The Federal Reserve Bank of New York (the “FRB-NY”) expanded the number of counterparties eligible to participate with the FRB-NY in reverse repurchase agreements.  The new eligible participants are 26 money market funds (managed by a total of 14 investment managers, including, e.g., Bank of America, BlackRock, Fidelity, Goldman Sachs, Legg Mason, Vanguard and Wells Fargo).  The 26 new money market fund participants will join the existing 18 primary dealers currently eligible to participate in reverse repurchase transactions with the FRB-NY.  The addition of the 26 new potential counterparties is a matter of “prudent advance planning,” said the FRB-NY, and is intended to enable the FRB-NY, when it deems it appropriate, to lower bank reserves and tighten monetary policy.

The FRB issued final guidance relating to the incentive compensation policies and practices of banking organizations under the FRB’s supervision.  The guidance applies to all banking organizations supervised by the FRB, the Office of the Comptroller of the Currency, the Office of the Thrift Supervisors and the Federal Deposit Insurance Corporation (the “Agencies”).

The final guidance contains three key principles that banking organizations should follow to ensure that compensation incentives do not encourage employees to take risks that could jeopardize the safety and soundness of the organization.  These principles are:

• Incentive compensation arrangements at a banking organization should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risk.
• These arrangements should be compatible with effective controls and risk-management.
• These arrangements should be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The final guidance provides banking organizations with considerable flexibility in structuring their incentive compensation arrangements in ways that both promote safety and soundness and that help achieving the arrangement’s other objectives.  It does not impose any pay cap requirement or use a “one size fits all” approach.  It also includes several provisions designed to reduce burdens on smaller banking organizations and other banking organizations that are not significant users of incentive compensation.  Large banking organizations (“LBOs”) are expected to develop and adhere to more systematic and formalized policies, procedures and processes relating to incentive compensation.

The FRB also announced that the Agencies’ special horizon review of incentive compensation at the LBOs is well underway.  The Agencies intend to continue to regularly review incentive compensation arrangements at LBOs through the supervisory process.  The review of incentive compensation at other banking organizations will be part of the regular, risk focused examination process for those organizations.

The Congressional Budget Office (the “CBO”) issued a report entitled The Budgeting Impact and Subsidy Costs of the Federal Reserve’s Actions During the Financial Crisis (the “Report”).  The Report describes the various actions taken by the FRB to stabilize the financial markets during the recent financial crisis and analyzes how these FRB actions are likely to affect the federal budget in the future.  The Report also estimates the “risk-adjusted (or fair value) subsidies that the [FRB] provided to financial institutions through [the FRB’s] emergency programs.”  In summarizing the actions taken by the FRB to stabilize the financial markets during the financial crisis, the Report specifically reviews the FRB’s: (1) expanded lending to depository institutions; (2) creation of new lending facilities for nondepository financial institutions; (3) purchases of mortgage-related securities and medium- and long-term length U.S. treasuries in the open market; and (4) support of financial institutions whose potential failure posed a systemic risk.  The CBO concluded in the Report that the approximately $21 billion of subsidies provided by the FRB to support financial institutions during the financial crisis provided benefits to the financial system that exceeded its costs.  Furthermore, had the FRB not taken these actions, the Report states, the financial crisis would have in all likelihood been more protracted and the broader economy would have been more extensively damaged.

The Federal Reserve Bank of New York (“FRBNY”) released a white paper (the “White Paper”) addressing policy concerns with weaknesses in the infrastructure of the tri-party repurchase agreement (“repo”) market.  The White Paper includes the recommendations of the Tri-Party Repo Infrastructure Reform Task Force (the “Task Force”) created by the Payments Risk Committee, which is a private-sector group of senior U.S. bank officials that is sponsored by the FRBNY.  The White Paper notes three significant policy concerns associated with the design of the tri-party repo market infrastructure: (1) the market’s reliance on large amounts of intraday credit made available to cash borrowers by the clearing banks that provide the operational infrastructure for these transactions, (2) the risk management practices of cash lenders and clearing banks, and (3) a lack of effective plans by market participants for managing the tri-party collateral of a large securities dealer in default without creating potentially destabilizing effects on the broader financial system.  [Read more →]

In a March 15, 2010 letter to the staff of the SEC (the “FINRA Letter”), the FINRA staff agreed to create rules that would, in broad terms, allow its broker-dealer members to act as placement agents in soliciting government entities on behalf of investment advisers provided the placement agents observe prohibitions on “pay-to-play” activities conducted on their own behalf or on behalf of investment advisers employing them (“FINRA Pay to Play Rule”).  The FINRA Letter appears to be an indication that the SEC is considering limiting its proposed pay-to-play rule under the Investment Advisers Act of 1940 (the “Advisers Act”) which would prohibit an investment adviser from paying any third parties (e.g., solicitors, finders, placement agents or pension consultants) to solicit a state or local government entity as an advisory client (the “SEC Pay-to-Play Rule”).

The SEC Pay-to-Play Rule was part of proposed regulations published by the SEC during the summer of 2009, which are designed to address practices that may influence the selection of an investment adviser to manage money on behalf of state and local government entities (e.g., for public pension plans, retirement plans and 529 plans) (as discussed in the August 18, 2009 Alert.)  The FINRA Letter appears to be a response to a December 18, 2009 letter from the SEC staff asking FINRA to consider promulgating the FINRA Pay-to-Play Rule, with the apparent understanding that the final SEC Pay-to-Play Rule would contain an exemption permitting an adviser to retain FINRA members to act as placement agents in soliciting state and local government entities as advisory clients so long as they comply with FINRA Pay-to-Play Rule. [Read more →]

In actions designed to bring borrowing from the FRB’s discount window closer to terms and conditions that prevail in a normal, stable economic environment the FRB announced that it would: (i) increase the primary credit rate at the FRB discount window to 0.75% from 0.50% effective February 19, 2010; (2) reduce the maximum maturity of most discount window loans to overnight (from maturities of 28 days) as of March 18, 2010; and (3) raise the minimum bid rate for the FRB’s Term Auction Facility (“TAF”) from 0.25% to 0.50%.  The FRB also announced that its final TAF auction will be held on March 8, 2010.  Primary credit is short-term funding provided by the FRB on a fully secured basis to depository institutions that are in a “generally sound condition.”  The FRB intends that primary credit be used by borrowing depository institutions as a backup source of funding.

The FRB said that it was able to make these changes to discount window practices because of “continued improvement in financial market conditions.”  The FRB also noted in its announcement that is expects that as a result of these changes, depository institutions will use private funding sources (rather than the discount window) for normal short term credit needs.  Morever, the FRB stated that its changes in discount window rates and maturities are not expected to lead to tighter financial conditions for households and businesses “and do not signal any changes in the FRB’s outlook for the economy or for monetary policy.”

In written testimony to the House Financial Services Committee, FRB Chairman Ben Bernanke outlined the FRB’s exit strategy from the extraordinary lending and monetary policies it established in response to the financial crisis and recession which have caused the FRB’s balance sheet to grow to more than $2.2 trillion.  “As a result of the very large volume of reserves in the banking system, the level of activity and liquidity in the federal funds market has declined considerably, raising the possibility that the federal funds rate could for a time become a less reliable indicator than usual of conditions in short-term money markets,” Chairman Bernanke stated.  Instead, Chairman Bernanke indicated that the FRB is turning to the interest rate paid on reserves – currently at 0.25%   as an alternative short term interest rate.  The FRB was granted the authority to pay interest on reserves in October 2008.  As of February 3, 2010, U.S. banks had more than $1.1 trillion on deposit with the Federal Reserve Banks.  An increase in the interest rate paid on reserves would encourage banks to increase their reserve deposits, which would result in less money in the banking system. [Read more →]

The FRB issued a Notice of Proposed Rulemaking (“NPR”) that would amend the FRB’s Regulation D to establish a program under which the FRB would offer and sell term deposits to eligible depository institutions (“Eligible DIs”).  Under the NPR, term deposits would generally bear maturities of from one month to one year.  The interest rate paid on a term deposit would be set either through an auction process or through application of a formula.  The maximum allowable interest rate set through an auction would not be higher than the general level of short-term interest rates.  Short-term interest rates are defined by the NPR to mean:

“the primary credit rate and rates on obligations with maturities of up to one year in which eligible institutions may invest, such as rates on term federal funds, term repurchase agreements, commercial paper, term Eurodollar deposits and other similar rates.”

The FRB issued the NPR establishing term deposits to help the FRB manage and absorb excess liquidity in the U.S. banking system resulting from the extraordinarily high level of funding provided by the FRB over the past two years to combat the unprecedented economic and financial crisis.  The FRB stated that term deposits would be one of several tools the FRB could use “to drain reserves to support the effective implementation of monetary policy.”

Under the NPR, term deposits would differ from balances held by Eligible DIs in their master accounts at the FRB because the term deposits could not be withdrawn prior to maturity, would not satisfy required FRB reserve balances or contractual clearing balances and would not be available to clear payments or cover daylight or overnight overdrafts.  Term deposits, which the FRB characterized as “roughly analogous” to certificates of deposit issued by depository institutions to their customers, would be eligible for use as collateral at the FRB’s discount window.

Under the NPR, term deposits would be issued by the various federal reserve banks, but one of the federal reserve banks would be selected by the FRB to administer the term deposit program for the federal reserve system as a whole.  Comments to the NPR are due by February 1, 2010.

The FRB terminated the availability of its temporary exemption from the limitations of Section 23A of the Federal Reserve Act that had temporarily allowed all insured depository institutions to provide liquidity to their affiliates for assets generally funded in the tri-party repurchase agreement (“repo”) market.  The FRB instituted the temporary exemption on September 14, 2008 as a response to the financial crisis and to the weakness in the tri-party repo market.  The temporary exemption, which was extended on January 30, 2009 expired on October 30, 2009 and the FRB stated that, “the functioning of the tri-party repo market has improved considerably [since January 2009].”

On October 22, 2009, the FRB issued proposed guidance and announced two initiatives relating to the incentive compensation policies and practices of banking organizations under the FRB’s supervision.  The FRB’s release (1) sets forth a set of principles designed to ensure that banking organizations’ incentive compensation practices do not undermine the safety and soundness of such organizations or encourage excessive risk taking, and (2) announces the following two new FRB supervisory initiatives:

• a special “horizontal review” of the incentive compensation practices at 28 large complex banking organizations (“LCBOs”); and
• a review of incentive compensation practices at smaller regional, community and other banking organizations not classified as LCBOs, as part of a regular risk-focused examination process.

[Read more →]

The FRB released proposed final rules amending the credit card provisions of Regulation Z. The proposal would add several new provisions to Regulation Z to implement those sections of the Credit Card Accountability, Responsibility and Disclosure Act of 2009 that go into effect on February 22, 2010. The FRB also proposes to amend several provisions regarding unfair credit card practices, which were adopted in January 2009 as part of Regulation AA, and to incorporate them into Regulation Z. A summary of some of the major provisions of the proposal follows.

Limits on APRs and Fees. The proposal generally would prohibit the application of increased annual percentage rates and certain fees to existing balances, with several exceptions: (1) when a temporary rate lasting at least six months expires; (2) when the rate is variable; (3) when the minimum payment has not been received within 60 days after the due date; and (4) when the consumer successfully completes or fails to comply with the terms of a workout arrangement. The proposal also would permit the application of an increased APR when the rate has been reduced pursuant to the Servicemembers Civil Relief Act, and the SCRA ceases to apply. Creditors generally also would be prohibited from increasing an APR during the first year after an account is opened. In addition, certain account opening and other fees charged during the first year, other than fees for late payments, returned payments, and exceeding the credit limit, would be limited to 25% of the initial credit limit. After the first year, creditors would be permitted to increase the APR applicable to new transactions upon 45 days’ advance notice. [Read more →]

The FDIC, FRB, OCC and OTS (the “Agencies”) jointly issued proposed guidance (the “Proposed Guidance”) concerning correspondent concentration risks.  The Agencies state that concentration risks can occur in correspondent relationships when a financial institution (“FI”) engages in a significant volume of activities with another FI.  These relationships can result in credit (asset) concentration risks and funding (liability) concentration risks.  The Agencies note that correspondent risks represent a lack of risk diversification, and the Proposed Guidance states that the Agencies generally consider credit exposures of more than 25% of Tier 1 capital as concentrations and funding exposures as low as 5% of an FI’s liabilities as concentrations.  The Proposed Guidance provides that management of FIs should (1) identify an FI’s aggregate credit and funding exposures to other FIs and their respective affiliates; (2) specify what information, ratios or trends will be monitored for each correspondent; (3) set prudent correspondent concentration limits and tolerances for factors being monitored and plan for managing concentrations in excess of those limits; and (4) conduct an independent analysis before entering into any credit or funding transactions with another FI.  The Proposed Guidance would supplement rather than supersede prior regulatory guidance.  Comments on the Proposed Guidance are due no later than October 26, 2009.

The Federal Reserve Bank of Cleveland has issued a policy discussion paper that proposes a set of criteria to identify systemically important financial institutions (“SIFIs”) and recommends the development of a regulatory infrastructure based on the nature and source of their importance.  The paper, entitled “On Systemically Important Financial Institutions and Progressive Systemic Mitigation” (“the SIFI Paper”), states that the regulation of SIFIs is one of the most important regulatory reform issues.  The Obama Administration has proposed legislation regarding the consolidated supervision and regulation of SIFIs.  For more on the Obama Administration’s proposed legislation, please see the July 28, 2009 Alert.  The SIFI Paper asserts that establishing a financial stability supervisor alone will not achieve stability, it is also crucial to deal proactively with systemically important financial institution and have a workable definition of “systemically important.”  The resolution of SIFIs is not discussed in the SIFI Paper, but will be the subject of a forthcoming companion paper. [Read more →]

The FRB and the Treasury have announced the extension of the Term Asset-Backed Securities Loan Facility (the “TALF”).  For more on the TALF, please see the May 5, 2009 Alert.  The FRB and the Treasury approved extending TALF loans against newly issued asset-backed securities and legacy commercial mortgage-backed securities (“CMBS”) through March 31, 2010.  Because new CMBS deals can take a significant amount of time to arrange, the FRB and the Treasury approved TALF lending against newly issued CMBS through June 30, 2010.  The FRB stated that it will continue to monitor financial conditions and will consider in the future whether unusual and exigent circumstances warrant a further extension of the TALF to help promote financial stability and economic growth.  The FRB and the Treasury also announced that they are holding in abeyance any further expansion in the types of collateral eligible for the TALF.

As discussed in the July 28, 2009 Alert, the Obama Administration, through the Treasury, released the text of proposed legislation for various elements of its financial regulatory reform program (the “Program”) that it has submitted to Congress. The proposed legislation provides significant detail concerning many segments of the Program described in the Treasury’s June 2009 White Paper (as discussed in the June 23, 2009 Alert.) Many elements of the proposed legislation concerning the Program were described in the July 28, 2009 Alert, and additional segments are discussed below. There continues to be significant Congressional and industry opposition to certain elements of the Program and some or all of the segments of the Program may not be enacted. The Treasury, however, is reportedly continuing to pursue these initiatives in their current form. The Alert will continue to cover developments related to Treasury’s proposals as well as significant Congressional proposals dealing with financial regulatory reform.

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