Agencies Adopt Final Rule to Establish Risk-Based Capital Floor
Three federal banking agencies adopted a final rule that establishes a floor for the risk-based capital requirements applicable to banking organizations as required by Dodd-Frank section 171 (commonly known as the Collins Amendment). Each organization implementing the advanced approaches rules will continue to calculate its risk-based capital requirements under the agencies’ general risk-based capital rules, and the capital requirement it computes under those rules will serve as a floor for its risk-based capital requirement computed under the advanced approaches rules. The agencies note that the effect of this rule on banking organizations is to preclude certain reductions in capital requirements that might have occurred in the future, absent the rule and absent any further changes to the capital rules. The final rule will become effective on July 28, 2011.
In written testimony for a recent House committee hearing, Acting Comptroller John Walsh expressed a number of concerns relating to the implementation of the Collins Amendment including its potential to result in more stringent standards for U.S. firms and an uneven playing field. He also noted that in practical terms the Collins Amendment will limit the incentives for large internationally active U.S. banks to undertake the complex and costly task of implementing the Basel II framework, since the simpler Basel I framework will still govern. He also highlighted that the primary reason the Basel Committee decided to replace the Basel I framework was its lack of risk sensitivity. As a result, the OCC is concerned that implementation of section 171 may lead to perverse incentives for U.S. banks. For example, if an institution can take on additional risk without triggering an additional capital charge under the Basel I standards, it may be tempted to do so if Basel I is the bank’s operative constraint.
Newly Proposed Bank Stress Testing Guidance
The banking regulators are seeking comment on proposed supervisory guidance regarding stress testing practices at banking entities with total consolidated assets of more than $10 billion. The proposed guidance provides an overview of how an organization should develop a structure for stress testing and describes certain stress testing approaches and applications banking organizations should strongly consider including scenario analysis, sensitivity analysis, and reverse stress testing. Reverse stress testing is a tool that allows a banking organization to assume a known adverse outcome, such as suffering a credit loss that breaches regulatory capital ratios, and then deduce the types of events that could lead to such an outcome. For instance, reverse stress testing may help a bank recognize that a certain level of unemployment would have a severe impact on credit losses, that a market disturbance could create additional losses and result in rising funding costs, and that a firm-specific case of fraud would cause even further losses and reputational impact that could threaten a bank’s viability. While the guidance does not explicitly address the stress testing requirements outlined in the Dodd-Frank Act, the agencies anticipate that rulemakings implementing these requirements will be consistent with the principles in the proposed guidance. The agencies also expect the guidance to be consistent with other supervisory initiatives, including those related to capital and liquidity planning. The comment period ends on July 29, 2011.
Pre-proposal Industry Comments on Volcker Rule
In anticipation of the banking agencies’ issuance of proposed rulemaking on the Volcker Rule which is expected soon, a number of industry associations have submitted supplemental comment letters. The Financial Services Roundtable (the Roundtable) which represents large financial services companies providing banking, insurance, and investment products and services, urged the agencies to narrow the Dodd-Frank Act definition of “hedge fund” and “private equity fund” and included support from both Dodd-Frank and the Financial Stability Oversight Council’s (FSOC’s) Volcker recommendations that give the agencies the authority to do so. The Roundtable also submitted that BOLI and COLI should not be subject to the Volcker Rule since other than separate account products’ reliance on the Investment Company Act exemptions, BOLI/COLI has no resemblance to the traditional hedge funds and private equity funds that Volcker intended to police.
We agree with the Roundtable that Congress did not intend to make BOLI contracts subject to the Volcker Rule, and, further, we do not believe banks should have to divest their current BOLI holdings or be prohibited from purchasing BOLI contracts in the future. However, we are concerned that the industry responses to regulators that completely dismiss the possibility that a bank could use a BOLI contract to invest in hedge funds is flawed. Several banks have incurred significant losses in their BOLI programs which were attributable to underlying investments in hedge fund, fund of funds. We think it would be wiser to acknowledge the limited circumstances in which a bank could conduct otherwise prohibited activity through a BOLI contract and address those activities directly. This could be addressed by the banking regulators in a similar manner to how equity-linked allocations are currently restricted.
White House Announces FSOC Insurance Member Nominee
On June 24, President Barack Obama announced his intent to nominate individuals to key Administration posts including his nominee for the only voting insurance expert on the Financial Stability Oversight Council (FSOC). The Administration has nominated Roy Woodall a former Kentucky Commissioner of Insurance, serving in that capacity from 1966 to 1967. He recently retired as a Treasury Senior Insurance Policy Analyst, where he served from 2002 to 2011. Previously, he served as President of the National Association of Life Companies (NALC), and upon NALC’s merger into the American Council of Life Insurers (ACLI), he served as ACLI’s Managing Director for Issues and Vice President/Chief Counsel for State Relations. Woodall still has to be confirmed by the Senate in order to take the post. Missouri Insurance Director John Huff as the NAIC representative and new Federal Insurance Office Director Michael McRaith are non-voting insurance members on the FSOC.
Obama Announces FDIC Chairman Nominee
Shelia Bair will end her five-year term as Chairman of the Federal Deposit Insurance Corporation (FDIC) on July 8, 2011. Obama has announced that he intends to nominate FDIC Vice Chairman Martin Gruenberg to succeed Bair. Gruenberg has been on the FDIC board since 2005.
House Hearings on Dodd-Frank Implementation
This month the House Financial Services Committee and/or its subcommittees held a number of hearings relating to financial reform. One such hearing was entitled “Financial Regulatory Reform: The International Context.” SEC Chairman Mary Schapiro’s written testimony regarding the Volcker Rule indicated that the SEC will be seeking extensive comment on the issues of global competiveness to the extent they can address them in any proposed rulemaking. Acting OCC Comptroller John Walsh advised the House committee that U.S. regulators’ goal must be to address the problems that led to the financial crisis without undermining the ability of domestic banking institutions to support a strong national economy, or placing U.S. institutions at an unfair competitive disadvantage relative to foreign competitors. Walsh also referenced the divergence that will occur between domestic banks’ capital rules and international standards in light of Dodd-Frank requiring federal agencies to use a standard of credit-worthiness other than credit ratings while Basel III relies heavily on credit ratings to set specific regulatory requirements.
FRB Governor Daniel Tarullo discussed the need for international congruence concerning regulatory capital and liquidity standards. Tarullo’s testimony also highlighted the need for more work on the additional requirements that will be required for systemically important financial institutions (SIFIs). The Dodd-Frank Act directs the Federal Reserve to impose enhanced prudential standards, including capital requirements, on bank holding companies with consolidated assets of $50 billion or more. Lastly, U.S. regulators have proposed development of a comparable enhanced international capital requirement for SIFIs. It’s believed that such a requirement would promote international financial stability while avoiding significant competitive disadvantage for any country’s firms. Taurullo stated that the work on the subject of SIFI capital surcharges in the Basel Committee started slowly, and while there is not yet a consensus, the FRB is hopeful that in the next several months the Committee will agree upon a proposal which can be put forth for public comment.
BB&T v. MassMutual (Update)
MassMutual has filed a motion for summary judgment as well as a motion to exclude the reports and testimony of BB&T’s proposed expert witnesses. The related briefs were filed under seal. As we reported in our May LRA, BB&T voluntarily dismissed their complaint against former defendant Clark Consulting.
Collier v. American Greetings (Update)
A representative of another estate has filed a motion to intervene in an attempt to preserve the class if American Greetings argues that the named plaintiff Collier is not an adequate class representative. American Greetings filed its summary judgment motion in April and the court has yet to make a ruling on the motion and at this time discovery has not commenced.
Hunnicutt v. AstraZeneca (Update)
This month the plaintiff’s attorney filed an amended complaint to include Stauffer Management Company, the employer of the insured at the time the policy was allegedly purchased, as a defendant. The complaint claimed that Stauffer Management is “the alter ego, subsidiary and agent” of AstraZeneca. AstraZeneca filed its amended motion to dismiss arguing that the Oklahoma federal court does not have personal jurisdiction over it, the plaintiff failed to state a claim, and alternatively plaintiff’s claims are governed by California law and not Oklahoma law. AstraZeneca also claims that it did not purchase or receive any benefits from an insurance policy on the plaintiff. And further that the plaintiff has no basis to hold AstraZeneca responsible for claims arising from its separate legal subsidiary Stauffer Management purchasing and benefiting from an insurance policy on the plaintiff.
Merged Accounting Standards May Prove Costly for Insurers
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have been meeting at least twice a month to craft a unified accounting standard for insurance contracts. However, it is still not certain that they will actually be able to issue a single, global standard for insurance contracts. June was the target date for completing the insurance contracts project, but in April the boards announced that the date would be delayed and have not issued a new date. The American Council of Life Insurers (ACLI) has predicted that the costs for U.S. life insurers to implement the broader accounting standards convergence may be more than $1 billion. The projected costs of implementation include reconfiguring the chart of accounts, changing the closing process, retraining staff, possibly hiring new staff, and purchasing new accounting systems. Two drivers for the convergence are to more accurately assess risk and to allow investors to have comparable data in evaluating investment opportunities across the globe.
New International Insurance Supervisory Forum
The International Association of Insurance Supervisors (IAIS) has established a Supervisory Forum as part of its efforts to strengthen the effectiveness of insurance supervision and to foster convergence of supervisory practices. The new Forum will provide a platform for insurance supervisors to exchange experiences of supervisory practices and will focus on large insurers and insurance groups. Earlier this year, the National Association of Insurance Commissioners (NAIC) picked Assistant Director of the Arizona Financial Affairs Division Steven Ferguson to represent the U.S. on the Forum and the IAIS selected Ferguson to be the Forum’s first chair. The Forum held its first meeting on June 15 during the IAIS committee meetings.