Transactions that reduce regulatory capital requirements for banks have recently come under media and regulatory scrutiny. The New York Times characterized them as a “trading sleight of hand.” The Basel Committee on Banking Supervision has proposed limiting the ways in which capital requirements can be reduced by such transactions. This post discusses the new Basel proposals in light of prior guidance published by Basel and the Federal Reserve. As banks seek ways to meet heightened capital requirements and surcharges that are being implemented, they may find greater difficulties in reducing their exposures.

…continue reading: Basel Developments: Credit Risk Mitigation Transactions and Regulatory Capital Arbitrage

Triggered by the recent financial crisis, the regulation of banks has gained new traction among academics, regulators, and politicians. One of the key challenges in effective regulation is time inconsistency of regulation. While a regulator would like to commit not to bail out banks in order to set the right ex-ante incentives, this threat is generally not credible since the government does not follow through in the event of a crisis. Banks therefore have an incentive to expose themselves to risk that is partially insured by the government.

To mitigate this problem, regulators attempt to reduce the likelihood of banking crises by regulating both banks’ asset side and liability side. While there has been a recent push to focus on the liability side by mandating higher equity capital requirements, the very nature of a deposit-taking institution implies that leverage is an integral part of the business model of banks, unlike for other firms. In this paper, we therefore focus on the regulation of banks’ asset holdings. The starting point of our paper is the natural assumption that a regulator cannot directly observe the riskiness of assets, but needs to rely on an external (private) assessment of risk. Since the introduction of the Basel I framework, credit ratings have played an important role in bank regulation as “objective” measures of credit risk. This role has been confirmed in the Basel III (2011) guidelines, which still rely on credit ratings as measures of creditworthiness.

…continue reading: Bank Regulation with Private-Party Risk Assessments

As noted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), “In the aftermath of the financial crisis, executives and their boards realize that ad hoc risk management is no longer tolerable and that current processes may be inadequate in today’s rapidly evolving business world.” [1] However, especially for nonfinancial companies that may be relatively new to these topics, enhancing risk management can be a somewhat daunting task.

This article focuses on two key aspects of the relationship between risk and strategy: (1) understanding the organization’s strategic risks and the related risk management processes, and (2) understanding how risk is considered and embedded in the organization’s strategy setting and performance measurement processes. These two areas not only deserve the attention of boards, but also fit closely with one of the primary responsibilities of the board — risk oversight.

…continue reading: Strategic Risk Management: A Primer for Directors

I. Introduction

The most significant impact of SEC registration on private fund advisers is that the adviser becomes subject to inspection by the SEC’s Office of Compliance Inspections and Examinations (OCIE). The greatest risk arising from an examination is that the inspection staff decides to refer finding from an inspection to the Division of Enforcement for an investigation. This article discusses the risks of an examination becoming an investigation and strategies for anticipating and mitigating those risks. [1]

II. The Risk That an Examination Results in a Referral to Enforcement

Asset managers are particularly vulnerable to collateral consequences of a government investigation. Particularly in the wake of recent cases, many investors have little tolerance for fund managers who are subject to an investigation, thus making flight of capital a real risk for advisers under investigation. Stark examples of this played out over the last year when the F.B.I. executed search warrants in November 2010 on four hedge funds. Of the four funds raided, three ceased doing business even in the absence of criminal charges. [2]

…continue reading: The Blurring Line Between SEC Examinations and Enforcement

During the financial crisis, investors learned the hard way about financial liabilities of many institutions that were not previously disclosed. For example, many banks had large contingent liabilities to off balance sheet entities that they had sponsored. The extent of these liabilities surprised investors when the banks were forced in late 2007 and 2008 to take on their books these off balance sheet entities.

Outside directors on the audit committees of these banks were also surprised by the scope and size of these off balance sheet liabilities. To paraphrase Donald Rumsfeld, these directors did not know what they did not know. Their blissful ignorance shows that the SOX reforms for audit committees have not been effective and that a different approach is needed.

…continue reading: What Audit Committees Don’t Know

Our eighth Annual Survey of Selected Corporate Governance Practices of the Largest US Public Companies (the “Survey”) reflects a year of consolidation, rather than innovation, in compensation disclosure by the largest US public companies. The proxy statements of the Top 100 Companies [1] continue many of the trends noted in prior years: enhanced attention to the risk profile of compensation strategies; more companies adopting clawback policies; increased acceptance of shareholder say-on-pay votes; and increased use of independent compensation consultants.

Few proxy statements report new compensation strategies or novel approaches to compensation disclosure. One possible reason for the relative stability in compensation practice and disclosure was the absence of significant new legislation during the period covered by this Survey. Companies were not required to assimilate and react to anything nearly as dramatic as the legislation implementing the Troubled Asset Relief Program (“TARP”) of the prior year.

…continue reading: Director and Executive Compensation of the 100 Largest US Public Companies