certain transactions in which a
member bank engages with an unaffiliated party where the
transaction benefits an affiliate. It also applies to
transactions with an unaffiliated party if an affiliate has a
financial interest in the unaffiliated party or is a
participant in the transaction.
Q.7. Finally, many of these foreign bank subsidiaries are so-
called ``Edge Act'' corporations, which I understand are
consolidated with the insured depository subsidiary for many
purposes. Please comment on whether there is any chance that
losses in these Edge Act corporations, particularly losses in
their derivatives operations, could impact the deposit
insurance fund.
A.7. A bank's Edge Act subsidiaries are consolidated with the
bank for financial reporting purposes under GAAP. However,
accounting consolidation does not affect the bank's legal
liability for its subsidiaries. Absent a guarantee or similar
arrangement, the bank is not ordinarily liable for an Edge Act
subsidiary's losses. See 12 U.S.C. 621 (shareholders in an Edge
Act corporation are liable for the amount of their unpaid stock
subscriptions). If an Edge Act subsidiary incurred losses in
excess of the bank's equity investment, then the bank could
place the subsidiary in bankruptcy (or a similar proceeding).
Under GAAP, this would deconsolidate the subsidiary from the
bank's balance sheet. In addition, Edge Act corporations
generally may not take deposits in the United States, and the
FDIC only insures U.S. deposits.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN
FROM THOMAS J. CURRY
Q.1. During the July 15th Semiannual Monetary Policy Report
hearing with Chair Yellen, I outlined the importance for State
and local governments of including municipal securities as
``High Quality Liquid Assets'' in the Liquidity Coverage Ratio
(LCR) rule proposed by the Federal Reserve, FDIC, and OCC. I
was therefore disappointed to learn that municipal securities
were excluded from eligibility when the rule was recently
finalized, in spite of comments by the Federal Reserve
suggesting municipal securities are sufficiently liquid and
their inclusion as HQLA should be given additional
consideration. I was also pleased to hear your responses during
the hearing indicating you would be open to revising the
inclusion of municipal securities as HQLA if additional
analysis showed they had similar liquidity levels. As banks are
now beginning the process of optimizing their balance sheets
around the final LCR rule, it is important that the issue of
municipal securities is addressed expeditiously to avoid an
impact on this market.
What is the timeline for issuing a proposal specific to
municipal securities and the LCR, given that Federal Reserve
Board staff analysis has demonstrated that some municipal
securities are at least as liquid as corporate bonds that are
included as HQLA?
A.1. The OCC looks forward to discussing with the Federal
Reserve Board any additional research or specific proposals on
the possibility of calibrating an LCR standard that
differentiates certain municipal securities from others with
broader illiquid characteristics. If such a standard is
identified that is consistent with the liquidity risk
management goals of the LCR rule, the OCC will work with the
Federal Reserve Board and the Federal Deposit Insurance
Corporation (FDIC) to adjust the rule accordingly. The OCC
generally regards banks' investments in municipal securities as
a prudent activity, in which banks have historically engaged
for purposes of yield and community support, not for liquidity
risk management. In fact, banks covered by the LCR rule have
substantially increased their investments in municipal
securities since the agencies issued the LCR proposal and final
rule that did not include municipal securities as HQLA. Over
the past year, LCR banks' percent increase in holdings of
municipal securities is nearly double the percent increase in
such holdings for the overall banking industry.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM THOMAS J. CURRY
Q.1. On the Liquidity Coverage Ratio (LCR) Rule: A number of
ABS classes, including securitized auto and credit card loans,
were denied any HQLA status in the recently finalized LCR rule.
What was your reasoning for this?
A.1. Evidence from the 2007-2009 financial crisis and the
period following indicates that the market demand for a variety
of securitization issuances can decline rapidly during a period
of stress and may not rapidly recover. ABS may be dependent on
a diverse range of underlying asset classes, each of which may
suffer from adverse effects during a period of significant
stress. Furthermore, the characteristics of ABS securitization
structures may be tailored to a limited range of investors. The
ability to monetize these securitization issuances and whole
loans through or in the repurchase market may be limited in a
period of stress.
Moreover, although certain ABS issuances, such as ABS
backed by loans under the Federal Family Education Loan Program
and residential mortgage-backed securities (RMBS) backed solely
by securitized ``qualified mortgages'' or mortgages guaranteed
by the Federal Housing Authority or the Department of Veterans
Affairs, may have lower credit risk, the liquidity risk profile
of such securities, including the inability to monetize the
issuance during a period of stress, does not warrant treatment
as HQLA. The ace notes that ABS and RMBS issuances have
substantially lower trading volumes than MBS that are
guaranteed by U.S. GSEs and demand for such securities has
decreased, as shown by the substantial decline in the number of
issuances since the recent financial crisis.
Q.2. Because many of the banks that need to comply with the LCR
comprise a significant number of the investors in these ABS,
will denying HQLA status to ABS increase borrowing costs for
consumers and small businesses? Was a cost-benefit analysis
conducted on this particular provision of the rule? Would you
be open to sharing that analysis, on this provision or on the
rule as a whole, with Congress?
A.2. The OCC reviewed investments in ABS by banks that need to
comply with the LCR final rule and notes that holdings by these
banks comprise less than 10 percent of the total ABS market as
of the second quarter of 2014. Furthermore, the final rule does
not prohibit covered companies from continuing to invest in
ABS. Banks covered by the LCR rule generally have already
adjusted their funding profile and assets in anticipation of
the LCR requirement with little impact on the overall market.
Moreover, because the LCR rule applies to a limited number of
U.S. financial institutions, we do not expect a significant
general increase in costs or prices for consumers. Therefore,
we do not believe the final rule will have a significant impact
on overall demand for ABS and increase the cost of funding.
The OCC has analyzed the final rule, as a whole, under the
factors set forth in the Unfunded Mandates Reform Act of 1995
(UMRA) (2 U.S.C. 1532). For purposes of this analysis, the ace
considered whether the final rule includes a Federal mandate
that may result in the expenditure by State, local, and tribal
governments, in the aggregate, or by the private sector, of
$100 million or more (adjusted annually for inflation) in any 1
year. The OCC's UMRA written statement is available at: http://
www.regulations.gov, Docket ID OCC-20130016.
Q.3. Additionally, the finalized LCR rule confers no HQLA
status to private-label mortgage-backed securities while
conferring GSE-guaranteed mortgage-backed securities Level 2A
HQLA status. Republicans and Democrats are committed to
attracting more private capital to housing finance. To what
extent did you consider the ramifications of this decision as
it relates to broader housing finance reform?
A.3. In identifying the types of assets that would qualify as
HQLA in the final rule, the agencies considered the following
categories of liquidity characteristics, which are generally
consistent with those of the Basel III Revised Liquidity
Framework: (a) risk profile; (b) market-based characteristics;
and (c) central bank eligibility. The agencies continue to
believe that private-label mortgage-backed securities do not
meet the liquid and readily marketable standard in U.S.
markets, and thus do not exhibit the liquidity characteristics
necessary to be included as HQLA under the final rule. Evidence
from the 2007-2009 financial crisis and the period following
indicates that the market demand for a variety of
securitization issuances can decline rapidly during a period of
stress, and that such demand may not rapidly recover. In
contrast, the OCC recognizes that some securities issued and
guaranteed by U.S. GSEs consistently trade in very large
volumes and generally have been highly liquid, including during
times of stress.
Q.4. Doesn't the disparate treatment of PLMBS and GSE MBS
direct more funding into GSE-guaranteed mortgages and make it
harder for private capital (without Government guarantees from
the GSEs, FHA, VA, or USDA) to reenter the market?
A.4. The agencies recognize the importance of capital funding
to the U.S. residential mortgage markets and highlight that the
final rule does not prohibit covered companies from continuing
to invest in private label MBS. The agencies do not expect, and
have not observed, that banking organizations base their
investment decisions solely on regulatory considerations and do
not anticipate that exclusion of this asset class from HQLA
will significantly deter investment in these assets.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
FROM THOMAS J. CURRY
Q.1. As we examine Wall Street regulation and soundness, it is
critical that we be alert to outside threats as well. Over the
past year, there have been a number of extensive cyberattacks
on American companies, including large financial institutions.
Combatting these transnational crimes requires cooperation
across Government and industry.
As I have previously asked both Secretary Lew and Chair
Yellen--Do you pledge to make cybersecurity a priority?
Do you believe FSOC can fulfill its statutory mandate to
identify risks and respond to emerging threats to financial
stability without making cybersecurity a priority?
As a member of FSOC, can you identify any deficiencies in
the U.S.'s ability to prevent cyberattacks that require
Congressional action?
What steps has FSOC taken to address the prevention of
future cyberattacks on financial institutions, such as the
recent breach at JPMorgan Chase?
A.1. As noted in my written testimony, the operational risks
posed by cyberattacks is one of the most pressing concerns
facing the financial services industry today. It is a priority
that FSOC members share and is one of the emerging threats that
the FSOC identified and discussed in its annual reports. FSOC
provides a mechanism to achieve collaborative efforts to
address emerging cyberthreats and has set forth specific
recommendations to advance efforts on cybersecurity. For
example, in its 2014 annual report, FSOC recommended that
Treasury continue to work with regulators, other appropriate
Government agencies and private sector financial entities to
develop the ability to leverage insights from across the
Government and other sources to inform oversight of the
financial sector and to assist institutions, market utilities,
and service providers that may be targeted by cyberincidents.
The Council also recommended that financial regulators continue
their efforts to assess cyber-related vulnerabilities facing
their regulated entities, identify gaps in oversight that may
need to be addressed, and to inform and raise awareness of
cyber threats and incidents.
Shoring up the industry's defenses against cyberthreats
also is one of my key priorities as Comptroller and as chairman
of the Federal Financial Institutions Examination Council
(FFIEC). Combating the threats posed by such attacks requires
ongoing vigilance and close cooperation and collaboration by
regulators, law enforcement, and industry participants. To help
foster such coordination, one of my first actions as chairman
of the FFIEC was to call for the creation of the Cybersecurity
and Critical Infrastructure Working Group (CCIWG). This group
coordinates with intelligence, law enforcement, the Department
of Homeland Security, and industry officials to provide member
agencies with accurate and timely threat information.
The FFIEC's CCIWG work is consistent with the FSOC's
recommendations. A key activity of the working group is to
monitor and issue alerts to the industry about emerging
threats. Within its first year, this working group released
joint statements on the risks associated with ``distributed
denial of service'' attacks, automated teller machine
``cashouts,'' and the wide-scale ``Heartbleed'' vulnerability.
Last month, the group prepared and issued an alert to
institutions about a material security vulnerability in Bourne-
again shell (Bash) system software widely used in servers and
other computing devices that could allow attackers to access
and gain control of operating systems. The joint statements and
alerts outline the risks associated with the threats and
vulnerabilities, the risk mitigation steps that financial
institutions are expected to take, and additional resources to
help institutions mitigate the risks. In addition to these
actions, OCC staff and other CCIWG members work closely with
law enforcement, Treasury, and other Government officials to
share information about emerging threats on both a classified
and unclassified basis. The threat of cyberattacks is not
limited to large institutions. Earlier this year, the CCIWG
hosted an industry webinar for over 5,000 community bankers to
help raise the awareness of cybersecurity issues and steps that
smaller banks can take to guard against such threats. The group
recently conducted a cybersecurity assessment of over 500
community institutions. The information from this assessment
will help FFIEC members identify and prioritize actions that
can enhance the effectiveness of cybersecurity-related guidance
to community financial institutions.
The CCIWG is also working to identify any gaps in the
regulators' legal authorities, examination procedures and
examiner training in connection with our supervision of the
banking industry's cybersecurity readiness and its ability to
address the evolving and increasing cyberthreats. If our work
identifies gaps in our legal authorities that require
Congressional action, we will be happy to share those with the
Committee.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
FROM THOMAS J. CURRY
Q.1. Last year, I wrote to the Office of the Comptroller of the
Currency (OCC) regarding the implementation of rules and
guidance regarding private flood insurance policies, as
required under the Biggert-Waters Flood Insurance Reform Act.
In passing that legislation, it was the intent of Congress to
reaffirm existing law that lenders accept private flood
insurance policies to provide more choices for consumers. The
OCC, Federal Reserve, FDIC and several other agencies issued a
guidance memo claiming private insurance provisions in Biggert-
Waters are not effective until final rulemaking. This has
caused confusion among lenders who now routinely reject all
private flood insurance policies.
In response to my letter, the OCC wrote back explaining,
``We expect to issue a proposed rule within the next several
months.'' That was over a year ago I received that response and
there is still no progress on this issue.
I would like to receive a status update on the details
about this proposed rule on private flood insurance and receive
a timeline of when it will be issued.
If there is not going to be regulations anytime soon, is
there any way the OCC, FDIC, Federal Reserve can allow lenders
to accept private flood insurance at their discretion without
penalty until there is a final rule?
Senator Tester and I have introduced legislation that would
solve this problem by allowing private flood insurance to be
sold if approved by State regulators. Would the OCC, FDIC, or
Federal Reserve consider supporting a legislative solution to
this problem instead of rulemaking?
A.1. Agency staffs are meeting regularly to draft rules that
take into account the public comments received from our notice
of proposed rulemaking implementing the Biggert-Waters Act and
the many issues they raised. With respect to private flood
insurance, commenters generally supported adding a provision to
the final rule specifically permitting the discretionary
acceptance of private flood insurance, and requested more
guidance as to the statute's definition of private flood
insurance. The agencies are working to determine the best way
to provide this guidance in our rule.
Until the agencies issue final rules, current law
applicable to private insurance will continue to apply. Under
current law, banks and thrifts may continue to accept private
flood insurance in satisfaction of the National Flood Insurance
Program (NFIP) requirements, without penalty, if certain
conditions are met. \1\ The Biggert-Waters Act did not change
the discretionary acceptance of private flood insurance, but
merely mandated the acceptance of certain private policies that
meet the statutory definition of ``private flood insurance.''
The agencies have consistently advised institutions that they
may continue to accept such private flood insurance at this
time, and that the requirement to accept private flood
insurance that meets the Biggert-Waters definition is not
effective until our final rule is issued. We specifically made
these points in the preamble to our notice of proposed
rulemaking. \2\
---------------------------------------------------------------------------
\1\ In general, a lender may accept a private flood insurance
policy that meets the criteria for a standard flood insurance policy
(SFIP) set forth by FEMA in its former Mandatory Purchase of Flood
Insurance Guidelines. To the extent a policy differs from a SFIP, a
lender should carefully examine the differences before accepting the
policy. See ``Loans in Areas Having Special Flood Hazards; Interagency
Questions and Answers Regarding Flood Insurance'', 74 FR 35914 (July
21, 2009). See also OCC regulations at 12 CFR 22.3, which require that
a designated loan be covered by ``flood insurance'' without specifying
that it be flood insurance provided under the NFIP or a private policy.
Furthermore, the sample flood insurance notice included in Appendix A
of part 22 includes language informing the borrower that flood
insurance coverage may be available from private insurers that do not
participate in the NFIP.
\2\ See 78 FR 65108, at 65110 and 65114. (Oct. 30, 2013).
---------------------------------------------------------------------------
We believe that a regulatory solution regarding private
flood insurance is possible and that it is premature to pursue
legislation such as the Heller-Tester bill.
Q.2. Recently, the Treasury Department indicated that the
Financial Stability Oversight Council was switching the focus
of its asset management examination toward activities and
products rather than individual entities.
Will you confirm that individual asset management companies
are no longer being considered for possible systemically
important designation?
A.2. At its recent meetings, the FSOC discussed the Council's
various work streams related to asset managers, including its
work related to analyzing industrywide and firm-specific risks.
Based on those discussions, the Council agreed to undertake a
more focused and fuller analysis of industrywide products and
activities. The objective of this work is to inform the Council
about what, if any, additional policy actions by FSOC or its
members may be appropriate. The Dodd-Frank Act provides FSOC
with a range of policy tools, including making recommendations
to regulators and the industry in the FSOC's annual report,
issuing formal recommendations to primary financial regulatory
agencies to apply new or heightened standards or safeguards to
an activity, designating a nonbank financial company to be
supervised by the Federal Reserve, or designating payment,
clearing, or settlement activities as systemically important.
It would be premature to determine which, if any, of these
policy tools may be most appropriate until the Council's more
in-depth analysis of the industry and its activities is
completed.
------
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM RICHARD CORDRAY
Q.1. In your testimony before this Committee in June, you
discussed the progress being made on coming up with a rural
definition for the Bureau's mortgage rules. Can you provide an
update on that process?
A.1. The Consumer Financial Protection Bureau (Bureau) has
received extensive feedback on its definitions of
``underserved'' and ``rural'' since it first interpreted the
statutory term ``rural or underserved areas'' for purposes of
its mortgage rules under Title XIV of the Dodd-Frank Wall
Street Reform and Consumer Financial Protection Act. As you
know, the Bureau amended the Ability-to-Repay Rule last year to
provide a 2-year transition period, during which balloon loans
made by small creditors and held in portfolio will be treated
as Qualified Mortgages regardless of where a particular
creditor originates mortgage loans. During this transition
period, the Bureau committed to reviewing whether its
definitions of ``rural'' and ``underserved'' should be
adjusted. We committed to such a review to ensure that the
Bureau's definitions reflect significant differences among
geographic areas, to calibrate access to credit concerns, and
to facilitate implementation and consumer protection as
mandated by Congress. The Bureau expects to release in early
2015 a notice of proposed rulemaking in connection with certain
provisions that modify general requirements for small creditors
that operate predominantly in ``rural or underserved'' areas,
while it continues to assess possible additional guidance that
would facilitate the development of automated underwriting
systems for purposes of calculating debt-to-income ratios in
connection with qualified mortgage determinations and other
topics.
Q.2. Although the CFPB does not have examination authority over
financial institutions with total assets of less than $10
billion, its rules can have an impact on smaller institutions.
Can you describe what you have done to ensure that the needs
and concerns of community banks and credit unions are
considered at the Bureau?
A.2. Community banks and credit unions play critical roles in
ensuring a fair, transparent, and competitive marketplace for
consumer financial products and services. They generally base
their businesses on building personal, long-term customer
relationships, and can be a lifeline to hard-working families.
As you note, the Consumer Financial Protection Bureau
(Bureau) has supervisory authority over depository institutions
and credit unions with total assets of more than $10 billion
and their respective affiliates, but other than the limited
authority under the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the Dodd-Frank Act), the Bureau does not have
supervisory authority regarding credit unions and depository
institutions with total assets of $10 billion or less. Although
the Bureau does not have regular contact with these
institutions in its supervisory capacity, the Bureau takes
steps to ensure that the agency considers the needs and
concerns of community banks and credit unions.
Before proposing certain rules that may have a significant
impact on a substantial number of small entities, the Bureau
convenes a Small Business Review Panel pursuant to the Small
Business Regulatory Enforcement Fairness Act and meets with and
gathers input from community banks and credit unions under $550
million in assets. The Bureau also engages in other outreach
efforts to gather feedback from community banks and credit
unions, including holding roundtables and other outreach
meetings and consulting with the financial regulatory agencies
that have primary examination authority over such entities. In
fact, the Bureau has met with representatives from community
banks and credit unions in all 50 States.
After issuing significant substantive regulations, the
Bureau continues to support community banks and credit unions
with their regulatory implementation and compliance efforts.
For example, in connection with the new mortgage rules recently
issued pursuant to Title XIV of the Dodd-Frank Act, the Bureau
published small entity compliance guides and other support
materials on its Web site, held educational webinars, and
participated in numerous presentations and speaking events
attended by community banks and credit unions.
As you know, the Bureau also created the Community Bank
Advisory Council and the Credit Union Advisory Council, at your
and others' urging. Those councils, which consist of community
bankers and credit union leaders from across the country,
advise the Bureau on regulating consumer financial products or
services and specifically share their unique perspectives and
provide feedback on the Bureau's activities. The Bureau also
established the Office of Financial Institutions and Business
Liaison to ensure that the Bureau understands the needs and
concerns of financial institutions, including community banks
and credit unions.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM RICHARD CORDRAY
Q.1. The issue of FSOC accountability and transparency is one
that I have raised numerous times. Given the magnitude of the
regulatory burden and other costs imposed by a SIFI
designation, it is imperative that the designation process be
as transparent and objective as possible.
Do you object to the public disclosure of your individual
votes, including an explanation of why you support or oppose
such designation?
Will you commit to pushing for greater accountability and
transparency reforms for FSOC? Specifically, will you commit to
push the FSOC to allow more interaction with companies involved
in the designation process, greater public disclosure of what
occurs in FSOC principal and deputy meetings, publish for
notice and comment any OFR report used for evaluating
industries and companies, and publish for notice and comment
data analysis used to determine SIFI designations? If you do
not agree with these proposed reforms, what transparency and
accountability reforms would you be willing to support?
A.1. The Financial Stability Oversight Council (Council) is
firmly committed to conducting its business openly and
transparently. For example, consistent with this commitment,
the Council voluntarily solicited public comment three separate
times on its process for designating nonbank financial
companies. The Council published a final rule and interpretive
guidance in 2012. As described in the rule and interpretive
guidance, firms under review have extensive opportunities to
engage with staff representing the Council members before any
vote on a proposed designation. Before the Council votes on
whether to make a proposed designation, the company is invited
to submit information and meet with staff, and the Council
carefully considers the submitted information and the views of
the company. For example, for one of the companies that has
been designated, the Council spent over a year conducting its
analysis and considered more than 200 data submissions from the
company that totaled over 6,000 pages. Council staff engaged
with this company at least 20 times, including seven meetings
with senior management and numerous other telephone meetings.
After the Council votes to make a proposed designation, it
provides the company with a detailed written explanation of the
Council's basis. Before any decision to designate becomes
final, the company has a right to a hearing to contest the
proposed designation, for which the company can submit written
materials. The company may also request an oral hearing. These
procedures provide the company with an opportunity to respond
directly to the specific information that the Council has
considered. Of the three companies that the Council has
designated, only one firm requested a hearing, and the Council
heard directly from the company's representatives. The Council
considered the information presented during this hearing in its
evaluation of the company before a final designation was made.
Although the Council is not subject to the Sunshine Act, it
has voluntarily adopted nearly all of the statute's
transparency-related provisions in its own transparency policy.
For example, the Council opens meetings to the public whenever
possible, publicly announces meetings and information about
meeting agendas 1 week in advance, and publishes minutes that
include a record of all votes. The minutes of the meetings
describing the vote also detail the votes of individual members
of the Council.
Regarding the information used by the Council in its
analysis, it is critical to recognize that much of this
information contains supervisory and other market-sensitive
data, including information about individual firms,
transactions, and markets that may only be obtained if
maintained on a confidential basis. Protection of this
information is necessary in order to, among other things,
prevent the disclosure of trade secrets and commercial or
financial information obtained from the firm and to prevent
potential destabilizing market speculation that could occur if
that information were to be disclosed.
Q.2. In the July FSOC meeting, the Council directed staff to
undertake a more focused analysis of industrywide products and
activities to assess potential risks associated with the asset
management industry.
Does the decision to focus on ``products and activities''
mean that the FSOC is no longer pursuing designations of asset
management firms?
Did the FSOC vote on whether to advance the two asset
management companies to Stage 3? If so, why was this not
reported? If not, why was such a vote not taken in order to
provide clarity to the two entities as well as the industry?
A.2. At its meeting on July 31, 2014, the Council discussed its
ongoing assessment of potential industrywide and firm-specific
risks to the United States' financial stability arising from
the asset management industry and its activities. At that
meeting, the Council directed staff to undertake a more focused
analysis of industrywide products and activities to assess
potential risks associated with the asset management industry.
At its meeting on September 4, 2014, after discussing Council
members' views of priorities for the analysis of potential
risks associated with the asset management industry, the
Council directed staff to further develop their detailed work
plan for carrying out the analysis of industrywide products and
activities. As the Council continues to review this industry,
it is important to note that there are no predetermined
outcomes. There are a number of options available if the
Council identifies meaningful risks to United States' financial
stability.
Q.3. I understand that the Department of Education (DOE) has
been collaborating with the CFPB on a rulemaking for student
bank accounts so I want to raise the same concerns with you
that I raise in a letter to Secretary Duncan last month.
Specifically, I am concerned that a final DOE rule that fails
to take into account existing prudential and consumer finance
regulations for the underlying banking products will create
regulatory confusion and cause some financial institution to
exit this market to the detriment of students.
Please explain the scope and extent of CFPB's collaboration
with the DOE on this rulemaking. Specifically, please explain
how the CFPB has advised the DOE on ensuring that DOE's
regulations are not in conflict with existing laws and
guidance.
Has the CFPB conducted any analysis on the cost and
availability of credit and banking products to students as a
result of the DOE's proposed rules? If not, why not and will
the CFPB undertake such analysis at a future date?
A.3. The Consumer Financial Protection Bureau (Bureau) shares
many of the concerns raised by the Government Accountability
Office and the Department of Education's Inspector General,
among others, about challenges in the market for student
banking products, particularly financial products used to
access Federal grants and scholarships.
In 2012, the Federal Deposit Insurance Corporation (FDIC)
reached a settlement with one of the largest participants in
this market. Among other things, the FDIC found that Higher One
was: charging student account holders multiple nonsufficient
fund (NSF) fees from a single merchant transaction; allowing
these accounts to remain in overdrawn status over long periods
of time, thus allowing NSF fees to continue accruing; and
collecting the fees from subsequent deposits to the students'
accounts, typically funds for tuition and other college
expenses. The settlement provides for $11 million in refunds to
approximately 60,000 student victims, in addition to civil
money penalties. \1\
---------------------------------------------------------------------------
\1\ https://www.fdic.gov/news/news/press/2012/pr12092.html
---------------------------------------------------------------------------
In July of this year, the Federal Reserve Board of
Governors (Board) also issued a consent order to Cole Taylor
Bank to address illegal conduct related to its partnership with
Higher One. The order requires Cole Taylor Bank to cease its
illegal conduct and pay a civil money penalty of approximately
$3.5 million. The Board is also pursuing remedial actions
against Higher One, including the payment of restitution for
its past practices. Actions are also being pursued against
another State member bank that has a similar arrangement with
Higher One. \2\
---------------------------------------------------------------------------
\2\ http://www.federalreserve.gov/newsevents/press/enforcement/
20140701b.htm
---------------------------------------------------------------------------
On March 26, 2014, at the invitation of the Department of
Education, the Bureau provided a technical presentation to the
negotiated rulemaking committee established to consider
regulations related to third-party disbursement of Federal
student aid. The presentation was conducted at a public meeting
hosted by the Department of Education. Written materials are
available on both the Department of Education's and the
Bureau's Web sites. \3\
---------------------------------------------------------------------------
\3\ http://www.consumerfinance.gov/f/201403_cfpb_presentation-to-
department-education-rulemaking-committee.pdf
---------------------------------------------------------------------------
One of the primary purposes of the Department of
Education's consultation with the Bureau is to ensure that any
potential regulations do not overlap or conflict with Federal
consumer financial laws. As the Secretary considers any
potential regulations, Department of Education staff solicited
feedback from the Bureau on the applicability of certain
Federal consumer financial laws on products heavily used in
this marketplace, such as debit and prepaid cards. To date, the
Department of Education has not proposed any regulations
related to third-party disbursement of Federal student aid.
However, in the Bureau's presentation to the Department of
Education's negotiated rulemaking committee on March 26, 2014,
Bureau staff shared relevant analysis at the request of the
Department of Education to assess whether marketing
partnerships between institutions of higher education and
financial institutions increase availability of banking
products to enrolled students.
The Bureau, in coordination with the FDIC, analyzed the
2011 National Survey of Unbanked and Underbanked Households, a
supplement to the Census Bureau's Current Population Survey.
The analysis suggests that almost all students without bank
accounts have the ability to access one outside of any school
marketing partnership, but have not yet done so or have chosen
not to open one. Very few students (< 0.5 percent) are unable
to open a bank account. Reasons include:
Negative reporting to specialty credit bureaus due
to past issues (e.g., Chex Systems)
Undocumented students who are unable or have not
obtained Individual Taxpayer Identification Numbers
Suspicion of being a threat to national security or
engaging in money laundering
The Bureau also looked at the student banking product
offerings for many financial institutions with a national
reach. Many of these financial institutions offer products to
students at schools which do not have a marketing arrangement
with a financial institution.
This preliminary analysis suggests that students currently
have choice in a competitive marketplace, even when their
institution of higher education is not being paid to market a
product for a particular financial institution.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM RICHARD CORDRAY
Q.1. On Data Gathering: In questions for the record following
the Senate Committee on Banking, Housing, and Urban Affairs
hearing on ``The Consumer Financial Protection Bureau's Semi-
Annual Report to Congress'', I noted that both the CFPB and the
OCC had each gathered similar data from nine credit card
issuers. I also noted that gathering data from ten issuers
would have triggered an OMB review and a period for public
comment. It would appear that the decision to gather data from
nine issuers each and then share that data, as agreed to in a
memorandum of understanding, was made to circumvent the
important safeguards of OMB review and public comment.
My question to you was ``With a data mining exercise of
this size and scope, shouldn't it be reviewed and shouldn't the
public have the opportunity to express their opinions on what
is happening with their data?'' Unfortunately, your response
that the ``Bureau made the determination that the PRA does not
apply . . . '' did not directly address my question. Can you
please provide a more thorough answer to my question? Does the
CFPB believe that there is no value in being transparent and
gathering public comment before a large-scale data collection
effort begins?
A.1. The Consumer Financial Protection Bureau (Bureau) values
transparency in its work. We have been open about the fact that
we collect information on the credit card industry, and have
been responsive to inquiries from Members of Congress and other
oversight bodies about the nature of our credit card data
collection. Please note that the Bureau's credit card database
does not contain any directly identifying personal information
such as name, address, social security number, or credit card
account numbers.
The Bureau has a robust Paperwork Reduction Act (PRA)
program designed to ensure the transparency, quality, and
economy of information gathered by the Bureau. This program
includes reviewing potential data collections with the Office
of Management and Budget (OMB), and providing public notice and
seeking comment on the Bureau's proposed information
collections as defined by the PRA.
The Bureau, through its PRA Officer, recently consulted
again with the OMB regarding the applicability of the PRA to
the Bureau's ongoing collection of credit card information, and
the Bureau's credit card data information-sharing agreement
with the Office of the Comptroller of the Currency (OCC).
Following its consultation with the Bureau, OMB has confirmed
that the Bureau's data collection, including its information-
sharing agreement with the OCC, is in compliance with the PRA.
In its written response to the Bureau, OMB states that the
Bureau's credit card data collection effort ``is not covered by
the Paperwork Reduction Act (PRA)'' (emphasis in original) and
therefore does not require any additional action by the Bureau.
Q.2. In questions for the record following the Senate Committee
on Banking, Housing, and Urban Affairs hearing on ``The
Consumer Financial Protection Bureau's Semi-Annual Report to
Congress, I asked the question, ``When the Bureau decides to
publish a Bulletin, does it follow an established process?''
The answer I received stated that the Administrative Procedure
Act does not apply to bulletins and that the CFPB values public
input. Setting aside the APA, could you please elaborate on
what process (either established or ad-hoc) the CFPB goes
through when putting out a bulletin?
A.2. The Administrative Procedure Act (APA) sets out certain
procedures that Federal agencies must follow when they take
agency actions. When an agency promulgates a rule in certain
cases, the APA requires the agency to issue a notice and
solicit comments from the public about the proposed rule. The
APA, however, does not impose a notice and comment requirement
for a general statement of policy, an interpretive rule, or
actions that do not constitute rules.
Whether or not required by statute, the Bureau values
public input in our formulation of policy, and engages
stakeholders using a variety of mechanisms. For example, our
staff engages in informal consultations with industry and other
interested parties. The Bureau has also voluntarily provided
notice and sought comment for various rules for which notice-
and-comment rulemaking were not required under the APA. We
sometimes find, however, that a notice-and-comment process may
not be the optimal process for a particular type of action we
are considering. For example, in October 2013 the Bureau issued
a bulletin explaining the meaning of certain provisions in its
mortgage servicing rules. The Bureau issued that bulletin in
response to requests from various stakeholders that we provide
additional information about certain topics before the mortgage
rules came into effect. Seeking notice and comment in that
circumstance could have impaired our ability to provide needed
information to the industry in sufficient time for them to use
the information to comply with the mortgage rules that were
about to take effect. In that situation, we determined that
issuing a bulletin was the best option to address the
industry's concerns.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
FROM RICHARD CORDRAY
Q.1. As we examine Wall Street regulation and soundness, it is
critical that we be alert to outside threats as well. Over the
past year, there have been a number of extensive cyberattacks
on American companies, including large financial institutions.
Combatting these transnational crimes requires cooperation
across Government and industry.
As I have previously asked both Secretary Lew and Chair
Yellen--Do you pledge to make cybersecurity a priority?
A.1. Yes, the Consumer Financial Protection Bureau (Bureau)
continues to be committed to cybersecurity in its operations
and as cybersecurity relates to the Bureau's mission and
purview. We also carry that commitment to our work with the
Financial Stability Oversight Council and the Federal Financial
Institutions Examinations Council.
Q.2. Do you believe FSOC can fulfill its statutory mandate to
identify risks and respond to emerging threats to financial
stability without making cybersecurity a priority?
A.2. The Financial Stability Oversight Council (Council)
recognizes the importance of cybersecurity as a priority in the
means and methods by which the Council meets its statutory
mandates to identify and monitor risks to the United States'
financial system. In the Council's 2014 Annual Report, the
Council reported that the vulnerabilities posed by cross-sector
dependencies and interconnected systems across firms, markets,
and service providers can lead to significant cybersecurity
risks. The Council recommended in the report that Treasury
continue to work with the public and private sector, as
appropriate, to work toward developing methods to manage risk.
The Council also recommended that regulatory agencies continue
to promote awareness and assess the use by regulated entities
of both regulatory as well as nonregulatory methods to support
risk management, including the National Institute of Standards
and Technology (NIST) Cybersecurity Framework. \1\ While the
report recommends that financial regulators continue to assess
cyber-related vulnerabilities facing regulated entities and
identify gaps in oversight that need to be addressed, the
Council also noted the role that the private sector plays in
supporting the cybersecurity posture of the national
infrastructure.
---------------------------------------------------------------------------
\1\ http://www.nist.gov/cyberframework/
Q.3. As a member of FSOC, can you identify any deficiencies in
the U.S.'s ability to prevent cyberattacks that require
---------------------------------------------------------------------------
Congressional action?
A.3. The Council has recognized the importance of removing
legal barriers to information sharing between public and
private sector partners to enhance overall awareness of
cyberthreats, vulnerabilities, and attacks, including through
Congress' passage of comprehensive cybersecurity legislation.
Q.4. What steps has FSOC taken to address the prevention of
future cyberattacks on financial institutions, such as the
recent breach at JPMorgan Chase?
A.4. The vulnerabilities posed by cross-sector dependencies and
interconnected systems across firms, markets, and service
providers can lead to significant cybersecurity risks. These
risks could impact economic security, demanding a coordinated
and collaborative Governmentwide commitment and partnership
with the private sector to promote infrastructure security and
resilience.
The Council has recommended that the Treasury continue to
work with regulators, other appropriate Government agencies,
and private sector financial entities to develop the ability to
leverage insights from across the Government and other sources
to inform oversight of the financial sector and to assist
institutions, market utilities, and service providers that may
be targeted by cyber incidents. The Council has recommended
that regulators continue to undertake awareness initiatives to
inform institutions, market utilities, service providers, and
other key stakeholders of the risks associated with cyber
incidents, and assess the extent to which regulated entities
are using applicable existing regulatory requirements and
nonregulatory principles, including the National Institute of
Standards and Technology (NIST) Cybersecurity Framework.
The Council has recommended that financial regulators
continue their efforts to assess cyber-related vulnerabilities
facing their regulated entities and identify gaps in oversight
that need to be addressed. The Council has also recognized the
overarching contribution the private sector makes to
infrastructure cybersecurity and urges continued expansion of
this work to engage institutions of all sizes and their service
providers.
The Council has recommended that the Finance and Banking
Information Infrastructure Committee, financial institutions,
and financial sector coordinating bodies establish, update, and
test their crisis communication protocols to account for cyber
incidents and enable coordination, and with international
regulators where warranted, to assess and share information.
As previously noted, the Council has recognized the
importance of removing legal barriers to information sharing
between public and private sector partners to enhance overall
awareness of cyberthreats, vulnerabilities, and attacks,
including through Congress' passage of comprehensive
cybersecurity legislation.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
FROM RICHARD CORDRAY
Q.1. Recently, the Treasury Department indicated that the
Financial Stability Oversight Council was switching the focus
of its asset management examination toward activities and
products rather than individual entities.
Will you confirm that individual asset management companies
are no longer being considered for possible systemically
important designation?
A.1. At its meeting on July 31, 2014, the Financial Stability
Oversight Council (Council) discussed its ongoing assessment of
potential industrywide and firm-specific risks to the United
States' financial stability arising from the asset management
industry and its activities. At that meeting, the Council
directed staff to undertake a more focused analysis of
industrywide products and activities to assess potential risks
associated with the asset management industry. At its meeting
on September 4, 2014, after discussing Council members' views
of priorities for the analysis of potential risks associated
with the asset management industry, the Council directed staff
to further develop their detailed work plan for carrying out
the analysis of industrywide products and activities. As the
Council continues to review this industry, it is important to
note that there are no predetermined outcomes. There are a
number of options available if the Council identifies
meaningful risks to the United States' financial stability.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM MARY JO WHITE
Q.1. The issue of FSOC accountability and transparency is one
that I have raised numerous times. Given the magnitude of the
regulatory burden and other costs imposed by a SIFI
designation, it is imperative that the designation process be
as transparent and objective as possible.
Do you object to the public disclosure of your individual
votes, including an explanation of why you support or oppose
such designation?
A.1. As I have previously stated publicly, I support FSOC's
efforts to enhance transparency surrounding the nonbanking
designation process. These efforts are ongoing. In addition, as
discussed in the meeting minutes from the October 6, 2014, FSOC
meeting, the Council has asked staff to review and evaluate
certain potential process changes to the nonbanks designation
process. See http://www.treasury.gov/initiatives/fsoc/council-
meetings/Documents/
October%206,%202014%20(Meeting%20Minutes).pdf. We are actively
engaged in these discussions and look forward to considering
the staff's recommendations.
Q.2. Will you commit to pushing for greater accountability and
transparency reforms for FSOC? Specifically, will you commit to
push the FSOC to allow more interaction with companies involved
in the designation process, greater public disclosure of what
occurs in FSOC principal and deputy meetings, publish for
notice and comment any OFR report used for evaluating
industries and companies, and publish for notice and comment
data analysis used to determine SIFI designations? If you do
not agree with these proposed reforms, what transparency and
accountability reforms would you be willing to support?
A.2. As discussed above, FSOC staff is in the midst of a
process to review and evaluate changes to the nonbanks
designation process. The process includes continuing to reach
out to the financial industry, the advocacy community, and
others for input. See http://www.treasury.gov/initiatives/fsoc/
council-meetings/Documents/
November%2012,%202014,%20Outreach%20Engagement.pdf. As I have
previously said publicly, I support the effort on enhancing the
Council's transparency, public disclosures, and engagement with
nonbank companies under consideration for designation. At the
same time, the nonbank designation process requires
consideration of sensitive company information. Any approach
must balance these competing interests.
Q.3. In the July FSOC meeting, the Council directed staff to
undertake a more focused analysis of industrywide products and
activities to assess potential risks associated with the asset
management industry.
Does the decision to focus on ``products and activities''
mean that the FSOC is no longer pursuing designations of asset
management firms?
A.3. Although the FSOC has not designated any investment
adviser as systemically important, it has not stated that it
will no longer consider asset management companies for
designation. However, as your question notes, the FSOC did
state in the readout of the July 31, 2014, FSOC meeting
available at http://www.treasury.gov/initiatives/fsoc/council-
meetings/Documents/July%2031%202014.pdf that the FSOC has
directed staff to undertake a more focused analysis of
industrywide products and activities to assess potential risks
associated with the asset management industry. On December 18,
2014, FSOC released a notice seeking public comment regarding
potential risks to U.S. financial stability from asset
management products and activities.
Q.4. Did the FSOC vote on whether to advance the two asset
management companies to Stage 3? If so, why was this not
reported? If not, why was such a vote not taken in order to
provide clarity to the two entities as well as the industry?
A.4. All Council votes are announced publicly. See, e.g.,
http://www.treasury.gov/initiatives/fsoc/council-meetings/
Documents/August%2019,%202014,%20Notational%20Vote.pdf. Under
its current guidance, the Council does not disclose the
identities of firms under consideration for designation unless
and until a final designation is made.
Q.5. At a Senate Banking Committee hearing in July about the
role of regulation in shaping equity market structure, market
participants expressed concerns regarding the stability,
resiliency and undue complexity of the equity markets resulting
from the SEC's ``one size fits all'' set of regulations.
Given your June speech as well as the comments made by
other Commissioners, what does the SEC plan to do to address
such concerns and when can we expect such SEC action?
A.5. I agree that one market structure does not fit all. I have
emphasized the importance of accounting for the varying nature
of companies and products, with a particular sensitivity to the
needs of smaller companies. To this end, the SEC published an
order in June 2014 directing the exchanges and FINRA to submit
a tick size pilot plan that is designed to gather and evaluate
data related to whether wider tick sizes would benefit small
capitalization companies and their investors. At the conclusion
of the pilot, the exchanges and FINRA would complete and submit
a data driven impact assessment to the Commission. The
exchanges and FINRA have filed a plan in response to the June
2014 order that was published for public comment in November
2014. The comment period has now closed and we have received
several thoughtful and substantive letters from commenters. We
are actively considering these comments in evaluating how to
proceed with this initiative.
I also have directed the staff to develop recommendations
for the Commission to address a range of market structure
issues, including potential initiatives to address disruptive
trading practices and to enhance transparency of institutional
order routing practices and ATS operations. In addition, I have
directed the staff to explore whether changes to the current
market structure are warranted for smaller companies, such as
affording more flexibility to exchanges that are targeted
specifically toward the needs of smaller companies. In
developing rulemaking initiatives, I anticipate that the staff
and Commission will carefully consider the varying nature of
companies and markets and whether any potential regulatory
requirements should be tailored to reflect these differences.
Q.6. Additionally, what does the SEC expect to accomplish in
this space by the end of the year and what review is the SEC
undertaking in terms of the fixed income market, specifically
municipal and corporate debt market?
A.6. The staff is advancing all of the equity market structure
rulemakings I directed in my June speech, with a focus in the
near-term on enhancements to our core regulatory tools of
registration and firm oversight. In particular, we are making
significant progress on rules to clarify the status of
unregistered active proprietary traders to subject them to our
rules as dealers and to eliminate an exception from FINRA
membership requirements for dealers that trade in off-exchange
venues. In addition, we recently have established the Market
Structure Advisory Committee to aid us in evaluating more
fundamental questions in equity market structure.
As you know, the U.S. regulatory regime also assigns
important responsibilities to the SROs, which work in close
coordination with the Commission to determine the optimal
market structure for the equity markets. Since my speech in
June, the SROs have made significant progress in addressing
equity market structure concerns. These steps include: (i)
enhancing the technological resilience of the consolidated
market data systems and other critical market infrastructure;
(ii) publicly disclosing how and for what purpose the SROs are
using consolidated and direct market data feeds; (iii)
improving the consolidated market data feeds by adding new time
stamps for when a trading venue processed the display of an
order or execution of a trade; (iv) providing greater public
disclosure of trading volume by alternative trading systems;
and (v) comprehensively reviewing exchange order types and how
they operate in practice. SEC staff is now reviewing the
results of SRO order type audits.
With respect to fixed income, the Commission recently
approved a new MSRB rule to require municipal securities
dealers to seek best execution of retail customer orders for
municipal securities. We also are committed to working closely
with FINRA and the MSRB to encourage their development of
further guidance on best execution of trades in both the
municipal and corporate debt markets. In addition, FINRA and
the MSRB recently published regulatory notices requiring better
disclosures of pricing information for certain same-day
principal trades.
These steps are related to a broader initiative that I have
asked the staff to undertake to enhance the public availability
of pre-trade pricing information in the fixed income markets.
This initiative would potentially require the public
dissemination of the best prices generated by electronic
systems, such as alternative trading systems and other
electronic dealer networks, in the corporate and municipal bond
markets. This potentially transformative change would broaden
access to pricing information that today is available only to
select parties.
Q.7. It was reported in the press the week of September 8th
that the SEC is preparing additional disclosure rules as well
as stress test rules for asset managers. What is the expected
timeline for such new rules and how would they work together
with the recent money market fund rules that the SEC adopted
this summer?
A.7. Staff from the Division of Investment Management has been
developing a set of rulemaking recommendations for Commission
consideration to strengthen our efforts to address the
increasingly complex portfolio composition and operations of
today's asset management industry. The recommendations will
include reporting and disclosure enhancements and new stress
testing requirements, as well as several additional
initiatives. I outlined these initiatives in a recent speech.
See http://www.sec.gov/News/Speech/Detail/Speech/1370543677722.
The Commission regularly evaluates and enhances its
regulations to address risks, such as the money market fund
reforms that required enhanced reporting and provided new tools
to address certain risks of those funds. The new staff
recommendations the staff is considering would complement the
Commission's money market fund reforms, but it is not expected
that they would include changes specific to money market funds.
Q.8. Chair White, I have repeatedly stated that the SEC and
CFTC need to move in a more coordinated fashion with respect to
Dodd-Frank implementation and cross-border initiatives for
derivatives. In a hearing in February, I asked you and then-
Acting Chairman Mark Wetjen about their efforts to ensure
coordination on the remaining Title VII rulemakings, and they
responded that the two agencies are continually in discussions
and that coordination is a priority for both agencies. What
specific progress has your agency made in this venue since
February, and what key obstacles still exist?
A.8. Since I became Chair in April 2013, I have prioritized the
coordination between the SEC and CFTC at both the senior staff
level and principal level. In addition to numerous staff
consultations, Chairman Massad and I frequently consult on a
range of issues, including implementation under the Dodd-Frank
Act of the rules governing derivatives. Our close coordination
with the CFTC is not new. In particular, the SEC has been
consulting over the past several years with the CFTC on our
respective approaches to the application of Title VII. For our
part, since February, the SEC has proposed rules relating to
books and records and proposed rules to enhance the oversight
of clearing agencies deemed to be systemically important or
that are involved in complex transactions, such as security-
based swaps. In June of this year, we adopted a critical,
initial set of cross-border rules and guidance, focusing on the
swap dealer and major swap participant definitions. Most
recently, on January 14, we adopted 21 new rules that would
increase transparency and provide enhanced reporting
requirements in the security-based swap market. In connection
with all of these actions, we have benefited greatly from our
consultations and coordination with the CFTC.
For example, in connection with our final cross-border
rules adopted in June, we and the CFTC discussed and compared
our respective approaches to the registration and regulation of
foreign entities engaged in cross-border swap and security-
based swap transactions involving U.S. persons to determine
where those approaches converge and diverge. The results are
reflected in the final rules we adopted in June, which brought
the Commission's cross-border framework to the same place as
the CFTC in key respects. As those final rules illustrate, we
recognize the importance of consistency. At the same time, the
Dodd-Frank Act gave the CFTC and the SEC different statutory
authority for addressing activity that occurs outside the
United States. In particular, Dodd-Frank included in the
Commodity Exchange Act a focus on activities outside the United
States that ``have a direct and significant connection with
activities in, or effect on, commerce of the United States.''
The Dodd-Frank Act did not include a similar focus in the
Securities Exchange Act.
As the Commission proceeds with finalizing the Title VII
rules, including the cross-border application of those rules, I
and my staff intend to continue working closely with the CFTC
to reduce divergence where possible, where reasonable in light
of our different markets, and where consistent with our
statutory authority.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TESTER
FROM MARY JO WHITE
Q.1. Chair White, investor protection was one of the most
significant issues contemplated in Dodd-Frank, including the
direction given to the SEC to examine the standards of care for
broker-dealers and investment advisors in providing investors
advice. I know we've had many conversations about the
importance of the SEC and the DOL harmonizing a Fiduciary
standard for broker-dealers.
Can you provide us with an update on where the SEC is in
regards to a fiduciary duty rule?
A.1. As you know, the question of whether and, if so, how to
use the authority provided under Section 913 of the Dodd-Frank
Act is very important to investors and the Commission. Whenever
you have substantially similar services regulated differently,
I believe you should carefully consider whether the
distinctions make sense from both the perspective of investors
and strong or optimal regulation, and if not, what to do about
it. I have directed the staff to evaluate all of the potential
options available to the Commission on this matter, including
whether to impose a uniform fiduciary standard on broker-
dealers and investment advisers when providing personalized
investment advice to retail customers.
At the same time, the staff continues to provide regulatory
expertise to Department of Labor (DOL) staff as they consider
potential changes to the definition of ``fiduciary'' under the
Employee Retirement Income Security Act (ERISA). While we are
separate and distinct agencies, I understand the importance of
consistency and the impact the DOL's rulemaking may have on SEC
registrants, particularly broker-dealers. Accordingly, the
staff and I are committed to continuing these conversations
with the DOL, both to provide technical assistance and
information with respect to the Commission's regulatory
approach and to discuss the practical effect on retail
investors, and investor choice, of DOL's potential amendments
to the definition of ``fiduciary'' for purposes of ERISA.
Q.2. One other quick question and I apologize that it's JOBS
Act related, not Dodd-Frank related: Do you have a timeframe
for finalizing Reg A+ rules?
A.2. While we are unable to provide a specific date for the
adoption of final rules, the Commission has included the
adoption of the Regulation A+ rules on its most recent
Regulatory Flexibility Act agenda, which covers the period from
November 2014 to October 2015. Finalizing the rules mandated by
the Dodd-Frank and JOBS Acts, including Regulation A+, remains
a top priority for the Commission.
To date, the Commission has received more than 100 comment
letters on the Regulation A+ rule proposal. These commenters
have expressed a variety of different views on how the
Commission should implement Regulation A+, including the
proposed approach to state securities law registration and
qualification requirements and other important aspects of the
rulemaking. The staff is carefully reviewing the comments as it
works to develop recommendations for final rules for the
Commission's consideration. In addition, the staff is closely
monitoring the development and implementation of the North
American Securities Administrators Association's multistate
coordinated review program for Regulation A offerings.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM MARY JO WHITE
Q.1. With the Volcker Rule, we finally learned the lessons from
the bailout of Long-Term Capital Management and then the 2008
financial crisis that we simply cannot afford to have big,
systemically significant firms making big bets on the ups and
downs of the market. Casino banking is over--if you stick to
your guns and enforce the Rule.
I deeply appreciate the hard work you did to getting to a
final rule last December, and I recognize the hard work you are
doing now to implement it. However, we are still at the
beginning legs of the journey, and I believe in ``trust but
verify''--which requires full, continued cooperation by our
regulators and engagement with the public.
During the financial crisis, we all saw the horrific
results when different regulators saw only parts of the risks
to some firms. There were too many regulatory silos, which do
not work because firms do not function that way. You also need
a complete picture of what is going on in any one institution
and across different firms. Indeed, one of the least recognized
benefits of the Volcker Rule is to force the regulators to pay
attention, together, to trading activities, which have become
so important at so many banks. But critically, this means all
the regulators need full access to all collected data and
information.
In addition, accountability to the public through
disclosure provides another layer of outside oversight and
analysis, as well as equally importantly, public confidence
that Wall Street reform is real.
Based on the track record of various public disclosure
mechanisms out there already--including for example, the CFTC's
positions of traders--there is significant space for reasonably
delayed disclosures of metrics data to enhance Volcker Rule
accountability and public confidence. Now Treasury Deputy
Secretary and then-Federal Reserve Governor Sarah Bloom Raskin
highlighted disclosure in her statement on adoption of the
final rule, and financial markets expert Nick Dunbar has
similarly called for disclosure as a key tool. (See Nick
Dunbar, ``Volcker Sunlights Should Be the Best Disinfectant'',
July 25, 2014, http://www.nickdunbar.net/articles/volcker-
sunlight-should-be-the-best-disinfectant/.) The OCC's Quarterly
Trading Activity Report may be a perfect venue to engage in
this type of disclosure, provided it is expanded to cover the
entire banking group.
First, will each of you commit to working to ensure that
each of your agencies has a complete picture of an entire
firm's trading and compliance with the Volcker Rule, which can
best be accomplished by having all data in one place so that
all regulators have access to it?
A.1. The final rule is largely constructed around the trading
desk, with many of the rule's requirements applying at that
level. Importantly, the definition of trading desk is based on
the operational functionality of banking entities' trading
activities, and the final rule recognizes that a trading desk
may book positions in different affiliated legal entities.
Under the final rule, if a trading desk spans more than one
affiliated legal entity, each agency with regulatory authority
over a relevant legal entity under section 13(b)(2)(B) of the
Bank Holding Company Act will have access to records and data
regarding the trading desk. For example, if a market-making
desk manages positions booked in two affiliated entities, a
banking entity must be able to provide supervisors or examiners
of any agency that has regulatory authority over the banking
entity pursuant to section 13(b)(2)(B) of the Bank Holding
Company Act with records, promptly upon request, that identify
any related positions held at an affiliated entity that are
being included in the trading desk's financial exposure for
purposes of the market-making exemption. Similarly, metrics
data for a trading desk is generally provided to each agency
with regulatory authority over any legal entity in which the
trading desk books trades, although a few firms have determined
to provide all metrics data to all relevant agencies. As a
result, in most cases, metrics data for a particular trading
desk is provided to multiple agencies.
Given the rule's focus on activity at the trading desk
level, the metrics are designed to help identify activity that
may warrant further review to determine whether an individual
trading desk is complying with the rule. As discussed in the
preamble to the final rule, the agencies will be revisiting the
metrics requirement based on data collected by September 30,
2015. This review process will enable us to assess the utility
of the metrics, including how they can better foster compliance
with the final rule and support agency monitoring and
enforcement efforts.
Q.2. Are you committed to using disclosure to help advance
compliance with and public trust from the Volcker Rule?
A.2. Metrics data required under the rule is not intended alone
to show compliance with the prohibition on proprietary trading
or related exemptions. Instead, this data is intended to be
used to identify activities that may warrant further review by
examiners. The agencies have committed to review the metrics
reporting requirement, based on data received through September
30, 2015. As part of that process, we should consider whether
there is any aggregate information derived from the metrics
that might be meaningfully disclosed to the public.
Q.3. The success of the Volcker Rule over the long term will
depend upon the commitment of regulators to the vision of a
firewall between high risk, proprietary trading and private
fund activities, on the one hand, and traditional banking and
client-oriented investment services on the other hand. One of
the most important parts of ensuring that vision is
meaningfully implemented is the December 2013 final rule's
application of its provisions at the ``trading desk'' level,
defined as the ``smallest discrete unit of organization'' that
engages in trading.
Unfortunately, reports have emerged suggesting that banks
are already attempting to combine and reorganize what had been
separate trading desks into one ``trading desk'' for Volcker
Rule purposes, as a way to game the metrics-based reporting
essential to effective monitoring by regulators of each
institution's compliance with the Volcker Rule. The OCC has
already identified this risk in its Interim Examination
Procedures, and attempted to limit such actions to instances
where the desks were engaged in ``similar strategies,'' the
combination has a ``legitimate business purpose,'' and the
combination assists the firm to ``more accurately reflect the
positions and fluctuations'' of its trading. I feel that the
OCC's interim protections may not, however, be enough ensure
compliance with the final rule.
I am deeply concerned that combining or reorganizing
trading desks would undermine the strength of the metrics-based
oversight, particularly related to whether market-making is
truly to serve near-term customer demand and whether hedging is
truly that. To avoid obscuring evasion by changing the mixture
and volume of the ``flow'' of trading that is reported by the
``trading desk'' unit, I would suggest that examiners ought to
strictly apply the final rule's approach to ``trading desk''
and apply the guidance set out by the OCC extremely narrowly,
along with additional protections. For instance, ``similar
strategies'' would need to include both the type of the trading
(e.g., market-making) but also the same or nearly identical
products, as well as be serving the same customer base, among
other standards. As an example, if two desks traded in U.S.
technology stocks and technology stock index futures, combining
those into one desk might make sense, depending on other
factors, such as where the desks were located and what
customers they were serving. But combining, for example,
various industry-specific U.S. equities desks that today are
separate would not pass muster for complex dealer banks.
It also is important to remember that an important
supervisory benefit from implementing the Volcker Rule at a
genuine trading desk level is that regulators will gain a much
deeper, more granular understanding of the risks emanating the
large banks' many different trading desks--the kind of risks
that led one particular trading desk to become famous as the
London Whale.
When confronted with attempts to reorganize trading desks,
regulators should look carefully at whether submanagement
structures, bonus structures, or other indicia exist that would
suggest that the reorganized ``trading desk'' is not actually
the smallest discrete unit of organization contemplated by the
final rule and essential to the metrics-based oversight system
being developed.
Will you commit to scrutinizing, for the purposes of the
Volcker Rule, any reorganizations of trading desks as posing
risks of evasion and will you commit to working jointly to
clarify any guidance on the definition of trading desk for
market participants?
A.3. Yes, I agree that the trading desk structure is a core
component of the final rule, and preventing evasion in this
area is critical. Since many of the rule's proprietary trading
and compliance provisions are built around the trading desk,
improperly constructed trading desks could lead to outcomes
that are counter to the goals of section 13 of the Bank Holding
Company Act and the final rule. As a result, we will closely
focus on potentially unsuitable interpretations of the
definition of trading desk. To the extent additional guidance
on the definition of trading desk is needed, we will work
together with our fellow regulators to develop and implement
that guidance.
Q.4. Ensuring speedy compliance with the provisions of the
Merkley-Levin Volcker Rule is a top priority for strong
implementation. It has already been four years since adoption,
and banks should be well on their way to conforming their
trading and fund operations.
However, as you know, we also provided for an additional
five years of extended transition for investments in ``illiquid
funds,'' which were expected to include some types of private
equity funds. We did this because some private equity funds,
such as venture capital funds, do not usually permit investors
to enter or exit during the fund's lifetime (usually 10 years
or so) because of the illiquidity of those investments.
As you know, the Federal Reserve Board's rule on the
``illiquid funds'' extended transition interprets the statutory
provision of a ``contractual commitment'' to invest as
requiring a banking entity, where a contract permits divestment
from a fund, to seek a fund manager's and the limited partners'
consent to exit a fund. The rule, however, provides for the
Board to consider whether the banking entity used reasonable
best efforts to seek such consent but that an unaffiliated
third party general partner or investors made unreasonable
demands.
I strongly support the Board's desire to implement the
Volcker Rule in a speedy manner. In addition, the Board's
approach in the final conformance rule goes a long way to
ensuring that the illiquid funds extended transition only be
available for investments in truly illiquid funds, and not a
way to avoid divestment of hedge funds and private equity
funds.
At the same time, we designed the provision to provide for
a smooth wind-down for illiquid funds. Indeed, I am sensitive
to the legitimate business needs of firms seeking to comply
with the Volcker Rule while maintaining relationships with
important customers to whom they may seek to provide
traditional banking services.
Accordingly, I would urge the Board to clarify that a
banking entity's requirement to make ``reasonable efforts'' to
exercise its contractual rights to terminate its investment in
an illiquid fund could be satisfied, for example, by a
certification by the banking entity (a) that the banking
entity's exit from the fund would be extraordinary from the
perspective of how most investors enter or exit the fund (i.e.,
the investment contract does not routinely or ordinarily
contemplate entry or exit, and/or such other indicia as are
necessary to help distinguish between illiquid private equity
funds and other funds, like hedge funds, that ordinarily and
routinely permit investor redemptions), (b) that inquiring with
third-party fund managers and limited partners regarding
termination would result in a significant detriment to the
business of the banking entity and (c) that the banking entity
believes that the divestment would result in losses,
extraordinary costs, or otherwise raise unreasonable demands
from the third-party manager relating to divestment (or the de
facto equivalent thereto).
Such a certification from the banking entity, along with
the language of the relevant fund agreements and such other
requirements as the Board determines appropriate, would obviate
the need to seek consent from third-party fund managers. Have
you considered clarifying this in a FAQ?
A.4. While the Agencies acted together in adopting the final
rule and are continuing to work closely together with regard to
the implementation of the Volcker Rule, the Federal Reserve
Board alone is authorized under section 13 of the Bank Holding
Company Act to grant extensions to the conformance period
provided by section 13.
Q.5. We've recently seen reports that the largest Wall Street
banks are nominally ``deguaranteeing'' their foreign affiliates
in order to avoid coverage under U.S. regulatory rules,
especially those related to derivatives. This
``deguaranteeing'' appears to be based on a fiction that U.S.
banks do not actually guarantee the trading conducted by
foreign subsidiaries, and hence would not be exposed to any
failure by the foreign subsidiary.
Can you comment on that, and specifically, whether you
believe that U.S. bank or bank holding company could be exposed
to losses from--or otherwise incur liability related to--a
foreign affiliate's trading even when no explicit guarantee to
third parties exists. Please specifically address whether an
arrangement, commonly known as a ``keepwell,'' provided by the
U.S. parent or affiliate to the foreign affiliate potentially
could create such exposure--and specifically, liability--for
the U.S. entity.
Moreover, please comment on whether the size and importance
to the U.S. parent or affiliate of the foreign affiliate's
activities could itself create an implied guarantee such that
the U.S. firm would have major reputational or systemic risk
reasons to prevent the foreign affiliate from incurring
significant losses or even failing--similar to rescues that
occurred during the financial crisis of entities that were
supposed to be bankruptcy remote.
Finally, many of these foreign bank subsidiaries are so-
called ``Edge Act'' corporations, which I understand are
consolidated with the insured depository subsidiary for many
purposes. Please comment on whether there is any chance that
losses in these Edge Act corporations, particularly losses in
their derivatives operations, could impact the deposit
insurance fund.
A.5. We and our fellow regulators have been following closely
the reports that at least some U.S. financial institutions have
begun removing guarantees from some swap transactions of their
foreign affiliates. The reports I have seen attribute the
change, at least in part, to the cross-border guidance issued
in July 2013 by the CFTC.
The CFTC has apprised us of its efforts to monitor this
shift in the marketplace, and we plan to continue discussions
with the CFTC as they continue their efforts. We also are
coordinating with the CFTC and other authorities in the U.S.
and overseas to monitor changes to industry practices as
regulations are implemented. More generally, as we move forward
with the further adoption and implementation of the SEC's Title
VII-related rules, we will pay close attention to the changing
state of the OTC derivatives markets.
With respect to your question regarding keepwells, the
Commission's focus is on the substance of the agreement. The
Commission's final rules require the foreign affiliate of a
U.S. person to include in its de minimis calculation any
security-based swap transaction arising out of its dealing
activity to the extent that the transaction is subject to a
recourse guarantee. This final rule clarifies that for these
purposes a counterparty would have rights of recourse against
the U.S. person ``if the counterparty has a conditional or
unconditional legally enforceable right, in whole or in part,
to receive payments from, or otherwise collect from, the U.S.
person in connection with the security-based swap.'' To the
extent that an agreement, such as a keepwell, gives rise to
this type of conditional or unconditional legally enforceable
right under a security-based swap against the U.S. person, the
Commission would treat that agreement as a recourse guarantee.
At the same time, the Commission recognizes that more
general financial support arrangements, including certain
keepwells (depending on their terms), also may pose risks to
U.S. persons and potentially to the U.S. financial system, even
if all recourse guarantees are removed from the foreign
affiliate's transactions. U.S. entities that are affiliated
with non-U.S. persons for reputational reasons may determine to
support their non-U.S. affiliates at times of crisis. As
reflected in your question, this reputational concern may be
particularly strong in the case of a non-U.S. affiliate that
holds significant assets or is otherwise important to the
financial institution as a whole. To the extent that these new
financial arrangements do not include a legally enforceable
right of recourse against a U.S. person, our rules may not
bring these affiliates within the SEC's regulatory oversight
due to the limits of our statutory authority.
Notwithstanding these limits, I believe that the risks to
U.S. financial firms associated with the activities of these
deguaranteed foreign affiliates should be addressed. While the
SEC will continue to look into these developments and act where
necessary and authorized to do so, these risks can also be
addressed through other tools established by Congress, such as
holding company oversight. By accounting for risks at the
consolidated level, these tools address risks posed by
guaranteed and nonguaranteed subsidiaries within U.S.-based
financial groups, regardless of whether the subsidiaries are
based in the United States or outside the United States. I and
my staff recognize the need for continued close coordination
across regulators, both in the U.S. and overseas, to address
regulatory issues in this market.
With respect to your question on ``Edge Act'' corporations,
I would note that the Edge Act is administered by our
colleagues at the Federal Reserve, and thus they would be in a
better position to provide a definitive response, including how
the Edge Act addresses any potential risks to domestic
operations of insured depository institutions from the
international operations of ``Edge Act'' corporations. However,
to the extent that arrangements between ``Edge Act''
corporations and their affiliates give rise to legally
enforceable rights of the type described above, the Commission
would treat the arrangement as a recourse guarantee.
Q.6. The banking regulators made important progress in the past
year in completing Dodd-Frank Wall Street reforms, especially
in the realm of prudential banking oversight, but the pace of
SEC rulemaking has not kept up.
Can you please provide a rough timeframe for when you plan
on completing the following rulemakings, all of which were due
years ago:
Section 621's prohibitions on designing asset-
backed securities and betting on their failure,
All compensation provisions,
All security-based swaps reforms,
Crowdfunding, Regulation A+, and investor
protection provisions of the JOBS Act, and
Risk retention rules.
A.6. Since April 2013, the Commission has proposed or adopted
over 25 substantive rules called for by the Dodd-Frank Act and
other rules directly responding to the financial crisis. These
actions include the Volcker rule and major reforms addressing
money market funds, credit rating agencies, asset-backed
securities, and security-based swaps, among others. Most
recently, we adopted rules that would increase transparency and
provide enhanced reporting requirements in the security-based
swap market, and also adopted final rules for risk retention
jointly with our fellow regulators.
With these efforts, we have completed our rulemaking
mandates in many of the central areas targeted by the Dodd-
Frank Act. And we have finalized nearly all of the more than
two dozen studies and reports that it was directed to complete
under these Acts.
Some areas remain to complete--in security-based swaps and
executive compensation in particular--and I expect that we will
soon be making significant progress in both areas. It is
important to finish these rules, as well as those required
under Section 621, but we must take the time necessary to
carefully consider all of the issues raised by commenters and
perform rigorous economic analysis, which is critically
important and helps inform and guide our rulemaking decisions.
With respect to the JOBS Act, we have, since April 2013,
either adopted or proposed all of the required rules, and we
will soon be moving to adopt the most critical that remain to
be finalized.
Q.7. In addition, the SEC's capital framework for broker-
dealers has remained unchanged after the financial crisis,
despite its catastrophic failure and despite significant
progress by other regulators on capital, leverage, and
liquidity.
When will your agency begin work on this important task?
A.7. Since the financial crisis, the Commission has taken a
number of actions to strengthen broker-dealer financial
responsibility requirements, including capital requirements.
For example, in response to the crisis, the Commission staff
began targeting the short-term funding activities of the larger
broker-dealers, and in general these firms have extended the
terms of their repurchase transactions under that enhanced
focus. They also are required to apply greater capital charges
for certain structured finance products.
In addition, in 2012, the Commission proposed additional
liquidity requirements for certain of the largest broker-
dealers as well as raising their minimum net capital
requirements as part of its rulemaking to establish financial
responsibility requirements for security-based swap dealers.
\1\ Under the proposal, these broker-dealers would be required,
among other things, to conduct a liquidity stress test at least
monthly that takes into account certain assumed conditions
lasting for thirty consecutive days and to establish a written
contingency funding plan. \2\ Based on the results of the
monthly liquidity stress test, the broker-dealers also would
need to maintain at all times liquidity reserves comprised of
unencumbered cash or U.S. Government securities. \3\ In
addition to these proposals, the Commission staff is actively
working on recommendations that would apply the proposed
liquidity requirements to a broader range of broker-dealers and
would impose a leverage ratio requirement for broker-dealers to
complement existing leverage constraints in the rule. \4\
---------------------------------------------------------------------------
\1\ See ``Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap Participants
and Capital Requirements for Broker-Dealers'', Exchange Act Release No.
68071 (Oct. 18, 2012), 77 FR 70213 (Nov. 23, 2012).
\2\ Id. at 70252-70253.
\3\ Id.
\4\ See, e.g., Chair Mary Jo White, Chairman's Address at SEC
Speaks (Feb. 2014), available at http://www.sec.gov/News/Speech/Detail/
Speech/1370540822127 (``We will also increase our oversight of broker-
dealers with initiatives that will strengthen and enhance their capital
and liquidity, as well as providing more robust protections and
safeguards for customer assets''); Office of Management and Budget,
Office of Information and Regulatory Affairs, Broker-Dealer Leverage
Ratio, available at http://www.reginfo.gov/public/do/
eAgendaViewRule?pubId=201404&RIN=3235-AL50.
---------------------------------------------------------------------------
In addition, in July 2013, the Commission adopted a set of
amendments to the broker-dealer financial responsibility rules
(including the broker-dealer net capital rule). \5\ Among other
things, these amendments require broker-dealers to document
their risk management procedures, report on secured financing
transactions, and take 100 percent capital charges relating to
nonpermanent capital infusions. Also, in July 2013, the
Commission adopted amendments to the broker-dealer reporting
rule that, among other things, promote capital compliance. \6\
In particular, broker-dealers that carry customer securities
and/or cash (which includes the largest broker-dealers) are
required to annually file a ``compliance report'' in which they
must state whether their internal controls over compliance with
the financial responsibility rules (including the broker-dealer
net capital rule) were effective during the most recently ended
fiscal year. \7\ They cannot state that their internal controls
were effective if there was a material weakness in the internal
controls. In addition, the statements in the compliance report
must be examined by an independent public accountant registered
with the Public Company Accounting Oversight Board. \8\
---------------------------------------------------------------------------
\5\ See ``Financial Responsibility Rules for Broker-Dealers,
Exchange Act Release No. 70072'' (July 30, 2013), 78 FR 51824 (Aug. 21,
2013).
\6\ See ``Broker-Dealer Reports, Exchange Act Release No. 70073''
(July 30, 2013), 78 FR 70073 (Aug. 21, 2013).
\7\ Id. at 51916-51920.
\8\ Id. at 51928-51937.
---------------------------------------------------------------------------
These activities reflect the Commission's ongoing efforts
to ensure that the broker-dealer financial responsibility rules
continue to achieve their objectives.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM MARY JO WHITE
Q.1. As you know, during your nomination process, we discussed
how you would handle potential conflicts of interest--or the
appearance of conflicts of interest--between your
responsibilities as Chair of the SEC and your husband's ongoing
work as a partner representing financial institutions at the
law firm of Cravath, Swaine & Moore LLP. I believe that
conflicts of interest, or the appearance thereof, should not
undermine the SEC's critical work enforcing our securities laws
and regulating and supervising the securities industry.
Now that you have been Chair for over a year, I'd like to
revisit that discussion.
Is there a written policy in place that governs when you
must recuse yourself in any matter--enforcement, regulatory,
supervisory, or otherwise--in which Cravath, Swaine & Moore is
involved? If so, can you provide a copy of it? If not, do you
have an informal policy in place, and can you describe it?
Since you were confirmed as Chair of the SEC, have you
recused yourself from any matter in which Cravath, Swaine &
Moore was involved? If so, how many times have you recused
yourself? Please categorize those recusals by the type of
matter--enforcement, regulatory, supervisory, or other.
A.1. As part of my confirmation as Chair, I entered into an
Ethics Agreement that governs my recusal from matters in which
the law firm that employs my spouse, Cravath, Swaine & Moore
LLP, represents a party. Such ethics agreements are entered
into by all Commissioners to address a variety of potential
conflicts of interest or other issues. My Ethics Agreement is
public and was provided to the Senate Banking Committee as part
of my confirmation, and is publicly available on the Office of
Government Ethics Web site. My staff and I also follow
procedures (which contain nonpublic and/or confidential client
information) to determine whether recusals are appropriate. Out
of the over a thousand Enforcement matters in which I have
participated since becoming Chair, I have been recused from
approximately 10 matters, as well as one nonenforcement matter,
as a result of the participation of Cravath on behalf of a
party. I have not been recused from any rulemakings.
Q.2. Last June, you announced that the SEC would seek more
admissions of fault in its settlement agreements, rather than
allowing settling parties to ``neither admit nor deny''
liability. Since that announcement, how many settlement
agreements has the SEC entered into? In how many of those
agreements did the SEC require an admission of fault? If those
agreements including admissions of fault are not confidential,
can you provide copies to my office?
A.2. As you indicate, in 2013 we made an important modification
to our settlement practices, and we now demand an additional
measure of public accountability through an acknowledgement of
wrongdoing in certain of our cases, including from major
financial institutions and senior executives. Under this
policy, the Division of Enforcement now considers requiring
admissions in cases where the violation of the securities laws
includes particularly egregious conduct; where large numbers of
investors were harmed; where the markets or investors were
placed at significant risk; where the conduct obstructs the
Commission's investigation; where an admission can send a
particularly important message to the markets; or where the
wrongdoer poses a particular future threat to investors or the
markets.
Additionally, we do not accept ``no admit, no deny''
settlements where a defendant has admitted relevant facts in a
settlement with other criminal or civil authorities. This
regularly occurs in connection with guilty pleas that arise
from a parallel criminal investigation, which frequently are
matters that we referred to a criminal prosecutor in which our
own investigation assisted in securing a favorable resolution
on the criminal side as well. Often in such cases a person
allocutes to certain facts as part of a guilty plea, or is
found guilty after trial, and the involvement of the criminal
authorities in such cases may indicate that these cases involve
particularly egregious misconduct. In such cases, our practice
is to remove the ``no admit, no deny'' language from our
settlement documents and incorporate a reference to the guilty
plea or other resolution.
In other cases, we have determined that it is appropriate
to continue to settle on a ``no admit, no deny'' basis, as do
other Federal agencies and regulators with civil enforcement
powers. We made this decision because the practice allows us to
get significant relief, eliminate litigation risk, return money
to victims more expeditiously, and conserve our enforcement
resources for other matters. That protocol too is a very
important tool in a strong enforcement regime.
From the time we instituted the admissions policy change
through the end of September, the Commission settled
approximately 520 enforcement actions. \1\ During that period,
the Commission entered into settlements requiring admissions on
a dozen occasions, including cases involving JPMorgan Chase and
Bank of America, among others, as defendants. \2\ More
recently, the Commission has entered into settlements requiring
admissions in four additional cases, bringing the total to 16.
Those settlement documents are public, and I have instructed my
staff to contact your staff to provide copies of them to you.
In addition, there have been dozens of SEC settlements in that
period that settled without permitting defendants to include
``no admit no deny'' language and that incorporated a reference
to guilty pleas or other admissions made in non-SEC criminal or
civil cases.
---------------------------------------------------------------------------
\1\ This figure is an approximation. It excludes follow-on
administrative proceedings (e.g., where someone is barred from the
industry following the imposition of an injunction by a district court
in an action brought by the Commission, which action would be counted
separately). It also excludes cases against issuers who are delinquent
in their filing obligations.
\2\ Two of these occasions arose from the same matter, but
occurred approximately 1 year apart.
Q.3. In Section 922 of Dodd-Frank, Congress directed the SEC to
provide awards to whistleblowers whose assistance helped the
SEC obtain monetary sanctions against a private party. The SEC,
through its new Office of the Whistleblower, has already
furnished several awards to whistleblowers. However, according
to a recent Washington Post story, \3\ companies are using
nondisclosure agreements and other tools to limit the ability
of employees to go to the SEC after they have reported
purported misconduct internally.
---------------------------------------------------------------------------
\3\ Scott Higham, and Kaley Belval, ``Workplace Secrecy Agreements
Appear To Violate Federal Whistleblower Laws'' (June 29, 2014),
available at http://www.washingtonpost.com/investigations/workplace-
secrecy-agreements-appear-to-violate-federal-whistleblower-laws/2014/
06/29/d22c8f02-f7ba-11e3-8aa9-dad2ec039789_story.html.
---------------------------------------------------------------------------
Under SEC Rule 21F-6 (17 CFR 240.21F-6), a whistleblower's
``participation in internal compliance systems'' is a ``factor
that may increase the amount of a whistleblower's award.''
Given concerns about companies using internal compliance
systems to deter whistleblowing activity, why does the SEC give
potential whistleblowers a financial incentive to report
internally before coming to the SEC? More broadly, if the SEC
believes that whistleblowers play an important enforcement
role, why does it encourage employees not to blow the whistle
and to instead report concerns internally?
A.3. Our whistleblower program is making significant
contributions to the enforcement work of the Commission. In
this past fiscal year, among other accomplishments, our program
awarded nine whistleblowers approximately $35 million in the
aggregate. In addition, the Commission made the first use of
its authority to bring antiretaliation enforcement actions. As
a result of the Commission's issuance of significant
whistleblower awards, enforcement of the antiretaliation
provisions, and protection of whistleblower confidentiality,
the agency has continued to receive an increasing number of
whistleblower tips. In Fiscal Year 2014, our whistleblower
office received over 3,600 whistleblower tips, a more than 20
percent increase in the number of whistleblower tips in just 2
years. The program has thus been an early success, and as
awareness of the program increases, it should continue to be an
important part of our enforcement efforts.
With respect to your question regarding corporate
compliance programs, as you note, Rule 21F-6 provides that, in
determining the size of a whistleblower award, the Commission
will assess whether, and the extent to which, the whistleblower
participated in internal compliance systems. Among other
considerations, internal reporting may increase the size of an
award, while interfering with established compliance procedures
may decrease the size of an award. However, Rule 21F-5 states
that discretion remains with the Commission, and Rule 21F-6
states in part that the Commission ``may consider [the
enumerated factors] in relation to the unique facts and
circumstances of each case'' (emphases added).
The Commission's rules give discretion to each
whistleblower to decide how best to report suspected
wrongdoing: he or she may report internally before going to the
Commission, may go directly to the Commission right away, or
may report to both simultaneously. In other words, he or she
does not lose eligibility for an award by reporting internally.
And it is not the case that anyone who first comes directly to
the Commission necessarily will receive a lower award as a
result of not having participated in his or her employer's
internal compliance systems. \4\
---------------------------------------------------------------------------
\4\ In its Adopting Release, the Commission stated:
[A] whistleblower would not be penalized for not satisfying any
one of the positive factors. For example, a whistleblower who provides
the Commission with significant information about a possible securities
violation and provides substantial assistance in the Commission action
or related action could receive the maximum award regardless of whether
the whistleblower satisfied other factors such as participating in
internal compliance programs. In the end, we anticipate that the
determination of the appropriate percentage of a whistleblower award
will involve a highly individualized review of the facts and
circumstances surrounding each award using the analytical framework set
forth in the final rule.
Implementation of the Whistleblower Provisions of Section 21F of
the Securities Exchange Act of 1934, at 124, available at http://
www.sec.gov/rules/final/2011/34-64545.pdf.
---------------------------------------------------------------------------
This rule was passed in 2011 following a robust debate over
the question of whether an SEC whistleblower should be required
to first report internally to be eligible for an award. The
Commission declined to require an internal report, but did
provide that making an internal report could be weighed as a
factor to potentially increase the size of an award. This
decision was driven by several considerations. It is a simple
fact that, as an agency with limited resources, the SEC needs
to leverage its resources by promoting stronger internal
compliance. That has long been an emphasis and priority of the
SEC, as it has with other Federal agencies. The Commission
concluded that a strong whistleblower program can and should
coexist with credible, robust internal reporting mechanisms.
The objective was to support effective internal controls while
not requiring a whistleblower to choose between internal and
external reporting. This rule should create an incentive for
companies to take a fresh look at their compliance systems to
make them as strong and transparent as possible. Had the
Commission not provided some incentive for internal compliance
reporting, companies might not have thought it worth the time
and expense to bolster their internal functions under the
assumption that their employees would never report internally.
With respect to your reference to nondisclosure agreements,
I share your concerns about any misuse of employee
confidentiality, severance, and other kinds of agreements to
hinder an employee's ability to report potential wrongdoing to
the Commission. To address issues such as this, the Commission
adopted Rule 21F-17(a), which makes it an independent violation
of the Commission's rules for any person to ``take any action
to impede an individual from communicating directly with the
Commission staff about a possible securities law violation,
including enforcing, or threatening to enforce, a
confidentiality agreement . . . with respect to such
communications.'' This rule provides the Commission with
express authority to take action whenever we find that
otherwise legitimate employment agreements are being used in a
manner that discourages or curtails employee whistleblowing.
Commission staff is focused on cases in which the use of
confidentiality or other agreements may violate this Commission
rule, and will continue to concentrate on practices that may
result in silencing employees from reporting securities
violations to the Commission by threatening liability or
employee discipline. In appropriate cases, I expect the
Commission will bring enforcement actions under Rule 21F-17(a).
Q.4. Additionally, do you believe the SEC has sufficient
authority to issue a rule banning efforts to curtail
evidentiary disclosures to the Commission, as undertaken
through job perquisites, personnel actions such as termination,
lawsuits seeking damages, or any other form of retaliation? If
so, please cite and describe those sources of authority. If
not, please describe what additional statutory authority is
needed.
A.4. Yes, at this time we believe we have sufficient authority,
and we have implemented that authority by passing Rule 21F-
17(a). It provides in part as follows (emphasis added):
No person may take any action to impede an individual
from communicating directly with the Commission staff
about a possible securities law violation, including
enforcing, or threatening to enforce, a confidentiality
agreement . . . with respect to such communications.
By prohibiting ``any action'' that could curtail
evidentiary disclosures to the Commission, this rule provides
the Commission with the broadest authority and most effective
tool possible to deter the kinds of conduct described in your
question. Although I cannot comment on any specific ongoing
investigation, enforcing this provision is a high priority for
our whistleblower program.
Q.5. Large brokers and other financial intermediaries are
taking advantage of individual mutual fund investors by
charging them excessive fees for administrative and
distribution activities. Rule 12b-1 fees, account management
charges, and revenue-sharing payments are extracting billions
of dollars each year out of the pockets of the 96 million
individual investors who rely on mutual funds for their savings
goals. I understand that the SEC is gathering information about
some or all of these mutual fund administrative and
distribution fees. What is the status of this investigation and
does the SEC plan on taking action to reduce these fees?
A.5. The staff of the Commission currently is engaged in a
series of risk-targeted examinations of investment companies,
advisers, and intermediaries designed to gather information on
current fee practices related to distribution and
administrative services provided to funds. These examinations
are ongoing, with more than a dozen major market participants
already examined. The staff has reviewed the size and purpose
of administrative, distribution, and revenue sharing payments
at these firms, how they were negotiated, and how they are
disclosed to investors as well as the funds' directors, among
many other issues. These exams already have resulted in certain
of the targeted firms changing some of their practices to the
benefit of investors. This particular series of examinations is
expected to be completed in the near future, and the results of
the exams will inform any policy changes that the Commission
may undertake to address issues with distribution and
administrative fee payments made by funds and advisers to
intermediaries.
Q.6. The mutual fund industry has evolved into a ``pay to
play'' business model in which brokers and other intermediaries
are compensated handsomely to sell certain funds to their
customers, despite the merits of investing in these funds. As
an example, revenue-sharing payments from fund management
companies are being paid to intermediaries based on the amount
of fund shares sold to investors. These payments are not
disclosed properly to mutual fund investors because the
payments are not being made directly from fund assets. Do you
believe this is a problem? If so, what steps can the SEC take
to ensure that both funds and their intermediaries are
specifically disclosing the amount of these payments and their
potential impact on fund performance?
A.6. While not disclosed in the same way as fees deducted
directly from fund assets, the Commission requires that the
existence of revenue sharing payments and the nature and extent
of the conflicts they present be disclosed to investors.
Intermediaries can make these disclosures through several
channels, such as fund prospectuses and other disclosure
documents. Nonetheless, I share the concern about the
effectiveness of such disclosure and the impact of revenue
sharing on fund recommendations by intermediaries. As
previously noted, the staff of the Commission currently is
engaged in an ongoing series of examinations with a focus on
revenue sharing practices, including how they are negotiated
and disclosed. I expect that the results of these examinations
will be used to inform policy changes that the Commission might
take to address any problems identified, including potential
disclosure reforms.
Q.7. A mutual fund investor receives a prospectus that
describes the terms and conditions of investing in each fund
regulated by the SEC. These terms and conditions--which include
a number of protections and benefits for investors--are not
being applied uniformly to mutual fund investors because more
than 50 percent of fund shares are traded using omnibus
accounts. An intermediary holding customer shares in an omnibus
account does not provide underlying investor information to a
fund for prospectus compliance purposes. Mutual funds are,
therefore, not able to ensure that frequent trading rules,
sales load discounts and other investor-friendly policies in
the prospectus are available to investors who invest through
these third-party accounts. Do you believe this is a problem?
If so, what can the SEC do to ensure that investors who
purchase mutual fund shares through brokers and other
intermediaries are treated the same as investors who invest
directly, with regard to prospectus terms and conditions?
A.7. Funds have a number of ways to assure themselves of
compliance with prospectus terms and conditions for
shareholders investing through omnibus accounts. These include
third party audits of intermediaries, certifications,
questionnaires, on-site reviews, and independently developed
compliance tools such as the Statement on Standards for
Attestation Engagements (SSAE) No. 16 and the Financial
Intermediary Controls and Compliance Assessments (FICCA).
Even with these tools, compliance in an omnibus account
environment can pose difficulties for funds and their
directors. As noted above, the staff is engaged in a series of
exams on distribution and administration fees which have
included an exploration of issues related to compliance through
omnibus accounts. The results of these exams should help better
inform the Commission of any issues in omnibus account
compliance, and I expect will be used to inform any policy
changes that the Commission might take to address any problems
identified.
Q.8. Public companies are not currently required to report
their political spending to shareholders. Academics who have
studied this issue have shown that public companies spend
significant amounts of shareholder money on politics, but that
it is impossible to know how much money companies are spending,
or who is benefiting from that spending. \5\ I believe that
public companies should not be able to spend huge sums of
shareholder money on political communication without informing
investors, and that it is appropriate for the SEC, whose core
mission is to protect investors, to issue a rule on this
matter.
---------------------------------------------------------------------------
\5\ Lucian A. Bebchuk and Robert J. Jackson, Jr., ``Shining a
Light on Corporate Political Spending'', 101 GEO. L.J. 923, 925 (2013).
---------------------------------------------------------------------------
To date, a petition for SEC rulemaking on corporate
political spending disclosure has generated more than one
million comments--most of which support a disclosure rule.
Despite that overwhelming public support, last December, the
SEC removed from its regulatory agenda a proposed rule to
require public companies to disclose political spending.
In January, I joined Senator Menendez and other Senators in
a letter asking you when the SEC planned to move forward with a
disclosure rule for corporate political spending. Although I
appreciated the response I received from you in February, you
did not indicate when the SEC planned to address this issue.
Please detail what the Commission has done this year to
look into implementing a corporate political spending
disclosure rule. Please also state when the Commission plans to
initiate a rulemaking proceeding, and when it intends to
complete that rulemaking proceeding.
A.8. As I indicated in my February 28, 2014, letter to you, I
recognize the public interest in the topic of mandated
corporate political spending disclosure. And as I noted in my
testimony last September, a number of companies--including a
significant percentage of the companies in the S&P 100--are
voluntarily providing public disclosures for political
contributions. Shareholders also can, and do, submit
shareholder proposals on the topic for inclusion in companies'
proxy materials, and a number of these proposals have been
voted on by shareholders. With respect to a consideration of a
mandatory disclosure rule, in light of the numerous rulemakings
and other initiatives mandated for the SEC by the Dodd-Frank
Wall Street Reform and Consumer Protection Act and the
Jumpstart Our Business Startups Act, as well as the need to act
on pressing issues such as money market fund reform and
strengthening the technology infrastructure of the U.S.
securities markets, the Commission and its staff have focused
on implementing these rules during the last year and have not
devoted resources to a consideration of a corporate political
spending disclosure rule. As indicated by the Regulatory
Flexibility Act agenda published in the fall of this year, I
expect that completion of the remaining statutorily-mandated
rulemakings and projects will continue to be a primary focus of
the Commission's agenda for the upcoming year, along with
rulemakings that seek to enhance our equity market structure
and risk monitoring and regulatory safeguards for the asset
management industry.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
FROM MARY JO WHITE
Q.1. As we examine Wall Street regulation and soundness, it is
critical that we be alert to outside threats as well. Over the
past year, there have been a number of extensive cyberattacks
on American companies, including large financial institutions.
Combatting these transnational crimes requires cooperation
across Government and industry.
As I have previously asked both Secretary Lew and Chair
Yellen--Do you pledge to make cybersecurity a priority?
A.1. I fully agree with your concerns about cyber risks.
Cybersecurity has been, and will continue to be, a priority for
the SEC and for me personally. Our efforts and initiatives
related to cybersecurity span multiple divisions and offices,
including the Divisions of Trading and Markets, Investment
Management, Enforcement, the Office of Compliance Inspections
and Examination (OCIE), the Office of Credit Ratings, and the
Division of Corporation Finance. They include the following:
In 2014, OCIE's examination priorities included a
focus on technology, including cybersecurity
preparedness. As part of this effort, OCIE issued a
Risk Alert on April 15, 2014, to provide additional
information concerning its cybersecurity initiative.
The initiative was designed to assess cybersecurity
preparedness in the securities industry and to obtain
information about the industry's recent experiences
with certain types of cyberthreats. On January 13,
2015, OCIE announced that its 2015 Examination
Priorities again include examination of broker-dealers'
and investment advisers' cybersecurity compliance and
controls, and also announced that it would expand this
initiative to cover transfer agents.
In the spring of 2014, the SEC hosted a
cybersecurity roundtable to encourage a discussion of
sharing of information and best practices in this area.
Participants included representatives from industry,
law enforcement, the legal community and the SEC.
At my direction, in the summer of 2014, the staff
formed a Cybersecurity Working Group to facilitate
communication within the SEC on issues relating to
cybersecurity and keep abreast of cybersecurity issues
and trends relevant to the securities industry. This
group assists the SEC's divisions and offices by
providing a forum for sharing information and
coordinating activities relating to cybersecurity.
The Division of Corporation Finance issued staff
cybersecurity guidance in 2011 setting forth the
staff's views on how existing disclosure requirements
under the Federal securities laws apply to
cybersecurity risks and cyber incidents. Since issuing
the guidance, the staff has routinely evaluated public
company disclosures, including cybersecurity
disclosure, and issued comments to elicit better
compliance with applicable disclosure requirements when
it believes material information may not have been
provided.
Staff participate in interagency groups focused on
cybersecurity issues, including the Financial and
Banking Information Infrastructure Committee (FBIIC)
and the Interagency Cybersecurity Forum.
Q.2. Do you believe FSOC can fulfill its statutory mandate to
identify risks and respond to emerging threats to financial
stability without making cybersecurity a priority?
A.2. I agree that part of FSOC's role in identifying threats to
the financial stability of the United States includes
highlighting, identifying and analyzing the risks to
cybersecurity. Each of FSOC's Annual Reports has identified
cybersecurity as a focus for regulators and financial
institutions. In its most recent Annual Report, published in
June 2014, the Council provided a more detailed set of
recommendations on cybersecurity issues. Among the
recommendations in the 2014 Annual Report are:
The Council recommends that regulators and other
agencies work with private sector financial
institutions to share insights from across the
Government and inform institutions, market utilities,
and service providers of the risks associated with
cyber incidents.
The Council recommends that regulators assess the
extent to which regulated entities are employing
principles such as the National Institute of Standards
and Technology's Cybersecurity Framework.
The Council recognizes the overarching contribution
of the private sector to cybersecurity infrastructure.
The Council recommends the continued use of FBIIC
to establish, update, and test crisis communication
protocols, as well as the equivalents in the private
sector.
Q.3. As a member of FSOC, can you identify any deficiencies in
the U.S.'s ability to prevent cyberattacks that require
Congressional action?
A.3. Cybersecurity and the need to specifically address the
threats from cyberattacks must be high priorities for both
Government agencies and the private sector. As described above,
the SEC has prioritized cybersecurity issues within the bounds
of our jurisdictional mandate. We also are involved in
interagency efforts to coordinate and share information across
the Government. Similarly, the FSOC has made recommendations in
its annual reports regarding steps that regulators and
financial market participants should consider to improve
coordination and communication about the threats of cyber
incidents. Although there may be areas where cybersecurity
legislation would be helpful--for example, in areas such as
information sharing and data breach notification--I am not
aware of deficiencies specific to the SEC and its jurisdiction
that might require Congressional action at this time.
Q.4. What steps has FSOC taken to address the prevention of
future cyberattacks on financial institutions, such as the
recent breach at JPMorgan Chase?
A.4. Certain members of FSOC, including the SEC, participate in
FBIIC, which has been coordinating information sharing related
to cyber incidents, including the recent breach at JPMorgan
Chase. As a member of FBIIC, the SEC has participated in those
discussions.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
FROM MARY JO WHITE
Q.1. Recently, the Treasury Department indicated that the
Financial Stability Oversight Council was switching the focus
of its asset management examination toward activities and
products rather than individual entities.
Will you confirm that individual asset management companies
are no longer being considered for possible systemically
important designation?
A.1. Although the FSOC has not designated any investment
advisor as systemically important, it has not stated that it
will no longer consider asset management companies for
designation. However, as your question notes, FSOC did state in
the readout of the July 31, 2014, FSOC meeting available at
http://www.treasury.gov/initiatives/fsoc/council-meetings/
Documents/July%2031%202014.pdf that the FSOC has directed staff
to undertake a more focused analysis of industrywide products
and activities to assess potential systemic risks associated
with the asset management industry. And on December 18, 2014,
FSOC released a notice seeking public comment regarding
potential risks to U.S. financial stability from asset
management products and activities.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM TIMOTHY G. MASSAD
Q.1. The issue of FSOC accountability and transparency is one
that I have raised numerous times. Given the magnitude of the
regulatory burden and other costs imposed by a SIFI
designation, it is imperative that the designation process be
as transparent and objective as possible.
Do you object to the public disclosure of your individual
votes, including an explanation of why you support or oppose
such designation?
Will you commit to pushing for greater accountability and
transparency reforms for FSOC? Specifically, will you commit to
push the FSOC to allow more interaction with companies involved
in the designation process, greater public disclosure of what
occurs in FSOC principal and deputy meetings, publish for
notice and comment any OFR report used for evaluating
industries and companies, and publish for notice and comment
data analysis used to determine SIFI designations? If you do
not agree with these proposed reforms, what transparency and
accountability reforms would you be willing to support?
A.1. The Council releases the minutes of its meetings, and I
think that process is working well. In practice, the votes of
the individual Council members are disclosed, and I have no
objection to the disclosure. These are collective decisions of
the Council, however, just as the decisions of the Federal
Reserve Board, FDIC, SEC, and CFTC are decisions of those
collective bodies.
Regarding your second question, in the Dodd-Frank Act, the
Council was required to assess potential risks to financial
stability. The Council also was given authority to designate
nonbank financial companies for supervision by the Federal
Reserve if the material financial distress or activities of the
company could pose risks to U.S. financial stability. These
responsibilities involve information and deliberations that can
be very market sensitive. Due to the sensitive nature of its
mission, the Council must carefully balance confidentiality
with transparency. While I understand that some may see it
differently, I believe that the Council generally has done a
good job of reaching the right balance. In practice, there have
been no limits on the amount of materials companies have been
able to submit, and it is carefully reviewed and considered.
It's also fair to say that we're open to suggestions on how
the Council can do better in any of its activities, and I
pledge to be vigilant in this regard. Staff and principals of
the agencies have an ongoing dialogue about possible
improvements to the process, including whether to make official
any the practices the Council has been following that provide
greater access to the process.
Q.2. In the July FSOC meeting, the Council directed staff to
undertake a more focused analysis of industrywide products and
activities to assess potential risks associated with the asset
management industry.
Does the decision to focus on ``products and activities''
mean that the FSOC is no longer pursuing designations of asset
management firms?
Did the FSOC vote on whether to advance the two asset
management companies to Stage 3? If so, why was this not
reported? If not, why was such a vote not taken in order to
provide clarity to the two entities as well as the industry?
A.2. The Council continues to study the asset management
industry, and I look forward to being involved in that process.
In addition, the SEC has announced actions concerning asset
managers that may have an impact on the issues. At this point,
I don't think any of us can say where a fuller examination of
the issues will take us.
I cannot comment--one way or the other--on any nonpublic
matters that may or may not be pending before the Council. As
stated above, I look forward to being actively involved as the
Council moves forward on asset management issues. Determining
the extent to which an individual company potentially may
contribute to systemic risk is a difficult issue, and clear
answers are seldom available. A more fulsome examination of
issues in the asset management industry will help our analysis,
but at this point, I cannot say where that analysis will lead
us.
Q.3. CFTC-SEC Coordination: Chairman Massad, I have repeatedly
stated that the SEC and CFTC need to move in a more coordinated
fashion with respect to Dodd-Frank implementation and cross-
border initiatives for derivatives. In a hearing in February, I
asked Chair White and then-Acting Chairman Mark Wetjen about
their efforts to ensure coordination on the remaining Title VII
rulemakings, and they responded that the two agencies are
continually in discussions and that coordination is a priority
for both agencies. What specific progress has your agency made
in this venue since February, and what key obstacles still
exist?
A.3. CFTC-SEC Coordination on Margin for Uncleared Swaps: The
SEC and CFTC have a long history of interagency coordination in
a wide variety of ways in terms of surveillance, enforcement,
development of complementary rules, trading in security-related
products, and dual-registrant issues. With the passage of the
Dodd-Frank Act, interagency cooperation has only grown. The
chairs and staff of the CFTC and SEC talk regularly in order to
coordinate efforts. We are also working with our international
counterparts to harmonize the rules across borders as much as
possible, consistent with our statutory responsibilities.
Regarding the remaining Title VII rulemakings, CFTC staff
has been in regular contact with the SEC, sharing information
and providing detailed input. The SEC also provides input to
the CFTC. For example, in developing margin requirements for
uncleared swap transactions for SDs and MSPs, Commission staff
has continued to consult with staff of both the SEC and banking
regulators.
Section 4s(e) of the Dodd-Frank Act requires the CFTC to
adopt rules imposing initial and variation margin on uncleared
swap transactions entered into by SDs and MSPs that are not
subject to regulation by a Prudential Regulator (i.e., the
Federal Reserve Board (FRB), the Office of the Comptroller of
the Currency (OCC), the Federal Deposit Insurance Corporation
(FDIC), the Farm Credit Administration, and the Federal Housing
Finance Agency). Section 4s(e) further provides that the CFTC,
Securities and Exchange Commission (SEC), and Prudential
Regulators shall, to the maximum extent practicable, adopt
comparable margin regulations.
The CFTC initially proposed margin requirements for
uncleared swap transactions in April 2011 (76 FR 23732 (Apr.
28, 2011)). Subsequent to the initial proposal, the Basel
Committee on Banking Supervision and the International
Organization of Securities Commissions, in consultation with
the Committee on Payment and Settlement Systems and the
Committee on Global Financial Systems, formed a working group
to develop international standards for margin requirements for
uncleared swaps. Representatives of more than 20 regulatory
authorities participated, including from the United States, the
CFTC, the FDIC, the FRB, the OCC, the Federal Reserve Bank of
New York, and the SEC.
In July 2012, the working group published a proposal for
public comment. In addition, the group conducted a study to
assess the potential liquidity and other quantitative impacts
associated with margin requirements. A final report was issued
in September 2013 outlining principles for margin rules for
uncleared derivative transactions.
The CFTC considered the comments received on its initial
proposal and the report issued by the international working
group and decided to repropose margin rules for uncleared swap
transactions. The reproposal was approved by the CFTC on
September 23, 2014 (``Margin Requirements for Uncleared Swaps
for Swap Dealers and Major Swap Participants'', 79 FR 59898
(Oct. 3, 2014)). In developing the reproposal, CFTC staff
worked closely with the staff of the Prudential Regulators, and
consulted with staff of the SEC.
The comment period for the reproposal closed on December 2,
2014, and staff is currently considering the comments in
developing the final margin rules. Staff also will consult with
staff of the Prudential Regulators and SEC in developing its
final regulations.
Q.4. Cross-Border: In November 2013, CFTC staff issued an
advisory indicating that in certain instances U.S. rules would
apply to a transaction between a non-U.S. swap dealer and a
non-U.S. person, without the possibility of substituted
compliance. As I indicated in my November 15th letter, this
surprised the market, creating uncertainty and the potential
for market disruptions. The CFTC has since solicited comments
on the advisory and extended its effective date to December
31st of this year. Given that the effective date is rapidly
approaching, is the CFTC considering extending the effective
date given the continued issues implementation would cause, the
concerns raised by commenters, and the need to provide market
participants sufficient time to come into compliance with
however the CFTC resolves those issues?
A.4. As you noted, the Commission invited public comment on the
staff advisory on cross-border, issued on November 14, 2013,
and the staff subsequently extended time-limited no-action
relief from the relevant provisions of the CEA and Commission
rules. The relief was intended to be responsive to industry's
concerns regarding implementation and thereby ensure that
market practices would not be unnecessarily disrupted. The
staff has extended this relief through September 30, 2015. The
staff has reviewed the public comments on the advisory and is
developing recommendations. I can assure you that the
Commission will carefully consider these public comments and
staff recommendations. In doing so, the Commission will also
consider extending appropriate relief in order to ensure that
market participants have sufficient time to come into
compliance with applicable provisions of the CEA and Commission
rules.
Q.5. Swap Dealer De Minimis: The swap dealer de minimis level
is set to automatically drop to $3 billion unless the CFTC
takes action. Will you commit to publish for public notice and
comment any proposal to drop the de minimis level? As you know,
many parties will be affected by any drop in the de minimis
level, and the public should be afforded an opportunity to
comment on any such changes.
A.5. Commodity Exchange Act section 1a(49)(D) directs the
Commission to exempt from designation as a swap dealer an
entity that engages in a de minimis quantity of swap dealing.
CFTC regulation 1.3(ggg)(4) sets the de minimis level at $3
billion subject to a phase-in period during which the level is
$8 billion until: (1) five years after a swap data repository
first receives data pursuant to the Commission's regulations at
which time the level would automatically go to $3 billion, or
(2) another date set by the Commission based on a study to be
performed by CFTC staff. I think it will be important to study
this rule, incorporating public input and current market data
into the analysis. Any changes to current rules would need to
be data-driven and carefully considered. As of December 5,
2014, there were 105 swap dealers provisionally registered with
the Commission of which approximately 60 belong to one of 15
corporate families that have registered from 2 to 10 affiliates
as swap dealers.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM TIMOTHY G. MASSAD
Q.1. Volcker Rule: Will you commit to working to ensure that
each of your agencies has a complete picture of an entire
firm's trading and compliance with the Volcker Rule, which can
best be accomplished by having all data in one place so that
all regulators have access to it?
A.1. Pursuant to the jurisdictional provisions of sections 2
and 619 of the Dodd-Frank Act, banking entities covered by the
Volcker Rule are required to report metrics data for certain of
their trading desks to specific regulatory agencies depending
on the activities of those desks and the legal entities in
which those desks book trades. The CFTC is working with the
other four agencies to coordinate oversight of the banking
entities' trading activities and to analyze and improve the
metrics data. We believe that the agencies can work together to
obtain a coherent, informative picture of the trading
activities of each reporting firm.
Q.2. Are you committed to using disclosure to help advance
compliance with and public trust from the Volcker Rule?
A.2. The CFTC remains committed to utilizing our oversight of
certain of the banking entities' trading operations to advance
compliance with, and public trust from, the Volcker Rule. The
metrics reporting required by the Volcker Rule is a critical
piece of that oversight.
Q.3. Volcker Rule: Will you commit to scrutinizing, for the
purposes of the Volcker Rule, any reorganizations of trading
desks as posing risks of evasion and will you commit to working
jointly to clarify any guidance on the definition of trading
desk for market participants?
A.3. The CFTC is aware that the flexibility afforded in the
Volcker Rule's definition of ``trading desk'' could be misused
by some banking entities in an attempt to evade detection of
impermissible trading activities. We are actively monitoring
the trading desk reorganizations in light of the reported
metrics data and will coordinate with the other four agencies
on any possible related guidance.
Q.4. Volcker Rule: I would urge the Board to clarify that a
banking entity's requirement to make ``reasonable efforts'' to
exercise its contractual rights to terminate its investment in
an illiquid fund could be satisfied, for example, by a
certification by the banking entity (a) that the banking
entity's exit from the fund would be extraordinary from the
perspective of how most investors enter or exit the fund (i.e.,
the investment contract does not routinely or ordinarily
contemplate entry or exit, and/or such other indicia as are
necessary to help distinguish between illiquid private equity
funds and other funds, like hedge funds, that ordinarily and
routinely permit investor redemptions), (b) that inquiring with
third-party fund managers and limited partners regarding
termination would result in a significant detriment to the
business of the banking entity and (c) that the banking entity
believes that the divestment would result in losses,
extraordinary costs, or otherwise raise unreasonable demands
from the third-party manager relating to divestment (or the de
facto equivalent thereto).
Such a certification from the banking entity, along with
the language of the relevant fund agreements and such other
requirements as the Board determines appropriate, would obviate
the need to seek consent from third-party fund managers. Have
you considered clarifying this in a FAQ?
A.4. The CFTC supports the Board's efforts to determine the
veracity of claims of illiquidity for various covered funds and
will coordinate with the other agencies on the appropriate
method through which to clarify the issue, should the agencies
choose to clarify.
Q.5. Deguaranteeing of Wall Street Banks: We've recently seen
reports that the largest Wall Street banks are nominally
``deguaranteeing'' their foreign affiliates in order to avoid
coverage under U.S. regulatory rules, especially those related
to derivatives. This ``deguaranteeing'' appears to be based on
a fiction that U.S. banks do not actually guarantee the trading
conducted by foreign subsidiaries, and hence would not be
exposed to any failure by the foreign subsidiary. Can you
comment on that, and specifically, whether you believe that
U.S. bank or bank holding company could be exposed to losses
from--or otherwise incur liability related to--a foreign
affiliate's trading even when no explicit guarantee to third
parties exists. Please specifically address whether an
arrangement, commonly known as a ``keepwell,'' provided by the
U.S. parent or affiliate to the foreign affiliate potentially
could create such exposure--and specifically, liability--for
the U.S. entity.
A.5. The CFTC is aware of ``deguaranteeing'' activities by five
registered swap dealers that have U.S. based parents. We are
concerned about these activities both from the perspective of
whether they are compliant with the CEA and CFTC regulations
and the effect they may have on risk transfer back to the U.S.
We have gathered detailed information from all five registrants
on the how, what, why and when of such activities and are now
assessing this information and consulting with prudential
regulators. As stated in the Commission's cross border
guidance, the Commission believes that ``it is the substance,
rather than the form, of the [financial support] arrangement
that determines whether the arrangement should be considered a
guarantee for purposes of the application of section 2(i) [of
the CEA].'' 78 FR 45320 (2013). In a footnote to the quoted
text, the Commission noted that ``keepwells'' would, in
essence, be guarantees for purposes of section 2(i).
Q.6. Please comment on whether the size and importance to the
U.S. parent or affiliate of the foreign affiliate's activities
could itself create an implied guarantee such that the U.S.
firm would have major reputational or systemic risk reasons to
prevent the foreign affiliate from incurring significant losses
or even failing--similar to rescues that occurred during the
financial crisis of entities that were supposed to be
bankruptcy remote.
A.6. The size and importance of an affiliate's activities could
influence a U.S. parent's assessment of how much financial
support to provide to that affiliate to prevent its failure.
Reputational concerns could lead a parent to provide financial
support to an affiliate. This is a concern that the Commission
acknowledged in its cross border guidance when declining to
identify only certain types of guarantees as relevant for
registration purposes. 78 FR 45320. We note that if there is no
agreement under which the parent is obligated to another party
to provide financial support, then providing such support is
not a legal requirement. Another possible way of addressing
this issue may be through effective resolution plans that
provide for the winding up of such an affiliate instead of
``rescuing'' the affiliate.
Q.7. Many of these foreign bank subsidiaries are so-called
``Edge Act'' corporations, which I understand are consolidated
with the insured depository subsidiary for many purposes.
Please comment on whether there is any chance that losses
in these Edge Act corporations, particularly losses in their
derivatives operations, could impact the deposit insurance
fund.
A.7. The CFTC does not oversee the deposit insurance fund and
therefore does not have the information necessary to answer
this question.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
FROM TIMOTHY G. MASSAD
Q.1. Cybersecurity: As I have previously asked both Secretary
Lew and Chair Yellen--Do you pledge to make cybersecurity a
priority?
A.1. Yes, working to improve the cyber and information security
and the cyber-related resilience, preparedness, and mitigation
capabilities of the financial sector, and of U.S. futures and
swap markets and clearing organizations in particular, is and
will continue to be a priority.
Q.2. Do you believe FSOC can fulfill its statutory mandate to
identify risks and respond to emerging threats to financial
stability without making cybersecurity a priority?
A.2. Cyber and information security must be a high priority for
the financial sector. Recognizing that automated systems play a
central and critical role in the modern, predominantly
electronic financial marketplace, cybersecurity is a statutory
and regulatory priority for the CFTC: the Commodity Exchange
Act and CFTC regulations require the infrastructures that we
supervise, namely designated contract markets, swaps execution
facilities, clearing organizations, and swap data repositories,
to have programs of risk analysis and oversight that address
cyber and information security. In addition, I agree it should
be a priority generally for U.S. financial regulators: the
Financial and Banking Information Infrastructure Committee or
FBIIC--which is chaired by the Department of the Treasury and
includes the CFTC--aids U.S. financial regulators in their
efforts to strengthen financial sector resilience,
preparedness, and mitigation capabilities with respect to
cybersecurity, business continuity, and disaster recovery. The
FBIIC also has an effective partnership concerning
cybersecurity and automated system resiliency with its private
sector counterpart, the Financial Services Sector Coordinating
Council, which includes major markets, clearing organizations,
and firms across the U.S. financial sector.
Q.3. As a member of FSOC, can you identify any deficiencies in
the U.S.'s ability to prevent cyberattacks that require
Congressional action?
A.3. One key way to increase financial sector resiliency with
respect to cybersecurity is ensuring timely information sharing
concerning cyberthreats, to the greatest extent practicable.
Before undertaking a legislative initiative, we should endeavor
to work within existing authorities to examine ways that
financial regulators, the Intelligence Community, and law
enforcement agencies might facilitate timely cyberthreat
information-sharing. In that connection, the Commission already
has authority under the CEA to share information with Federal
and State agencies, as well as foreign regulators, subject to
assurances of confidentiality.
Q.4. What steps has FSOC taken to address the prevention of
future cyberattacks on financial institutions, such as the
recent breach at JPMorgan Chase?
A.4. U.S. financial regulators work closely together through
the FBIIC to improve financial sector resiliency and
preparedness with respect to cyberattacks. Both the FBIIC and
its private sector counterpart, the FSSCC, have response
protocols in place for use when cyberattacks occur. FBIIC and
FSSCC are currently engaged in updating these protocols in
light of recent experience in this area, and they are working
to match up the protocols of the public and private sectors
even more closely, to help facilitate timely coordination
concerning cyber incidents. FBIIC and FSSCC are conducting
exercises, with participation of financial regulators, the
private sector, and law enforcement and other parts of the
Government with specialized cyber expertise, to enhance our
joint understanding and planning processes. In addition, FBIIC,
FSSCC, and the Financial Sector Information Sharing and
Analysis Center are working together, and consulting with the
Intelligence Community and law enforcement, to identify
measures and best practices for strengthening the resiliency,
preparedness, and mitigation capabilities of the financial
sector with respect to cyberthreats.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR MORAN
FROM TIMOTHY G. MASSAD
Q.1. Position Limits: Mr. Chairman, in a recent media
appearance, you said that the CFTC intends to address end-user
concerns with position limits. I have heard concerns about the
aggregation of positions even where a person does not control
day-to-day trading. Does the CFTC intend to address these types
of concerns in its work on end-user issues?
A.1. CFTC is now considering public comments received on a
notice of proposed rulemaking (NPRM) that would modify the
aggregation provisions of the position limit regime under part
150 of CFTC's regulations. We are soliciting extensive input on
the position limits rule--78 FR 68946 (Nov. 15, 2013), comment
period extended 79 FR 2394 (Jan. 14, 2014), comment period
reopened 79 FR 30762 (May 29, 2014), June 19, 2014, staff
roundtable, \1\ comment period extended 79 FR 37973 (July 3,
2014), comment period reopened 79 FR 71973 (Dec. 4, 2014). In
light of the language in section 4a of the Commodity Exchange
Act (CEA), its legislative history, subsequent regulatory
developments, and CFTC's historical practices in this regard,
CFTC noted in the NPRM that it believes CEA section 4a requires
aggregation on the basis of either ownership or control of an
entity. The NPRM would add a new exemption, by way of notice
filing, for a person seeking disaggregation relief, under
specified circumstances, for positions held or controlled by a
separately organized entity (owned entity), for ownership or
equity interests of not more than 50 percent in the owned
entity. The proposal also would add a new exemption, by way of
application, for a person seeking disaggregation relief, under
specified circumstances, for positions held or controlled by an
owned entity, for ownership or equity interests of greater than
50 percent in the owned entity.
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\1\ Transcript available at http://www.cftc.gov/PressRoom/Events/
opaevent_cftcstaff061914.
Q.2. Swap Dealer De Minimis: Mr. Chairman, as you know the swap
dealer de minimis level is set to automatically drop to $3
billion unless the CFTC takes action. Will any action taken by
the CFTC to address the swap dealer de minimis issue be open to
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public notice and comment?
A.2. Commodity Exchange Act section 1a(49)(D) directs the
Commission to exempt from designation as a swap dealer an
entity that engages in a de minimis quantity of swap dealing.
CFTC regulation 1.3(ggg)(4) sets the de minimis level at $3
billion subject to a phase-in period during which the level is
$8 billion until: (1) five years after a swap data repository
first receives data pursuant to the Commission's regulations at
which time the level would automatically go to $3 billion, or
(2) another date set by the Commission based on a study to be
performed by CFTC staff. I think it will be important to study
this rule, incorporating public input and current market data
into the analysis. Any changes to current rules would need to
be data-driven and carefully considered. As of December 5,
2014, there were 105 swap dealers provisionally registered with
the Commission of which approximately 60 belong to 1 of 15
corporate families that have registered from two to ten
affiliates as swap dealers.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
FROM TIMOTHY G. MASSAD
Q.1. FSOC: Recently, the Treasury Department indicated that the
Financial Stability Oversight Council was switching the focus
of its asset management examination toward activities and
products rather than individual entities. Will you confirm that
individual asset management companies are no longer being
considered for possible systemically important designation?
A.1. As you know, the OFR released a report on asset management
issues a year ago, and the Council held an asset management
conference last spring. This topic is an important one. The
Council continues to study issues that affect the asset
management industry and the financial markets. I expect the
Council will provide industry and the public ample opportunity
to comment further later this year as it further explores these
issues, and I look forward to being involved in that process.
At this point, I do not know where further discussion of the
issues will take us, but I hope to gain a better understanding
of the risks surrounding this industry.