Archive for the ‘Financial Regulation’ Category

Operational Risk Capital: Nowhere to Hide

Posted by Yaron Nili, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Saturday November 22, 2014 at 10:39 am
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Editor’s Note: The following post comes to us from PricewaterhouseCoopers LLP and is based on a PwC publication by Dietmar Serbee, Helene Katz, and Geoffrey Allbutt; the complete publication, including appendix and footnotes, is available here.

The Basel Committee on Banking Supervision (BCBS) last month proposed revisions to its operational risk capital framework. The proposal sets out a new standardized approach (SA) to replace both the basic indicator approach (BIA) and the standardized approach (TSA) for calculating operational risk capital. In our view, four key points are worth highlighting with respect to the proposal and its possible implications:
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Bank Capital Plans and Stress Tests

Posted by Yaron Nili, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday November 18, 2014 at 9:12 am
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Editor’s Note: The following post comes to us from Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication authored by H. Rodgin Cohen, Andrew R. Gladin, Mark J. Welshimer, and Lauren A. Wansor.

On October 16, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) issued its summary instructions and guidance [1] (the “CCAR 2015 Instructions”) for its supervisory Comprehensive Capital Analysis and Review program for 2015 (“CCAR 2015”) applicable to bank holding companies with $50 billion or more of total consolidated assets (“Covered BHCs”). Thirty-one institutions will participate in CCAR 2015, including the 30 Covered BHCs [2] that participated in CCAR in 2014, as well as one institution that is new to the program. [3]

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A Closer Look at US Credit Risk Retention Rules

Editor’s Note: David M. Lynn is a partner and co-chair of the Corporate Finance practice at Morrison & Foerster LLP. The following post is based on a Morrison & Foerster publication by Jerry Marlatt, Melissa Beck, and Kenneth Kohler.

In a flurry of regulatory actions on October 21 and 22, 2014, the Federal Deposit Insurance Corporation (the “FDIC”), the Office of the Comptroller of the Currency, the Federal Reserve Board, the Securities and Exchange Commission, the Federal Housing Finance Agency (the “FHFA”), and the Department of Housing and Urban Development (collectively, the “Joint Regulators”) each adopted a final rule (the “Final Rule”) implementing the credit risk retention requirements of section 941 of the Dodd-Frank Act for asset-backed securities (“ABS”). The section 941 requirements were intended to ensure that securitizers generally have “skin in the game” with respect to securitized loans and other assets.

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The Institutions of Federal Reserve Independence

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday November 6, 2014 at 9:03 am
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Editor’s Note: The following post comes from Peter Conti-Brown of Stanford Law School.

On December 23, 2013, the Federal Reserve System celebrated its centennial. Over the course of that century, the Fed has become one of the most important governmental agencies in the history of the American republic, a transformation one scholar has labeled “the most remarkable bureaucratic metamorphosis in American history.” Its policies influence nearly every aspect of public and private life. Given this importance and influence, “[n]o one can afford to ignore the Fed.”

At the core of that “remarkable bureaucratic metamorphosis” is a much-invoked but as often misunderstood set of institutional arrangements that constitute the Fed’s unique independence. In the standard popular and academic account, law is at the center of that independence: indeed, it is the statute itself, under this view, that defines that independence. Economists and political scientists interested in central bank independence—having written enough on the phenomenon to give it an acronym (CBI)—take as given that law defines central bank independence. And legal academics, in the exceptional event that they have taken note of the Fed, have analyzed its independence within the context of administrative law and agency independence generally. Again, unsurprisingly, statutes are at the center of that analysis, too.

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Ten Key Points from the Final Risk Retention Rule

Posted by Yaron Nili, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday November 2, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from PricewaterhouseCoopers LLP and is based on a PwC publication by Christopher Merchant, Frank Serravalli, and Daniel Sullivan.

This week six federal agencies (Fed, OCC, FDIC, SEC, FHFA, and HUD) finalized their joint asset-backed securities (ABS) risk retention rule. As expected, the final rule requires sponsors of ABS to retain an interest equal to at least 5% of the credit risk in a securitization vehicle.

1. A win for the mortgage industry: The final rule effectively broadens the original proposal’s exemption from risk retention requirements for Qualified Residential Mortgages (QRM) by tying the definition of QRM to the Consumer Finance Protection Bureau’s definition of Qualified Mortgage (QM). This alignment abandons the proposal’s most stringent requirements to obtain the QRM exemption, including that a residential mortgage have at least a 20% down payment. The final rule also provides an additional exemption for certain mortgages that would not meet the QRM standards, e.g., community-focused residential mortgages. The immediate impact of the rule on the industry is further muted, given the significant amount of mortgages issued by government sponsored entities (i.e., Fannie Mae, Freddie Mac, and Ginnie Mae) that are currently exempt from the rule’s requirements. It may however be too soon for the industry to celebrate, as the final rule states that the agencies will reassess the effectiveness of the QRM definition at reducing securitization risk at most four years from now, and every five years thereafter.

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CFTC Clarifies and Expands Relief Relating to Delegation of CPO Responsibilities

Posted by Yaron Nili, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Saturday November 1, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Cary J. Meer, partner in the Investment Management practice group at K&L Gates LLP, and is based on a K&L Gates publication by Ms. Meer and Lawrence B. Patent.

On October 15, 2014, the Division of Swap Dealer and Intermediary Oversight (the “Division”) of the Commodity Futures Trading Commission (“CFTC” or “Commission”) issued CFTC No-Action Letter No. 14-126 (“Letter 14-126”), which sets forth a number of conditions with which commodity pool operators (“CPOs”) that delegate their CPO responsibilities (the “Delegating CPO”) to registered CPOs (the “Designated CPO”) must comply in order to take advantage of no-action relief from the requirement to register as a CPO. The CPO community has anxiously awaited this letter because it clarifies the activities in which a Delegating CPO may engage and still qualify for relief from the requirement to register as a CPO. Essentially, the Letter makes more liberal several of the conditions set forth in CFTC Letter No. 14-69 (May 12, 2014) (“Letter 14-69” and, together with Letter 14-126, the “Letters”), [1] with which many Delegating CPOs could not comply. In addition, Letter 14-126 makes the relief self-executing, i.e., no form requesting relief or even a notice need be filed.

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Shadow Banking and Bank Capital Regulation

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday October 27, 2014 at 9:17 am
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Editor’s Note: The following post comes to us from Guillaume Plantin, Professor of Finance at the Toulouse School of Economics.

The term “shadow banking system” refers to the institutions that do not hold a banking license, but perform the basic functions of banks by refinancing loans to the economy with the issuance of money-like liabilities. Roughly speaking, licensed banks refinance the loans that they hold on their balance sheets with deposits or interbank borrowing, whereas the shadow banking system refinances securities backed by loan portfolios with quasi-deposits such as money market funds shares.

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Opacity in Financial Markets

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday October 23, 2014 at 9:17 am
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Editor’s Note: The following post comes to us from Yuki Sato of the Department of Finance at the University of Lausanne and the Swiss Finance Institute.

In my paper, Opacity in Financial Markets, forthcoming in the Review of Financial Studies, I study the implications of opacity in financial markets for investor behavior, asset prices, and welfare. In the model, transparent funds (e.g., mutual funds) and opaque funds (e.g., hedge funds) trade transparent assets (e.g., plain-vanilla products) and opaque assets (e.g., structured products). Investors observe neither opaque funds’ portfolios nor opaque assets’ payoffs. Consistent with empirical observations, the model predicts an “opacity price premium”: opaque assets trade at a premium over transparent ones despite identical payoffs. This premium arises because fund managers bid up opaque assets’ prices, as opacity potentially allows them to collect higher fees by manipulating investor assessments of their funds’ future prospects. The premium accompanies endogenous market segmentation: transparent funds trade only transparent assets, and opaque funds trade only opaque assets. A novel insight is that opacity is self-feeding in financial markets: given the opacity price premium, financial engineers exploit it by supplying opaque assets (that is, they render transparent assets opaque deliberately), which in turn are a source of agency problems in portfolio delegation, resulting in the opacity price premium.

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The Institutional Framework for Cost Benefit Analysis in Financial Regulation

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday October 21, 2014 at 9:27 am
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Editor’s Note: The following post comes to us from Robert Bartlett, Professor of Law at UC Berkeley School of Law.

Four years after the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the use of cost benefit analysis (CBA) in financial regulation has come to play a critical role in an increasingly heated debate concerning the statute’s implementation. Requiring nearly three hundred rule-makings across twenty agencies, Dodd-Frank’s enormous regulatory mandate represents for many an especially dangerous risk of the typical “drift” and “slack” problems long associated with administrative rule-making. The fact that Dodd-Frank was enacted in the midst of an economic recession only heightens these fears, particularly the concern that overworked and/or overzealous agencies might discharge their regulatory mandate by promulgating cost-insensitive regulations. In light of these concerns, a number of Congressional proposals now exist that would subject financial rule-making to more formal CBA reflecting the conventional belief that rigorous CBA can provide much-needed accountability over regulatory agencies.

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How Do Bank Regulators Determine Capital Adequacy Requirements?

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday October 15, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Eric Posner, Kirkland & Ellis Distinguished Service Professor of Law and Aaron Director Research Scholar at the University of Chicago.

The incentive to take socially costly financial risks is inherent in banking: because of the interconnected nature of banking, one bank’s failure can increase the risk of failure of another bank even if they do not have a contractual relationship. If numerous banks collapse, the sudden withdrawal of credit from the economy hurts third parties who depend on loans to finance consumption and investment. The perverse incentive to take financial risk is further aggravated by underpriced government-supplied insurance and the government’s readiness to play the role of lender of last resort.

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