Our take: PwC's financial services update

Change remains a constant in financial services regulation. Read "our take" on the latest developments and what they mean.


Current topics - August 18, 2017

Fed proposed new expectations for the Board of Directors

On August 3rd, the Federal Reserve (Fed) proposed new supervisory guidance for boards of directors of Fed-supervised institutions. The proposed guidance is the result of a multi-year review by the Fed of existing guidance and practices of boards of directors, and is intended to consolidate, revise, and replace existing board supervisory expectations from 27 SR Letters, which include 170 supervisory expectations for boards, with 33 expectations of effective boards.

The proposed guidance responds to criticism that supervisory expectations for boards of directors and senior management have become increasingly difficult to distinguish, and seeks to refocus board expectations on five key attributes: (1) setting clear direction for the firm; (2) actively managing information and board discussions; (3) holding senior management accountable; (4) supporting independent risk management and internal audit; and (5) maintaining a capable board composition and governance structure. The Fed plans to evaluate each of these attributes more explicitly in the examination process under the Governance and Controls component included in the Fed’s newly proposed rating system for large financial institutions, as discussed below.

The proposed guidance is open for comment until October 10th.

Our take

The proposed guidance is an early example of rebalancing post-crisis regulations and streamlining responsibilities of the board and senior management. It is an effort to return the board to setting strategy, providing clear direction, and holding senior management accountable for their core role of handling

day-to-day operations. The Fed will seek to further clarify this distinction by issuing additional proposed guidance on supervisory expectations relating to senior management’s role with respect to core business lines, independent risk management, and controls in the near future. Clarifying board and management expectations and tying them to the exam process will allow both groups to sharpen their focus on the execution of their duties, which has been challenging given the expansion of scope over the last decade.

We expect the proposed guidance to be finalized in early 2018.

For more, read our First Take:  Five key points from the Fed’s new board expectations guidance

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New Fed rating system for large financial institutions

In addition to the proposed board guidance, the Fed proposed a new supervisory rating system last week to assess the safety and soundness of large financial institutions (LFI) (generally firms with more than

$50 billion in assets). This would be the first change to the Fed’s supervisory rating system since the financial crisis, and it aims to simplify and clarify the existing five-component supervisory assessment process by assigning ratings across three pillars: (1) capital, (2) liquidity, and (3) the effectiveness of governance and controls. The proposed rating system no longer have an overall rating and instead would have firms rated on a four point scale on each of the three pillars: Satisfactory, Satisfactory Watch, Deficient-1, and Deficient-2. Firms would need a Satisfactory or Satisfactory Watch rating for each pillar to avoid additional scrutiny or enforcement actions. The new Satisfactory Watch category comes with a limited period of time to remediate issues, and while the Deficient 1 and 2 ratings would still come with some regulator discretion as to enforcement actions, the proposal is clear that there would be formal or informal enforcement actions.

The Fed would use this system for LFIs , and would continue to use the current rating system for all other supervised institutions. The proposal is designed to focus future ratings on two areas where the Fed has made the most changes to its supervisory process since the financial crisis by factoring in the findings from a firm’s Comprehensive Capital Analysis and Review (CCAR) and Comprehensive Liquidity Analysis and Review (CLAR) exercises. The third pillar of the proposed rating system, the effectiveness of governance and controls, would incorporate all of the risk management assessments and ratings of the current ratings system. This part of the rating will rely heavily on the new supervisory guidance for boards as well as the upcoming guidance on management of core business lines and independent risk management and controls. The proposal also removes ratings for subsidiary depository institutions (DIs) and instead would rely on supervisory assessments from the DI’s primary supervisor, representing a continuation of the Fed’s focus of the holding company.

The industry has 60 days to comment on the proposed system and the Fed expects to apply its updated rating system to LFIs in 2018.

Our take

Capital, liquidity, financial resilience and governance jump to the fore in this revamped exam rating system, which closely aligns to the Fed’s framework for supervising firms in its Large Institution Supervision Coordinating Committee (LISCC) portfolio. Watch for this new emphasis to increase industry pressure on making capital and liquidity rules more coherent. Further, although it has fewer components, no composite rating, and a distinct four point rating scale, do not expect the proposed system to lower standards or overall supervisory expectations. The proposed system’s emphasis on simplifying expectations should garner industry support and even if commenters quibble over a feature or two, expect the final version to closely mirror the proposal and for the new system to be in use in 2018.

For more, read our First Take: Five key points from the Fed’s new rating system for large financial institutions

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Resolution planning delays

Last week, the Fed and the Federal Deposit Insurance Corporation (FDIC) (together, the Agencies) extended resolution plan filing deadlines for 21 banks and allowed two more to submit “reduced-content plans.” Nineteen of the 21 banks that received extensions and the two banks that were allowed to submit reduced-content plans are foreign banking organizations (FBOs) that vary in their US banking footprint, ranging from those primarily operating wholesale businesses to others with large, multi-state regional banking franchises. Most of the banks in this group submitted their last resolution plans in 2015 which means the next plans will appear on a three-year cycle (December 31, 2018).

Our take

This latest resolution plan extension continues the Fed and FDIC’s trend of spreading out the timing for submitting resolution plans, this time in line with industry expectations and the recommendation in the Treasury report on financial regulation to move away from annual submissions and shorten feedback timelines. However, we suspect the impetus is more about managing the Agencies’ workload and less than about granting reprieves. At the same time, the extension may hinder the Agencies’ horizontal reviews of plans, as several of the FBOs have substantial US operations that closely compare with US-based regional banking companies who still must file plans this December. While the 21 banks have another year on these resolution plans, many still have to file the FDIC’s Insured Depository Institution (IDI) plans and the Office of the Comptroller of the Currency’s new recovery plans within the next year.

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DOL to extend fiduciary rule exemptions delay

The Department of Labor (DOL) has sent proposed amendments to that would delay the start dates for three core fiduciary duty rule exemptions (which allow commission based compensation) by 18 months, according to a court filing. While the language is not yet public, the DOL states in the filing that amendments would extend the transition period for the Best Interest Contract (BIC) Exemption, Principal Transactions Exemption, and Prohibited Transaction Exemption 84-24 from January 1, 2018 to July 1, 2019.

These extensions appear one month after the DOL requested comments on when the fiduciary rule’s provisions should go into effect and how they might be changed. The DOL specifically asked whether delaying the three provisions would benefit the finance industry or harm consumers.

Our take

More delay for the core exemptions comes as no surprise as the new DOL Secretary Alexander Acosta continues to wrestle with how to adjust a controversial final rule he inherited. This delay would give the DOL ample time to make adjustments, especially to the particularly controversial BIC exemption requirements, and to coordinate with the Securities and Exchange Commission on its standards of conduct for advisors to non-retirement accounts. However, as we’ve said, any further delays or modifications to the fiduciary rule are not likely to divert the investment industry’s considerable efforts underway to meet the core, still effective requirement of providing retirement advice that is in the client’s best interest.

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SEC on cybersecurity

Last week, the SEC published a risk alert summarizing the results of their recent cybersecurity examinations. Overall, firms showed notable improvement over previous examinations, with nearly all having written policies and procedures around cybersecurity, conducting periodic cyber risk assessments, and having data loss prevention programs. However, the SEC observed that many of these policies and procedures were not reasonably tailored to the firms’ unique cyber-related issues, but instead provided only general and vague guidance. Additionally, it observed that many firms did not enforce their written policies and procedures that were in place. For example, despite having policies that require staff to attend cyber awareness training, firms did not take steps to ensure such training had been completed. Finally, some firms did not take steps to remediate vulnerabilities identified in systems testing.

Our take

The SEC is sending a message that it is not enough to simply check-the-box and comply with cybersecurity requirements on paper, but firms must actually follow through – this means enforcing policies and remediating problems identified in testing. With so many recent high-profile cyber attacks, new Chairman Jay Clayton and his new enforcement leads have joined the chorus of regulators pinpointing cybersecurity as a top priority. Accordingly, firms should expect more enforcement to come and make sure their cyber programs are up to date with best practices. Getting it right will also help with the upcoming September 1st compliance deadline for new cyber requirements from the New York Department of Financial Services.

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Lower regulatory capital for cleared derivatives

On August 14th, the Fed, the Office of the Comptroller of the Currency (OCC), and the FDIC issued guidance that could allow banks to lower capital held against certain centrally cleared derivatives. Under this technical statement, a bank may treat variation margin (VM) received on certain cleared derivatives as a settlement payment, rather than collateral, if various conditions are met. By treating VM as a settlement payment, banks can lower the regulatory capital held for potential future exposure against the trades (under the standardized approach and the supplementary leverage ratio). This guidance follows from recent changes to rule books at certain clearing houses announced earlier this year and is consistent with Basel Committee guidance. 

The regulators issued this guidance despite concerns raised by FDIC Vice Chairman Thomas Hoenig that it would “artificially” lower capital since, despite the new treatment of VM, the economic terms and settlement risks associated with the trades remain the same.

Our take

This guidance is another sign of new regulators putting their stamp on existing rules, and is a good example of regulators taking industry feedback and aligning required capital to the risk and substance of transactions. The guidance gives banks a path to trim capital held against certain cleared derivatives, adding another incentive to clear. Interestingly, Vice Chair Hoenig remains a heckler but lacks a heckler’s veto – as the referees change, it will be easier to align on these changes. Still, capital is a blunt tool for managing the residual risks raised by Hoenig and you may want to recheck your settlement risk tool kit for derivatives.

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Julien Courbe
Financial Services Advisory Leader
Tel: +1 (646) 471 4771
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