United States: Dodd-Frank Implementation: Navigating The Road Ahead

Almost two-and-a-half years after the enactment of the Dodd-Frank Act, the various federal agencies charged with implementation have made measurable progress and have, in the last several months, taken on the major regulatory actions in earnest. 2013 accordingly may prove to be a watershed year for financial reform. Before the year gets underway, the industry and the regulators should stop to consider how the implementation of Dodd-Frank has evolved.

As we approach 2013, banking organizations, securities firms, insurance companies, and other participants in the financial services industry should stop to consider how the implementation of the Dodd-Frank Act has unfolded and to plan for new compliance duties that will or are likely to take effect. Regulators likewise would be advised to take a step back themselves and consider how implementation has proceeded. The incoming 113th Congress will certainly debate possible changes to Dodd-Frank, although the prospects for substantive follow-up legislation, corrective or otherwise, are uncertain at best.

This booklet broadly reviews the critical developments under Dodd-Frank that occurred during the second half of 2012 and considers how and what events may occur, as well as what trends may emerge in 2013. This is not an exhaustive review of all of the Dodd-Frank issues, but we have tried to identify those issues with important consequences for the financial services industry.

One set of developments we can be sure about is the finalization of at least some of the major pending regulations. Attached as an appendix is a series of charts that show the degree of progress that the federal financial regulators have made in issuing the hundreds of regulations required by Dodd-Frank. The results are mixed. In quantitative terms, the regulators have finalized a considerable number of regulations, and, although the regulators are behind schedule, they have been productive, considering their resource limitations.

At the more important qualitative level, however, the regulators have yet to complete most of the critical—albeit many of the most complicated—rules, which, when finalized, could require industry restructurings and other significant changes in the way various industry participants do business. Several such proposals are pending and may well be completed in the first half of 2013.

Outlined briefly below are the areas in which we expect significant action by the federal financial regulatory agencies. Readers should keep in mind, however, that economic and political developments outside the confines of Dodd-Frank will affect implementation. Residential mortgage lending is a case in point. Three different pending rulemakings— capital requirements, "qualified residential mortgages," and "qualified mortgages"—are likely to result in onerous limitations on, and additional costs to, the residential mortgage origination business; at the same time, broader issues—the recovery of the housing market, the nature of housing finance, and the roles of Fannie Mae and Freddie Mac— will influence the content of the final rules.

Regulatory activity on Dodd-Frank in 2013 is likely to include the following:

• Financial Stability Reform. Fundamental elements of systemic risk regulation should be completed in 2013. The Federal Reserve Board (the "Board") should finish the enhanced prudential standards that it proposed in December 2011 for U.S. banks with assets of $50 billion or more and nonbank financial institutions that have been designated as systemically important ("nonbank SIFIs"). Comparable standards for foreign banking organizations ("FBOs") were proposed on December 14, 2012; completion of this proposal is likely some months away but should occur before the end of 2013. Additionally, the Financial Stability Oversight Council (the "Council") should designate the first nonbank institutions as systemically important.
• Resolution Planning. Resolution planning, including "living will" submissions, is now well underway. The first wave of living will filings, involving bank holding companies and FBOs with $250 billion or more in assets began in July 2012. Banking organizations with less than $250 billion but $100 billion or more must file on July 1, 2013, and all other banking institutions with assets of more than $50 billion must file by December 31, 2013. In addition, the Federal Deposit Insurance Corporation ("FDIC") has announced its preferred "top-down" strategy for the liquidation of financial institutions whose failure could harm financial stability. Separately, on an international level, the crisis management groups for each of the 29 G-SIBs are expected to complete their own resolution strategies for these institutions in the first half of 2013 and then to assess these plans in the second half of 2013.
• Agencies and Agency Oversight Reform. Leadership changes at the Treasury Department and the Securities and Exchange Commission ("SEC") may affect Dodd-Frank implementation, but in what manner is difficult to predict. If the Administration and Congress take up housing finance reform—by no means a foregone conclusion—then changes to Federal Housing Finance Agency ("FHFA") may follow. Otherwise, all agency changes required by Dodd-Frank, both the creation of new agencies and the abolition of another, have been completed.
• Securitization Reform. The securitization market in the United States continues to suffer as market participants await clarity regarding risk retention requirements, and some insight into the future of the U.S. housing finance system. Although we may have to continue to wait a bit longer for any clarity on the future of the government-sponsored enterprises ("GSEs"), it is likely that the SEC and banking agencies will move toward finalizing risk retention requirements in the early part of 2013. In addition, the SEC remains committed to releasing a Regulation AB II reproposal early in 2013.
• Derivatives Regulation. For 2013, there are several major issues that are likely to garner significant attention as further implementation of Title VII proceeds. Such issues include the finalization of the rules and principles governing Swap Execution Facilities, the progress toward resolving the complex question of how to regulate the cross-border and international swaps market, the expansion of swaps clearing or alternatively the migration of swaps to the futures markets, and the real world efforts of the new regulated swaps entities to implement that vast new Title VII regime given the numerous technological, operational, cost and personnel challenges confronting these entities. An overriding issue that remains is, given the extensive compliance and liquidity burdens of the new regulatory regime, what type of swaps market will emerge and become the new norm?
• Investor Protection Reform. In 2013, we expect the SEC to continue its aggressive enforcement actions through examinations, proactive disclosure efforts and rulemaking focused on investor protection, particularly concerning investment advisers, broker-dealers and investment companies. We expect the SEC to move forward with recommendations from a staff report to consider a uniform fiduciary standard of conduct for investment advisers and broker-dealers when providing investment advice to retail investors about securities.
• Credit Rating Agency Reform. Rating agencies have become subject to numerous regulatory and compliance obligations since the passage of the Dodd-Frank Act; however, questions regarding the issuer-pay business model remain unaddressed. The SEC will be required to finalize a number of the proposed rulemakings related to reliance on ratings in existing regulations.
• Volcker Rule. The federal regulators should complete the Volcker Rule early in 2013—at least according to Federal Reserve Chairman Ben Bernanke. The timing is difficult to handicap, however, particularly given the change in leadership at the SEC, which is said to have had substantive differences with the federal banking agencies over the nature and requirements of the rule.
• Compensation, Corporate Governance, and Disclosure. SEC rulemaking actions on Dodd-Frank's "say-on-pay", compensation committee and adviser independence, and proxy access have been completed, and are now at the implementation stage for affected corporate issuers and self-regulatory organizations. Further regulatory action by the SEC and the banking agencies on executive compensation substance and disclosure requirements, as well as other related corporate governance requirements, is needed but may not be completed in 2013.
• Capital Requirements. We anticipate that, in the first half of 2013, the federal bank regulatory agencies will finalize the three capital proposals that were released in June 2012. Although the agencies had contemplated final capital rules would be in place by January 1, 2013, the delay should not affect compliance efforts dramatically, since the new requirements generally phase in over several years.
• Foreign Bank Regulation. The federal regulators will give the treatment of FBOs under Dodd-Frank increased attention in 2013. The recently proposed enhanced prudential standards for FBOs will be the centerpiece of regulatory action. In addition, the Federal Reserve Board and the FDIC are beginning discussions with the scores of FBOs subject to the resolution planning requirements, which will have to file plans in 2013. Extraterritoriality is a theme that runs throughout Dodd-Frank; finalization of the Volcker Rule, and further guidance from the Commodity Futures Trading Commission ("CFTC"), will be the first test of how far the regulators intend to push Dodd-Frank.
• Consumer Protection Reform. The Consumer Financial Protection Bureau (the "Bureau") will likely issue several final rules dealing with mortgage transactions in early 2013. In addition, in 2013, we anticipate the Bureau will focus on several additional matters, including gift cards and the reporting of mortgage data under the Home Mortgage Disclosure Act. The Bureau may also explore actions dealing with credit reporting and debt collection issues during the coming year.
• Mortgage Origination and Servicing. The Bureau will, we expect, complete at least five of six wide-ranging rulemakings that were proposed in the last half of 2012 and that would give effect to many of the major mortgage reforms in Title XIV of the Dodd-Frank Act. The sixth, which may or may not be finished, involves the integration of Regulation X and Regulatory Y disclosures. Additionally and perhaps most importantly, we expect that, before the end of January 2013, the rule defining "qualified mortgage" will be finalized.
• Specialized Corporate Disclosures. All SEC rulemakings in this area that are required by Dodd-Frank – conflict minerals, mine operators and resource extraction issues – have been completed. The tasks of implementing these new requirements, however, will present significant challenges for corporate issuers. Mine operator reporting requirements already are effective, whereas initial disclosures for conflict minerals will not be required until May 2014; the resource extraction disclosure requirements become effective for fiscal years ending after September 30, 2013.

FINANCIAL STABILITY REFORM

Progress on the regulatory agencies' implementation of the Dodd-Frank Act's financial stability reform requirements (Titles I and VIII) has been irregular and, like much of Dodd-Frank in general, has been caught up in controversy on several fronts.

Enhanced Prudential Standards

The regulatory agencies—primarily the Board—are continuing their work in fleshing out the regulatory and prudential requirements for systemically important U.S. banks and foreign banking organizations. Progress has lagged, however, on the designation of systemically significant nonbank financial institutions.

• With the exception of the rules on capital planning and stress testing, the federal banking agencies' proposed rules on systemic regulation and early remediation of large financial firms under Sections 165 and 166 of the Dodd-Frank Act, announced in December 2011, have not been adopted. However, the Board's recently released proposed enhanced prudential standards for large FBOs are firmly modeled on the December 2011 proposal, which suggests that the Board may be confident about the terms of that proposal and may be prepared to act on it in the near future. In any case, substantial work on building the systemic regulation framework continues:
  
  
  • The banking agencies have continued their efforts in developing and applying stress-testing requirements for large U.S. banks. In October 2012, the Board published final separate but related stress-testing rules under Section 165(i) of the Dodd-Frank Act for the systemically important banks, as well as banking organizations with between $10 billion and $50 billion in consolidated assets.
  • The Board's third annual Comprehensive Capital Analysis and Review (CCAR) program for the 19 largest U.S. bank holding companies, and the Capital Plan Review (CapPR) program for other bank holding companies with $50 billion or more in consolidated assets are underway for 2013.
  • The nine banking organizations with assets of $250 billion or more and located or doing business in the U.S., as well as two other U.S. banking organizations, submitted initial resolution plans, or "living wills," under Section 165(j) of the Dodd-Frank Act. The FDIC and the Board are now reviewing the plans.
  • As discussed in "Capital Requirements" below, the banking agencies have proposed rules to implement the Basel III regulatory capital requirements, including the "advanced approaches" requirements for the largest, internationally active U.S. banking organizations.
  • Thus far, however, the regulators have not finalized the credit exposure reporting requirements (required under Dodd-Frank Act Section 165) that were proposed with the living will requirements. Completion is linked to finalization of the proposed rule on third-party credit exposures of large banking organizations.
  • Enhanced prudential standards for foreign banking organizations—the counterpart to the standards proposed for U.S. banking organizations in 2011—were just proposed by the Board on December 14, 2012. Some but not all FBOs would be required to create intermediate holding companies in the United States for all of their non-branch/ agency activities, and many FBOs would become subject to prudential regulatory requirements akin to those proposed last year for large U.S. bank holding companies. Application of these complex proposed rules varies, depending on the total size of the FBO, its assets within the United States, and the size of the U.S. intermediate holding company (if there is one).

Nonbank SIFIs

• Less, however, has been accomplished in the regulation of systemically important nonbank financial institutions.
• • Although the FSOC had adopted rules setting forth the criteria for the designation of nonbank financial institutions as systemically important, the FSOC (and its constituent regulatory agency representatives) have been unable to come to a conclusion on the designation of specific nonbank financial institutions as systemically important. Among other impediments, there appear to be continuing substantive disagreements among the agencies as to which nonbank financial institutions are truly systemically important. In addition, portions of the financial services community—in particular, the large domestic insurers and investment management firms—have opposed being designated and have been actively making their case(s) before the regulatory agencies on this issue.
  • In November 2012, however, the FSOC exercised for the first time its authority under Dodd-Frank Act Section 120—which allows FSOC, in consultation with the financial regulatory agencies, to designate specific financial institution activities as systemically important and subject them to increased regulation—to propose reforms to money market mutual fund activities. This action was taken in the wake of the SEC's earlier failure to adopt money market mutual fund reform measures, and generally parallels some of the measures the SEC was considering but was unable to agree on.

Resolution Planning and the OLA

Among the basic tools of systemic risk regulation are resolution planning and the FDIC's power to liquidate a bank holding company or a nonbanking company "predominantly engaged" in financial activities if its distress or failure presents systemic risk. The liquidation power is known as the OLA. The FDIC has not had to employ this procedure, but the outlines are coming into view. Some major developments include:

• As described in more detail in "Resolution Planning," the FDIC and the Board have begun to review the resolution plans submitted by the very largest bank holding companies. Results of this review are likely to inform the content of other plans to be filed later in 2013.
• The FDIC proposed but has not yet finalized a definition of "predominantly engaged." The same phrase is used elsewhere in Dodd-Frank. A final rule is likely to be forthcoming only after an interagency consensus has been reached.
• The FDIC has announced its principal strategy of liquidation of a systemically risky institution: it will take over the top-tier holding company, which will wipe out that company's shareholders and likely affect unsecured creditors. Viable operating subsidiaries and their stakeholders should not be affected.
• International coordination will be essential to the success of a liquidation of a large banking organization or nonbank SIFI (see "Resolution Planning" below). The FDIC recently reached agreement with UK authorities on a set of principles for the resolution of large U.S. and UK banks. For each of the 29 globally active, systemically important banking institutions (G-SIBs) in the world, a crisis management group has been formed that includes the regulators of all countries in which a G-SIB is active. Participants in the international Crisis Management Groups ("CMGs") will produce their own resolution plans for all of the G-SIBs in the first half of 2013; whether any portions will be made public is uncertain.

FMUs

Another key element of the Dodd-Frank Act financial stability framework, that which requires the designation of critical financial payments, clearing and settlement providers, as financial market utilities ("FMUs"), has been largely put into place.

• In late July, the Board adopted final rules governing the risk management standards and requirements for payment systems and central securities depositories and central counterparties that are designed as FMUs. Shortly thereafter, the SEC similarly adopted risk management standards for SEC-regulated clearing agencies that are designated as FMUs.
• Also in July, the FSOC designated eight payment systems, depositories and clearinghouses as FMUs.
• The CFTC, however, thus far has not taken final action to adopt enhanced regulatory requirements for derivatives clearing and settlement intermediaries that are designated as FMUs.

U.S. Systemic Risk Regulation in 2013

• Capital planning and stress-testing activities will continue for the larger U.S. banking organizations; the regulatory framework for this process is essentially in place and the task ahead is implementation.
• Presumably, the Board will adopt in final form its proposed systemic regulations for U.S. banking organizations, although there are several controversial aspects of the rule proposals (in particular, the proposed counterparty credit limits for large U.S. banking organizations) that have slowed down the rulemaking process. In addition, finalization of the credit exposure reporting requirements of Dodd-Frank Act Section 165 might also occur at the same time.
• In 2013, the Board may adopt its proposed rules for the regulation of foreign banking organizations in the U.S. (see "Foreign Bank Regulation," below).
• The 100-odd U.S. and foreign banking organizations that are required to submit living wills (those designated as Phase 2 and Phase 3 banking organizations) will be required to submit their resolution plans by July 1 (Group 2) and December 31 (Group 3) of this coming year.
• There will be final action of some sort on regulatory capital requirements (see "Capital Requirements" below), possibly with some accommodation of the concerns of smaller banks on the application of the proposed Standardized Approach model. We expect, however, that the banking agencies will generally stand firm on their prior proposal regarding the components and levels of capital required under Basel III.
• We would also expect at least proposed regulatory action by the Board and other banking agencies to implement the liquidity standards of the Basel III accord. The Basel Committee, however, has not yet finished these standards.
• Final action to designate a limited number of nonbank financial institutions as systemically important must assuredly be in the works; but at this time, how many firms would fall into this category cannot be predicted.
• In our view, action on FSOC's money market fund regulatory initiative more likely than not will result in the issue being "tossed back" to the SEC for further action consistent with FSOC's recommendations, inasmuch as the reforms proposed by FSOC are broadly consistent with what the SEC had previously been considering on its own.

International Systemic Risk Regulation in 2013

The coming year holds the prospect of substantial developments in the regulation of systemic risk outside the United States, particularly in the European Union. The impact of decisions abroad may, however, have only a slight impact on U.S. financial stability regulation in 2013. U.S. banking organizations with substantial foreign operations will, of course, be affected, perhaps in material ways.

• Recent transnational actions, such as the Basel Committee's development of standards for the regulation of global and domestic systemically important banks, as well as its Core Principles for Effective Banking Supervision and its Principles for the Supervision of Financial Conglomerates published this past fall, are broadly consistent with ongoing financial stability regulatory activities in the U.S.
• One possible exception may be the impact of international cross-border resolution initiatives for global banking organizations on parallel U.S. resolution planning activities (see "Resolution Planning" and "Foreign Bank Regulation" below).
• Otherwise, to the extent that international regulatory activities may have an effect on U.S. regulatory actions, that impact most likely will be felt in the area of foreign banking organization regulation, where U.S. regulatory efforts by statute (see, e.g., Dodd-Frank Act Section 173) must take into account international supervisory requirements and activities.

Other Events or Developments in 2013

• As noted above, Dodd-Frank Act Section 120 permits FSOC to designate and regulate specific activities as systemically important. Apart from the money market mutual fund proposal discussed above, there is no immediate indication that FSOC is considering further uses of its Section 120 authority at this time.
• The Board has recently signaled that it is examining the issue of "industrial organization" in the context of systemic risk regulation, and looking at various structural alternatives as a means of limiting systemic (or "too-big-to-fail") risk, including breaking up large financial institutions by reinstating Glass-Steagall restrictions or limiting commercial bank affiliations with certain business lines, capping the nondeposit liabilities of financial institutions, or requiring large financial institutions to hold minimum amounts of long-term debt available for conversion ("bail-in" debt) to equity to avoid or facilitate an orderly resolution of a troubled firm. Of these alternatives, there appears to be a pronounced inclination towards requiring large financial institutions to hold such "bail-in" debt. In this regard, a July 2012 study conducted by FSOC on the feasibility and other aspects of a contingent capital requirement for systemically important financial institutions (required under the Dodd-Frank Act) provides at least some encouragement for this proposition. Hence, a 2013 proposal along the lines of what the Board is considering ought not to come as a complete surprise.
• Even as the elements of the systemic regulation framework take further shape, modifications and adjustments to the framework, either as the regulatory agencies acquire more data and experience or due to external events, should be expected. Systemic regulation can be fairly described as a "work in progress"—the evolution of the Board's capital planning and stress-testing programs from year to year is one notable example of this phenomenon—and the financial services industry should expect and be prepared to adapt to this evolutionary process.

RESOLUTION PLANNING

While much of the systemic risk regulation regime in the United States is forward-looking, two sets of provisions in Dodd-Frank address the back-end—what happens when a SIFI becomes distressed or fails. Section 165(d) requires all SIFIs to submit plans for their "orderly and rapid" resolution in the event of material financial distress or failure. Title II establishes an orderly liquidation authority ("OLA"), a receivership process managed by the FDIC for liquidating a failing or distressed "financial company" in order to avoid systemic risk. Title II includes not only the SIFIs subject to Section 165(d) but also any large financial company that is "predominantly engaged" in financial activities. Subsidiaries of SIFIs and "predominantly engaged" companies are also eligible for Title II liquidation.

Resolution Planning

Rules on resolution planning, or "living wills," went fully into effect by early 2012. Section 165(d) of Dodd-Frank requires all bank holding companies and FBOs with total consolidated assets of $50 billion or more to file resolution plans periodically with the Board and the FDIC that explain how the company can be unwound in a prompt and orderly manner. The statute does not require planning at the bank level, but, as a matter of supervisory discretion, the FDIC promulgated a separate resolution planning rule for banks with total consolidated assets of $50 billion or more. Approximately 130 banking organizations are subject to the rule, of which the large majority are FBOs.

• Planning and the submission of resolution plans are already well underway. The final rules created three groups of bank holding companies for the purpose of submission deadlines: the nine Group 1 institutions, generally those institutions with $250 billion or more in total consolidated assets were required and did file resolution plans on July 2, 2012. Group 2 bank holding companies, those with $100 billion or more in total consolidated assets, (and that are not in Group 1) must file by July 1, 2013. Group 3 organizations, the remaining firms with $50 billion or more in total consolidated assets, must file by December 31, 2013.
• The Board and the FDIC have described the planning process as "iterative," involving ongoing dialogue with the regulators. Banking organizations that have yet to file should be aware that the regulators' discussions with the institutions that have already filed are likely to result in regulatory judgments that will come into play during the review of plans submitted by the first wave of banking organizations. Accordingly, early communication with the two agencies will be critical.
• Institutions that have still to file should also be aware that other regulatory obligations— specifically, stress testing and capital planning— interact with the resolution planning process and will require careful attention.

Resolution Strategy

The effort in the Dodd-Frank Act to end the "too-big-to-fail" phenomenon is reflected in the establishment of the OLA. The OLA is the vehicle by which the FDIC may liquidate a bank holding company or a nonbanking company "predominantly engaged" in financial activities. If the FSOC and the Board make a series of findings on the risks or damage that would result from the failure of such a company, then the FDIC may be appointed as receiver with powers similar to those of a bank receiver. This authority potentially sweeps more broadly than the resolution planning requirement. A bank holding company with less than $50 billion in assets and a nonbank financial company that has not been designated as systemically important nevertheless could be subject to a liquidation through the OLA if their failure would affect financial stability.

The FDIC has not had to employ the OLA but the outlines are coming into view. Some of the major developments include:

• The FDIC proposed but has not yet finalized a definition of "predominantly engaged." The same term is used elsewhere in Dodd-Frank. A final rule is likely to be forthcoming only after an interagency consensus has been reached.
• One element of the FDIC's liquidation authority is the ability to draw on a line of credit from the Treasury Department. In June 2012, the FDIC finalized a rule, jointly with the Treasury Department, that sets a ceiling on such borrowings.
• The FDIC has announced its principal strategy of liquidation: it will take over the top-tier holding company, which will wipe out that company's shareholders and likely affect unsecured creditors. Losses that remain after shareholders' equity in the company has been eliminated will be allocated to unsecured creditors. Debt remaining after the write-down will be exchanged for equity in a newly chartered corporation (a "bridge" company that takes over all of the assets of the liquidated company), as well as subordinated debt. The approach thus causes unsecured debt to become a form of "bail-in" debt. Viable operating subsidiaries and their stakeholders should not be affected.
• The FDIC completed a final rule in October 2012 that permits it to enforce the contracts of an institution in liquidation under the OLA, even if the contract contains an acceleration or similar clause triggered by insolvency or receivership.
• International coordination will be essential to the success of a liquidation of a large banking organization or nonbank SIFI. The FDIC has had active bilateral discussions with the Bank of England and other UK authorities and recently reached agreement with the UK authorities on a set of principles for the resolution of large U.S. and UK banks. For each of the 29 G-SIBs in the world, a CMG has been formed that includes the regulators of all countries in which a G-SIB is active. The CMGs will produce resolution plans for all of the G-SIBs in the first half of 2013; whether any portions will be made public is uncertain at this time.

AGENCIES AND AGENCY OVERSIGHT REFORM

Nearly all of the changes to the federal financial services regulatory framework are in place, but leadership changes at the Treasury Department and the SEC are underway. Other agencies may see structural or organizational changes as well. Some events to anticipate in 2013 include:

• Treasury Department. Secretary Geithner is virtually certain to depart, perhaps following the conclusion of the "fiscal cliff" negotiations, having remained Secretary for at least a year longer than he apparently wanted. The White House has not yet nominated a successor but is likely to do so by early 2013, if not before the end of 2012.
• Bureau. The Bureau has entered into a series of memoranda of understanding and similar cooperation agreements with the federal financial regulatory agencies. Meanwhile, a constitutional challenge to the recess appointment of Richard Cordray as Director of the Bureau remains pending. Several states, including Michigan, Oklahoma, and South Carolina, have joined in this action. On November 20, 2013, the Justice Department, joined by the federal financial regulatory agencies moved to dismiss the complaint.
• SEC. Chairman Mary L. Schapiro stepped down on December 14, 2012. Commissioner Elisse Walter has been appointed Chairman until the expiration of her term at the end of 2013, unless a longer-term Chairman is appointed before then. There have been no reports on the Administration's thinking about the longer-term appointment for the post.
• FHFA. With respect to the agency's leadership, the acting director, Edward DeMarco, continues to run the agency. The Obama Administration did not nominate a permanent director in 2012. This non-decision probably reflects broader uncertainty about housing finance reform, which could result in different duties for the FHFA or even a new agency altogether. In this regard, what 2013 holds is anyone's guess. Housing finance reform was put aside both during consideration of Dodd-Frank in 2010 and in the 2012 election year, and it is not at all clear whether the President or Congress wishes to take up this issue in 2013. The most recent Administration position is a white paper from February 2011 that presents three different reform options without choosing one. The continuing conservatorships of Fannie Mae and Freddie Mac create some pressure for reform, particularly as the two entities may require future Treasury support, but the impetus for reform action in this area may not be enough for reform to actually happen.
• Office of Financial Research. Although technically leader-less, this office has been operating for some time—albeit not at full throttle—and the nomination and confirmation of a director may not be a high priority for the Obama Administration. In 2011, the President nominated Richard Berner to be Director of OFR. The nomination has since been in limbo. Two Senators reportedly have placed a hold on the nomination in order to express their dissatisfaction with the Treasury Department's response to the issues uncovered last summer with respect to LIBOR. Assuming the Senate does not act on the nomination before the 113th Congress convenes, the pending nomination will lapse, and a new nomination (of Mr. Berner or someone else) will be necessary.
• FDIC. Acting Chairman Martin J. Gruenberg became permanent Chairperson on November 15, when the Senate approved his full nomination. Chairman Gruenberg originally was nominated in June 2011, and the Senate confirmed him as Acting Chairperson in March 2012. Thomas Hoenig, formerly President of the Federal Reserve Bank of Kansas City, was confirmed as Vice Chairperson on November 15, 2012, as well.

Although not falling strictly under the realm of agency reform, other provisions of the Dodd-Frank Act found in titles III and VI may be relevant in 2013.

• The unlimited FDIC deposit insurance for non interest-bearing transaction accounts (the Transaction Account Guarantee, or TAG, program) provided under Dodd-Frank Act Section 343 is scheduled to expire on December 31, 2012. Recent industry and Congressional efforts, supported by the Administration, to pass legislation extending the TAG program appear to have failed.
• The "source of strength" requirements under Dodd-Frank Act Section 616(d), which requires bank and savings and loan holding companies, and other companies that control an insured depository institution, to act as sources of financial strength to their subsidiary depository institutions, became effective in July 2011. Regulatory action to implement this provision, however, has not yet been taken, although the agencies have promised to propose an implementing rule.
• The Board expects to propose a rule regarding the revisions to Federal Reserve Act Sections 23A and 23B (pertaining to the treatment of derivatives, securities lending and repurchase agreements in bank transactions with affiliates, and transactions with financial subsidiaries) that became effective on July 21, 2012 under DFA Sections 608 and 609.
• The Board expects to propose a rule to implement the Dodd-Frank Act Section 622 financial sector concentration limit, which prohibits a financial company from making an acquisition if the liabilities of the combined company would exceed 10 percent of the liabilities of all financial companies.

SECURITIZATION REFORM

Although quantitatively most of the Dodd-Frank Act's mandated rulemaking related to securitization has been adopted, the few remaining rules are the most important to the future of the securitization market. We anticipate that during early 2013, action will be taken in connection with the following:

• Conflicts of Interest (Section 621). The SEC issued proposed rules to implement the Dodd- Frank Act prohibition on material conflicts of interest relating to certain securitizations.
• Volcker Rule (Section 619). Among other things, the Volcker Rule prohibits (with certain exceptions) a bank, bank holding company, or any subsidiary or affiliate from investing in or sponsoring funds that are exempt from registration by virtue of sections 3(c)(1) or 3(c) (7) of the Investment Company Act. Although the federal financial regulatory agencies appear to believe that the prohibition should not apply to securitization vehicles established by any banking entity, the proposed rule that would implement this aspect of the Volcker Rule is not clear. The agencies may finalize the regulation early in 2013, but a lack of clarity about securitization vehicles in the final rule could interfere with the securitization market.
• Risk Retention Requirements (Section 941). The most anticipated rulemaking relates to a re-proposal of the risk retention requirements that will be imposed in connection with securitization transactions. Risk retention requirements are subject to certain exclusions, including exclusions for "qualified residential mortgages" ("QRM"), which term is likely to be defined in a manner that is consistent with the definition of "qualified mortgages" ("QM") that is formulated for purposes of the ability-to-pay rule. Action on risk retention requires coordination between the SEC and the banking agencies and, of course, is closely tied to the actions to be taken in connection with the U.S. housing finance market as a whole.
• Disclosure requirements (Section 942). The SEC is expected to adopt rules requiring asset-backed securities issuers to disclose certain information for each tranche or class of security information regarding the underlying assets. Rulemaking in relation to these disclosure requirements closely relates to proposed Regulation AB II (see below).
• Title VII. Various aspects of the derivatives regulations under Title VII of Dodd-Frank impact securitization transactions, including concerns that (1) there is no end-user exception available to securitization vehicles; (2) margin requirements and capital requirements would negatively affect the market; and (3) the commodity pool definition would, given its overly broad nature, include various securitization vehicles.
• Capital Requirements. In June 2012, the three federal banking agencies proposed capital requirements that, among other things, addressed risk weightings for securitization exposures and mortgage loans. Thousands of comments on all aspects of the proposed requirements included concerns that the proposals could negatively affect mortgage loan originations and the mortgage market. By Basel Committee agreement, new capital rules were to take effect beginning on January 1, 2013. The federal banking agencies have acknowledged that they will miss that deadline, but, in order to keep pace with developments in other countries, the agencies may feel the need to issue a final rule in the first half of 2013.
• Regulation AB II. Although not directly related to the Dodd-Frank Act, market participants have been awaiting further SEC action on Regulation AB II, which governs the registration and disclosure requirements for offerings of ABS. It is likely that a re-proposal of Regulation AB II will be coordinated with, or follow along after, the release of guidance regarding risk retention requirements.

DERIVATIVES REGULATION

The new regulation of swaps and derivatives in Title VII arguably constitutes the greatest set of changes to a single sector of the financial services industry made by the Dodd-Frank Act—placing voluminous demands on the rulemaking apparatus of the CFTC and the SEC. The two agencies have continued to forge ahead in recent months with Title VII implementation, including several notable actions in recent months.

• The CFTC and the SEC finalized several key definitions during the last seven months of 2012, including entity definitions, such as swap dealer, security-based swap dealer, major swap participant ("MSP"), major security-based swap participant ("MSBSP"), and eligible contract participant ("ECP"), as well as definitions and interpretations of swaps.
• The CFTC also finalized the end-user clearing exemption, core principles for designated contract markets, a phase-in schedule for mandatory clearing, reporting requirements for pre-enactment and transition swaps, and confirmation, portfolio reconciliation and compression and trading documentation requirements for swap dealers and MSPs.
• The SEC finalized rules establishing procedures for designating security-based swaps for clearing as well as standards for clearing agencies and proposed rules providing for capital, margin and margin segregation for security-based swap dealers and MSBSPs.
• During same seven months, the CFTC issued certain proposals, perhaps the most significant of which related to the cross-border application of its Title VII swap regulatory regime.
• In addition to finalizing many rules, the CFTC made its initial determination of swaps subject to mandatory clearing, designating certain interest rate and credit default swaps for this status, and provisionally registered multiple swap data repositories and derivatives clearing organizations.
• The vast regulatory regime contemplated by Title VII, as so far addressed by the CFTC's final regulations, has created enormous market uncertainty and confusion. As a result, the CFTC has been compelled to issue numerous forms of relief and guidance to the market. The CFTC has done so in two rounds, one round occurred around October 12, 2012, (which among other things, effectively delayed swap dealer and MSP registration until the end of the year) and a second round of no-action letters and interpretive guidance has been issued from late November through at least the first half of December 2012. It is possible that similar guidance or relief will continue to be issued through the remainder of the month.

The Treasury Department also has tasks under Title VII. Somewhat belatedly, Treasury issued a determination exempting certain "plain-vanilla" deliverable foreign exchange forwards and swaps from most of the Title VII regulatory requirements, other than swap data reporting and swap dealer/MSP business conduct requirements.

Still, the CFTC and the SEC have substantial work ahead of them.

• The CFTC has yet to finalize rules on several key regulatory issues, including capital requirements, margin requirements for uncleared swaps, and requirements and principles applicable to swap execution facilities.
• The lack of a finalized and internationally accepted cross-border regulatory framework represents an enormous unfinished piece of work.
• The CFTC has just adopted interim final rules for business conduct and documentation requirements, which became effective upon publication in the Federal Register, but has deferred the compliance dates for certain of these requirements to May 1, 2013 (documentation and business conduct) and July 1, 2013 (documentation).
• Though too numerous to list, the areas of uncertainty and confusion that have received relief (some of which is only temporary) include commodity pool operator ("CPO") and commodity trading advisor ("CTA") status relating to securitization vehicles, equity REITs, mortgage REITs, certain family offices and business development companies; ECP status relating to swaps; interim status of cross-border swap activities; interim relief regarding certain pre-trade and trade recording requirements; interim relief regarding reporting information for certain bespoke or customized trades; deferral of certain start dates for reporting to swap data repositories; and delayed CPO registration deadline for funds of funds. It is anticipated that the CFTC will also provide additional exemptive or no-action relief relating to cross-border swap activities.
• The CFTC has recently proposed significant changes to its rules governing the protection of futures commission merchant and derivatives clearing organization customer funds, which were developed to apply the "lessons" not only of the financial crisis, but also the failures of MF Global Holdings and Peregrine Financial. Preliminary indications are that some aspects of these proposals may be controversial.
• In late September 2012, the U.S. District Court for the District of Columbia vacated the CFTC's final rule relating to position limits on swaps referencing certain physical commodities in a lawsuit brought by ISDA. In November 2012, the CFTC announced its intention to appeal the decision. The decision has prompted speculation over whether further challenges to CFTC regulation may occur. The Investment Company Institute filed suit to challenge certain of the CPO and CTA rules adopted by the CFTC, but the suit was dismissed on December 12, 2012.
• For its part, although the SEC has proposed many of its Title VII rules, it has finalized fewer of these than has the CFTC and looks to be taking a much more deliberative approach to implementing its portion of Title VII. The SEC appears intent on finalizing all relevant rules before mandating registration or clearing. In addition, it has yet to broach the challenging issues of cross-border regulation in which the CFTC is now deeply embroiled.

INVESTOR PROTECTION REFORM

The SEC and the CFTC have continued to move forward on investor protection issues, having recently completed two regulatory actions regarding the rules on performance-based compensation for investment advisers and the narrowing of the exclusion for sponsors of mutual funds from the definition of commodity pool operator. A fiduciary duty standard for broker-dealers remains the metaphorical elephant in the room.

Fiduciary Standard

• In January 2011, as required by Section 913 of the Dodd-Frank Act, the SEC published a study evaluating the standards that apply to providing investment advice and recommendations about securities to retail customers. The study concluded, among other things, that despite extensive regulation of both investment advisers and broker-dealers, retail customers do not understand and are confused by the roles played by investment advisers and broker-dealers, and, more importantly, the standards of care that apply to investment advisers and broker-dealers when providing personalized investment advice and recommendations about securities. The study recommended that the SEC adopt and implement rules, with appropriate guidance, to establish uniform fiduciary standards of conduct for broker-dealers and investment advisers in this area.
• To date, the SEC has taken no further actions to implement a uniform standard of conduct for broker-dealers and investment advisers. In its annual report for fiscal 2012, however, the SEC said that it intended to "move forward" with recommendations from this study, and would continue to assess ways "to better harmonize" the regulatory duties of investment advisers and broker-dealers when they are providing the same or substantially similar services to retail investors.

Performance-based Compensation for Investment Advisers

• Section 205(a)(1) of the Investment Advisers Act generally restricts an investment adviser from charging performance-based compensation. Rule 205-3 under the Investment Advisers Act exempts advisers that charge performance fees to clients that meet a threshold of assets under management or net worth. The Dodd-Frank Act required the SEC to adjust for inflation the dollar amount thresholds in Section 205(a)(1), and to adjust the net worth standard for an "accredited investor" in the rules under the Securities Act of 1933, to exclude the value of a person's primary residence.
• To carry out the required inflation adjustment of the dollar amounts of the thresholds, the SEC increased the assets-under-management threshold to $1 million and the net worth threshold to $2 million, effectively codifying a previous order. In addition, the SEC amended the rule to provide that it will issue an order every five years to adjust for inflation the dollar amount of these thresholds.

Exclusion for Sponsors of Mutual Funds from the Definition of Commodity Pool Operator

• In February 2012, the CFTC amended Rule 4.5 under the Commodity Exchange Act to limit the ability of advisers to registered investment companies that use derivatives from relying on an exclusion from the definition of a CPO. The new rule was designed to be "consistent with the tenor of the provisions of the Dodd-Frank Act" and reflected CFTC concerns that certain registered investment companies were offering interests in de facto commodity pools while claiming exclusion from the definition of a CPO pursuant to Rule 4.5 under the Commodity Exchange Act.
• The CFTC also adopted new Rule 4.27, which requries CPOs and CTAs to report certain information on Forms CPO-PQR and CTA-PR respectively. CPOs that are usually registered with the SEC and are required to file Form PF must generally file Schedule A of Form CPO-PQR only. For CTAs, the CFTC adopted only Schedule A of Form CTA-PR.
• Revised Rule 4.5 reinstates the "5 percent threshold test," which the CFTC had eliminated in 2003. Generally, the 5 percent threshold test requires registered investment companies that hold certain commodity futures, commodity options contracts, or swaps whose aggregate initial margin and premiums exceed 5 percent of the liquidation value of the fund's portfolio to register as CPOs. The new rules distinguish between use of derivatives for risk management and for "bona fide hedging." The new rules count derivatives trades used for the purposes of managing portfolio risk toward the 5 percent limit, but exclude transactions used for bona fide hedging.
• The CFTC also adopted an "alternative net notional test." This test provides that an investment company's aggregate net notional value of the fund's commodity interest positions may not exceed 100 percent of the liquidation value of the fund's portfolio (taking into account unrealized profits). The rule, as published in the Federal Register, appears to require investment companies to satisfy both the 5 percent threshold and the alternative net notional test. The adopting release, however, implies that funds seeking to rely on the exemption can satisfy either the 5 percent threshold test or the alternative net notional test.
• Advisers to investment companies that qualify as CPOs but do not otherwise qualify for an exclusion from the definition of a CPO or another exemption from registration (including the exclusion set forth in amended Rule 4.5) must register with the CFTC.
• The CFTC also rescinded the exemption in Rule 4.13(a)(4) for operators of pools that are offered only to individuals and entities that satisfy the qualified eligible person standard in Rule 4.7 or the accredited investor standard under the SEC's Regulation D.
• The Investment Company Institute and the U.S. Chamber of Commerce filed suit in the U.S. District Court for the District of Columbia challenging the revised Rules 4.5 and 4.27. On December 12, 2012, the court dismissed the complaint.

SEC Financial Literacy Study

• In August 2012, the SEC released a study required by Section 917 of Dodd-Frank on financial literacy. The report concluded that U.S. retail investors lack basic financial literacy, particularly among women, African-Americans, Hispanics, the elderly, and those who are poorly educated.
• The SEC also sought comment on the most effective private and public efforts to educate investors. Based on findings regarding the characteristics of effective investor education programs, the staff set forth goals for improving the financial literacy of investors:
• Developing joint investor education programs that target specific groups;
• Increasing the number of investors who research investments or investment professionals before investing;
• Promoting the SEC's www.investor.gov website as the primary federal government resource for investing information; and
• Promoting awareness of the fees and costs of investing.

CREDIT RATING AGENCY REFORM

There were relatively few developments relating to ratings during the second half of 2012. The SEC has adopted a number of rules relating to rating agencies, including Rules 17g-1 through 17g-7, which generally impose certain compliance requirements on rating agencies. However, many proposed rules have yet to be adopted.

During the last several months of 2012,

• The SEC launched the Office of Credit Ratings, as required by the Dodd-Frank Act, in June 2012.
• In September 2012, the SEC published a study required by Section 939(h)(1) of Dodd-Frank on the feasibility and benefits of standardization of certain elements of ratings. The study concluded that the SEC would not take further action with respect to standardizing credit rating terminology, standardizing stress conditions under which ratings are evaluated, or standardizing ratings terminology across asset classes and instead would focus on finalizing the required rulemakings under the Dodd-Frank Act.
• In November 2012, the SEC published a Summary Report of Commission Staff's Examinations of Each Nationally Recognized Statistical Rating Organization, as required by Section 15E(p)(3)(C) of the Securities Exchange Act.
• The SEC released its Franken Amendment study (Section 939F) just as this booklet went to press. The study assessed the feasibility of alternatives to the issuer-pay model for credit ratings. The SEC recommends a roundtable be convened to discuss the study and its findings, given that this is a complex issue and will require additional consideration and a cost-benefit analysis.
• The federal banking agencies have acted on the prohibition on the use of credit ratings (Section 939A). The bank regulatory capital rules that were proposed in June 2012 eliminated the existing ability of a banking organization to risk weight securitization exposures according to such ratings. In place of ratings, a U.S. banking organization may use a complex formula designed to determine the credit risk of a specific exposure.

In 2013, the SEC is likely to take action in connection with the following:

• Amendments to the remaining SEC rules that reference ratings, such as Regulation M.
• The requirements of Section 932, including the adoption of rules related to reports of internal controls over the ratings process; rules regarding the transparency of ratings performance; rules requiring certain steps to be followed when adopting or revising ratings methodologies; and rules establishing fines and other penalties.
• The requirements of Section 936, which require rules establishing training, experience and competence standards and a testing program for ratings analysts.

VOLCKER RULE

Not surprisingly, the federal banking agencies, the SEC, and the CFTC continue to struggle with the implementation of the Volcker Rule's prohibitions against proprietary trading and private fund sponsorship and investment activities.

• The proposed Volcker Rule regulations, issued over a year ago, have generated literally thousands of adverse comments and widespread criticism from the U.S. banking industry, as well as the foreign banking community and several of their national supervisors. The agencies continue to review and digest these comments. While the agencies have not been very forthcoming in sharing their thinking on the status and direction of the Volcker Rule implementation process, several areas in particular appear to be especially problematic on the implementation front:
• • The scope and limitations of the major proprietary trading exceptions for underwriting, market-making, and risk reduction transactions.
  • The types of private funds to which the Volcker Rule's funds prohibitions will be applied.
  • The applicability of the Volcker Rule to proprietary trading and private fund activities outside the United States, as well as to trading in non-U.S. sovereign debt.
  • The operational complexity and burdens of the compliance management and oversight framework set forth in the proposed Volcker Rule regulations.
• Meanwhile, the July 21, 2012 effective date of the Volcker Rule prohibitions has come and gone. As a result, banking entities are almost six months into the two-year transitional period between the effective date of the Volcker Rule and the July 2014 date when the agencies may begin to enforce the Volcker Rule restrictions. On July 21, 2014, banking entities must be fully compliant with the Volcker Rule, yet they now must begin to develop compliance programs without the benefit of knowing precisely with what standards they must comply. In the meantime, the agencies expect entities to approach compliance "in good faith."
• The banking industry in general has urged the agencies to ease the more prescriptive requirements of the proposed regulations, but the current political climate does not favor a material easing of the Volcker Rule's core prohibitions. Certainly, any Congressional efforts to cut back the Volcker Rule in any significant respect would face a steep uphill battle, even if they were not "dead on arrival," in the Democrat-controlled Senate. Moreover, any regulatory agency appetite that previously existed for a more accommodative rulemaking approach probably has been curbed by the trading and investment "scandals" that came to light in 2012.
• Various financial agency officials have suggested that final action on the proposed Volcker Rule regulations may occur early in 2013, but this timetable is becoming increasingly unlikely, especially as it appears that the banking and securities/commodity regulatory agencies may still not see eye to eye on what the regulations should say. At the present time, however, we do not see the conclusion of the rulemaking process extending beyond the first half of 2013. Any delay beyond that would put banking entities in an almost impossible position in trying to ensure compliance.
• Predicting the final substantive outcome of the Volcker Rule is more difficult, but we expect the final rules to be substantively similar to what has been proposed, albeit with some possible accommodations of a modest nature for certain private fund activities and cross-border trading.

COMPENSATION, CORPORATE GOVERNANCE, AND DISCLOSURE

While Dodd-Frank principally focuses on changes to the financial regulatory system, Titles IX and XV include corporate governance, compensation and disclosure provisions that apply to public companies regardless of industry. The SEC has completed rules on "say-on-pay" and "say-on-frequency," and on listing standards regarding the independence of compensation committee members and compensation advisers. The federal financial agencies have proposed but not completed rules on incentive compensation arrangements at financial institutions. Still to come are proposed rules regarding listing standards with regard to the recoupment of compensation, additional disclosure requirements regarding the relationship of pay and performance, the ratio of the amount of total compensation paid to a median employee to the Chief Executive Officer's total compensation, and policies with respect to employee and director hedging.

Say-on-Pay

• In January 2011, the SEC completed its rulemaking to implement the requirement that companies include a resolution in their proxy statements asking shareholders to approve, in a non-binding, advisory vote, the compensation of their executive officers disclosed in the proxy statement—the "Say-on-Pay" vote.
• A separate resolution is also required to determine whether this Say-on-Pay vote takes place every one, two, or three years—the "Say-on-Frequency" vote.
• The proxy statement must include disclosure regarding: (1) the general effect of such vote; (2) the current frequency of the Say-on-Pay vote; (3) when the next scheduled Say-on-Pay vote will occur; and (4) how the company has considered the results of the most recent shareholder advisory vote on executive compensation.
• If a company solicits shareholders to vote on a merger, acquisition, or similar transaction that would trigger certain golden parachute compensation, then certain additional disclosures are required.
• The Say-on-Pay and Say-on-Frequency votes were required for the first annual or other meeting of shareholders occurring after January 21, 2011, except that "smaller reporting companies" must comply beginning with meetings occurring on or after January 21, 2013, and "emerging growth companies" as that term is defined in the Jumpstart Our Business Startups Act (adopted on April 5, 2012) are not required to comply with these provisions.

Compensation Committee and Advisor Independence

• In June 2012, the SEC finalized rules that direct the national securities exchanges to adopt listing standards regarding the independence of the compensation committee members, as well as the independence of advisers engaged by the compensation committee.
• • The exchanges must adopt listing standards that require: (1) each member of a compensation committee to be an independent member of the board of directors, taking into account specific factors regarding independence; (2) that compensation committees must have the authority to obtain or retain the advice of compensation advisers, must be directly responsible for the appointment, retention, compensation, and oversight of the work of compensation advisers, and must have the appropriate funding for payment of reasonable compensation to the compensation adviser; and (3) that compensation committees consider specific independence factors when retaining a compensation adviser.
  • The SEC adopted rules requiring public companies to disclose the nature of any conflict of interest and how it is being addressed if the work of the compensation consultant raised a conflict of interest.
• The exchanges have submitted proposed listing standards implementing the rules, with final listing standards required by June 27, 2013. The new disclosure regarding compensation consultant conflicts of interest will be required in proxy statements for annual meetings occurring on or after January 1, 2013.

Future Executive Compensation and Corporate Governance Rulemaking

• The SEC must adopt rules requiring disclosure of the relationship of the actual compensation paid to executives versus the company's financial performance, the ratio of median employee total compensation to the CEO's total compensation, and whether employees and directors are permitted to engage in hedging transactions, as well as rules mandating listing standards regarding compensation clawback policies.
• The federal banking agencies proposed rules in early 2011 pertaining to the standards for, and disclosures of, incentive-based compensation arrangements for regulated financial institutions. Final action on these rules might be taken in 2013, but the process could extend beyond that time.
• Broker discretionary voting has been prohibited in connection with executive compensation matters, and the SEC may specify other significant matters for which broker discretionary voting is prohibited.

Proxy Access

• The SEC adopted rules allowing certain shareholders to include director nominees in the company's proxy materials. The U.S. Court of Appeals for the District of Columbia Circuit vacated the SEC's proxy access rule, but rule changes affecting the ability to exclude proxy access shareholder proposals have become effective.

CAPITAL REQUIREMENTS

The development of a regulatory capital framework for U.S. banks continues to pose a challenge to the U.S. bank regulatory agencies. Two of the three June 2012 regulatory capital proposals to implement the Basel III regulatory capital regime—the "Basel III" proposal that specifies the components and levels of Basel III risk-based and leverage capital requirements, and the "Standardized Approach" proposal that incorporates large parts of the Basel II standardized approach for the credit risk-weighting of a banking organization's assets—have generated considerable opposition from the U.S. banking industry.

• This opposition has come primarily from the community banks, which have questioned the need for, and wisdom of, applying large parts of the Basel III framework—in particular the risk-weighing framework of Basel II's standardized approach—to the U.S. banking industry in general, rather than limiting the new Basel capital requirements to large, internationally active banking organizations. U.S. banks have also expressed concerns over possible capital volatility issues that might result from the deductions and adjustments to capital proposed under the Basel III proposal.
• As a result of the controversy generated by the agencies' proposed rules, final action on these proposals has been pushed back to at least early 2013.
• At the international level, regulatory developments on capital standards and requirements that would have a material impact on the U.S capital standards have been slight. The Basel Committee recently concluded a Basel III implementation study of regulatory capital requirements in the U.S., and found the U.S. to be largely compliant, with the exception of U.S. capital requirements for securitization exposures (which under the Dodd-Frank Act cannot be ratings-based, in contrast to the general Basel III requirements) pending the U.S.' adoption of final risk-based and leverage capital regulations that are Basel III-compliant.
• Basel III also requires participating national jurisdictions to adopt liquidity ratios (the liquidity coverage ratio, and the net stable funding ratio) to assure the availability of adequate immediate and short-term liquid assets to satisfy liabilities and funding needs as they come due. The Basel Committee released two liquidity standards in connection with the issuance of the Basel III requirements, but the liquidity measures remain under review. The federal banking agencies have indicated in general that they will adopt the final Basel III standards.
• The outlook for 2013 in the realm of regulatory capital is relatively straightforward at a high level. Almost without question, the federal bank regulatory agencies will adopt final risk-based and leverage capital rules—possibly by the end of the first quarter of 2013—that are at least broadly consistent with Basel III, and in the case of the largest banking organizations, that are more closely consistent with Basel III. The standards will, of course, omit the Basel accord provisions that are ratings-based, inasmuch as ratings-based regulatory requirements are not permitted under Section 939A of the Dodd-Frank Act.
• At a more granular level, however, there is significantly less certainty about how broadly the federal regulatory agencies will apply the Basel III regulatory regime, in particular the elements of the Basel II standardized approach for credit risk-weightings embodied in the Standardized Approach proposal.
• • There are two key questions raised by the Standardized Approach proposal: (1) to how broad a segment of the U.S. banking industry will the bank regulatory agencies apply the Standardized Approach proposal, and (2) what accommodations in the proposed risk-weightings are the regulatory agencies prepared to make in response to banking industry concerns, especially those of smaller banking organizations?
  • Recent public statements by the regulatory agencies do not reveal a great deal about the agencies' current thinking on these matters, other than that they are "carefully" considering the comments on the rule proposals and expect that some changes will be made.
  • The agencies have suggested, however, that they are concerned about "unintended consequences" of the proposed regulations, and the relative complexities of the Standardized Approach proposal—at least from the perspective of community banks—may encourage the agencies to ease or simplify some of the risk-weighting requirements.
• The Basel III proposal that specifies new required levels and components of risk-based and leverage capital, however, has more of the appearance of a proposal that will be adopted in final form without material changes.
• • The banking agencies as a group strongly favor higher regulatory capital requirements composed primarily of common equity Tier 1 capital, and it may be difficult for the agencies to create divergent definitions of regulatory capital for different classes of depository institutions.
  • Moreover, the agencies appear to have concluded that the higher levels of capital in the Basel III proposal would not be a short-term challenge for most of the banking industry, and as a result there may be little regulatory appetite for a substantial easing of those capital requirements.
  • To the extent that there may be changes made in the Basel III proposal, those changes may consist of modifications in some of the exclusions from, and adjustments to, capital (e.g., the proposal to include accumulated other comprehensive income, or AOCI, in regulatory capital calculations).
  • For the larger, systemically important banks, the debate is essentially over. They will be required, beginning in 2013, to transition towards materially higher levels of leverage and risk-based capital as part of the Basel III implementation process, which further down the road will include a capital conservation buffer and a possible countercyclical capital requirement.
• 2013 should see the proposal of liquidity standards for U.S. banking organizations, inasmuch as, under Basel III, these standards will begin to come into effect starting in 2015, and it would behoove the regulatory agencies to allow ample time to develop and finalize these new requirements. That being said, the specifics of these requirements have not been fully established at the international (Basel Committee) level, and that process does need to come to conclusion before U.S. regulators can take material substantive action on these requirements. Again, it will be interesting to see how broadly these proposals may be cast, although there is less of a regulatory policy argument to apply stringent Basel-type liquidity ratio requirements—which are designed primarily to assure that larger, systemically important banking organizations have adequate liquidity to meet their immediate and short-term needs—to community banks.
• Also, as noted in "Financial Stability Reform" above, the topic of contingent ("bail-in") capital may be a topic of discussion—and possible regulatory action—in 2013. The banking agencies, however, do not have a fully formed view on this issue. There is some support for the concept of additional debt-like instruments at the top-tier holding company level that would convert to equity in the event of the company's failure. At the same time, the FDIC's top-down approach to the resolution of a systemically important institution effectively creates "bail-in" capital, and a FDIC white paper released in conjunction with the Bank of England observes that top-tier U.S. bank holding companies already issue large amounts of debt and equity, in contrast to UK institutions that issue these instruments at lower levels.

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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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