Welcome to PwC's Financial Regulatory Reform Update where we update you on the latest developments relating to financial services regulatory reform.
September 26, 2011
"The payments which have been made into the Treasury show the very productive state of the public revenue." -President James Monroe
"Cleanliness becomes more important when godliness is unlikely." -P. J. O'Rourke
Speaking on September 22, 2011, before a Conference on "Financial Institutions in the New Regulatory Environment: Opportunities, Constraints and Global Challenges," sponsored by PwC and Georgetown University, Assistant Treasury Secretary Marisa Lago noted the great deal of progress that had been made in the G-20 financial reform agenda, but emphasized that "our efforts are far from over. We must now make sure that any global rules are robust enough to deal with the interconnection and integration of our global economy. And, we must act promptly to minimize opportunities for regulatory arbitrage and ensure a level playing field."
Secretary Lago went on to highlight five of the most critical financial reform issues that remain "works in progress".
Chairman Gary Gensler of the Commodity Futures Trading Commission (CFTC) gave the concluding keynote address at the PwC and Georgetown University Conference on September 22, 2011 and placed special emphasis on "two overarching goals of reform: bringing transparency to the swaps market and lowering the risks of this market to the overall economy".
In discussing the first overarching goal, the Chairman noted that the more transparent a marketplace is the more liquid it is and the more competitive it is. "In short, when markets are open and transparent, costs are lower for companies and the people who buy their products." The Dodd-Frank Act promotes both pre-trade and post-trade transparency by moving certain standardized swaps transactions to exchanges or swap execution facilities. This will allow buyers and sellers to meet in an open marketplace where prices are publicly available. The Dodd-Frank Act also requires the real-time reporting of the price and volume of transactions. Furthermore, it requires that once a swap transaction is arranged, its valuation must be shared on a daily basis with the counterparty. In the Chairman's view, "these measures of transparency and openness reduce some of the information advantages that dealers currently have over Main Street."
Of equal importance is the second goal of lowering risk to the overall economy by directly regulating dealers for their swaps activities as well as moving standardized swaps into central clearing. Clearinghouses mitigate the risks that arise from the interconnectedness in the financial system by standing between counterparties and guaranteeing the obligations of the parties in case of default.
Noting that the CFTC has largely completed the proposal phase of its rule-writing process it has begun finalizing rules to make the swaps marketplace more open and transparent for participants and safer for taxpayers. Next in its queue of final rules are critical regulations related to speculative position limits as well as risk management for clearinghouses. The CFTC is also actively consulting and coordinating with international regulators to promote robust and consistent standards in swaps oversight. The Commission also anticipates seeking public input on the application of Section 722(d), which says that the law doesn’t apply to activities outside the United States unless those activities have a direct and significant connection with or effect on U.S. commerce.
The agency is taking on a significantly expanded scope and mission. The Chairman stressed that the agency must be adequately resourced to ensure the new swaps market rules will be strictly enforced – rules that promote transparent markets, lower costs for consumers and protect taxpayers. Without sufficient funding, the CFTC will not have the resources to put enough cops on the beat for the public’s protection.
On September 15th, Special Advisor to the Secretary of the Treasury Raj Date addressed the National Constitution Center in Philadelphia. In his remarks, Mr. Date stated that "building a smart, effective and credible supervisory program" to evaluate consumer laws and ensure they're being followed will be a top Consumer Financial Protection Bureau (CFPB) objective.
Mr. Date acknowledged concern about added supervision from the new agency and vowed that the CFPB will monitor the impact of rulemakings and supervisory activity. He said, "There is understandable concern about the inconsistency that may result from separate supervision regimes... If we find that these interventions are not working as intended, we will adjust. And if we find that additional action is needed, we will act." In his remarks, Mr. Date further asserted that the Bureau's approach to supervision will be "tough-minded" yet fair. "We will be up front with the financial institutions we supervise so that there are no surprises…But… [m]ake no mistake: When we find unjustified practices that cause substantial consumer harm, we will take the necessary action to put an end to them."
Mr. Date remarked on key products that will have the attention of the Bureau, including mortgages, student loans, and checking accounts. He provided an update on the "Know Before You Owe" project, which focuses on streamlining mortgage disclosure forms. The project is in the fourth of five rounds of model disclosures and has so far received feedback from more than 10,000 entities.
At the PwC and Georgetown University Conference referenced above on September 22, 2011, David Silberman, Assistant Director for Research, Markets and Regulation at the CFPB, said that the Bureau would be making available in the near future its initial Examination Manual for compliance with designated consumer protection laws and regulations. Mr. Silberman noted that the Bureau's staff was about equally divided between those in supervisory and those in enforcement functions. Mr. Silberman also noted that the Bureau had a large, toolkit to protect consumers, a point well-made by Richard Cordray at his nomination hearing to be Director of the Bureau:
"As Ohio’s Attorney General, when I saw something wrong I typically had only two options to choose from: do nothing, or open an investigation that might lead to a lawsuit. …
At the Bureau, our bigger and more flexible toolbox includes research reports, rulemaking, market guidance, consumer education and empowerment, and the ability to supervise and examine both large banks and many nonbank institutions. I know from my own experience that lawsuits can be a very slow, wasteful, and needlessly acrimonious way to resolve a problem. The supervisory tool, in particular, offers the prospect of resolving compliance issues more quickly and effectively without resorting to litigation. We are continuing to build our capacity to make effective use of this entire range of tools." Opening Statement of Richard Cordray before the Senate Banking Committee, September 6, 2011.
The Securities and Exchange Commission (“Commission”) is proposing proposed for comment on September 19, 2011 a new rule under the Securities Act of 1933 (“33 Act”) to implement the prohibition under Section 621 of the Dodd-Frank Act on material conflicts of interest in connection with certain securitizations. Proposed Rule 127B under the 33 Act would prohibit certain persons who create and distribute an asset-backed security, including a synthetic asset-backed security, from engaging in transactions, within one year after the date of the first closing of the sale of the asset-backed security, that would involve or result in a material conflict of interest with respect to any investor in the asset-backed security. The proposed rule also would provide exceptions from this prohibition for certain risk-mitigating hedging activities, liquidity commitments, and bona fide market-making.
While there are many difficult interpretive and policy issues posed in the proposal, the Commission notes that "perhaps the most challenging issue in implementing Section 27B is to identify those conflicts of interest involving securitization participants and investors that are “material” and intended to be prohibited under Section 27B and our proposed rule.
The proposed rule does not define the term “material conflict of interest.” The Commission noted that any attempt to precisely define this term in the text of the proposed rule might be both over- and under-inclusive in terms of identifying those types of material conflicts of interest intended to be prohibited, especially given the complex and evolving nature of the securitization markets, the range of participants involved, and the various activities performed by those participants. Accordingly, the Commission proposes to clarify the scope of conflicts of interest that are material and intended to be prohibited under Section 27B and the proposed rule through interpretive guidance rather than through a detailed definition in the proposed rule.
In particular, the Commission noted that it was not aware of any basis in the legislative history of Section 621 to conclude that this provision was expected to alter or curtail the legitimate functioning of the securitization markets, as opposed to targeting and eliminating specific types of improper conduct. Moreover, as a preliminary matter, the Commission believe that certain conflicts of interest are inherent in the securitization process, and accordingly that Section 27B and its proposed rule should be construed in a manner that does not unnecessarily prohibit or restrict the structuring and offering of an ABS.
The Commission expressed its preliminary belief that a formulation of a conflict of interest that is material would directly address those types of activities that Section 27B was intended to prohibit – e.g., situations in which a securitization participant engages in a transaction through which it benefits when the related ABS fails or performs adversely or has the potential to fail or perform adversely and there is a substantial likelihood that a reasonable investor would consider the fact of such benefit important to his or her investment decision.
Comments on the proposed rule are due on December 19, 2011.
In a speech before the American Banker Regulatory Symposium on September 19th, Acting Comptroller of the Currency John Walsh noted that among the issues that will be "front and center for the new Comptroller are mortgage foreclosures and mortgage servicing." Comptroller Walsh emphasized that, the scope of the enforcement actions that the OCC took in April is very broad and comprehensive and the enforcement orders tackle a large number of problems that go beyond “robo-signing" of documents -- they address the entire system of controls that must be in place to ensure that those practices don’t occur in the first place.
He said the orders also raise the bar for the oversight and management of third-party service providers who process loss mitigation applications and foreclosures, and manage acquired properties, including law firms that provide services and counsel for all of these processes.
In addition to changes aimed at ensuring the process works going forward – the “fixing what’s broken” piece, the OCC also had to determine what kind of restitution should be provided for homeowners that were financially harmed due to servicers In the words of Comptroller Walsh, it " is the most ambitious and complex aspect of our enforcement actions – the independent foreclosure review."
The independent review sets out to identify borrowers who suffered financial injury as a result of errors, misrepresentations, or other deficiencies in the foreclosure process. The scope of this review includes any mortgage serviced by these companies on a borrower’s primary residence that was in any stage of foreclosure between January 1, 2009 and December 31, 2010. Comptroller Walsh said the OCC had begun defining an acceptable process even before it issued the enforcement orders in April: independent consultants and law firms to advise them would have to be hired to administer the review under OCC direction; a comprehensive complaint process for borrowers to submit claims was deemed a critical and necessary component of the foreclosure review; and sampling was greatly expanded to help catch foreclosure cases with potential for financial injury.
Homeowners who faced foreclosure of their primary residence will be able to request a review of their case if they believe they suffered financial injury as a result of errors, misrepresentations, or other deficiencies in the foreclosure process between January 1, 2009 and December 31, 2010. Affected borrowers in this timeframe will be contacted through direct mailings and other tracing techniques. The independent consultants will also launch a coordinated advertising campaign to help contact borrowers who cannot be reached through direct mailings or other means. Rather than instituting 14 different servicer processes, which would be a source of confusion for homeowners, the OCC insisted that all of the independent consultants use a single claims processing vendor that will provide common intake forms, a single Web site, and a common phone number for eligible individuals who want a review of their case.
Comptroller Walsh said the OCC expects independent consultants to employ a robust quality assurance process, and OCC examiners will review and assess this process on a continuing basis. If the OCC finds material issues, it will require prompt corrective action. To ensure consistency, the OCC issued guidance on financial injury, and instructed the independent consultants to use it.
Finally, the Comptroller indicated that the OCC enforcement actions require independent consultants to develop a Foreclosure Review Report identifying financial injuries with recommendations for remediation. The OCC will review these reports individually, and also plans to conduct a horizontal review of the reports to ensure there are no material inconsistencies. These reports will be used by servicers to develop and submit the remediation plans required by the OCC orders.