Welcome to PwC's Financial Regulatory Reform Update where we update you on the latest developments in financial services regulatory reform. To read previous editions please click here.
February 27, 2012
"The great dialectic in our time is not, as anciently and by some still supposed, between capital and labor; it is between economic enterprise and the state." - John Kenneth Galbraith
"A boy can learn a lot from a dog: obedience, loyalty, and the importance of turning around three times before lying down." - Robert Benchley
The Commodity Futures Trading Commission (CFTC or Commission) met on February 23, 2012 to approve an internal business conduct rule covering four topics and to propose a block rule. In opening the meeting, Chairman Gensler noted that the meeting was the 24th open meeting on Dodd-Frank rules and that with the Commission's action on the 23rd; it will have approved 28 final rules. The Chairman stated his view that all final regulations should be approved by the end of 2012. The Chairman emphasized that two of the main objectives leading the Commission's regulatory efforts to implement Dodd-Frank were to lower risk and increase transparency in the economy. He stated that in January, the CFTC completed the first reforms to regulate dealers. The Commission is requiring registration so, for the first time, regulators are able to monitor swap dealers and major swap participants; and second, the Commission is establishing and enforcing robust sales practices in the swaps markets.
Final Business Conduct Rule
The final internal business conduct rule that was approved at the meeting is in fact a collection of five CFTC rule proposals in four key topic areas.
The Block Rule Proposal
The block rule proposal is intended to promote both pre-trade and post-trade transparency. The CFTC indicated that this proposal benefits from the comments received by the CFTC on the real-time public reporting proposal, which included a block rule. The new methodology makes a number of significant changes from the earlier proposal.
The CFTC is seeking public comment about alternative methodologies, including the possibility of using the 50 percent notional amount calculation. The rule also includes additional measures to protect the identities, market positions and business transactions of swap counterparties when their swap transactions and pricing are reported to the public.
Views of Other Commissioners
Commissioner Jill Sommer -- Concerns About Lack of Mutual Recognition and Implications for Extraterritoriality. Commissioner Sommers noted that during the course of the comment period the Commission received requests to allow substituted compliance for entities subject to comparable regulation by a prudential regulator. In her view, this made "perfect sense" from both resource and policy perspectives. Instead, the Commission “has determined that its interests in ensuring that all registrants are subject to consistent regulation outweighs any burden that may be placed on registrants that are subject to regulation by a prudential regulator.”In light of this view in the final regulation, she expressed concern that it "does not bode well for how the Commission may be approaching extraterritoriality issues. While we have been hearing for months that staff has been developing guidance on the application of Dodd-Frank to activities outside the U.S., nothing of substance has been shared with my office to date. Given the Commission’s unwillingness to rely on comparable regulation by a U.S. prudential regulator, I am left wondering whether we will be abandoning our long standing policy of recognizing and relying on comparable foreign regulators. I hope the answer to that question is no."
Commissioner Bart Chilton -- The High-Wire Balancing Act in Setting Policy. Commissioner Chilton emphasized that "the balancing test" is particularly evident with regard to the proposed block trading rule. While voting for this proposed rule, Commissioner Chilton did so with the caveat that "we must, as we go forward, be extremely cognizant that all of these swaps rules are an interdependent set." In his view, it is a grave error to look at each rule as free-standing—they are not. These swaps regulations—the SEF rule, the block trade rule, the reporting rules, for example—all have to work together, have to be perfectly balanced, in order for the markets to function and for consumers to be protected. Commissioner Chilton noted an example in Section 733 of the Dodd/Frank Act that provides a good visual of the balancing act the Commission must undertake. In a “rule of construction,” Congress tells the CFTC that the goal of that swaps execution facility provision is to 1) promote the trading of swaps on SEFs, and at the same time, with co-equal importance, 2) promote pre-trade price transparency in the swaps market. "As we look at the block trading rule, the SEF rule, and the reporting rules—again, in concert—we can see that, if we go too far in, for example, setting block levels too low, we will possibly not promote SEF swaps trading. On the other hand, if we set the block level too high, then we risk impairing the ability of participants to effectively utilize the markets at all. In other words, certain large trades simply wouldn’t happen, because dealers would not be able to efficiently lay off their risk. "The Commissioner stated that he looked forward to a "robust debate on the block trading rule. In particular, I would like to hear from the industry as to whether different block levels are appropriate for commodity swaps as differentiated from all other asset classes, and the rationale for such distinction."
Public Roundtable on Enhancing Protection of Customer Funds
Chairman Gensler also announced a two-day, public roundtable on February 29 and March 1, 2012, which will look at the critical issues surrounding further enhancements to customer protection. Segregation of customer funds is a core foundation of customer protection in both the futures and swaps markets. He noted that the Commission had already taken a number of steps, such as enhancement of protections regarding investment of customer funds (through amendments to the rule 1.25) and the requirement for FCMs and derivatives clearing organizations to segregate customer collateral supporting cleared swaps -- ensuring customer money is protected individually all the way to the clearinghouse.
Panel topics will include alternative custodial arrangements for segregated funds; enhanced customer protections and transparency provisions for FCMs; additional protections for the collateral of futures customers; revisions to the bankruptcy rules for FCMs; protection of customer funds at FCMs to be traded on foreign futures markets; issues associated with entities dually registered with the CFTC as FCMs and the SEC as broker-dealers; and enhancing the self-regulatory structure.
On February 22, 2012, the Consumer Financial Protection Bureau (CFPB or Bureau) commenced an inquiry into checking account overdraft programs to determine how these practices are impacting consumers. As part of that inquiry, the CFPB is seeking public input on a prototype “penalty fee box” – a disclosure on a consumer’s checking account statement that would highlight the amount overdrawn and total overdraft fees charged. The launch includes a "prototypical penalty box" for disclosures at the following link: http://www.consumerfinance.gov/wp-content/uploads/2012/02/Sample_Fee_Penalty_Box.pdf
CFPB Director Richard Cordray stated that "[w]ith today’s technologies, consumers have more opportunities to access their checking accounts and cause overdrafts. But overdraft practices have the capacity to inflict serious economic harm on the people who can least afford it. We want to learn how consumers are affected, and how well they are able to anticipate and avoid paying penalty fees.” The CFPB noted that an overdraft occurs when a consumer spends or withdraws more money than is available in his or her checking account and the financial institution advances funds on the consumer’s behalf. Banks generally charge an overdraft fee for each transaction that they choose to cover.
For point-of-sale debit card and ATM transactions, regulations by the Federal Reserve Board (FRB) that became effective in 2010 prohibit a bank from charging the overdraft fee unless the consumer has opted-in. For check and online bill payments, as well as recurring debits, banks can charge an overdraft fee without any affirmative request from the consumer. The CFPB said that according to various industry sources, the average overdraft fee ranged from $30-$35 in 2011 and has increased by 17 percent over the past five years. A study by the Federal Deposit Insurance Corporation (FDIC) published in 2008 found that consumers who overdrew 20 or more times per year paid an average of $1,610 in overdraft fees annually.
The inquiry the CFPB is launching — through a data request that is being sent to a number of banks and a Notice and Request for Information from the public — is intended to provide insight into overdraft practices. The inquiry is focused on four main areas:
The CFPB’s inquiry builds on actions taken by other federal banking regulators. In February 2005, the FDIC, Office of the Comptroller of the Currency (OCC), National Credit Union Administration, and FRB issued supervisory guidance that suggested best practices for overdraft programs. Many of these best practices have not been consistently adopted. The FDIC issued additional guidance that applies only to FDIC-regulated institutions and the OCC issued proposed guidance in 2011. The opt-in rules for overdrafts issued by the FRB took effect in July 2010 and transferred to the CFPB in July 2011.
The CFPB will use the input collected through the inquiry to assist with policymaking on overdraft practices and prioritize its own regulatory and education work. In addition to the inquiry, the Bureau will collect data from several of the largest banks in the country to evaluate how those institutions’ overdraft policies affect consumers. The notice, along with information on how to submit comments electronically, is located on the CFPB’s website at: http://www.consumerfinance.gov/wp-content/uploads/2012/02/FR-Notice_Overdraft.pdf
Also on February 22, 2012, the CFPB issued a "consumer advisory" on overdraft coverage and fees. The focus is on making consumers aware of their option --
American Bankers Association (ABA) Supports an Appropriate Study by the CFPB
President and CEO Frank Keating of the ABA said on the 22nd that the ABA supports a CFPB overdraft protection program study that is data-driven, analytical and stands up to peer review' “We are not concerned about a study based on fact, as we believe that overdraft protection is a service that customers freely elect to have, they know the fee in advance and they can opt-out of overdraft protection at anytime,” Keating said. He added that the study should include a survey of the entire banking industry, since CFPB rules will apply to all banks. “ABA member banks that offer [overdraft protection programs] have a track record of introducing a range of competitive features that customer's value,” he said. “Richard Cordray’s comments illustrate that the Bureau recognizes this competitive diversity drives a wealth of consumer choices among banking products."
On February 21, 2012, Edward J. DeMarco, the Acting Director of the FHFA, sent Congress "A Strategic Plan for Enterprise Conservatorships: The Next Chapter in a Story That Needs an Ending." The Plan notes that since establishing conservatorships for Fannie and Freddie (the Enterprises) in 2008, the FHFA and the Enterprises have focused on three key goals:
Three Strategic Goals
The plan sets forth three strategic goals for the next phase of conservatorship:
The first goal – building a new infrastructure – recognizes that the country would be without a secondary market for non-government-insured mortgages without the Enterprises. No private sector infrastructure exists today that is capable of securitizing the $100 billion per month in new mortgages being originated. Simply shutting down the Enterprises would drive up interest rates and limit mortgage availability. This goal establishes the steps FHFA and the Enterprises will take to create that necessary infrastructure, including a securitization platform and national standards for mortgage securitization that Congress and market participants may use to develop the mortgage market of the future.
The second goal – contracting Enterprise operations – describes steps that FHFA plans to take to gradually shift mortgage credit risk from the Enterprises to private investors and eliminate the direct funding of mortgages by the Enterprises. This goal is consistent with the fundamental goals of the conservatorship, of the Enterprises operating in a sound and solvent condition, and of limiting future risk exposure in the face of uncertainty.
The third goal – maintaining foreclosure prevention efforts and credit availability – recognizes that the work begun three years ago is not finished. Programs and strategies to ensure ongoing mortgage credit availability, assist troubled homeowners, and minimize taxpayer losses while restoring stability to housing markets continue to require energy, focus, and resources.
Benefits of the Plan
In the FHFA's view, if properly implemented, this strategic plan should benefit:
Congress Must Write the Final Chapter
The FHFA concludes that the "final chapter, though, remains the province of lawmakers. Fannie Mae and Freddie Mac were chartered by Congress and by law, only Congress can abolish or modify those charters and set forth a vision for a new secondary market structure."
In that regard, FHFA emphasizes that the steps envisioned in this strategic plan "are consistent with each of the housing finance reform frameworks set forth in the white paper produced last year by the U.S. Department of the Treasury and the U.S. Department of Housing and Urban Development as well as with the leading congressional proposals introduced to date. This plan envisions actions by the Enterprises that will help establish a new secondary mortgage market, while leaving open all options for Congress and the Administration regarding the resolution of the conservatorships and the degree of government."
On January 4, 2012, the Federal Reserve Board (FRB) quietly sent to the Congress a White Paper (Paper) developed by its staff on "The U.S. Housing Market: Current Conditions and Policy Considerations." Chairman Bernanke noted that in the Paper, "we do not attempt to address every problem faced by the housing market; rather, it is our intention to provide a framework for thinking about certain issues and tradeoffs that policymakers might consider."
The Paper reviews housing market conditions, addresses a REO to rental strategy for foreclosed properties, discusses credit access and pricing, homeowners at risk of default or foreclosure and improving accountability and aligning incentives in mortgage servicing. The Paper can be found at the following link:http://www.federalreserve.gov/publications/other-reports/files/housing-white-paper-20120104.pdf
FRB's View of Public Policy Considerations
In its conclusion, the Paper notes that the challenges faced by the U.S. housing market today reflect, in part, major changes taking place in housing finance; a persistent excess supply of homes on the market; and losses arising from an often costly and inefficient foreclosure process (and from problems in the current servicing model more generally). The significant tightening in household access to mortgage credit likely reflects not only a correction of the unsound underwriting practices that emerged over the past decade, but also a more substantial shift in lenders' and the GSEs' willingness to bear risk. In particular, the Paper suggests that if the currently prevailing credit standards had been in place during the past few decades, "a larger portion of the nation's housing stock probably would have been designed and built for rental, rather than owner occupancy."
The FRB says that the challenge for policymakers is to find ways to help reconcile the existing size and mix of the housing stock and the current environment for housing finance. Fundamentally, the Paper notes that such measures involve adapting the existing housing stock to the prevailing tight mortgage lending conditions--for example, devising policies that could help facilitate the conversion of foreclosed properties to rental properties—or supporting a housing finance regime that is less restrictive than today's, while steering clear of the lax standards that emerged during the last decade. "Absent any policies to help bridge this gap, the adjustment process will take longer and incur more deadweight losses, pushing house prices lower and thereby prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large."
To address the deadweight losses from foreclosures, the Paper indicates that policymakers might consider minimizing unnecessary foreclosures through the use of a "broad menu of types of loan modifications, thereby allowing a better tailoring of modifications to the needs of individual borrowers; and servicers should have appropriate incentives to pursue alternatives to foreclosure." The Paper suggests that policymakers also may want to consider supporting policies that facilitate deeds-in-lieu of foreclosure or short sales in order to reduce the costs associated with foreclosures and minimize the negative effects on communities.
The Paper concludes that "restoring the health of the housing market is a necessary part of a broader strategy for economic recovery. As this paper suggests, however, there is unfortunately no single solution for the problems the housing market faces. Instead, progress will come only through persistent and careful efforts to address a range of difficult and interdependent issues."
What Should the FRB's Role Be in Housing Policy?
A story in the Washington Post of February 21, 2012 reported that the Paper has stirred controversy in Congress, as some believe that the FRB is trying to insert itself in a public policy issue within the domain of Congress and that even some within the FRB system expressed concern that the FRB needs to be careful not to weaken in any way its special independence. For his part, Chairman Bernanke has indicated that the FRB was not advocating particular policies but rather providing a balanced analysis of steps that might improve the health of the housing market. Most of the controversy surrounds the FRB's discussion of more ways to help homeowners including having the GSEs take more short-term losses in the near term (at a cost to the taxpayer) that would nonetheless speed up the economic recovery.
On February 16th, the House Financial Services Committee reported out several bills including HR 1838 which does not repeal the swaps pushout rule of Dodd-Frank, but which makes three significant changes.
The bill had bipartisan sponsorship and was reported by voice vote. At the same mark-up, the House Financial Services Committee also passed two other important bills that received bipartisan support, including H.R. 3606 which reduces the cost of smaller companies going public by phasing in SEC requirements and which passed the Committee by a vote of 54 to 1 Also passed on a voice vote was H.R. 4014 which amends the FDI Act so that information filed with CFPB does not waive any privilege that may exist with respect to such information in litigation.