Senator Warren Asks Bank CEOs to Publicly Take Positions on CFPB Arbitration Rule

Senator Elizabeth Warren (D-MA) sent letters to the CEOs of 16 major financial institutions asking for information related to the Consumer Financial Protection Bureau (“CFPB”) arbitration rule.

Both House and Senate Republicans have recently introduced resolutions to block the rule using the Congressional Review Act, and the House resolution was approved on July 25, 2017. In light of this effort, Senator Warren requested that the CEOs of the 16 banks publicly express whether they support or oppose the rule. Senator Warren pointed to the lobbying groups that represent these banks and questioned why the financial institutions themselves would not take a position publicly:

“These organizations represent your bank and your industry, but you – and other CEOs of large banks – have remained silent on the rule. If your lobbyists are taking such strong positions against the rule, is there a reason both you and your bank have been unwilling to take a public position?”

While asking the banks to take a public position, Senator Warren also maintained that the information would be used in order to contribute to a better understanding of potential effects that may come from a reversal of the rule:

“This rushed process leaves little time for public hearings and other traditional congressional fact-gathering. I am seeking this information so that the public, my colleagues, and I can better analyze the impact of reversing this CFPB rule.”

In addition to requesting information regarding the banks’ positions on the rule, Senator Warren solicited data on outcomes of customer arbitration cases against the banks. She also requested that the banks provide copies of internal or public documents that demonstrate the impact of the rule on customers or company profits, and asked that each of the banks respond to her letter by September 1, 2017.

Lofchie Comment: There is little mystery as to why banks might choose to “remain silent” at this stage. They do not want to subject themselves to overtly political attacks, or be used in an obvious political stunt by Senator Warren. Senator Warren’s requests for a mountain of information from these banks suggest that the information gathered to date by the CFPB is lacking and that the resolutions under the Congressional Review Act are warranted. The fact that the Senator feels it necessary to ask these questions, rather than being able to argue from evidence already gathered by the CFPB, seems like an admission that the rulemaking was insufficiently considered.

OCIE Cybersecurity Report Shows “Overall Improvement”

The SEC Office of Compliance Inspections and Examinations (“OCIE”) examined 75 broker-dealers, investment advisers and investment companies as part of its Cybersecurity 2 Initiative to assess industry practices concerning cybersecurity preparedness. OCIE National Examination Program staff reported an overall improvement in awareness of cyber-related risks and the implementation of certain cybersecurity practices since the OCIE’s Cybersecurity 1 Initiative.

According to the OCIE Risk Alert, the Cybersecurity 2 Initiative examinations focused on written policies and procedures, and included more testing of controls. Specifically, it addressed:

  1. governance and risk assessment;
  2. access rights and controls;
  3. data loss prevention;
  4. vendor management;
  5. training; and
  6. incident response.

Notably, the OCIE found that all broker-dealers, all funds, and nearly all advisers examined in the Cybersecurity 2 Initiative maintained written cybersecurity policies and procedures around the protection of customer/shareholder records. These findings contrasted with those of the Cybersecurity 1 examinations. The OCIE also found firms that were not “adhering to or enforcing” policies and procedures, and firms where guidance for employees was too general. The OCIE report included recommendations for improving controls in their respective cyber programs.

In a related white paper on cyber risk, the Bank for International Settlements Financial Stability Institute evaluated the regulatory and supervisory initiatives in a number of leading jurisdictions, including Hong Kong SAR, Singapore, the United Kingdom and the United States. The report reviewed supervisory approaches to assessing the cyber-risk vulnerability and resilience of banks. The paper also identified a trend toward “threat-informed” testing frameworks, which use threat intelligence to design simulated cyber attacks when testing the cybersecurity of an entity.

Federal Register: OCC Requests Comments on Volcker Reforms

The Office of the Comptroller of the Currency (“OCC”) requested public comment on the Volcker Rule. The request was published in the Federal Register and comments are due by September 21, 2017.

As reported previously, the OCC identified four areas of the rule for consideration: (1) the scope of the entities to which the final rule applies, (2) the proprietary trading restrictions, (3) the covered fund restrictions, and (4) the compliance program and metrics reporting requirements.

The OCC requested public input in order to improve and inform proposed changes that could be made to the rule (without requiring revisions to the underlying statute). The OCC also asked for comments on how regulators could implement the existing rule more effectively.

Regulatory Agencies to Review Volcker Rule Provisions for Foreign Funds

Five federal financial regulatory agencies will review the treatment of certain funds under section 13 of the Bank Holding Company Act (“BHCA”), as added by the Volcker Rule.

According to a joint statement, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the SEC, and the CFTC (collectively, the “agencies”) will undertake a coordinated review of how the Volcker Rule (codified at BHCA Section 13) applies to certain foreign funds that are excluded from the definition of “covered funds.” The purpose of the review is to examine “possible unintended consequences” and impacts of the Volcker Rule.

The agencies stated that market participants are concerned about potential competitive disadvantages that could arise as a result of certain foreign funds being subjected to the Volcker Rule’s requirements due to their affiliations with a foreign banking entity, while other foreign funds remain exempt from the Volcker Rule’s requirements because they are not affiliated with a banking entity. Such foreign funds often fall outside (or are excluded from) the Volcker Rule’s definition of “covered fund,” and thus foreign banking organizations are free to invest in or sponsor such funds without violating the Volcker Rule. Nonetheless, the act of sponsoring or investing in the so-called “foreign excluded funds” can create certain problems for the funds themselves.

A foreign banking entity’s investment in or sponsorship of such a foreign excluded fund can cause the fund to be viewed as “affiliated” with the foreign banking entity. If deemed to be affiliated, foreign excluded funds are themselves “banking entities” and the funds themselves must comply with the Volcker Rule’s requirements – in particular, such funds are prohibited from engaging in proprietary trading or investing in other covered funds, absent an exception in the Volcker Rule. In addition, such funds must maintain a Volcker compliance program.

In this regard, the agencies noted that the Volcker Rule incorporates the BHCA’s existing concept of “affiliation.” For example, a foreign excluded fund would be “affiliated” with a foreign banking entity if the foreign banking entity were the general partner of the foreign excluded fund, or if the foreign banking entity were to own more than 25% of the voting shares of the fund.

The agencies also are not willing to simply exempt all foreign excluded funds from the scope of the Volcker Rule. There is no clear definition of what is a “foreign excluded fund” – other than an entity that isn’t a Volcker Rule regulated “covered fund.” The agencies expressed concern that exempting all foreign excluded funds from the “banking entity” definition could enable foreign banking organizations to use structures self-described as foreign excluded funds to engage in proprietary trading or covered fund investing in a manner that the foreign banking organization could not do so directly.

The agencies stated that until July 21, 2018, the agencies will not treat as a “banking entity” any foreign excluded fund that meets the agencies’ definition of a “qualified foreign excluded fund.” A “qualified foreign excluded fund” is defined as an entity that:

(1) Is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States;

(2) Would be a covered fund were the entity organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments;

(3) Would not otherwise be a banking entity except by virtue of the foreign banking entity’s acquisition or retention of an ownership interest in, or sponsorship of, the entity;

(4) Is established and operated as part of a bona fide asset management business; and

(5) Is not operated in a manner that enables the foreign banking entity to evade the requirements of the Volcker Rule or its implementing regulations.

The agencies further noted that ultimately any relief may require Congressional action to amend the Volcker Rule itself.

OCC Names New Chief Risk Officer

The Office of the Comptroller of the Currency (“OCC”) named William A. Rowe as Chief Risk Officer. Mr. Rowe will be in charge of the Office of Enterprise Risk Management, the Enterprise Risk Committee and will serve as Liaison to the Federal Deposit Insurance Corporation. Prior to his current appointment, Mr. Rowe served with the OCC as Deputy to the Chief of Staff.

Acting Comptroller of the Currency Keith Noreika Supports National Bank Charters for FinTech Companies

Acting Comptroller Keith A. Noreika described efforts by the Office of the Comptroller of the Currency (“OCC”) to support responsible innovation, particularly with regard to granting national bank charters to FinTech companies.

At the Exchequer Club in Washington, D.C., Mr. Noreika remarked that the federal banking system must be more “inclusive,” and voiced a commitment to removing barriers that prevent the establishment of new banks. Mr. Noreika said that granting national bank charters to banking-oriented FinTech companies is a “good idea” that warrants careful consideration by the OCC, and noted that the banking landscape has evolved. To keep pace with evolution, Mr. Noreika argued, the OCC must avoid defining banks in an overly restrictive manner. By creating an avenue for FinTech companies to receive national bank charters, Mr. Noreika said, the OCC would promote growth and potentially reduce regulatory burdens.

Mr. Noreika addressed two lawsuits filed against the OCC. The first was filed by the New York Department of Financial Services, and the second, by the Conference of State Bank Supervisors. Each lawsuit challenges the OCC’s authority to grant special-purpose charters to FinTech companies that do not take deposits. He asserted that the OCC does in fact have authority to grant the charters in “appropriate circumstances,” and added that the OCC plans to defend that authority “vigorously” in its litigation responses.

Mr. Noreika rejected the argument that established banks would be disadvantaged by allowing FinTech companies to receive national banking charters. Granting these charters might bring FinTech companies “out of the shadows,” he stated, and subject them to a more rigorous and structured regulatory regime, since they would be supervised as national banks.

Mr. Noreika also addressed the contention that granting national charters to FinTech companies could jeopardize consumer protection. Mr. Noreika said that (i) national banks also are subjected to state laws that are designed to protect consumers, and (ii) a multitude of regulations are tailored specifically to national banks and contain strong protections for consumers.

Mr. Noreika highlighted other efforts by the OCC Office of Innovation, such as “office hours,” which are meetings requested by companies with OCC staff to discuss the regulatory implications of financial technology.

OCC Releases Semiannual Risk Report

The Office of the Comptroller of the Currency (“OCC”) described the principal risks facing national banks and federal savings associations in its Semiannual Risk Perspective for Spring 2017 (the “Report”).

In the Report, the OCC identified the following key risk themes:

  • strategic risk due to a changing regulatory climate, low interest rates and competition from nonfinancial firms, including fintech companies;
  • increased credit risk and relaxed underwriting standards due to strong risk appetite and competitive pressures;
  • elevated operational risk as a result of increased reliance on third-party service providers and attendant cybersecurity risks; and
  • high compliance risk as banks navigate money laundering risks and new consumer protection requirements.

OCC supervisory priorities for the next 12 months will remain broadly the same as in 2016 and will include the objective of identifying and assigning regulatory ratings and risk assessments. The OCC also pledged a continued commitment to monitoring and evaluating risks presented by third-party service providers.

In remarks on the Report, Acting Comptroller of the Currency Keith A. Noreika stated:

“The OCC employs a risk-focused approach to supervision, and tailors examination strategies to the individual risks of each of its supervised institutions and will pay close attention to these key risk areas over the next six months.”

 

Lofchie Comment: A material portion of the “risk” that banks face, according to the report, is regulatory risk. The Comptroller’s remark that “[m]ultiple new or amended regulations are posing challenges” to banks and the financial system also echoes the comment made by the SEC’s Investor Advocate in his recent report to Congress that he would “encourage Congress to consider giving the [SEC] a respite from statutory mandates” (at 3). It is clear that the very rate and extent of regulatory change has itself become a threat to the financial system.

FRB Governor Powell Examines Liquidity Risks in Central Clearing

At the Federal Reserve Bank of Chicago Symposium on Central Clearing, Board of Governors of the Federal Reserve System (“FRB”) Governor Jerome H. Powell detailed the risks faced by central counterparties (“CCPs”) and their members.

Because they advocated for central clearing, Mr. Powell noted, global authorities (i) have a responsibility to make sure that CCPs do not become a point of failure in the system and (ii) must ensure that bank capital rules do not discourage central clearing.

Regarding bank capital, Mr. Powell argued that the supplementary leverage ratio for U.S. global systemically important banks fails to account for the relatively low risk of central clearing, as compared to riskier activities, and could discourage central clearing. He explained that the Basel Committee on Banking Supervision is considering a “risk-sensitive” approach to evaluating counterparty credit risk for certain centrally cleared derivatives, which could help to encourage central clearing. He also noted that the FRB is considering implementing a “settlement-to-market” approach for some cleared derivatives that would treat daily variation margin as a settlement payment, which means that banks would not have to hold capital against it.

On the subject of liquidity, Mr. Powell outlined the risks associated with central clearing. He noted the challenges that CCPs face with regard to outgoing and incoming payment flows. In the event of a member default, for instance, CCPs would need to be able to convert large amounts of non-cash collateral into cash in order to make payments to non-defaulting parties. For that reason, they must have lines of credit and ready access to the repurchase market. Mr. Powell’s example of a payment flow challenge led him to consider where CCPs should store their available cash. He mentioned central bank deposits as a safe and flexible option.

Mr. Powell also described the risks associated with incoming payment flows. Market volatility can trigger events that lead to an abnormal number of margin calls, which, in the first instance, requires liquidity on the part of clearing members to meet the margin call. It also requires a series of payments to be made simultaneously, so that the CCPs can obtain funds from the settlement bank quickly to meet margin requirements for its members. (In most instances, clearing members have an hour to meet intraday margin calls.) By way of example, Mr. Powell noted that data from the CFTC suggests that the top five CCPs requested $27 billion in additional margin over the two days following the Brexit referendum, which is about five times the average amount. Fortunately, members and CCPs were prepared in that instance, and were able to make the necessary payments.

In order to manage liquidity risk, Mr. Powell suggested, regulators should conduct expanded stress tests for CCPs:

“Conducting supervisory stress tests on CCPs that take liquidity risks into account would help authorities better assess the resilience of the financial system. A stress test focused on cross-CCP liquidity risks could help to identify assumptions that are not mutually consistent; for example, if each CCP’s plans involve liquidating Treasuries, is it realistic to believe that every CCP could do so simultaneously?”

He also urged regulators to (i) facilitate innovations that help to reduce liquidity risks, such as exploring the utilization of distributed ledger technology, (ii) make Federal Reserve bank accounts available to major CCPs, and (iii) take global market implications into account when developing solutions for managing liquidity risk for CCPs.

Lofchie Comment: The CFTC and the banking industry have long argued that the Basel III capital rules that require banks to reserve against collateral posted to a central clearing agency are mistaken. Governor Powell is coming around belatedly to that view. The existence of central clearing parties does not decentralize risk; it concentrates it. Yet a further risk of clearing emphasized in Governor Powell’s remarks is the power that the clearing agencies have to suck tremendous amounts of liquidity out of the market: $27 billion of additional margin in the two days following Brexit. (What this means is that, in demanding more margin to protect their own liquidity in a financial crisis, clearing agencies may bring down everyone else.)

It is certainly time for a full review of the benefits and risks of central clearing. Many of the concerns raised by clearing skeptics are being proved valid.

Banking Regulators Recommend Volcker Reassessment and Other Reforms

In a hearing on “Regulation and Economic Growth” held by the Senate Committee on Banking, Housing, and Urban Affairs, bank regulators testified on the current banking environment and outlined principles, recommendations, and objectives to promote future efficiency.

Board of Governors of the Federal Reserve System (“FRB”) Governor Jerome Powell focused on regulatory developments including (i) capital requirements for banks, including common equity tier 1 capital requirements and an additional surcharge for global systematically important banks, (ii) mandatory stress testing for large banks, (iii) the liquid coverage ratio requirement, and (iv) resolvability planning obligations. He testified that the FRB will explore the measures aimed at reducing regulatory burdens including a reassessment of Volcker Rule requirements that do not directly relate to its main policy goals, and an examination of the leverage ratio to ensure that it is properly calibrated to prevent market distortions. Mr. Powell also stated that the FRB is not in favor of reducing risk-based capital requirements, as recommended by a recent Treasury report.

Acting Comptroller of the Currency Keith A. Noreika also advocated for a fresh look at the Volcker Rule, and argued that a better approach may be to entirely exempt community banks from the rule’s requirements. Additionally, he expressed support for considering “off-ramp” provisions for institutions that clearly do not present risks that the Volcker Rule was implemented to mitigate. Mr. Noreika echoed Treasury suggestions for raising stress test thresholds, and asserted a commitment to streamlining reporting requirements for smaller banks.

FDIC Chair Martin Gruenberg explained that a recent review (conducted pursuant to the Economic Growth and Regulatory Paperwork Reduction Act of 1996) has resulted in several interagency actions aimed at reducing reporting requirements, simplifying certain capital rules, and moving towards a more individualized approach to bank examinations. Mr. Gruenberg argued against Treasury report recommendations to (i) remove the FDIC from the living wills process, and (ii) remove central bank deposits, Treasury securities, and initial margin on derivatives from the denominator of the supplementary leverage ratio and enhanced supplementary leverage ratio.

Federal Reserve Board Governor Powell Advocates Additional Regulatory Reform

At the Salzburg Global Seminar, Federal Reserve Board Governor Jerome H. Powell lauded the progress made by the U.S. financial system since the financial crises, particularly in the increased liquidity and improved loss-absorbing capacity of banks. Mr. Powell identified five “key areas” that would benefit from additional regulatory reform:

  • Small banks: Continue to improve regulations governing call reports and the frequency of examinations by simplifying the general capital framework for community banks.
  • Resolution plans: Extend the living will submission cycle from once a year to once every two years, and focus every other filing on key topics of interest and material changes from the previous year.
  • Volcker Rule: Work together with the other four Volcker Rule agencies to reevaluate the rule and ensure that it delivers policy objectives effectively.
  • Stress testing: Evaluate stress testing and comprehensive capital analysis and review, including through public feedback, in order to improve transparency of process.
  • Leverage ratio: Reexamine enhanced supplementary leverage ratio in order to adhere to the proper calibration of leverage ratio and risk-based capital requirements.