Regulatory Capital Proposals Update
We continue to review industry comments submitted to and posted by the federal banking agencies on the proposed regulatory capital rules. To date, there have not been any comments on the proposed rules impact on BOLI. At the request of clients, we have identified BOLI-specific issues in need of clarification. Questions include:
- Do the proposed rules replace the Interagency risk-weighting guidance issued in December 2004?
- Is variable, separate account BOLI classified as an Equity Exposure to an Investment Fund?
- Are direct exposures to insurance companies (e.g., general account BOLI and DAC assets) risk-weighted at 100%?
- How is hybrid BOLI treated under the proposed rules?
- Does the requirement to apply the same risk-weighting approach for all securitization exposures expand to interests in externally managed investment divisions such as SA BOLI programs?
Our comment letter also addresses aspects of using the Standardized Approach’s Full Look-Through Approach and a number of other nuanced aspects.
Additionally, the federal banking agencies recently released Excel-based regulatory capital estimation tools to help community banking organizations and other interested parties evaluate the regulatory capital proposals. The tool is intended to help institutions estimate the potential effect the proposals could have on their capital ratios. The agencies included a caveat that the tools should not be relied on as an indicator of an institution’s actual regulatory capital ratios and is not a part of the proposed rules or any final rule the agencies may adopt. The comment period ends October 22, 2012.
Basel Committee Basel III Report
On September 20, the Basel Committee published the results of its Basel III monitoring exercise. The report is based on detailed non-public data as of December 31, 2011 submitted by participating banks on a voluntary and best-efforts basis. Applying the definition changes of capital and risk-weighted assets, the average common equity Tier 1 capital ratio of the 102 Group 1 banks was 7.7% as compared with the 4.5% Basel III minimum requirement. However on an institution-by-institution basis, the capital of five banks would have been below 4.5% and another 25 institutions would have been below 7%. In order for all the Group 1 banks to reach Basel III’s target of a 7% capital ratio, which includes a capital conservation buffer and a surcharge for globally systemically important banks, an increase of 374.1 billion Euros would have been required. Thirteen U.S. banks were included in Group 1 which refers to banks that are either internationally active or have capital over 3 billion Euros. The study did not account for any transitional periods and is based on the full application of the final Basel III rules.
FSOC Moving Forward with Nonbank SIFI Designation Process
On September 28, the Financial Stability Oversight Council held a closed meeting. Reportedly the Treasury gave a statement to reporters that the FSOC is entering the “third stage” of its process to determine what non-bank institutions should be designated as a systemically important financial institution (SIFI). Under Dodd-Frank Section 113, the FSOC may designate nonbank financial companies for supervision by the Federal Reserve under enhanced prudential standards if it determines such companies could pose a threat to U.S. financial stability. Companies included in the third stage are given an opportunity to respond to a request for information and to request a hearing to contest the proposed designation. The FSOC did not disclose which companies were considered in its meeting, but the list is speculated to be a relatively short list to include AIG, MetLife, Prudential and General Electric. A nonbank financial institution would receive a formal notice at least one business day before the FSOC publically announces its determinations. It is expected that the FSOC final designations will be announced late this year or early 2013.
IAIS Releases Public Comments on G-SII Designation Methodologies
This summer the International Association of Insurance Supervisors (IAIS) issued its assessment methodology for the identification of globally systemically important insurers (G-SIIs) with an 18-point methodology system for identifying G-SIIs. This month the IAIS released public comments it received. Commenters included the American Council of Life Insurers (ACLI), the American Insurance Association (AIA), National Association of Insurance Commissioners (NAIC), and MetLife. The NAIC noted that it was desirable to coordinate the national and international processes for determining SIFIs where appropriate, that non-traditional insurance activities should be segregated from non-insurance activities in the indicators and that non-traditional activities should receive a lower weight than non-insurance activities. The ACLI and MetLife expressed concern that the IAIS’s general position supported that size and diversification reduce risk, but the actual indicators of systemic risk used size, diversification and geographic reach as indicators of what is systemically risky.
On September 20, the IAIS issued clarifications and proposed resolutions to the main issues raised by commenters. There was a recommendation that the G-SII assessment methodology follow the U.S. Financial Stability Oversight Council (FSOC) guidelines for initial determination, but unlike the FSOC the IAIS does not have powers to obtain information and relies on voluntary participation by insurance regulators and insurers. The IAIS also responded that in stressed situations, the absolute size of financial institutions could affect the potential impact on the financial system and economy if concerns are raised about the solvency or liquidity of the institution. The IAIS also clarified that its used of the phrase “traditional insurance” does not mean that such products have existed for many years, but rather that it is insurance that is concerned with the interests that meet at least the principles of insurability based on insurance techniques and that is subject to insurance accounting. The IAIS plans to publish the list of G-SIIs in April 2013.
Geithner Letter to FSOC on Money Market Reform
On September 27, one day before the Financial Stability Oversight Council’s (FSOC’s) meeting, Treasury Secretary Timothy Geithner sent a letter to FSOC members on necessary money market fund reforms. The letter referenced the SEC announcement that it would not proceed with a vote to solicit public comment on potential structural reforms of money market funds. Geithner urged the FSOC to use its authority under Dodd-Frank Section 120 to recommend the SEC to proceed with money market reforms. First, the FSOC would have to seek public comment on recommendations and then issue a final recommendation to the SEC. Then the SEC would be required to either adopt the recommended standards or explain in writing to the FSOC why it had failed to act. Geithner has already requested staff to draft a formal recommendation and is hopeful that the FSOC will consider the recommendation at its November meeting. Geithner said that the two SEC proposals should be included in the recommendation. The two SEC proposed reform alternatives were that money market funds float the NAV and use mark-to-market valuation like every other mutual fund or, alternatively, implement a tailored capital buffer of less than 1% of fund assets, adjusted to reflect the risk characteristics of the money-market fund.
SEC Report on Credit Rating Standardization
On September 7, the SEC staff published a report to Congress, as required under Dodd-Frank Section 939(h), on the feasibility and desirability of standardizing credit rating terminology so that all credit rating agencies issue credit ratings using identical terms and standardizing the market stress conditions under which ratings are evaluated among other items. Based on its findings, the staff recommended that the SEC not take any further action at this time with respect to credit rating standardization. Instead, the staff stated its belief that it would be more efficient to focus on the Dodd-Frank rulemaking initiatives designed to promote transparency in the performance of credit ratings and methodologies used to determine credit ratings.
GAO Examines the FSOC and OFR
The Government Accountability Office (GAO) conducted a study of the Financial Stability Oversight Council (FSOC) and Office of Financial Research (OFR) to examine challenges the organizations face in fulfilling their missions and their efforts to establish management structures and mechanisms to carry out their missions. The GAO made 10 recommendations including that both entities develop a communication strategy to improve communications with the public. The GAO also found that the FSOC’s key accountability documents did not consistently identify which entities should monitor or implement identified recommendations or give time frames for specific action. To hold the FSOC accountable, GAO recommended that the FSOC designate a lead agency or agencies to monitor or implement each recommendation within specified time frames. The Treasury Secretary leads the OFR since it still does not have a confirmed director.
Baker v. American Greetings (Update)
As we have previously reported, Collier v. American Greetings was terminated and the claims were combined with a related matter in Ohio federal court (Baker). On September 19, American Greetings again filed a motion to dismiss the matter. On the same day, the federal judge denied the motion concluding that it was premature. Instead the judge instructed plaintiff’s counsel to amend its complaint to strengthen those areas criticized by American Greetings including giving greater details on the acts constituting fraudulent concealment and whether the discovery rule applies. The amended complaint must be filed by October 3, 2012.
Case Reference: Baker v. American Greetings Corp., 1:12-cv-65 (N.D. Ohio)
Texas Ruling that Life Settlements are not Securities
In Texas v. Life Partners Holdings, Inc. (LPHI), a state court judge ruled that interests in life insurance policies were not securities under the Texas Securities Act. In a state court complaint filed in August, Texas Attorney General Greg Abbott alleged that LPHI along with its subsidiary Life Partners, Inc. and its executives sold policy interests which were unregistered securities under the Texas securities laws and that the defendants misled investors about the life expectancies of the insureds to generate revenue. While this ruling was favorable to LPHI, the matter is expected to be appealed and LPHI is still defending itself against the SEC and in an ongoing investor class action suit.
Case References: State of Texas v. Life Partners Holdings Inc., D-1-GV-12-001128, District Court of Travis County, Texas, 2001st Judicial District (Austin); SEC v. Life Partners Holdings, Inc., 1-12-cv-00033 (W.D. Texas); Turnbow v. Life Partners, inc., 3:11-cv-1030 (N.D. Texas)