Yesterday, Senate Banking Committee Chair Sherrod Brown (D-OH) sent letters to four major banks requesting information on their risk management and compliance practices due to recent market turmoil related to family office Archegos Capital Management defaulting on margin calls. The letter asks the banks to provide details around their practices for family offices, including know your customer (KYC) processes, collection of initial and variation margin, credit decisioning, and whether they offer services that are not subject to registration and reporting requirements. It also asks if the banks have made or intend to make any policy changes regarding transactions with family offices going forward. Sen. Brown’s letter follows recent reports that the SEC is conducting a probe into the matter.
Archegos operates as a “family office,” which unlike traditional investment firms is exempt from many requirements, including those defined by the Dodd-Frank Act as well as from SEC and CFTC registration, notwithstanding size or strategy. The SEC had announced that it would review the definition of family offices last month - prior to the market turmoil - and CFTC Commissioner Dan Berkovitz released a statement last week calling upon the agency to strengthen its oversight of family offices.
Family offices were granted exemptions from many regulatory requirements as they were envisioned to be conservative investment vehicles aimed at preserving wealth, but the recent Archegos-related market turmoil highlights that these arrangements can obscure considerable risk. We expect Congress and the regulators to increase their scrutiny of these vehicles to determine whether they are in fact investment firms in family office clothing, potentially by looking at their size and strategy (e.g., whether they are highly leveraged or enter into higher-risk transactions). As family offices are generally exempt from reporting requirements, the SEC may look to enhance trade reporting to allow the regulators to connect the dots to see whether the same customer has large positions across a number of firms. Regulators may also increase scrutiny on dealers considering that significant selloffs due to the failure of a fund with concentration risk could have a material adverse impact on the markets. While some concerns around business conduct and reporting may be partially self-corrected with the implementation of security-based swaps requirements this October, certain aspects will not fully impact family offices and do not consider other high-risk transactions.
It remains to be seen whether Congress and the regulators will take any formal action with respect to family offices or develop new expectations for dealers, and any potential new requirements would inevitably take time to weave through the rulemaking process. In the meantime, dealers should consider reviewing their customer onboarding processes - particularly with regards to family office clients - to ensure that customer risk profiles are in line with their risk tolerance. They should also consider conducting monitoring to determine whether the volume and complexity of customer activity is in line with their risk profiles. It is also imperative for dealers to understand their contractual rights in swap agreements - including the types and quality of collateral that the clients can post, minimum transfer amounts, and margining rights - and consider incorporating protocols that allow for dynamic margining in times of volatility going forward. As time is of the essence during market crises, they should also ensure that they have real-time data availability regarding their collateral to facilitate prompt decision making.
Last week, two sets of documents on operational resilience were issued by regulatory bodies. On March 29, the UK’s Bank of England (BoE), Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) published their Final Policy and Supervisory Statements on Operational Resilience. Two days later, on March 31, the Basel Committee on Banking Supervision (BCBS) published its Principles for Operational Resilience. These publications build on a growing global regulatory emphasis on operational resilience, including in the US where the Fed, FDIC, and OCC published a joint paper last October outlining sound practices to strengthen operational resilience.1
Both of the final BCBS and UK documents are consistent with the tone and content found in their preceding discussion papers, but the UK regulators slightly eased their implementation timeline2 and BCBS clarified the details of some of their principles, including expectations for the accountability of the Board of Directors. The UK statements outline substantive and new expectations for firms and financial market infrastructures firms (FMIs) that operate in the UK, with a one-year implementation period ending in March 2022 followed by a transition period of up to three years ending in March 2025. One of the novel elements of the UK guidance is an expectation for firms to consider not only their internal risk appetite but also the impact on the markets and ultimately the end users of their services when determining the maximum disruption they should tolerate for their important business services. In contrast, the principles and practices outlined by the BCBS and the US agencies continue to anchor tolerance for disruption for a firm’s critical operations primarily to the firms’ own internal risk appetites.
Firms subject to the UK guidance have already been making progress on setting impact tolerances and should be able to move swiftly to meet the slightly-softened implementation timeline. Although the BCBS principles and US sound practices are not prescriptive, firms that operate on a global scale should strongly consider taking an approach that brings together these multiple perspectives. Specifically with regard to the different definitions of important business services and critical operations, firms should look at how these definitions can coexist in a unified framework that allows them to manage operational resilience across territories as consistently as possible. This approach will require greater initial investment, but not understanding and unifying different global nomenclatures at this early stage will result in additional future cost in maintaining multiple process data models as well as the mapping of technology services supporting them. Firms that have started efforts to harmonize their data models to map services, often as part of recovery and resolution planning or business process management efforts, will be in a better position to react to regulatory feedback. With these now-final publications from the BCBS and UK along with continuing focus from US regulators, it is clear that authorities are converging on a unified mindset that resilience needs to improve across the board.
Stay tuned for our First Take on key takeaways and comparisons between the UK, BCBS and US publications.
1For more, see PwC’s First take, Ten key points from the regulatory agencies’ operational resilience paper (November 2020).
2For more, see PwC UK’s Hot Topic, UK authorities finalise operational resilience approach (March 2021).