Dealing with divergence

Despite the work that banks currently have underway from building regulatory infrastructure and processes to sustaining and streamlining them, one potential headwind is the threat of regulatory divergence in substance and timing across jurisdictions.  For banks with a global presence, divergence adds to uncertainty and complexity, fosters an unlevel playing field, and hampers the ability to plan and optimize resources.  Successfully navigating the many challenges of regulatory divergence requires a deliberate disciplined approach that recognizes the regional tailoring of regulatory and compliance initiatives, and that regulatory strategy and business strategy should converge.

The growing divergence in regulatory standards is a reversal of previous post-crisis trends.  For example, since 2009, banking regulators around the world have been committed to strengthening the capital, liquidity, and leverage standards for banks. Those efforts embedded an equally strong commitment to address the unevenness and complexity of the global capital framework for internationally-active banks. Regulatory convergence initiatives, such as Basel III and the Financial Stability Board’s (FSB) work on resolution regimes, set the tone for an increasingly consistent banking rulebook across most jurisdictions.

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OCC requests comment on possible revisions to Volcker Rule

In the weeks following the 2016 Presidential election, members of the incoming Administration clearly expressed their views that certain aspects of Dodd-Frank, including the Volcker Rule, are overly complex.  Specifically, then-Treasury Secretary-nominee Steven Mnuchin argued that the “number one problem with the Volcker Rule is that it’s too complicated and people don’t know how to interpret it.”1

On June 12, 2017, the Treasury Department took a significant step on financial regulatory issues by releasing its first report pursuant to President Trump’s executive order setting forth “Core Principles” for regulating the US financial system.  Among other things, the report argues that the Volcker Rule requires “substantial amendment” and that its implementation has “hindered market-making functions necessary to ensure a healthy level of market liquidity.”2  Accordingly, the report proposes several changes—some of which could be implemented by the regulatory agencies and some of which would require Congressional action to amend the underlying statute—designed to “reduce the scope and complexity” of the rule.3

On August 2, 2017, the Office of the Comptroller of the Currency (OCC) issued a notice and request for comment4 on whether certain aspects of the regulation implementing the Volcker Rule should be revised to “better accomplish the purposes of the statute” while decreasing the compliance burden on banking entities and fostering economic growth.

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CCAR: Reaching the summit

The Federal Reserve (“Fed”) released the results of its Comprehensive Capital Analysis and Review (CCAR) for 2017 on June 28.  Key Facts:

  • For the first time in CCAR’s seven-year history, the Fed did not object to any of the capital plans or capital distributions.
  • One firm, Capital One, was required to resubmit its capital plan to address certain capital planning process weaknesses.
  • The aggregate quantitative results were very similar to last year’s test, with all 34 firms exceeding required minimums.
  • Two firms, American Express and Capital One, adjusted their original requested capital distributions taking advantage of a so called “mulligan” to fine tune their capital levels.

The prior week’s release of the Dodd-Frank Act Stress Test (DFAST) results provided more detailed information on the Fed’s stress test.  Compared to CCAR, those results exclude buybacks and capital issuances and hold past common dividends constant.

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2017 Dodd-Frank Act Stress Test (DFAST): Our take

The Federal Reserve (“Fed”) released the results of its Dodd-Frank Act Stress Tests (DFAST)1 that measure the potential impact of adverse or severely adverse economic conditions on the performance and condition of the 34 banks subject to the rule.  These results will be followed on June 28, 2017 by the Fed’s conclusions regarding the adequacy of bank capital plans as evaluated through the Comprehensive Capital Analysis and Review (CCAR).

Key takeaways for the severely adverse scenario results include:

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The new fiduciary standard is set to begin on June 9. Are you ready?

On Tuesday, April 4, 2017, the Department of Labor finalized a delay to the applicability date of the Fiduciary Rule until June 9, 2017

Introduction

Following President Trump’s February 3, 2017 memorandum (the “Presidential Memorandum”)1 directing the Department of Labor (DOL) to prepare an “updated economic and legal analysis concerning the likely impact” of its “Conflict of Interest Rule” on fiduciary investment advice (the “Rule”) and related prohibited transaction exemptions (PTEs), the DOL finalized a delay to the initial applicability date of the Rule until June 9, 2017.2

The DOL also delayed the initial applicability date of the Best Interest Contract (BIC) Exemption, the Class Exemption for Principal Transactions, and amendments to other previously granted exemptions until June 9, 2017.  The applicability date of the Impartial Conduct Standards in these exemptions is extended until June 9, 2017, while compliance with other conditions for transactions covered by these exemptions (e.g., specific disclosures and representations of fiduciary compliance in written communications with investors) is not required until January 1, 2018.3

In addition, the DOL delayed the initial applicability of amendments to PTE 84-24 for certain insurance companies and agents until January 1, 2018 (other than the Impartial Conduct Standards, which will be applicable on June 9, 2017).

The DOL argued that these extensions are necessary to enable it to examine whether the Rule may adversely affect the ability of Americans to gain access to retirement information and financial advice, and to prepare the updated economic and legal analysis pursuant to the Presidential Memorandum.  The extensions will also allow the DOL to “consider possible changes with respect to the Rule and PTEs based on new evidence or analysis developed pursuant to the examination.”4

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FRB, FDIC issue resolution planning guidance, one-year extension to four FBOs; Issue evaluation of 16 US BHC resolution plans

On March 24, 2017, the Federal Reserve Board (FRB) and Federal Deposit Insurance Corporation (FDIC)1 (collectively, the “agencies”) issued guidance to four foreign banking organizations (FBOs) for their next resolution planning submissions (the “2018 Guidance”) and announced credibility determinations for 16 resolution plans submitted by US bank holding companies (BHCs) in 2015.2

Notably, the agencies extended—from July 1, 2017 to July 1, 2018—the date by which the FBOs must submit their next resolution plans, but did not release credibility determinations for the FBOs’ 2015 resolution plans.

The agencies did not identify deficiencies in any of the plans submitted by the 16 US BHCs, but did identify shortcomings in one of the plans.

For a more detailed analysis of the credibility determinations for the resolution plans submitted by the 16 US BHCs, please click here.

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Department of Labor issues proposal to delay Fiduciary Rule

On Thursday, March 2, 2017, the Department of Labor published a proposal that would delay the Fiduciary Rule by 60 days; comments will be accepted until March 17, 2017

Introduction

On February 3, 2017, President Donald J. Trump issued a memorandum (the “Presidential Memorandum”) directing the Department of Labor (DOL) to examine its “Conflict of Interest Rule” on fiduciary investment advice (the “Rule”) and related prohibited transaction exemptions (PTEs) to “determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice.”1 The Presidential Memorandum also raised concerns that the Rule “may not be consistent with the policies of [the] Administration.”

The Presidential Memorandum did not directly delay or order a delay in the Rule’s initial April 10, 2017 applicability date, but directed the DOL to prepare an “updated economic and legal analysis concerning the likely impact” of the Rule.

If the DOL makes an affirmative determination pursuant to these considerations or if it concludes for any other reason that the Rule is inconsistent with the priorities outlined in the Presidential Memorandum, it is directed to publish a proposed rule to rescind or revise the Rule, as appropriate and consistent with law.

On March 2, 2017, the DOL published in the Federal Register a proposed rule that would extend the applicability date of the Rule and PTEs for 60 days (i.e., until June 9, 2017) to allow the DOL to “address questions of law and policy.”2

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Federal Reserve Board issues guidance on illiquid funds under the Volcker Rule

Since the December 2013 finalization of an interagency rule implementing Section 619 of Dodd-Frank (i.e., the Volcker Rule), covered banking entities have sought guidance on many related interpretive issues. The agencies have issued 21 responses to Frequently Asked Questions (FAQs) during this period,1 but none of the FAQs addressed key questions about investments in illiquid funds.

On December 12, 2016, the Federal Reserve Board (FRB) issued guidance—in the form of a statement of policy2 and Supervision and Regulation (SR) Letter 16-183 —regarding how banking entities may seek an extension to conform their investments in illiquid funds to the requirements of the Volcker Rule.

Section 619 of Dodd-Frank permits the FRB to provide a banking entity up to five years from the end of the conformance period (i.e., five years from July 21, 2017) to conform investments in certain illiquid funds.4

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The role of internal audit in recovery and resolution planning

Introduction

US regulators continue to flex their muscles and push resolution planning as a key regulatory driver to reduce systemic risk and the likelihood of an institution being “too big to fail.” On April 13, 2016, the Federal Reserve Board (FRB) and the Federal Deposit Insurance Corporation (FDIC) (collectively, the “Agencies”) jointly determined, for the first time, that certain resolution plans submitted by domestic systemically important banks (D-SIBs) were “not credible or would not facilitate an orderly resolution”1 under the US Bankruptcy Code. Further, the Agencies issued prescriptive guidance increasing expectations for the eight US D-SIBs’ resolution plan submissions due July 1, 2017 (2017 Guidance).2

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Regulatory reporting elements of new proposed rules on physical commodities and capital planning

Although large banking organizations are likely aware of the Federal Reserve Board’s (FRB) recent proposed rules to impose prudential requirements and limitations on certain physical commodity activities1 and modify the capital planning and stress testing rules for “large and noncomplex” firms,2 they may not have paid sufficient attention to the regulatory reporting components of the proposals.

Importantly, these two proposals would make changes to the following reports:

  • FR Y-9C, which collects consolidated financial statements for holding companies;
  • FR Y-9LP, which collects parent-only financial statements for large holding companies; and
  • FR Y-14A/Q/M series related to capital assessments and stress testing.

In addition to understanding the impact of the FRB’s proposals on their businesses, covered US and foreign banking organizations should carefully review the proposed changes to these key regulatory reports and understand what actions are required in order to comply.

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