September 27, 2016

Rules in Focus: Federal Reserve Report Suggests Repeal of Certain Bank Powers and Supervisory Exemptions

On September 8, three federal banking regulators released a joint report to the Congress and the Financial Stability Oversight Council Pursuant to Section 620 of the Dodd-Frank Act. The report analyzed permissible activities of different banking entities the three agencies currently regulate and the risks inherent in such activities. In a surprising development, the Federal Reserve Board (the “Board”) used the report to suggest that Congress curtail certain lending powers and terminate the ability of certain financial holding companies to evade direct supervision at the federal level. The co-authors of the report, the Federal Deposit Insurance Corporation (“FDIC”), and the Office of the Comptroller of the Currency (“OCC”), made no formal recommendations.

Rules in Focus: Federal Reserve Report Suggests Repeal of Certain Bank Powers and Supervisory Exemptions
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Rules In Focus

Rules in Focus is FSR’s regulatory newsletter featuring the latest insights from the Fed, CFPB, SEC and other major regulators that oversee the financial services industry and the implementation of the Dodd Frank law.

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Federal Reserve Report Suggests the Removal of Certain Banking Powers

On September 8, three federal banking regulators released a joint report to the Congress and the Financial Stability Oversight Council Pursuant to Section 620 of the Dodd-Frank Act. The report analyzed permissible activities of different banking entities the three agencies currently regulate and the risks inherent in such activities. In a surprising development, the Federal Reserve Board (the “Board”) used the report to suggest that Congress curtail certain lending powers and terminate the ability of certain financial holding companies to evade direct supervision at the federal level. The co-authors of the report, the Federal Deposit Insurance Corporation (“FDIC”), and the Office of the Comptroller of the Currency (“OCC”), made no formal recommendations.

The first section of the report, which has no binding authority, was provided by the Board, and covered the currently allowable activities of state member banks, depository institution holding companies, Edge Act and agreement corporations, and the U.S. operations of foreign banking organizations. Citing the importance of maintaining a fair market and a separation between banking and commerce, the Board recommended that several authorities that are held by these financial institutions should be repealed.

Specifically, the Board suggests the repeal of the merchant banking authority which allows financial institution to invest in ownership interests in bona fide nonfinancial companies. The report also recommends repealing the authority for certain, grandfathered entities to partake in a broad range of activities related to physical commodities. In addition, the Board suggests repealing regulatory exemptions that apply to the corporate owners of industrial loan companies and grandfathered unitary savings and loan holding companies. This would include their ability to engage in securities underwriting, insurance, and other financial activities without the Board’s direct supervision. Regrettably, the Board’s recommendations seem fail to cite empirical data or even anecdotal evidence.

The other two sections of the report from the FDIC and OCC contain no formal recommendations. The FDIC’s section notes it will undertake further review of its regulations on activities of state nonmember banks and state savings associations, particularly those regarding commodities activities. The OCC also failed to recommend any legislative action concerning the permissible activities of federal banking entities. Instead, the OCC claimed it will soon issue rule proposals and amendments on topics like restrictions on asset-backed securities holding, and compliance with the Volcker Rule.

Since the release of report, the Federal Reserve has moved forward with a notice of proposed rule to increase the risk-weights associated with bank activities related to physical commodities. The OCC also released a proposed rule to restrict investments in industrial and commercial metals by national banks and federal savings associations.

For more information, please contact Richard Foster,

Comptroller Curry Discusses OCC Agenda in the Area of Financial Innovation

On September 13, during the Marketplace Lending Policy Summit, Comptroller of the Currency Thomas J. Curry delivered remarks and shared his perspective on marketplace lending’s risks and related policy questions. Curry highlighted the concept of “responsible innovation” and revealed that the Office of the Comptroller of the Currency (“OCC”) is considering granting new federal “Fintech charters.” He further clarified that the Agency plans to hold these new types of technology lenders “to the same strict standards of safety, soundness, and fairness that other federally chartered institutions must meet.”

While Curry acknowledged the opportunities and exponential growth of marketplace lending, which originated $29 billion of consumer loans in 2015, he expressed concerns on the potential impact of financial technologies on consumers and the banking system. In particular, Curry noted “new underwriting and business models used in the marketplace lending space have not gone through a complete credit cycle” and that more may need to be done to develop appropriate safeguards to marketplace lending activities.
Curry further discussed several policy and regulatory issues raised by marketplace lending’s expansion. The first issue concerns whether new technologies and products comply with existing laws and regulations. For example, he noted all lenders must comply with the Equal Credit Opportunity Act. Curry then discussed whether laws and rules already in place are enough to answer the challenges triggered by marketplace lending or whether new regulations would better serve the public interest.

The development of a final framework on how the OCC will address emerging financial technologies is currently on the OCC agenda and will be released this fall. Curry stated that the OCC embraces financial innovation and will encourage all financial institutions to use these new technologies if they adopt effective risk management systems and sound corporate governance. He also noted that the OCC will cooperate with other regulators and will accept inputs from all stakeholders to develop a better framework.

For more information, please contact Richard Foster,

OCC Comptroller Discusses Financial Reform, Strength of the Banking System

In his remarks at the 2016 Robert Glauber Lecture at the Harvard Kennedy School, Comptroller of the Currency Thomas J. Curry provided his views on the strength of the U.S. banking system eight years after the financial crisis. Curry noted the 2008 financial collapse did not teach any new lesson but simply reminded regulators and financial institutions of some basic principles to enhance banking system’s resiliency. He warned that even though banks are safer today, this is not the moment “to let our guard down” or “to change course.”

First of all, Curry underlined that banks are stronger and have built enough capital to survive downturns and adverse shock scenarios. Curry recalled that “the capital of a bank should be a reality, not a fiction” as stated by the first Comptroller of the Currency Hugh McCulloch and that the joint efforts of regulators and institutions have applied this lesson as demonstrated by a $700 billion increase in common equity capital.

Concerning the danger of excessive leverage, Curry underlined the fundamental role of leverage ratio “to serve as an additional line of defense, or backstop, to the risk-based capital measures.” In response to those who advocate for the introduction of special exclusions to maintain certain businesses profitability, Curry firmly argued that (i) these initiatives would frustrate leverage ratio’s straightforward nature and effectiveness and that (ii) with the introduction of exceptions, market participants will be “less trusting at the most critical points of a downturn” or “when investors most need a clear understanding of a bank’s leverage and capital.”

Curry also highlighted the importance of maintaining ample liquidity and ensuring effective supervision to promote “a healthy risk culture,” endorsing the imposition of stronger capital and leverage requirements on institutions with systemic importance. He applauded the OCC’s achievements and underlined that bank regulation and supervision should look forward at what the banking system is becoming and will become in the next twenty years, providing sound guidance and an avenue for “responsible innovation.”
Curry acknowledged that banks are stronger, but downturns could be around the corner. For example, the possibility of increased interest rates or the threat of cyber-attacks could undermine U.S. financial stability. For this reason, supervisors should carefully apply the lessons on capital, leverage ratio, and liquidity to mitigate these risks and enhance financial system’s resiliency.

For more information, please contact Robert Hatch,

FSR Speaks In Support of Tailored Capital Standards for Insurance Companies

In a comment letter filed on September 16, FSR endorsed a framework outlined by the Federal Reserve Board (the “Board”) that leverages state-level risk-based capital standards to create a capital requirement that will be used at the federal level. FSR notes that the so-called “Building Block Approach” or BBA can be used in conjunction with the Board’s other regulatory authorities to ensure that insurance companies under the Board’s jurisdiction meet appropriate standards for safety and soundness.

The BBA requires the Federal Reserve to aggregate the capital standards of different entities within an insurance company to determine if the entity has sufficient levels of capital. The majority of these capital requirements will be based off of state regimes that are actively reviewed and accredited by the National Association of Insurance Commissioners. While in some cases the Board would need to aggregate the capital standards of many entities that exist within a single insurance holding company, FSR’s letter suggests that the Board should also be open to allowing insurance companies with a prudentially regulated top-tier holding company to employ a “single-block” approach to meet their capital requirements at the federal level. FSR also notes that there may be some situations where the Board will need to create scalar factors which adjust capital requirements for foreign subsidiaries or for non-insurance activities.

FSR’s press release associated with the filing of the letter can be accessed here.

For more information, please contact Robert Hatch,

FSR Reiterates Concern with Planned FIO Study on Auto Insurance

In a short submission to the Federal Insurance Office (“FIO”), FSR reiterated its concern with a research framework that FIO has adopted for determining whether auto insurance is affordable. FIO will attempt to determine whether there are areas in the United States where the average cost of auto insurance is more than 2% of average household income. FSR continues to believe that the 2% definition of affordable is overly simplistic and arbitrarily low. Despite these concerns, FIO has indicated that it will move forward in attempting to collect data in order to publish study results sometime next year.

For more information, please contact Robert Hatch,

Financial Industry Submits Recommendations on Improving Cybersecurity

On September 9, FSR as part of the Financial Services Sector Coordinating Council (“FSSCC”) submitted a letter to The Commission on Enhancing National Cybersecurity (the “Commission”) to provide information about the current and future status of cybersecurity efforts in the digital economy and making the case for continued cooperation between the public and the private sectors.

First, the letter suggests that the federal government should fund studies to identify emerging technology risks and adopt a forward-looking risk-based approach with coordinated efforts by several government agencies. Second, the FSSCC highlights the importance of adopting a “common cybersecurity lexicon and framework” to improve efficiency and save a substantial amount of resources. Harmonization between federal and state agencies is a necessary step and the Commission should take the NIST Cybersecurity Framework as reference.

Third, the letter suggests the adoption of a risk-based approach for the identification of strategically essential sectors, including financial services, within the Department of Homeland Security’s National Infrastructure Plan to “receive enhanced government assistance and support.” The fourth recommendation concerns the creation of a national cybersecurity workforce composed by trained and skilled cybersecurity professionals. To this end, the Commission should (i) increase awareness of the National Cybersecurity Workforce Framework among employers and recruiters by attending conferences and trade association meetings; (ii) enhance training and educational requirements to emphasize the importance of developing “soft skills” in addition to technical knowledge; and (iii) focus attention on K-12 students’ education.

The last recommendation addresses the global dimension of cybersecurity issues and suggests the development of cross-sector coordination and information sharing between foreign governments. Overall, cybersecurity is developing and changing at a fast pace and the FSSCC encourages the Commission to adopt appropriate initiatives as soon as possible.

For more information, please contact Josh Magri,

CFTC to Consider Extension of the Swap Dealer De Minimis Level

On September 15, CFTC Chairman Timothy Massad provided a keynote presentation at the Fourth Annual OTC Derivatives Summit North America, in Washington, D.C. where he revealed that he would recommend that the Commodity Futures Trading Commission (“CFTC”) delay a change in its swaps dealer the de minimis threshold for one year.

While speaking on the improved state of the OTC derivatives marketplace, Massad addressed the fact that if no further action is taken, the CFTC’s threshold for swap dealer registration will automatically drop from $8 billion in notional amount of swap dealing activity to $3 billion at the end of 2017. If this is allowed to happen, then starting January 1, 2017, firms will have to track their activity to determine whether they must register and be subjected to CFTC oversight and requirements.

Rather than allow the change to go through or eliminate it entirely, Massad believes that the best option is to collect more data over the next year to determine if $3 billion is the proper threshold. He stated that the CFTC still does not have reliable notional data for commodity swaps. Furthermore, the market may change significantly due to the new margin rules, and Massad also hopes to finalize a rule setting capital requirements for swap dealers before calculating the threshold. “Given its importance, a delay is the sensible and responsible thing to do – and doing it now will provide much-needed certainty to market participants,” said the Chairman.

Massad also pointed to concerns on how the change to the swap dealer registration threshold may affect smaller banks. The CFTC’s data shows that although more companies would be required to register after the change, the outstanding notional amount of interest rate (“IRS”) and credit default swaps (“CDS”) under agency oversight would increase by only one percent. Since smaller banks typically do not have significant market shares in IRS or CDS markets to begin with, Massad is unsure whether the threshold would only serve to burden smaller banks without reaping any substantial benefit. Massad will propose the delay through a Commission order, which he hopes will be adopted in the near future.

In addition to recommending a delay for the threshold change, Massad also explained the Commission’s decision to move forward with the rules setting margin requirements for uncleared swaps. These rules were intended to be set at the same time as the European Commission’s (“EC”) corresponding rules and be implemented on September 1. However, the EC announced later it would delay the implementation of their rule. Massad gave three reasons why the CFTC chose to move forward in imposing its own set of rules in spite of the EC’s decision: (i) despite the delay, the largest European institutions are still required to post margin in their transactions with U.S., Canadian, and Japanese institutions; (ii) EC Vice President Valdis Dombrovskis has shared his goal of implementing the EC’s rules by March 1, 2017 and (iii) regardless of international cooperation, the CFTC’s primary responsibility is to ensure full implementation of its own laws.

Chairman Massad noted that even though large European institutions are required to post margin in international transactions, without EC’s rule implementation, European firms dealing amongst each other will not have to post margin. Thus, he recommended that the rule be changed to a substituted compliance standard for these firms, instead of the current outright exclusion. Massad remained hopeful about global comparability: “We stand ready to review requests for such a determination from other jurisdictions.”

For more information, please contact Robert Hatch,

Senate Holds Confirmation for Two CFTC Nominees

On September 15, the Committee on Agriculture, Nutrition, and Forestry of the U.S. Senate held a hearing to consider two pending CFTC nominations. With the departures of Mark Wetjen and Scott O’Malia from the Commodity Futures Trading Commission (“CFTC”), Congress is looking to fill two vacant commissioner positions. At this hearing, the committee interviewed Dr. Christopher Brummer and Mr. Brian Quintenz for the positions. The committee members reacted favorably to both nominees, and it seems that both will receive bipartisan support.

Dr. Brummer is a professor of law at the Georgetown Law Center. He is the faculty director of Georgetown’s Institute of International Economic Law, where he conducts policy analyses on international markets. He recently concluded a three-year term as a member of the National Adjudicatory Council of FINRA. Prior to academia, he practiced law in the New York and London offices of Cravath, Swaine & Moore.

Brian Quintenz is the Founder, Managing Principal, and Chief Investment Officer of Saeculum Capital Management LLC, an investment firm that uses processes he developed for both traditional discretionary accounts and a managed-futures style, commodity pool hedge fund. Before starting Saeculum he was a consultant to Merrill Lynch’s Global Institutional Consulting Group, and a Senior Associate for Hill-Townsend Capital. Before his finance career, he was a senior policy aide to Congresswoman Deborah Pryce (R-OH) for seven years. In his opening statement, Quintenz shared that if selected, he intends to ensure that regulations made in response to the 2008 crisis do not “spill over” to harm regular businesses.

When questioned about the impending change in the de minimis threshold for swap dealer registration, the nominees differed. Quintenz shared concern that without further research, the $3 billion threshold could drive dealers out of the market and consolidate risk. On the other hand, Brummer was concerned that further delay of the change could leave too many transactions without CFTC oversight. Still, he noted that if a delay is to occur, then as a commissioner he would ensure that sufficient research on the proper threshold would be done.

Regarding cybersecurity, both nominees agreed that this should be a top priority of the CFTC, and that it currently does not have enough funding to meet growing cyber threats. Both also concurred that a “best practices” standard regarding cybersecurity measures would be superior to a more specific regime, as long as the standard is high. Quintenz noted that firms with the funds to target cybersecurity should be given the flexibility to innovate in this field.

A major point where the nominees differed was on their opinion of whether the CFTC should have moved forward with the global rules setting margin requirements for uncleared swaps, despite the European Commission’s implementation delay. Dr. Brummer believes that to create high quality international markets, the U.S. must “lead by example” then wait for other countries to follow. Contrarily, Quintenz believes that by moving forward the CFTC has placed U.S. firms in a weaker position, and is supporting regulatory arbitrage. Both nominees, however, were supportive of further comparability determinations with other countries to harmonize international derivatives markets.

For more information, please contact Robert Hatch,

FSR Cautions FSB Against Moving Too Quickly to Regulate Asset Management Activities

On Wednesday, September 21, 2016, the Financial Services Roundtable (“FSR”) submitted comments to the Financial Stability Board (“FSB”) regarding the “Proposed Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities” (the “Proposed Recommendations”).

The Proposed Recommendations relate to four possible financial stability risks identified by the FSB:  (i) a liquidity mismatch between fund investments and redemption terms and conditions for open-ended funds (excluding money market funds); (ii) the use of leverage; (iii) operational risks and challenges in transferring investment mandates under stressed conditions (in the context of asset managers that are large, complex, and/or provide critical services); and (iv) securities lending activities of asset managers and funds (with a focus on asset managers’ agent lender activities).

Upon review of the Proposed Policy Recommendations, FSR notes, however, that the FSB has not developed an empirical foundation to support the existence of the financial stability risks it attempts to identify. Instead, FSR believes any requirements and regulations should be recommended only if they are based on a clear connection between an asset management activity and disruption to the global financial system.  FSR urged the FSB to continue to formulate policy recommendations that take into account existing and proposed regulations by national regulators.

The FSB believes a key structural vulnerability is the potential liquidity mismatch of open-ended fund investments and the daily redemption of fund units.  FSR acknowledges the potential mismatch, but notes there is no clear market evidence or academic research that individual investment funds may impact global financial stability.  In addition, as acknowledged by the FSB, national regulators (including U.S. authorities) have imposed various requirements and restrictions on asset managers of open-ended funds to ensure their redemption requests comply with defined policy.

The FSB next identifies leverage as a potential risk to the global financial system through direct and indirect channels. FSR agrees leverage is an important factor in the assessment of global financial stability; however, FSR believes leverage incurred by investment funds is significantly less than leverage incurred by other financial institutions such as banks.  The FSB has also acknowledged leverage is subject to regulatory restrictions in many jurisdictions.  FSR suggests that uniform standards for measuring leverage should distinguish between derivative exposures that are utilized to manage or mitigate risk from other derivative exposures to assess any perceived financial stability risk to the global financial system.

The FSB believes that operational difficulties could become a financial stability concern in transferring mandates and accounts to a new asset manager, and investors or clients could potentially lose confidence in asset managers if they were to encounter significant difficulties.  FSR believes any vulnerabilities attributed to distress of an asset manager overemphasizes the asset manager’s potential to negatively impact the global financial system.  Asset managers do not suddenly fail, and investors regularly move assets between managers.

Finally, the FSB believes securities lending activities by asset managers and funds can pose financial stability risks, particularly in the context of agent lender indemnification commitments.  For example, the FSB noted an agent lender’s default under its indemnification agreement could lead to widespread concern that other agent lenders will fail to meet their obligations.  The FSB proposes that authorities monitor indemnifications in relation to securities lending activities.  FSR, however, does not agree securities lending activities pose global financial stability risks.  However, the indemnification commitment only requires indemnification by the agent lender when the borrower fails to return securities that have been lent and there is a shortfall between the value of the collateral (which is marked-to-market daily) and the value of the security.  As a result, the indemnification amounts are generally very small, the lender bears the risk of loss, and any risks to global financial stability are very remote.

For more information, please contact Felicia Smith,

House Passes Dodd-Frank Reform Bill along Partisan Lines

On September 13, 2016, the Committee on Financial Services of the U.S. House of Representatives met to markup H.R. 5983, the Financial CHOICE Act. The bill proposes an alternative regulatory framework that would replace the Dodd-Frank Act. Noting their complete opposition to the bill, Ranking Member Maxine Waters declared that there would be no Democratic amendments to the bill. The CHOICE Act was then passed by a vote of 30 to 26 largely along partisan lines, making it unlikely that the bill will be considered on the House floor.

Speaking support of the CHOICE Act, Republican members of the Committee stated that the complexity of Dodd-Frank’s regulatory framework is one cause of the slow U.S. economic recovery after the 2008 crisis. They claimed that Dodd-Frank is opaque and full of restrictive provisions that do not actually address the cause of the crisis. In addition, members argued that Dodd-Frank’s heavy regulations harm smaller banks, and that the overall number of financial institutions is decreasing as a result.

The bill’s supporters also argued that the Consumer Financial Protection Bureau (“CFPB”) has harmed the financial industry, in large part because of its single director structure and minimal Congressional oversight. The CHOICE Act would change the CFPB into a multi-member, bipartisan commission with more congressional oversight and transparency.

In opposition of the CHOICE Act, Democratic members claimed that the slow recovery has other causes, and that on the whole Dodd-Frank has proven beneficial. Instead of seeking to remove it entirely, the CHOICE Act’s opposition claimed that the committee’s attention should be focused on improving Dodd-Frank. Refusing to take the bill seriously, they proposed no amendments.

Before the mark-up hearing, FSR submitted a letter to the Committee noting sections of the CHOICE Act that its members approve of and areas where FSR believes more discussion is needed. FSR supports the bill’s proposal to repeal the Durbin amendment, as well as reforming the structure and accountability of the CFPB.

For more information, please contact Anthony Cimino,


For more information, please contact Robert Hatch,