Today, the Fed announced that temporary relief granted last year related to its supplementary leverage ratio (SLR) rule will expire as scheduled on March 31. The relief allows banks with over $250b in total consolidated assets to exclude US Treasury securities and deposits at Federal Reserve Banks from the calculation of the SLR and was intended to encourage them to lend during the pandemic-related crisis rather than increase distributions. The relief was granted as monetary policy, fiscal stimulus and market dynamics during the pandemic led to the growth of Treasury issuance and large deposits made at banks.
The accompanying press release notes that the Fed is ending the temporary relief as the Treasury market has stabilized, but it also acknowledges that the SLR may need to be recalibrated in light of recent growth in the supply of central bank reserves and the issuance of Treasury securities. To that effect, it explains that the Fed will soon seek public comment on potential SLR modifications.
The Fed’s decision not to extend interim SLR relief reflects its confidence in banks’ strength and ability to lend while maintaining sufficient capital reserves, which bodes well for this year’s stress test results. It comes with little surprise given that it was explicitly intended as a temporary measure and the trajectory of the economic recovery continues to be positive, particularly with the recent passage of additional stimulus, the accelerating vaccine rollout, and firms beginning to announce their back to work plans. The announcement that it is reviewing potential adjustments to the SLR should take some of the sting out of the expiration of this temporary relief as it may result in the codification of some long-sought recalibrations. With a high volume of expected fiscal measures related to the stimulus bills and other planned administration actions, the Fed will likely seek changes that would allow banks to manage growth in their balance sheets while continuing to take deposits and make markets in the rapidly growing Treasury market. The Fed will likely carefully consider these dynamics in evaluating how it can ensure that the SLR continues to serve as a backstop rather than a binding constraint in times of stress.
This week saw a number of notable developments related to climate risk and other environmental, social and governance (ESG) issues:
● SEC requests feedback on disclosures. On Monday, SEC Acting Chair Allison Herren Lee requested feedback on how the agency can better facilitate climate-related disclosures. The statement contains 15 questions on potential approaches to enhance climate disclosures, including whether new requirements should be incorporated into existing rules or advanced in a new regulation devoted entirely to climate, whether they should be tailored to the size or risk of individual companies, and the extent to which they should incorporate existing frameworks such as the Task Force on Climate-Related Financial Disclosures (TCFD). It also seeks input regarding how registrants should disclose their internal governance and oversight of climate-related risk, whether disclosures should require certification by a corporate officer, and whether such information should be subject to audit.
On the same day, Acting Chair Lee gave a speech where she explained that the request for feedback is just the beginning of a series of actions to be taken on ESG issues, noting that the agency is considering whether to expand disclosure requirements to areas such as workforce diversity, board diversity and political spending. She also noted that the SEC is looking into potential changes to the shareholder proposal process, including affirming that proposals cannot be excluded if they concern ESG issues as well as revisiting recent amendments that raised the criteria and thresholds for submitting proposals. The agency may also look into changes to the proxy voting process, including revisiting 2019 guidance reminding investment advisers of their responsibilities to vote in their clients’ best interest and to provide clarity on incorporating ESG factors into their decisions as well as finalizing a 2016 proposal that would require parties in a contested election to use universal proxy cards that include the names of all board of director nominees. Acting Chair Lee also indicated that the SEC is considering whether to advance an ESG-specific policies and procedures requirement.
● CFTC announces Climate Risk Unit. On Wednesday, CFTC Acting Chair Rostin Behnam announced the creation of a new Climate Risk Unit (CRU) at the agency. The CRU will focus on climate-related risk and the transition to a low-carbon economy from the standpoint of derivatives including their role in hedging, price discovery, market transparency, and capital allocation. The announcement also notes that the CRU will likely participate in efforts to build consistent standards and taxonomies for ESG disclosures.
● PRI issues US policy briefing. Yesterday, the UN-supported Principles for Responsible Investment (PRI) issued a policy briefing containing suggestions for ESG-related action by US regulators. The briefing largely focuses on actions by the SEC and endorses widespread mandatory ESG disclosures, including through revising Form 10-K to include ESG data and information related to physical and non-physical corporate assets. It also recommends that the SEC require investment advisers to adopt, independently verify and disclose sustainable investment policies that include the consideration of ESG factors as part of their fiduciary obligation. The briefing further advises the SEC to reverse recent changes to the proxy process in order to allow investors to more easily submit shareholder proposals.
Considering previous statements from the Biden Administration and regulators, the writing on the wall has been clear for some time that new disclosure requirements are coming. This week, Acting Chair Lee’s speech and request for comment revealed that these new requirements may be broader than anticipated as she expanded her early focus on climate disclosures to contemplate a wider range of ESG issues. With Gary Gensler, the Administration’s nominee for Chair, recently explaining in his confirmation hearing that he believes diversity disclosures can be material to investors, we may see the SEC taking action on this issue sooner rather than later. With regard to political spending disclosures, the agency is currently barred by the 2021 Appropriations Act from issuing new requirements, and it remains to be seen whether Congress would act to remove this restriction. The speech also requested comment on the potential for a third-party audit of climate and ESG disclosures for the first time. Taken together, these questions may imply that many companies will need to have their climate and other ESG data available on a greatly accelerated timeline. Acting Chair Lee’s sharper focus on asset managers’ proxy voting practices is another new area of scrutiny, and considering the likely bipartisan support for improving the transparency of funds’ ESG disclosures, asset managers should prepare for the possibility of increased regulatory scrutiny over their voting practices and fund disclosures.
On Monday, FINRA proposed a series of amendments to margin rules to clarify their application to extended settlement transactions, including transactions involving a security that has been announced but not yet issued (i.e., when-issued transactions). Under the proposed amendments, contracts that settle beyond T+2 would be classified as “extended settlement transactions,” thereby subjecting them to additional margin requirements. They would also require all extended settlement transactions to be margined as though they were in a margin account, with certain exceptions (e.g., those that meet FINRA’s Covered Agency Transactions definition and certain refunding transactions). Another proposed amendment with significant implications to broker-dealers will allow them to take a capital charge in lieu of collecting margin in all exempt accounts and bona fide Delivery Versus Payment (DVP) customers. The amendments would also clarify the scope of the public offering exception for US Treasury and municipal securities.
The proposed amendments will be open for comment until May 14, 2021.
FINRA’s proposal addresses long-standing issues the industry has had with its margin framework for extended settlement transactions, particularly related to uncertainty around how when-issued transactions fit into the framework as well as what constitutes delayed payment or delivery. By providing explicit standards in the proposal, FINRA is not only offering clarity but also opening the door to discussion and input from stakeholders before issuing a final rule. The ability for broker-dealers to take a capital charge as opposed to collecting margin from DVP customers will also come as a relief as it will alleviate the operational burden stemming from the need to develop infrastructure to collect margin. While this could be interpreted to create an unlevel playing field favoring firms that have more capital to withstand the capital charge, this viewpoint is mitigated by the limitations on the amount of capital charges a member may take in lieu of collecting margin. The message from FINRA is clear that they are listening, and it would be wise for stakeholders to review their margin collection processes to ensure that they are in line with the new proposed requirements and to determine whether to comment.