June 30, 2016

Rules In Focus: FSOC Rescinds GE Capital Designation

On June 29, the Financial Stability Oversight Council (FSOC) announced that it had voted unanimously to withdraw its determination that the failure of GE Capital would pose a threat to the stability of the United States. As a result of this determination, GE Capital will no longer be subject to the enhanced prudential standards or the supervision of the Federal Reserve Board.

Rules In Focus: FSOC Rescinds GE Capital Designation
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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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FSOC Rescinds GE Capital Designation

On June 29, the Financial Stability Oversight Council (FSOC) announced that it had voted unanimously to withdraw its determination that the failure of GE Capital would pose a threat to the stability of the United States. As a result of this determination, GE Capital will no longer be subject to the enhanced prudential standards or the supervision of the Federal Reserve Board.

In explaining the rescission of its earlier designation, Treasury Secretary and FSOC Chairman Jack Lew noted, “The Council’s rescission of GE Capital’s designation is the result of a methodical analysis of risks that is in keeping with the law and the lessons of the financial crisis. GE Capital has made fundamental strategic changes that have resulted in a company that is significantly smaller and safer, with more stable funding. After a rigorous review and engagement with the company over the last year, the Council determined that based on these changes, the designation is no longer warranted.”

FSOC conducts an annual review of all of its designation decisions. On March 31, 2016, GE Capital formally requested that FSOC’s earlier designation be rescinded. FSOC released an explanation of its decision, which noted since its designation in 2013, GE Capital had taken a variety of steps to divest itself of financial assets. These steps included an overall reduction in GE Capital’s assets by over 50%, including a complete divestiture of its retail banking and consumer finance operations. GE Capital also took steps to greatly reduce its participation in short-term wholesale funding markets from 3.3% of the market to only 0.1%. GE Capital was also reorganized as a wholly-owned subsidiary of the General Electric Corporation, reducing its interconnectedness with other large financial services companies. GE Capital’s internal structure was also simplified to focus on three primary business lines.

For more information, please contact Robert Hatch,

Banks Pass Federal Reserve Stress Test

The Federal Reserve Board has released the results of its 2016 supervisory stress test and Comprehensive Capital Analysis and Review (CCAR) exercise. Covered institution faired extremely well in both exercises, leading the Federal Reserve to conclude, “[t]he nation’s largest bank holding companies continue to build their capital levels and improve their credit quality, strengthening their ability to lend to households and businesses.”

Thirty-three banking institutions are required to participate in the Federal Reserve’s stress test and CCAR exam. All covered companies passed the stress test, showing that they have sufficient capital to weather a severe recession. In aggregate, covered companies were still projected to hold an average capital level of 8.4 percent under stressed conditions, which is still almost 4 percent above the regulatory minimum.

The capital plans of each covered bank were also tested against stressed conditions. From a quantitative standpoint, each bank showed the ability to make planned dividend payments and other capital distributions while staying above regulatory benchmarks on leverage and core equity. The Federal Reserve also considered a variety of qualitative factors such as risk management procedures, internal controls, and governance practices that play a role in an institution’s capital planning process. The Federal Reserve accepted 31 of the 33 plan submissions, and cited areas, such as auditing processes, that will be the focus of further reviews.

For more information, please contact Robert Hatch,

Yellen Open to Adjustments in Regulatory Standards

Federal Reserve Chair Janet Yellen testified before the Senate Banking Committee last week as part of her Semiannual Monetary Policy Report to Congress. In her testimony, Yellen expressed that the Federal Reserve was open to adjusting regulatory standards for banks and other financial institutions, particularly in regards to the annual Comprehensive Capital Analysis and Review (“CCAR”) and stress tests exercise.

In response to a question posed by Senate Banking Committee Chairman Richard Shelby (R-AL), Yellen stated that the Federal Reserve is conducting a comprehensive, five-year review of the CCAR process which takes into account information from financial sector participants as well as outside economists. Yellen echoed remarks made by Federal Reserve Governor Daniel Tarullo earlier this month that it was likely that bank holding companies with assets between $50 billion and $250 billion would be left out of the qualitative portions of CCAR. Yellen stated that these qualifying banks would be exempted from the qualitative part of CCAR that relates to capital planning, while still being subject to CCAR stress testing. Yellen also said that the Federal Reserve was looking at other changes that are designed to appropriately tailor the CCAR requirements so that its impact is most significant for the larger banks and most systemic firms.

Senator Mark Kirk (R-IL) posed a question to Chair Yellen about how the Federal Reserve’s recent Advance Notice of Proposed Rulemaking (“ANPR”) on liquidity requirements would affect the insurance industry. Yellen responded that the Federal Reserve had taken the unique aspects of the insurance industry into account. She also stated that when the final rule on liquidity requirements is released its application to insurance companies will be flexible and not bank centric.

Yellen also fielded questions from Senators Elizabeth Warren (D-MA) and Bob Corker (R-TN) in regards to the Federal Reserve’s living wills requirements for banks, stating that in 2017 the Federal Reserve will address deficiencies in this year’s living wills. Yellen was non-committal on if the Federal Reserve would raise capital requirements for the corresponding banks if the living wills requirements were not met by the October deadline.

In a separate House Financial Services Committee Hearing also held last week, Chair Yellen fielded a question from Representative Robert Pittenger (R-NC) regarding the addition of the G-SIB surcharge to the CCAR process. Yellen acknowledged Congressman Pittenger’s concerns about the impact of this addition and stated that the Federal Reserve would look to clarify this portion of the CCAR process moving forward.

Representatives Lynn Westmoreland (R-GA) and James Himes (D-CT) also asked Yellen about what the Federal Reserve was doing to alleviate the regulatory burden on smaller banks. Yellen replied that the Federal Reserve would continue to work to make their exams more tailored for community banks and that they are also working on a simplified capital rule for well-capitalized banks. Yellen also reiterated what she said in the Senate hearing in regards to how the Federal Reserve is likely to change the stress test regimes to reduce burdens on small banks.

For more information, please contact Robert Hatch,

FSOC Releases 2016 Risk Report

The Financial Stability Oversight Council (“FSOC”) released their 2016 annual Risk Report last week, highlighting significant financial and regulatory developments and potential emerging threats to the financial stability of the United States. In an open meeting following the report, FSOC members discussed twelve areas of focus that were identified in the annual report: (1) cybersecurity; (2) the asset management industry; (3) large, complex financial institutions; (4) CCP risk management; (5) short-term wholesale funding; (6) reference rates; (7) data gaps; (8) housing finance reform; (9) risk taking in the low interest rate environment; (10) market structure; (11) new products and delivery mechanisms; and (12) developments in emerging markets and Europe.

At the meeting, U.S. Treasury Department Director of Analysis Trent Reasons stressed that cybersecurity was one of the key themes identified by the Council in the report. Reasons stated that while malicious cyber activity is likely to continue, the Treasury and other regulators have prompted institutions to mitigate risk from malicious cyber activities, stressing the importance of data sharing and resilience.

In regards to housing finance reform, the report noted that while regulators and supervisors have taken steps to work within the constraints of the conservatorship of Fannie Mae and Freddie Mac to promote investment of private capital and improve operational efficiencies, federal and state regulators are approaching the limits of their ability to enact wholesale reforms that are likely to foster a vibrant, resilient housing finance system. The report stated that housing finance reform legislation is needed to create a more sustainable system that enhances financial stability.

Treasury Secretary Jacob J. Lew stated in his remarks to the Council accompanying the report that it “outlines potential threats on the horizon and offers an important roadmap to help guide the Council’s focus in the coming years.” Secretary Lew concluded his remarks by saying “I look forward to continued collaboration with members of the Council as we carry forward this work.”

For more information, please contact Robert Hatch,

IAIS Adopts Changes to Framework for Determining Systemically Important Insurance Companies

The International Association of Insurance Supervisors (“IAIS”) on June 16th released an Updated Assessment Methodology for Global Systemically Important Insurers (“G-SII”). This updated guide follows the November 2015 IAIS Proposed Updated Assessment Methodology and makes several key changes, some of which were recommended by the Financial Services Roundtable in a January comment letter.

The IAIS analysis involves the identification of G-SIIs whose distress or disorderly failure would potentially cause significant disruption to the global financial system and economic activity. In their most recent analysis, the most significant change is the elimination of the non-traditional non-insurance (“NTNI”) category. The indicators once included in that category are now distributed between the Interconnectedness category and a new Asset Liquidation category.

The latest assessment methodology moved consideration of an insurer’s large exposures, intra-group commitments, and derivatives trading from the indicator-based component in Phase II to the Phase III analysis. This helped with proportionality issues that were noted in the earlier assessment methodology by moving these three data points over.
The calibration of standards for which G-SIIs are identified was also improved in the latest framework by adjusting the weights of the indicators for which absolute reference values have been introduced, including indicators such as reinsurance, financial guarantees, and derivatives. This approach allows the IAIS to monitor growth or decline in activities measured by the indicators in a manner that a relative score would not.
These changes will help ensure that the IAIS methodology for G-SIIs designation successfully promotes safety and soundness of the global financial system without adding any inappropriate regulatory burdens on insurance groups.

For more information, please contact Robert Hatch,

Fed Vice-Chairman Stanley Fischer Defends Dodd-Frank Framework for Allowing Large Financial Companies to Fail

On Wednesday, June 22, 2016, Stanley Fischer, Vice Chairman of the Board of Governors of the Federal Reserve System, delivered remarks to the Riksbank Macroprudential Conference in Stockholm, Sweden about the benefits of the existing legal framework for resolving a failed financial organization and other Federal Reserve Board proposals aimed at increasing the stability of the financial system.

Vice Chairman Fischer stated that Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), known as orderly liquidation authority, has several features that reduce the systemic effect of a financial organization’s failure, in the situation where a resolution through the bankruptcy system is not possible. Specifically, the Vice Chairman noted that the establishment of an orderly liquidation fund would “provide government liquidity support for the failed firm and provisions to prevent the unwinding of the failed firm’s derivatives and other qualified financial contracts.”

The Federal Reserve Board has recently proposed two new rules that would aid in the orderly liquidation of a larger financial institution. The first proposed rule subjects large U.S. globally active banks (“GSIBs”) to total loss-absorbing capacity (“TLAC”) and long-term debt requirements. This rule would subject the systemically important firms to maintain larger amounts of long-term debt that would absorb losses and recapitalize the firm in an orderly resolution. The second rule proposes restrictions on GSIBs’ qualified financial contracts (“QFCs”) to guard against the mass unwinding of such contracts during the resolution of a GSIB.

Vice Chairman Fischer noted that Title II of Dodd-Frank recognized the inadequacy of the bankruptcy code to address the systemic impact of the resolution of a systemically important financial firm. The Vice Chairman also emphasized that government liquidity support and stay-and-transfer treatment for QFCs are also important supports to an orderly liquidation. Vice Chairman Fischer stated, “[U]nder the Board’s proposed TLAC rule, a failed GSIB would be recapitalized by its private-sector long-term creditors (whose debt claims would be converted into equity), not by the government. The orderly liquidation fund would be used only to provide liquidity support, not to inject capital.”
Vice Chairman Fischer concluded his remarks by noting that Dodd-Frank gave the Federal Reserve Board the proper tools to reduce the probability of failure and reduce the damage that a failure would do to the U.S. financial system.

For more information, please contact Richard Foster,

CFPB Releases Report on Supervisory Concerns in the Mortgage Market

The Consumer Financial Protection Bureau (“CFPB”) released a report on June 22nd that points to areas where the CFPB believes some mortgage servicers are still continuing to violate CFPB servicing rules. In 2014, the CFPB released a report on the use of failed technology and process breakdowns in the mortgage service industry. The agency’s updated mortgage servicing exam manual released last week is an attempt to spur industry compliance in what it perceives to be areas of continuing concern, particularly in regards to monitoring loss mitigation efforts and servicing transfers.

According to the CFPB’s studies, mortgage servicers – who serve as the middlemen between the mortgage borrower and owner of the loan by handling customer service, collections, foreclosures, and loan modifications – have a history of “bad practices” and “sloppy recordkeeping.” After the financial crisis, the CFPB created a series of requirements for the industry to address servicing problems. The requirements included various protections for consumers threatened by foreclosure and rules regarding the maintenance and accuracy of records, timely credit payments, and the ability to correct errors upon request.

The most recent CFPB report on mortgage servicers incorporates the agency’s supervision work from 2014 to the present. While the CFPB acknowledges that some mortgage servicers have made improvements, the purpose of the new exam manual and requirements is to address deficiencies that persist with the industry’s technology. Lack of updates, proper training, testing, and auditing of software platforms and computer programs are some of the problems identified by the CFPB. These problems have led to information about loan modifications being late or incorrect, as well as consumers being unable to gain access to service when loans are transferred to a new servicer with a different computer system.

Upon finding a violation of law or other weakness of a mortgage servicer, the CFPB alerts the institution to the violation or concern, outlines remedial measures, and – if necessary – opens an investigation moving towards an enforcement action. The third update to the CFPB’s exam procedures for mortgage servicing, as promulgated last week, emphasizes that going forward, the CFPB will put greater emphasis on whether the servicer has an adequate process for evaluating complaints or information requests in a timely or expedited manner from borrowers facing foreclosure. Additionally, the CFPB will use targeted reviews to insure servicers’ compliance with fair lending laws, in an effort to prohibit discrimination in any part of the lending process.

For more information, please contact Richard Foster,

FSB Asks for Comment on Vulnerabilities in the Asset Management Market

On June 22, the Financial Stability Board (“FSB”) issued a Consultative Document with policy recommendations regarding asset management structural vulnerabilities.  The document focuses on four potential vulnerabilities: (i) the mismatch between liquidity of fund investments and redemption terms and conditions for fund units; (ii) leverage within investment funds; (iii) operational risk and challenges in transferring investment mandates in stressed conditions; and (iv) securities lending activities of asset managers and funds.  The FSB will address a fifth structural vulnerability—pension funds and sovereign wealth funds—as part of its work on assessment methodologies for non-bank non-insurer global systemically important financial institutions. Public comments on the document will be accepted until September 21, 2016.

I. Liquidity mismatch between open-ended fund investments and redemption terms and conditions for fund units

The FSB recommends that authorities collect information on liquidity profiles in a manner proportionate to the financial stability risk fund investments pose.  Existing reporting and investor disclosure requirements should be reviewed and improved to ensure adequacy.

To reduce gaps in liquidity risk management tools, FSB proposes that first, authorities give guidance stating funds’ assets, thereby reducing material liquidity mismatches. Second, authorities should increase the availability of liquidity risk management tools and reduce barriers to their use.  Third, authorities should make liquidity risk management tools available to open-ended funds (e.g., swing pricing and redemption fees), in order to reduce any first-mover advantage.  Fourth, authorities should require and/or provide direction on stress testing for individual open-ended funds to support liquidity risk management to mitigate financial stability risk.

The FSB also suggests that authorities should use regulatory requirements or guidance to promote clear, transparent decision-making processes for open-ended funds’ use of liquidity risk management tools, which would insure the adequacy of these tools in the event of an exceptional circumstance.  Authorities should provide guidance regarding the use of extraordinary liquidity risk management tools by open-ended funds.  Finally, authorities should consider system-wide stress testing, when relevant, to understand the resiliency of the financial markets and financial system generally in the event of collective selling by investors.

The FSB also urged the International Organization of Securities Commissions (“IOSCO”) to review its existing guidance and improve if necessary to address these concerns.

II. Leverage within investment funds

FSB’s proposals regarding leverage within investment funds are meant to apply to all types of funds that may use leverage.

First, FSB urges IOSCO to develop streamlined measures of leverage in funds (including appropriate netting and hedging assumptions), which would increase authorities’ understanding of risks that the leverage may create, promote more useful monitoring of leverage, and facilitate comparisons across funds and globally. Second, authorities should collect data on leverage in funds and monitor the leverage use by funds that are not subject to leverage limits, as well as those that pose significant leverage-related risks to the financial system. Third, IOSCO should collect national/regional aggregated data on leverage based on simple and consistent measures that it develops.

III. Operational risk and challenges in transferring investment mandates in stressed conditions

The FSB urges authorities to provide requirements or guidance concerning risk management frameworks and practices for asset managers that are large, complex, and/or provide critical services.  These requirements or guidance would address business continuity plans and transition plans that would support the orderly transfer of clients’ accounts and investment mandates in stressed conditions.

IV. Securities lending activities of asset managers and funds

The FSB proposes that authorities monitor indemnifications provided by agent lenders/asset managers to clients for their securities lending activities.  If potential material risks or regulatory arbitrage develops that could threaten financial stability, authorities should verify and confirm that asset managers adequately cover potential credit losses from the indemnification provided to their clients.

For more information, please contact Felicia Smith,

SEC Proposes Business Continuity and Transition Planning Requirements for Investment Advisers

On June 28, the Securities and Exchange Commission (“Commission” or “SEC”) proposed new rule 406(4)-4 under the Investment Advisers Act of 1940 (“Advisers Act”) that would require SEC-registered investment advisers to implement “written business continuity and transition plans” that address risks of significant disruption in the investment adviser’s operations, and risk potential harm to clients. Additionally, the SEC proposed an amendment to rule 204-2 under the Advisers Act that would require advisers to make and preserve records of any business continuity and transition plans that are currently active or were active in the last five years. Advisers also would be required to preserve records documenting annual reviews of the plans. The SEC noted the investment adviser’s fiduciary duty requires it to protect client interests in the event that the adviser is unable to provide services, such as in times of market or industry stress. The proposal is part of the SEC’s initiative to address potential systemic risks related to the asset management industry. The Financial Stability Oversight Council continues to note its concerns with the potential for operational risks related to the industry to impact U.S. financial stability but appears to be allowing the SEC to take the lead on the appropriate policy response.

The regulations would affect an estimated 12,000 registered investment advisers that collectively manage over $67 trillion in assets. The SEC acknowledges that most investment advisers may address business continuity and transition planning as part of their compliance programs, but the uneven quality of some advisers’ plans could adversely impact clients and investors. The SEC believes the new rule is necessary to ensure each adviser has robust policies and procedures that should be effective and workable during a significant disruption in the adviser’s operations. The SEC has identified “fundamental operational risks” that apply across the board to investment advisers due to advisers’ (a) reliance on technology, (b) use of complex investment strategies, and (c) reliance on custodians, broker-dealers, technology vendors, and other third-party service providers to support their operations. The SEC believes there is a heightened possibility of harm to clients if the risks from internal technological issues, external attacks, or other emergency events are allowed to occur. The new rule would generally aim to protect against a loss of data or access to data, and address business continuity and transitional issues.

As proposed, SEC-registered advisers would be required to adopt and implement written business continuity and transition plans to address the risks of “significant disruptions in the investment adviser’s operations.” The plans would address business continuity issues such as natural disasters, acts of terrorism, cyber-attacks, equipment or system failures, or the loss of services from third-parties. It would also address business transition situations, including when an adviser exits a market, merges or sells the business, or enters bankruptcy proceedings. The specific components the business continuity and transition plans must address are: (1) maintenance of critical operations and systems, and the protection, backup, and recovery of data; (2) pre-arranged alternate physical locations(s) of the adviser’s office(s) and/or employees; (3) communications with clients, employees, service providers, and regulators; (4) identification and assessment of third-party services critical to the operation of the adviser; and (5) a transition plan that accounts for the possible winding down of the adviser’s business or transition of the adviser’s business to others if the adviser is unable to continue providing advisory services.  Each plan would be tailored to the risks associated with a given adviser’s operations, taking into account the nature and complexity of its business, clients, and key personnel.

The comment submission deadline will be 60 days after publication in the Federal Register.

For more information, please contact Felicia Smith,

House Republicans Release Text of Financial Reform Bill

Representative Jeb Hensarling, Chairman of the House Financial Services Committee, recently released more details and the proposed language of his financial reform legislation entitled the “Financial CHOICE Act of 2016” (the “Act”). The Act’s objective is to reform the financial regulatory system by (1) providing an election to be a strongly capitalized financial institution; (2) ending too-big-to-fail and bank bailouts; (3) reforming of the CFPB; (4) increasing accountability for financial regulators; (5) enhancing penalties for fraud; and (6) facilitating capital formation for small businesses and providing regulatory relief for Main Street.

First, the Act grants banks that choose to maintain a high level of capital—specifically a leverage ratio of at least 10 percent—regulatory relief from Dodd-Frank and Basel III heightened capital and liquidity standards. For banking organizations that have made the qualifying capital election, the Act would exempt the bank from any law that provides limitations on mergers or acquisitions to the extent those limitations relate to capital or liquidity standards, and exempt a bank from any rule that permits the banking agency to consider the stability of the U.S. financial system when reviewing an application to consummate a transaction or commence an activity. In addition, the Act would permit banking agencies to conduct stress tests but not to limit capital distributions of a bank that has made a qualifying capital election.

Second, the Act repeals Title I and Title VIII of the Dodd-Frank Act, which grants the Financial Stability Oversight Council the authority to designate firms as systemically important financial institutions and to designate central clearinghouses and payment systems as systemically important financial market utilities, respectively. The Act would replace Title II’s Orderly Liquidation Authority with a new chapter in the Bankruptcy Code. It would also place more restrictions on access to the Fed’s discount window and prohibit the use of the Exchange Stabilization Fund as a bailout mechanism to financial firms.

Third, the Act changes the name of the Consumer Financial Protection Bureau to the Consumer Financial Opportunity Commission (“CFOC”) and changes its mission to consumer protection and competitive markets. The CFOC would have a five-member bipartisan commission and would be required to obtain explicit permission from consumers before collecting personally identifiable information. The Act would also repeal the CFPB’s authority to ban bank products or services it deems abusive and repeals its indirect auto lending guidance.

Fourth, the Act subjects all financial regulatory agencies to the following: a cost-benefit analysis of all proposed regulations, Congressional oversight and funding through the Appropriations process, congressional approval of all major regulations, and bi-partisan commissions. The Act also reauthorizes the SEC for five years, abolishes the Office of Financial Research, and demands greater accountability for the Federal Reserve by requiring it to submit to an annual audit by the Government Accountability Office.

Fifth, the Act allows the SEC to triple the monetary fines sought in administrative and civil actions where the penalties are tied to the defendant’s illegal profits. It also allows the Department of Justice to increase the maximum criminal fines for individuals and firms that engage in insider trading and other corrupt activity. The Act requires all fines to be remitted to the Treasury for deficit reduction and allows defendants in SEC administrative proceedings the right to remove the enforcement action to federal court.

Sixth, the Act attempts to enhance funding opportunities for start-up companies by repealing the Volcker rule, the Durbin amendment, the SEC’s authority to eliminate or restrict securities arbitration, and non-material disclosures on items such as conflict minerals. It would also incorporate more than two dozen Committee or House-passed capital formation bills and regulatory relief bills for community financial institutions.

For more information, please contact Richard Foster,

OCC Holds Conference on Financial Innovation

Remarking on the promises and challenges of financial innovation, Comptroller of the Currency Thomas J. Curry opened the OCC’s Forum on Responsible Innovation last week with a roadmap of impending FinTech regulatory conversations. Curry’s introduction launched the forum – comprised of banks, financial technology companies, scholars, and consumer groups – into discussions on innovation; business, consumer, and community impact; and regulatory objectives to maintain safety and soundness requirements.

Curry specified that the forum should be a place for dialogue between innovators and regulators. The comment illustrated an overarching theme of Curry’s comments – that a robust dialogue was vital to the process of creating effective FinTech regulation. While financial innovation has the capacity to make the federal banking system stronger, more inclusive, and provide consumers with greater convenience and mobility, it also poses a risk to consumers, businesses, and communities. As interconnectivity grows, the OCC worries that cyber criminals will have more avenues for identity theft, phishing schemes, and fraud. Likewise, the agency is concerned that some innovative approaches to banking could lead to dangerous risks in lending and securities. According to Curry, “responsible innovation,” therefore, is vital to helping companies “achieve their public purposes” without conceding “their safety and soundness.”

Curry assured his audience that the OCC is striving to support constructive new FinTech. The OCC’s white paper on responsible innovation and the comments that the OCC received launched a series of future conversations for the agency. From the OCC’s perspective, implementing a framework for innovation is an important next step. The conversations that followed, which delved into how/whether FinTech companies and banks can coexist, the business of innovation, impacts of innovation on consumers and communities, and the OCC’s innovation goals, are an effort to shape the structure of discussions and regulations to come.

For more information, please contact Richard Foster,