Talking Bank Oversight; SEC Market Resiliency Plan Spurs Pitched Battle; House Oversight Tells Fed to Bear Down on Asset Managers
Capitol Account: Free Weekly Edition
The biggest news in financial regulation this week was that the SEC finally set a vote for the long-pending rule that has bedeviled Chair Gary Gensler and turned the agency into a political football — climate disclosure. As we noted, the plan has been scaled back, but the changes are unlikely to head off the inevitable court challenge. The public meeting is on Wednesday. We also took a look at a few more under-the-radar issues, including a market resiliency plan that has sent Wall Street banks into lobbying overdrive and a push by the House Oversight panel to get the Fed to crack down on “woke” asset managers. For our Friday interview, we talked to a former top OCC official about the banking agencies’ packed agenda.
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Friday Q and A: Between responding to last spring’s banking panic, trying to finalize the Basel capital rules and now weighing the blockbuster Capital One-Discover deal, it’s been a jam-packed year for the banking regulators. And those are just the highest profile issues they are grappling with.
One agency leader who’s gotten a lot of attention lately is Michael Hsu, the acting comptroller. He’s given a series of talks that have touched on a variety of knotty topics – mergers, liquidity rules and monitoring the systemic risks posed by hedge funds and private equity. While it’s not exactly clear where the OCC chief is heading, he seems to be enjoying stirring the pot (and confounding more than a few financial firms).
Looking to get more insight about Hsu’s policy push and everything else that is going on, we sat down this week with OCC veteran Julie Williams. Now a senior counsel at WilmerHale, she spent two decades at the OCC as chief counsel and first senior deputy comptroller, serving twice as the acting comptroller. Before joining the law firm, Williams was global head of strategy at Promontory Financial Group. Read on to learn her take on the Basel resistance, the industry’s newfound love of lawsuits and why it’s not always easy to figure out what regulators are actually saying. What follows is our (lightly edited and condensed) conversation.
Capitol Account: We’re coming up on the year anniversary of the regional bank crisis. Has it caused regulators to change any of their focus?
Julie Williams: The spring bank turmoil highlighted an area of risk management that does deserve more attention – liquidity risk management…Since the beginning of this year, both Michael Barr, the vice chair for supervision at the Fed, and also Mike Hsu have given speeches and talked about the need to look more closely…into how the agencies look at liquidity risk management and liquidity adequacy.
CA: What is liquidity? Does it mean that banks need enough money on hand to pay out depositors who are leaving?
JW: Yes, to be able to handle short-term funding needs…There's some specific rules that banks need to manage toward, and they are quite complicated.
CA: What’s the gist of what the banking agencies are looking at?
JW: I call it operationalizing liquidity risk management…It requires thinking about, for example, if you hold a large portfolio of securities and you might need short-term money, how do you translate that portfolio of securities into money that you can use to pay off depositors? There are repo-type transactions that can be constructed. There's borrowing from the Fed discount window, using those securities as collateral.
CA: How is this new focus playing out for banks?
JW: One way is just through the supervisory process...Regulators are asking questions of the banks like: Are you ready to monetize some of your assets if you need them to meet liquidity needs? Do you have arrangements set up with the Fed? Do you have arrangements set up with the Federal Home Loan Banks? Do you have the paperwork in place? And have you tested to see if it works? Mike Hsu recently suggested maybe even a requirement that banks go to the discount window for a little bit [of funding], just to take away the stigma. But also, it's sort of like practice. So you know what you have to do if you really have to do it in exigent circumstances.
CA: Why is it stigmatizing for banks to borrow from the discount window?
JW: It’s a perception that has just grown up over the years. In my experience, it's always sort of been the case that folks thought that was the last chance for getting funding – and therefore that implied something negative about the financial condition of the bank.
CA: Let’s talk about the hottest regulatory issue right now – the Basel endgame. What are your thoughts?
JW: Well, it's incredibly complicated. I'll start with that. I did a presentation in the beginning of January for a banking lawyers group…My piece of the presentation was actually to go back and talk about the history of capital regulation. It was very interesting because it shows – what is that plant that grows on trees and houses down south?
CA: Kudzu. It swallows up trees. You see a parallel?
JW: Yes. Capital requirements have been growing more and more complex, and [there is] more and more trying to tailor capital requirements to particular risks. So not just credit risk, but credit risk of this type of credit…It's just a progression of more detailed capital requirements.
CA: Is this a good way to make banks safer?
JW: When you look back at…some of the changes in the capital rules that occurred post the financial crisis, and ask: `Would any of these really have made any difference in the financial crisis?’ The answer for the most part is no.
CA: So why do regulators keep turning to capital as the solution?
JW: They always have. How do I say this? There are lots of people that have invested a lot of time in becoming experts in the minutia of capital regulation. And they just sort of keep going.
CA: The opposition to this latest effort suggests that large banks may be fed up.
JW: The reaction to the Basel endgame proposals, I have to say, has been quite remarkable. I'm based in Washington, D.C., and every morning I listen to WTOP news. They're running radio ads challenging the Fed regulation every day…(Friday)
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Worth Watching: Gensler’s push to require large brokerages to install the same safeguards that stock exchanges have for preventing trading breakdowns has fallen through the cracks a bit. But on Wall Street trading floors, a frenzy of opposition has been building behind the scenes. Though the SEC plan is designed to capture less than two dozen firms, it hits many of the biggest names in finance. And they contend that the price tag could be staggering — adding an estimated hundreds of millions of dollars to annual compliance costs — while doing very little to boost the resiliency of financial markets.
The advocacy has coalesced in recent weeks, as executives from JPMorgan, Bank of America, Morgan Stanley and Citadel Securities (among others) descended on the SEC for multiple meetings with staff and commissioners, public disclosures show. The Securities Industry and Financial Markets Association is leading the lobbying charge after warning its members late last year that the rule has been elevated on the SEC’s priority list, people familiar with the matter said.
Even some critics concede that, on the surface, extending what’s known as Regulation Systems Compliance and Integrity to more firms sounds like a benign idea. The SEC adopted the rule for exchanges nearly a decade ago following several high-profile mishaps – the 2010 flash crash, glitches that hampered Facebook’s IPO and disruptions caused by Hurricane Sandy. It requires the trading platforms to have backup systems that they routinely test, as protection if their main facilities suffer outages.
When the SEC put the new proposal out last March, Gensler emphasized that the expansion was needed because the biggest brokers “play a significant role” in the markets. “Their resiliency to technological events is too important for the commission not to consider requiring these entities to meet Reg SCI’s requirements,” he said.
Banks and trading firms, however, have pointed out that there is a huge and important difference between how they operate versus the exchanges: if a brokerage’s systems go down, investors can just route their trades to one of its many competitors. But there are a lot fewer exchanges – and if one isn’t functioning it could easily wreak havoc on the entire market.
This distinction has left many firms wondering exactly what problem the SEC is trying to solve. And their discussions with agency officials seem to have provided little clarity.
“The commission has not provided a coherent justification for extending a regulatory regime specifically designed for exchanges to broker-dealers,” Citadel wrote in a comment letter to the SEC earlier this month. “Indeed, the commission has not cited in the proposal a single example of a broker-dealer systems disruption that had a significant market-wide impact, and we have been left to grapple with conflicting feedback from the commission and staff regarding why the proposal is necessary.”…(Thursday)
Woke Investing Wars: Several prominent asset managers have been getting attention for exiting a controversial climate change group. But the industry’s ESG backpedaling isn’t yet resonating with a particularly important group of antagonists – Republican lawmakers.
One case in point: James Comer. Despite the departure of JPMorgan, State Street and Pimco this month from Climate Action 100+, the chairman of the House Oversight and Accountability Committee is still scrutinizing firms’ membership in organizations that push companies to cut carbon emissions.
The Kentucky congressman fired off a letter to the Federal Reserve’s top lawyer asking whether asset managers’ work with groups like Climate Action or the Net Zero Asset Managers Initiative requires them to be regulated like banks. The oversight panel is reviewing “whether the broader asset management industry” may be subject to the Bank Holding Company Act and other laws “as a result of ESG related pledges,” Comer wrote.
The issue, though complex, could have scary consequences for firms like BlackRock, Vanguard and State Street. Under the law, firms that exercise “direct or indirect control” over a lender need to become a bank holding company – a designation that triggers extra oversight, including capital requirements. The biggest asset managers have managed to dodge the question, even when they own a huge amount of stock in a bank, by arguing that they are passive investors. And the Fed has issued letters to BlackRock (in 2020) and Vanguard (in 2019) assuring them that it isn’t a problem if they acquire up to 25 percent of a bank’s voting shares – as long as they follow certain conditions to show they don’t have sway over management or corporate policies.
But in his letter, Comer pointed out that the promises asset managers have made to the pro-environmental groups they’ve joined belie their commitments to be passive owners. “In recent years, several alliances were created to coordinate engagement within the financial services community to compel companies to take action to meet the goals of the Paris Climate agreement and institute other ESG measures,” Comer wrote. “These alliances incorporate varying responsibilities of their members and certainly appear to require concerted actions by their signatories.” That, he added, may “appear to manifest as control of” a bank.
The lawmaker told Mark Van Der Weide, the Fed general counsel, to investigate whether this could be a breach of the agreements that the Fed has in place with BlackRock and Vanguard. “Public pledges they have made to work in concert with other market players to bring about policy changes (which could impact underwriting and investing among other activities) at their portfolio companies raises questions of whether conditions of your determination letter are being violated,” Comer stressed.
He also asked what is being done to ensure that the broader industry is complying with the rules: “It is critical we understand whether asset managers are abiding by the conditions the Federal Reserve has set for them and whether the Federal Reserve and other federal banking regulators are monitoring the asset management industry’s activities.”
The pressure on the Fed comes after Republican FDIC member Jonathan McKernan took up the issue. In a speech last month, he called for the agency to revamp its process for ensuring that asset managers’ stakes in banks don’t amount to control. In particular, he wants regulators to monitor whether funds are honoring their commitments to stay passive…(Tuesday)
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