Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, President Obama signed the Dodd-Frank Act into law. We will be following the implementation of this Act and will report deadlines created by the Act for select regulatory milestones.
“Systemically Important” Designations Forthcoming. The Dodd-Frank Act established the 10-member Financial Stability Oversight Council, led by the Treasury Department. Treasury officials have said that the Council will conduct its first meeting in September. At that first meeting, the Council is expected to establish an integrated road map for the first stages of reform. The Council is charged with designating those companies that will be classified as “systemically important.” The label aims to ensure that regulators closely monitor certain companies to quickly identify problems that could rock the entire financial system. Bank holding companies with $50B or more in consolidated assets are automatically designated as systemically important. In addition to identifying those bank holding companies that are automatically designated, the Council is also required to identify nonbank financial companies that are deemed systemically important. A nonbank financial company may be determined to be systemically important if the material financial distress at the nonbank financial company or the nature, scope, scale, concentration, interconnectedness, or mix of activities of the nonbank financial company could pose a threat to the financial stability of the United States. The Council will designate nonbank financial companies as systemically important by a vote of not less than two-thirds of its voting members. Once a company is deemed subject to the Act’s systemic risk provisions, it will become subject to a variety of new and/or enhanced requirements and limitations. These heightened prudential standards may include increased risk-based capital requirements, leverage limits, liquidity requirements, and concentration limits. The Federal Reserve may exempt a systemically designated company from such risk-based capital and leverage capital standards if such standards are deemed inappropriate for the company based on its activities.
Use of Credit Ratings in Regulatory Capital Guidelines. On August 10, the federal banking agencies issued an advance notice to gather information as they begin to develop alternatives to the use of credit ratings in their capital rules. The Dodd-Frank Act requires federal agencies to review regulations that 1) require an assessment of creditworthiness of a security or money market instrument and 2) contain references to or requirements regarding credit ratings. The agencies are required to remove such references and requirements and substitute in their place uniform standards of creditworthiness, where feasible. The notice solicits comments on alternative standards of creditworthiness, the set of criteria the agencies believe are important in evaluating creditworthiness standards, and potential approaches. The notice outlines three general alternative approaches: 1) Risk Weights Based on Exposure Category – delete all references to credit ratings in the risk-based capital standards and retain the remainder of the risk-based capital rules. Under this approach, all non-securitization exposures generally would receive a 100% risk weight unless otherwise specified (e.g., certain sovereign or bank exposures would be assigned a 0% and 20% risk weight, respectively); 2) Exposure-Specific Risk Weights – exposures would be assigned a risk weight based on certain market-based measures such as credit spreads, obligor-specific financial data, or debt-to-equity ratios; and 3) an approach similar to the one the National Association of Insurance Commissioners (NAIC) adopted for debt securities where a third-party financial assessor would inform the agencies’ understanding of risks. The comment period closes October 25.
Fifth Third v. Transamerica and Clark Consulting (Update)
On August 3, according to a stipulated dismissal, the parties settled this matter for an undisclosed amount. The bank was suing Transamerica and Clark Consulting based on significant losses in its bank-owned life insurance (BOLI) portfolio specifically due to money invested in a hedge fund named the Falcon Fund. The bank alleged that the defendants made certain misrepresentations and failed to provide the bank with sufficient information to mitigate the loss by reallocating out of the fund. According to Fifth Third’s Q2 10-Q filing, the bank expects to record a pre-tax benefit, net of expenses, of approximately $125M in the third quarter of 2010 in accordance with ASC Topic 450-30, “Gain Contingencies.”
FSA Calls for Tougher Bank Oversight
On August 25, the United Kingdom Financial Services Authority (FSA) issued a new discussion paper on the prudential regime for trading activities. The paper describes the FSA’s current perspectives regarding major areas of reform that should be considered to address areas of structural weakness. The recommendations set forth in the paper are grouped into three key areas: 1) Valuation – recommendation to increase regulatory focus on the valuation of traded positions, along with the need for specific assessment of valuation uncertainty; 2) Coverage, Coherence and the Capital Framework – recommendation to change the structure of the capital framework to bring greater coherence and reduce opportunities for structural arbitrage within the banking sector and the wider financial system; and 3) Risk Management and Modeling – recommendation to develop specific measures aimed at improving firms’ risk management and modeling standards and to ensure that these measures are aligned with regulatory objectives. The comment period ends November 26 and the FSA expects to issue a Feedback Statement in the first half of 2011.
NAIC Releases Updated SMI Roadmap
On August 17, the National Association of Insurance Commissioners (NAIC) released an updated Solvency Modernization Initiative (SMI) Roadmap. The SMI Task Force reviewed international developments regarding insurance supervision, banking supervision, and international accounting standards and their potential use in U.S. insurance regulation. The new version of the roadmap now includes both short-term and long-term plans for putting that knowledge to use. While U.S. insurance solvency regulation is updated on a continuous basis, SMI focuses on five key areas: capital requirements, governance and risk management, group supervision, statutory accounting and financial reporting, and reinsurance. For risk-based capital, the NAIC should develop a plan for modification of the formulas to implement missing risk charges, make other significant improvements, and conduct an Industry Impact Study by December 2010 with a determination of changes by December 2012. The NAIC is also evaluating expanding current group supervision to include any entity within an insurance holding company system that may or may not affect the holding company system, but that could pose reputational or financial risk to the insurer. The evaluation and any determination will be completed by December 2012.