United States: Analysis Of Banking Agencies’ Rule To Implement Basel III And Dodd-Frank Capital Reforms (Financial Services Alert For July 9, 2013)

Last Updated: July 10 2013
Article by Robert M. Kurucza

Edited by: Eric R. Fischer, Jackson B.R. Galloway and Elizabeth Shea Fries

In This Issue:

  1. Analysis of Banking Agencies' Rule to Implement Basel III and Dodd-Frank Capital Reforms
  2. Employee Benefits Update - DOMA's Demise in Supreme Court's Windsor Decision Affects Employee Benefits
  3. Goodwin Procter Alert – SEC Forecasts an Increase in Whistleblower Cases and Awards
  4. July 10 SEC Meeting Agenda Includes Action on Proposed Rule Changes Implementing JOBS Act Mandate to Remove General Solicitation Prohibition for Rule 506 and Rule 144A Offerings
  5. IOSCO Releases Final Report on Principles for ETF Regulation

Analysis of Banking Agencies' Rule to Implement Basel III and Dodd-Frank Capital Reforms

On July 2, 2013, the FRB approved a 972-page final rule (the "Final Capital Rule"), briefly described in the July 2, 2013 Financial Services Alert, that enhances bank regulatory capital requirements and implements certain elements of the Basel III capital accords ("Basel III") in the U.S. as well as certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). The FRB also issued for public comment a notice of proposed rulemaking (the "Market Risk NPR") that would modify the FRB's market risk rule. The FRB, OCC and FDIC (the "Agencies") had previously issued three joint proposed rules (the "Proposed Capital Rules") regarding enhanced capital requirements and have received thousands of public comment letters on the Proposed Capital Rules. Please see the June 12, 2012 Financial Services Alert for prior coverage of the Proposed Capital Rules. Earlier today, the Agencies issued a notice of proposed rulemaking (the "Supplementary Leverage Ratio NPR") that would increase the supplementary leverage ratio for certain very large banking organizations. In addition, earlier today, the OCC announced that it had approved the Final Capital Rule. Moreover, the FDIC announced that it had approved the Final Capital Rule as an interim final rule. The interim final rule approved by the FDIC is identical to the Final Capital Rule except that it seeks comment on the interaction between the Final Capital Rule and the Supplementary Leverage Ratio NPR. The Final Capital Rule will be jointly issued by the Agencies and published in the Federal Register. Comments to the FDIC regarding the interaction between the Final Capital Rule and the Supplementary Leverage Ratio NPR are due 60 days after its publication in the Federal Register.

The Final Capital Rule makes significant changes to the U.S. bank regulatory capital framework, generally increases capital requirements for banking organizations, and requires banking organizations to increase the level of "high quality" capital they hold, such as common equity and retained earnings. In addition, the Final Capital Rule modifies many of the definitions and elements of bank regulatory capital and significantly revises the risk weightings for banking assets. As part of these changes, the Final Capital Rule requires increased levels of capital to mitigate the types of risks incurred by banking organizations (and in particular larger banking organizations) during the recent financial crisis in connection with securitization transactions and counterparty exposures.

The scope of the Final Capital Rule is broad. It applies to all depository institutions, all top-tier bank holding companies other than bank holding companies that are subject to the FRB's Small Bank Holding Company Policy Statement (generally, those with less than $500 million in consolidated assets) and all top-tier savings and loan holding companies other than savings and loan holding companies substantially engaged in insurance underwriting or commercial activities. In response to the many comments received by the federal banking agencies from community banks, the Final Capital Rule directly addresses concerns about, among other things, trust preferred securities, unrealized gains and losses on available-for-sale securities in accumulated other comprehensive income ("AOCI") and mortgage risk weights.

Banking organizations that are not subject to the advanced approach for risk-weighted assets (which applies to large banking organizations or organizations with large trading portfolios) must begin to be in compliance with the Final Capital Rule by January 1, 2014. The Final Capital Rule, however, grants community banking organizations (and savings and loan holding companies, even if they use advanced approaches) an additional year, until January 1, 2015, to begin compliance with its requirements. Moreover, the Final Capital Rule provides an overlay of transition, phase-in and phase-out periods for specific requirements so that all of the elements of the Final Capital Rule are not expected to be fully implemented until January 1, 2019.

Although the Final Capital Rule, the Market Risk NPR, and the Supplementary Leverage Ratio NPR reflect substantial modifications to the bank regulatory capital framework, the federal banking agencies are expected to issue additional capital-related regulations in the future (all of which will be covered in the Alert) concerning enhanced, short-term wholesale funding, and combined equity and long-term debt.

The balance of this Article provides a discussion in some detail of the major elements of the Final Capital Rule and a brief summary of the changes proposed in the Market Risk NPR and the Supplementary Leverage Ratio NPR.

Read more.

Employee Benefits Update - DOMA's Demise in Supreme Court's Windsor Decision Affects Employee Benefits

Goodwin Procter issued a client alert that examines the implications for retirement, health and other employee benefit plans of the Supreme Court's recent ruling in the Windsor case that struck down Section 3 of the Defense of Marriage Act. The client alert identifies some steps employers should consider taking to ascertain and address the impact the Windsor decision will have on their employee benefit arrangements while awaiting guidance from the relevant federal agencies.

Goodwin Procter Alert – SEC Forecasts an Increase in Whistleblower Cases and Awards

Goodwin Procter issued a client alert that (1) discusses the SEC's announcement of its second-ever Dodd-Frank whistleblower award, (2) reviews public statements by SEC officials and data from the first full year of the SEC's new Dodd-Frank whistleblower program that suggest an upward trend in cases and awards over the next 6 to 12 months, and (3) reviews key benchmarks for companies to consider in ensuring that they have an effective whistleblower program.

July 10 SEC Meeting Agenda Includes Action on Proposed Rule Changes Implementing JOBS Act Mandate to Remove General Solicitation Prohibition for Rule 506 and Rule 144A Offerings

The SEC's proposed agenda for its July 10, 2013 meeting includes final action on proposed amendments to eliminate the general solicitation/advertising prohibitions in Regulation D and Rule 144A under the Securities Act of 1933, as mandated by the Dodd-Frank Act. The proposed amendments were discussed in the September 4, 2012 Financial Services Alert. The agenda also includes consideration of whether to (1) issue a proposal to amend Regulation D, Form D, and Rule 156 under the Securities Act to facilitate SEC monitoring of changes in offering practices under the Rule 506 registration exemption in Regulation D and (2) adopt final rule amendments that would foreclose reliance on the Rule 506 exemption for a securities offering involving certain "bad actors," as mandated by the Dodd- Frank Act. The SEC's proposal relating to "bad actor" disqualification under Rule 506 was discussed in the May 31, 2011 Financial Services Alert. The meeting, which is scheduled for 10 a.m. Washington, DC time, will be webcast here.

IOSCO Releases Final Report on Principles for ETF Regulation

In June 2013 the Board of the International Organization of Securities Commissions (IOSCO) published its Final Report on Principles for the Regulation of Exchange Traded Funds (the "Final Report"), which articulates nine high level principles designed to provide both the industry and regulators with the means to assess across multiple jurisdictions the quality of regulation and industry practices concerning exchange-traded funds (ETFs). The Final Report generally defines ETFs as open-ended collective investment schemes (CIS) that seek to replicate the performance of a target index (but may be actively managed) and trade throughout the day like a stock in the secondary market (i.e., an exchange). The Final Report addresses only ETFs, and its recommendations do not apply to other forms of exchange traded products (ETPs) not organized as CIS, such as exchange-traded commodities (ETCs), exchange-traded notes (ETNs), exchange-traded instruments (ETIs), and exchange-traded vehicles (ETVs).

In a related release, IOSCO noted that numerous consultations among IOSCO's member regulators and repeated engagements with representatives of the global ETF industry have led to the Final Report and, as a result, it reflects a shared consensus within the global regulatory community about an approach to ETF regulation.

The nine principles are set forth below. The Final Report also includes commentary for each set of principles discussing various means of implementation.

Disclosure - differentiation among ETFs, and from other CIS and ETPs

  1. Regulators should encourage disclosure that helps investors to clearly differentiate ETFs from other ETPs.
  2. Regulators should seek to ensure a clear differentiation between ETFs and other CIS as well as appropriate disclosure for index-based ETFs and non index-based ETFs.

Index tracking and portfolio transparency

  1. Regulators should require appropriate disclosure with respect to the manner in which an index-based ETF will track the index it references.
  2. Regulators should consider imposing requirements regarding the transparency of an ETF's portfolio and other appropriate measures in order to provide adequate information concerning:

    • Any index referenced and its composition; and
    • The operation of performance tracking.

Disclosure - costs, expenses and offsets

  1. Regulators should encourage the disclosure of fees and expenses for investing in ETFs in a way that allows investors to make informed decisions about whether they wish to invest in an ETF and thereby accept a particular level of costs.
  2. Regulators should encourage disclosure requirements that would enhance the transparency of information available with respect to the material lending and borrowing of securities (e.g., disclosure on related costs).

Disclosure – strategies and related risks

  1. Regulators should encourage all ETFs, in particular those that use or intend to use more complex investment strategies, to assess the accuracy and completeness of their disclosure, including whether the disclosure is presented in an understandable manner and whether it addresses the nature of risks associated with the ETF's strategies.

Conflicts of interest

  1. Regulators should assess whether the securities laws and applicable rules of securities exchanges within their jurisdiction appropriately address potential conflicts of interests raised by ETFs (e.g., arising out of the involvement of an index provider, authorized participant, or swap counterparty affiliated with an ETF's sponsor).

Managing counterparty risks

  1. Regulators should consider imposing requirements to ensure that ETFs appropriately address risks raised by counterparty exposure and collateral management in the contexts of both physical EFTs (in which the assets tracked by the ETF are owned by the ETF) and synthetic ETFs (in which the performance of the assets tracked by the ETF may be obtained with the use of derivative instruments).

A concluding section of the Final Report briefly addresses several issues that ETFs share with other financial products, such as the role of intermediaries in the marketing and sale of ETFs and the potential for ETFs to affect market stability, and references separate IOSCO recommendations relating to those issues.

Goodwin Procter LLP is one of the nation's leading law firms, with a team of 700 attorneys and offices in Boston, Los Angeles, New York, San Diego, San Francisco and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.

This article, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP or its attorneys. © 2013 Goodwin Procter LLP. All rights reserved.

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