## _cr10250 ## Source details **Canonical URL:** [_cr10250](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10250.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10250.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10250.pdf.json) --- ### Summary of Compliance with the Basel Core Principles—ROSC (DAR completed October/November 2009; ROSC summary published May 2010) - The ROSC summarizes the Detailed Assessment Report (DAR) on the U.S. implementation of the Basel Core Principles for Effective Banking Supervision published in May 2010. - Assessment context and methodology: - DAR completed during October/November 2009 as part of an IMF Financial Sector Assessment Program undertaken during October–November 2009 and reflects the regulatory and supervisory framework in place as of the date of completion of the assessment. - Assessment undertaken in the immediate aftermath of a period of extreme market stress and continued general economic downturn. - Assessors examined whether the four Federal banking agencies (FBAs)—the Federal Reserve, the OCC, the OTS, and the FDIC—by themselves provide sufficiently effective supervision to meet the BCPs; where gaps were identified, assessors considered whether state banking agencies’ work would compensate. - Three key weaknesses identified: - (i) a complicated regulatory structure that necessitates a heavy burden of cooperation and coordination between agencies; - (ii) legislative provisions that have hindered and discouraged strong consolidated supervision; - (iii) certain material weaknesses in the oversight of banks’ risk monitoring and risk management practices. - Preconditions and public infrastructure: - Business laws, independent judiciary, well-regulated accounting/auditing/legal professions. - U.S. GAAP established by FASB; audit requirements strengthened by the Sarbanes-Oxley Act (2002). - Market-discipline infrastructure and disclosures: - Major banks disclose considerable quantitative and qualitative information quarterly and annually; FBAs publish bank performance reports and formal enforcement actions. - Payment systems and settlement: - Fedwire (RTGS) and CHIPS; Automated Clearing Houses and card schemes for retail payments. - Remedial powers and deposit insurance: - FBAs have remedial powers up to formal cease and desist orders enforceable by Federal Court injunctions. - Deposit insurance by the FDIC insures deposits at insured banks up to US$250,000 per depositor. The amount was temporarily increased from US$100,000 to US$250,000 until year-end 2013. - Federal Reserve emergency lending authority: - Liquidity assistance to: (i) solvent but illiquid banks; (ii) undercapitalized banks certified by their primary supervisor to be viable; (iii) any individual, partnership, or corporation “in unusual and exigent circumstances” unable to obtain financing from banks. - Main supervisory findings: - Capital framework still on Basel I; advanced approaches of Basel II enacted and will apply to major banks over next 2–3 years. - Shortcomings relative to CP 6: definition of Tier 1 capital for holding companies regarding innovative instruments; absence of capital rules for SLHCs; allowing intangibles to count for a very high portion of a bank or thrift’s Tier 1 capital. - Severe shortcomings in enterprise-wide risk monitoring and management at banks revealed in the crisis (CP 7). - Material weaknesses in market risk monitoring and management, valuation (MTM), and market stress testing at certain major firms. - FBA guidance on liquidity risk management consistent with international standards and likely to evolve with pending interagency liquidity guidance and Basel liquidity standards. - Supervision of operational risk and interest rate risk broadly effective, though operational risk could benefit from greater specialization. - AML: FATF assessment (2006) identified deficiencies relevant to banks that need remediation. - Supervisory methods: - On-site examinations are primary tool; full-scope on-site examinations at least once every year or 18 months. - Substantial continuous supervision program at major banks. - CAMELS-based rating system considered somewhat outdated. - Accounting and disclosure issues: - Alignment of regulatory reporting with U.S. GAAP (particularly allowance for loan losses) criticized for not permitting consideration of future events when estimating loan losses; undermines efficacy of the PCA regime. - Corrective powers and PCA: - PCA regime applies when a bank’s capital falls below prescribed minimum ratios/levels and provides a backstop; tension exists between supervisory assessments and PCA definitions. ### Consolidated supervision — principal findings and recommendations (section 24) - Principal findings: - "The existing legislation for consolidated supervision needs to be strengthened." - "Restrictions, both statutory and practical, on access to information on various parts of a group make it difficult to assess risks from a group-wide perspective." - Some remedial steps: "FBAs have ramped up their consolidated supervision efforts including for the former investment banks that are now BHCs." - A legal regime providing "clear, ready, and direct access, legally supported, for whichever agency is responsible for consolidated supervision is desirable." - Current legislative language permitting supervisors to circumvent restrictions only when there is "a material risk to the bank" is described as "not workable." - Conclusion: "The legislative restrictions need to be repealed." - Information sharing and cross-border cooperation: - "The FBAs have clear authority to share confidential supervisory information with foreign banking and other sector supervisors." - Sharing is conditional: information "must be used for lawful supervisory purposes, and the recipients must keep the information confidential" and not impinge on "U.S. interests". - FBAs provide adequate data to host country supervisors and have ongoing contact with foreign supervisors, including periodic visits. - Relevant CP assessments (selected): - CP 1: authorities "comply" but need "Greater clarity" on mandates where bank and holding company supervisors are different agencies. - CP 6: "important shortcomings exist in the definition of Tier 1 capital for holding companies..., in the absence of capital rules for SLHCs, and in allowing intangibles ... to count for a very high portion of a bank or thrift’s Tier 1 capital." - CP 7: "Severe shortcomings in enterprise-wide risk monitoring and management at banks, were revealed in the recent crisis." - CP 19: "Authorities need to improve their approach to the group-wide oversight of financial groups, including unregulated entities." - CP 24: "Present legislation and practices hinder effective conduct of consolidated supervision of financial groups..." - CP 11 (related numeric limit): "The limit for aggregate lending to a single related party or to a connected group of related parties is set at 15 percent of the bank's own fund plus surplus funds ... The overall limit for lending to all related parties in aggregate is set at 100 percent of own funds plus surplus funds." - Selected recommended actions: - "Consider formally setting out the mandate and objectives of the FBAs in legislation. Ensure core safety and soundness mandates and individual accountability for each FBA are clear. Clarify expectations and accountability for the primary federal bank regulator and the holding company regulator..." - "Strengthen inter-agency coordination of supervisory processes... more integrated supervision planning; more commonality of forward-looking risk rating systems, more sharing of off-site surveillance methodology and results, and more joint reviews." - "Make changes in legislation and practices to ensure effective conduct of consolidated supervision of financial groups." - Introduce regulatory limits and reporting on the consolidated group level for large exposures and related lending, including at the holding company level. - CP 6 recommendation: "Work with the BCBS and domestically to strengthen the definition of what counts as Tier 1/core capital... Revisit ability for banks and thrifts to have a large part of their Tier 1 capital composed of intangibles by capping the percentage allowed at a lower level. Put in place formal capital rules for SLHCs." - CP 7 recommendation: "Conduct regular inter-agency horizontal detailed assessment of all risk monitoring, management and risk governance improvements at major complex banking groups... Include detailed testing of the robustness of improvements." - CP 19 recommendation: "Improve the capacity for group-wide oversight of financial groups, including unregulated entities. Introducing domestic 'supervisory colleges' involving all main regulators (not just the FBAs) of major banking groups may assist..." ### Authorities’ response and acknowledgements (paras. 28–33) - Acknowledgement of limitations: - Report acknowledges many weaknesses are being addressed but assessment could not incorporate or give credit for those actions (para. 28). - Examples: some firms (GSEs and various investment banks) were not subject to FBA oversight before the crisis; their failures were major contributors to the crisis (para. 28). - FBAs have expressed desire to move forward with legislative changes (para. 28). - Supervisory actions and progress: - FBAs are making substantial progress in oversight of risk management, including credit, market, and liquidity risk, and consolidated supervision (para. 29). - Supervisors’ crisis actions are important in judging effectiveness (para. 29). - Statutory and organizational mandates: - Authorities state each FBA has statutory and organizational mandates; agencies have authority to compel improvements in risk management (para. 30). - Assessment of CP 6 and capital standards (para. 31): - U.S. banks held to higher capital standard due to Prompt Corrective Action law and regulation. - "Currently, approximately 96 percent of U.S. banks, representing approximately 99 percent of total bank assets, hold 50 percent or more capital than international minimums." - Prior to the crisis most U.S. banks had Tier 1 capital composed mostly of common equity "80–90 percent or higher." - As a result of the SCAP, the largest U.S. banks now have risk-based ratios of Tier 1 capital and Tier 1 common equity that far exceed Basel minimum capital requirements. - Substantive supervisory actions cited (para. 32): - The SCAP stress assessment on the 19 largest bank holding companies (together hold two-thirds of assets and more than one-half of loans). - Joining international efforts to initiate supervisory colleges for large, globally active U.S. banks. - Directing large banks to improve risk aggregation across legal entities and product lines and requiring improved contingency funding plans. - Targeted leveraged lending reviews, high quality Basel II implementation, interagency guidance on subprime and non-traditional mortgages, and new data gathering (project covering over 60 percent of residential mortgages serviced in the United States). - Authorities’ intended follow-up priorities (para. 33): - Enhance communication and information-sharing among agencies; - Ensure more effective oversight of systemic risks; - Require increased liquidity buffers at systemically important institutions. ### Selected findings on market conduct, securities, and enforcement (IOSCO ROSC excerpts) - Principles for issuers (Principles 14–16): - Extensive initial and ongoing disclosure for most public issuers; limited authority over municipal government issuers. - Enforcement mechanisms: SEC, the exchanges, civil suits by investors. - Collective investment schemes (Principles 17–20): - Operators and marketers of CIS offered to the public are subject to registration requirements; initial eligibility criteria should be more extensive. - Assets valued according to U.S. GAAP and verified by independent auditor at least annually; custodian need not be arm’s length. - Market intermediaries (Principles 21–24): - Minimum entry standards include integrity criteria; capital and internal control requirements apply to futures commission merchants and broker dealers; advisers not subject to capital requirements or operational capacity assessments prior to licensing. - Capital formulae do not address full range of risks (funding, liquidity, reputational, affiliate) in some business models. - Secondary market (Principles 25–30): - Post-trade and pre-trade transparency generally comprehensive, but roughly a quarter of liquidity is not publicly displayed (dark pool ATSs and broker dealer internalization). - SEC concern about a two-tier market for NMS stocks is "justified." - Market surveillance and enforcement: - Market surveillance by exchanges and FINRA is effective; a comprehensive surveillance system for securities trading across exchanges, ATS, and SEC would be beneficial. - Significant shortcomings in the SEC enforcement program noted; a program of change is generating improvements but important elements remain "work in progress." - Funding and resources for CFTC and SEC insufficient for long-term needs; consideration of direct self-funding suggested. - Recommended actions (selected): - Continuous disclosure requirements should apply to all public issuers; SEC should have power to mandate disclosure obligations on municipal government issuers. - Increase resources at regulators for routine examinations of CIS operators; require notice of changes affecting investor rights prior to effective date. - Complete the SEC Enforcement Division and OCIE program implementing the 21 OIG recommendations as a high priority. - Pursue legislative change to secure enhanced CFTC powers over futures exchanges and consider SEC/FINRA registration delegations. ### Enforcement metrics cited by U.S. authorities (fiscal year 2009) - Orders that required disgorgement of ill-gotten gains: approximately US$2.09 billion. - Orders that imposed money penalties: approximately US$345 million, a 35 percent increase over the previous fiscal year. - Filing of 664 cases against 1,787 persons. - SEC distributed approximately US$2.1 billion to harmed investors from disgorgement funds and Fair Funds during fiscal year 2009. ### CCPs, CSDs, and market infrastructure assessments (selected RCCP/RSSS findings) - FICC-GSD (CPSS-IOSCO assessment): - Observes the majority of the CPSS-IOSCO Recommendations for central counterparties (RCCPs) and broadly observes the others. - Key recommended actions (selected): - Consider an additional liquidity buffer for extreme situations where repo arrangements cannot be used. - Minimize FICC-GSD’s exposure and concentration risk vis-à-vis the two clearing banks. - Consider conducting more frequent stress testing than once a month in times of unusual market volatility and disclose stress testing assumptions to participants. - Continue to monitor and mitigate risks from holding assets at only two commercial banks; avoid unsecured investments to the largest extent possible. - Test and review backup sites to critical participants’ backup sites. - Provide FICC-GSD direct access to Fedwire Securities and Fedwire Funds services to settle DVP transactions in central bank money. - SEC should formally require FICC-GSD to perform a self-assessment based on the RCCPs; ensure SEC rules comply with RCCPs; provide legal mandate to the Federal Reserve to oversee FICC-GSD. - Key FICC-GSD statistics (2007–09 as presented): - Number of contracts and transactions cleared (millions): 30.4 34.4 28.7 - Value of contracts and transaction cleared (USD billions): 1,006,100 1,014,500 905,100 - Average daily value of transactions (USD billions): 44 3,6 - Peak value of transactions (USD trillions): 5.9 7.0 5.8 - Total number of clearing members, of which: 103 97 98 - Foreign clearing members: 11 11 13 - Clearing fund (USD millions)1/: 13,701.7 18,896.8 14,141.4 - 1/ Includes the value of cash and securities. - NSCC (CPSS-IOSCO assessment highlights): - NSCC registered as clearing agency with the SEC; provides CCP services for broker-to-broker trades. - Key NSCC statistics (2007–09): - Number of contracts and transactions cleared (millions): 2007: 13,537; 2008: 21,877; 2009: 23,254 - Value of contracts and transaction cleared (USD billions): 2007: 283,200; 2008: 315,100; 2009: 209,690 - Average daily value of transactions (USD billions): 2007: 1,137; 2008: 1,255; 2009: 835 - Peak value of transactions (USD billions): 2007: 2,230; 2008: 3,373; 2009: 1,091 - Total number of clearing members: 2007: 226; 2008: 221; 2009: 206 - Clearing fund (USD millions)1: 2007: 4,866.6; 2008: 6,620.4; 2009: 2,941.0 - 1. Includes the value of cash and securities. - Selected recommended actions: - Align definitions of margins and clearing funds with international standards. - Consider additional liquidity buffer; more frequent stress testing; disclose stress testing assumptions. - Monitor and mitigate concentration at two commercial banks; avoid unsecured investments. - Test and review backup sites with critical participants. - Give NSCC access to central bank accounts and Fedwire Securities Services. - SEC should require NSCC RCCP self-assessments; provide Federal Reserve legal mandate to oversee NSCC. - DTC / DTCC (RSSS assessment highlights): - DTC operates an indirect holding system; DVP Model 2 settlement; does not provide intraday finality for cash transfers. - Key recommended actions (selected): - Explore instructions matching mechanism prior to settlement. - Conduct cost-benefit analysis of introducing a CCP for transactions not cleared by NSCC. - Consider additional net funds settlement batches during the day to provide intraday finality for cash transfers. - Provide DTC access to central bank liquidity facilities; monitor settlement bank concentrations; consider direct participation in Canadian RTGS for Canadian dollar settlement. - Test backup sites to critical participants’ backup sites; improve governance transparency and board selection criteria; establish formal co-operation with Authorities in Peru. - Fedwire Securities Service (FSS) assessment (selected): - Institutional context: Reserve Banks operate FSS through FRBNY Wholesale Product Office; FSS is key interbank settlement system for Fedwire-eligible securities; FSS overseen by Federal Reserve Board; SEC and Treasury provide market perspectives. - Key FSS statistics (2007–09): - Turnover (USD trillions): 435.6 (2007), 419.3 (2008), 295.7 (2009) - Instructions processed (millions, total for the year): 24.2 (2007), 25.0 (2008), 21.1 (2009) - Average daily value of transfers (USD trillions): 1.73 (2007), 1.66 (2008), 1.17 (2009) - Peak daily value of securities settled (USD trillions): 2.60 (2007), 2.81 (2008), 2.55 (2009) - Total value of securities held (USD trillions): 43.18 (2007), 47.27 (2008), 52.58 (2009) - Treasury securities: 4.54 (2007), 5.80 (2008), 7.27 (2009) - Securities issues by federal agencies: 2.78 (2007), 3.12 (2008), 3.82 (2009) - Securities issued by GSE: 35.81 (2007), 38.28 (2008), 40.41 (2009) - Number of participants: 7,500 (2007), 6,700 (2008), 6,300 (2009) - Number of active participants: 2,645 (2007), 2,558 (2008), 2,566 (2009) - Selected recommended actions: - Explore introducing an instructions matching mechanism prior to settlement. - MBS should be settled no later than T+3. - Continue to monitor residual risks from uncollateralized intraday credit and assess collateralization options; implement explicit collateralization policy in late 2010 or early 2011. - Include representatives of smaller and midsize participants in WPO advisory group. - Provide Federal Reserve legal authority to open accounts and provide services for other payment, clearing and settlement infrastructures; reassess FSS operating hours. - Consider monitoring indirect cross-border links where major custodians are involved. ### Insurance sector assessment — key findings and recommended actions (selected) - Overall findings: - "Insurance regulation in the United States is generally thorough and effective, although there are areas where development is needed." - Preconditions generally met; need development in framework relating to insurance and financial stability and international issues. - Need reform of laws governing state insurance departments (appointment/dismissal of commissioners, budgetary framework, remuneration) to secure independence. - NAIC data collection and analysis capabilities are "world-leading" but absence of complete group-wide consolidated data hinders supervisors. - Examinations generally thorough; approach to supervision of groups needs significant development. - Sector statistics (end-2008 / 2008 figures): - Number of licensed insurance companies at end-2008: 7,948. - Total premium volume in 2008: US$1.24 trillion (29 percent of the global market). - Insurance density (premiums per capita) in 2008: US$4,078, ranking ninth. - Insurance penetration in 2008: 8.7 percent of GDP, ranking thirteenth. - Three main sectors: life, property and casualty, and health insurance. - Sector performance through the crisis: - Capital and surplus fell by 6.7 percent in life and 8.5 percent in property and casualty between end-2007 and mid-2009. - Companies at regulatory intervention levels under RBC accounted for only 3 percent of the total in 2008. - Selected recommended actions (mapped to ICPs): - ICP 1: Increase information-sharing and coordination between state regulators and federal authorities; agree policies for systemically important institutions. - ICP 3: Reform commissioner appointments to provide fixed terms, permit mid-term dismissal only for prescribed causes, and make departments fully self-funding. - ICP 11/12: Collect more complete group-wide consolidated data for insurance groups and broader financial conglomerates; introduce formal reporting. - ICP 15: Change laws to provide supervisors power to fine individual directors and senior managers and to bar them from acting in responsible capacities in the future. - ICP 17: Include fuller assessment of the financial condition of the whole group and ensure colleges of supervisors for U.S.-based international groups are established. - ICP 18: Require insurers to have comprehensive risk management policies and systems. - ICP 23: Consider specifying a target safety level for reserving and an associated target safety level for capital. - ICP 28: Set a timetable for agreement and implementation of new arrangements between state insurance departments and federal authorities for AML/CFT examination cooperation. *Source: Excerpts from the IMF Financial Sector Assessment Program — United States of America (ROSC/DAR excerpts and related assessment text provided in the content unit).* ### 1. Summary of Compliance with the Basel Core Principles—ROSC .....................................11 ### 1. Summary of Compliance with the Basel Core Principles—ROSC ### Summary, introduction, and methodology - The ROSC summarizes the Detailed Assessment Report (DAR) on the U.S. implementation of the Basel Core Principles for Effective Banking Supervision published in May 2010. - The DAR was completed during October/November 2009 as part of an IMF Financial Sector Assessment Program undertaken during October–November 2009 and reflects the regulatory and supervisory framework in place as of the date of completion of the assessment. - The assessment was undertaken in the immediate aftermath of a period of extreme market stress and continued general economic downturn. The assessment is not intended to assess the merits of reforms being proposed and adopted within the United States. - Three key weaknesses identified: - (i) a complicated regulatory structure that necessitates a heavy burden of cooperation and coordination between agencies; - (ii) legislative provisions that have hindered and discouraged strong consolidated supervision; - (iii) certain material weaknesses in the oversight of banks’ risk monitoring and risk management practices. - The assessment team held extensive discussions with staff from the main supervisory agencies and industry representatives, worked with a comprehensive self-assessment completed by the U.S. agencies, and received required information. - The assessors’ approach examined whether the four Federal banking agencies (FBAs)—the Federal Reserve, the OCC, the OTS, and the FDIC—by themselves provide sufficiently effective supervision to meet the BCPs. Where gaps or shortcomings in the FBAs’ operations relative to the BCPs were identified, the assessors considered whether state banking agencies’ work would be sufficient to compensate. ### Institutional and market structure—overview - At end-2007, total U.S. financial assets amounted to almost four and a half times the size of GDP; less than a quarter of total financial assets were accounted for by traditional depository institutions. - The crisis radically changed the U.S. financial system: top investment banks reconfigured as bank holding companies, nonbanks severely weakened, housing GSEs in government conservatorship, and private securitization largely dormant. ### Preconditions for effective banking supervision - Public infrastructure supporting effective banking supervision in the U.S. is well-developed: - Business laws (contract, bankruptcy, property) are well-developed and reliable; contract law by common law and state statute; property rights protected under the Bill of Rights and state laws. - An independent judiciary and well-regulated accounting, auditing, and legal professions. - U.S. GAAP established by the Financial Accounting Standards Board (FASB) and widely accepted; financial statement audit requirements strengthened by the Sarbanes-Oxley Act (2002). - Market-discipline infrastructure: - Well-developed continuous disclosure obligations by public companies; extensive disclosure obligations for certain other investments; active rating agencies and analyst community. - Major banks disclose considerable quantitative and qualitative information quarterly and annually; FBAs regularly publish bank performance reports and formal enforcement actions are routinely made public. - Payment systems: - Systemic wholesale payment systems settle in central bank money: Fedwire (RTGS) and CHIPS (private sector net and gross real time settlement). - Retail payments use Automated Clearing Houses, regional/interregional check exchanges, and card payment schemes. - Remedial powers and deposit insurance: - FBAs have a broad range of remedial powers up to formal cease and desist orders enforceable by Federal Court injunctions. - Deposit insurance by the FDIC insures deposits at insured banks up to US$250,000 per depositor. The amount was temporarily increased from US$100,000 to US$250,000 until year-end 2013. - Deposit Insurance Fund may be used, on a least-cost basis, to compensate depositors or facilitate resolution (typically purchase-and-assumption). - Federal Reserve emergency lending: - Fed authority includes liquidity assistance to: (i) solvent but illiquid banks; (ii) undercapitalized banks certified by their primary supervisor to be viable; (iii) any individual, partnership, or corporation “in unusual and exigent circumstances” unable to obtain financing from banks. - Fed used this authority in the current crisis to support financial institutions and non-financial entities (e.g., commercial paper market). - FDI Act and resolution: - FDI Act provides a comprehensive scheme for resolution of an insolvent bank; deposits of state and federally chartered banks conducting retail deposit taking are insured by the FDIC. - The FDI Act provides a comprehensive definition of insolvency (balance sheet test, liquidity test, various tests of viability) and authorizes placing a bank in receivership before capital exhausted. As Receiver, the FDIC has a broad array of tools for resolution. ### Main findings Objectives, independence, powers, transparency, and cooperation (CP 1) - The multiplicity of agencies can impede effective supervision: - Multiple supervisory/regulatory agencies can lead to overlap diluting accountability, unproductive rivalry, lessened focus on safety and soundness, material coordination costs, and undue compliance costs for banks. - The system carries a heavy burden of ensuring cooperation and coordination between agencies to avoid overlap and gaps. - There is a general absence of detailed, clearly stated objectives and mandates for each agency in original governing statutes. - FBAs exhibit strong tradition of authority and accountability vested in bank- and holding-company-level supervisors; crisis revealed need to better integrate institution-specific information with system-wide perspectives. - Improvement plans need to be inter-agency, requiring strong governance. Licensing and structure (CPs 2–5) - Banks have an unusual degree of choice over their regulator due to dual banking structure (state and Federal charters) and multiple federal regulators. - Existence of an “implicit threat” of conversion between charters/supervisors. - Stated minimum capital of US$2 million for new banks is relatively low; in practice higher capital required for de-novo banks. Prudential regulation and requirements (CPs 6–18) - Capital framework: - U.S. system still on Basel I risk-based capital framework; advanced approaches of Basel II enacted and will apply to major banks over next 2–3 years. - U.S. Basel I framework includes additional features (e.g., securitization approach) and minimum leverage ratio requirements. - Shortcomings relative to CP 6 include: definition of Tier 1 capital for holding companies regarding innovative instruments; absence of capital rules for SLHCs; allowing intangibles to count for a very high portion of a bank or thrift’s Tier 1 capital. - Risk management and supervision: - Severe shortcomings in bank risk management revealed in recent crisis; supervisory oversight did not effectively identify and remedy those weaknesses. - Shortcomings were sufficiently large to create serious problems for individual banks and the financial system; many shortcomings not unique to the United States. - Weaknesses resulted partly from confluence of credit (including counterparty credit), market, and liquidity risk under extreme conditions. - Broad, shared understanding of needed improvements and strategy to achieve them; monitoring processes for progress in place. - Specific supervisory strengths and weaknesses: - FBAs have well-developed policies and processes for traditional credit risk, but these were not fully effective for certain markets and products in the turmoil. - Material weaknesses in market risk monitoring and management: suitability of market risk measurement and monitoring processes and models at certain major firms; lack of reliable and prudent valuation of mark-to-market (MTM) positions; incompleteness and use of market stress testing. - FBA guidance on liquidity risk management and supervision consistent with existing international standards and likely to evolve due to pending interagency liquidity guidance and Basel liquidity standards. - Supervision of operational risk appears effective overall, though greater focus/specialization might be beneficial. - Supervision of interest rate risk is broadly consistent across FBAs in most material respects. - Anti–money laundering (AML): - Banks maintain comprehensive programs to reduce operational abuse risk, including physical safety. The FATF assessment (2006) identified deficiencies relevant to banks that need remediation. Methods of ongoing banking supervision (CPs 19–21) - Legal authority and supervisory tools: - FBAs collectively have broad, but not unlimited, legal authority to regulate and supervise banks and holding companies subject to their jurisdiction. - FBAs use authority for on-site reviews and off-site analyses to understand banks’ and holding companies’ risk profiles. - Primary tool is the on-site examination; FBAs conduct full-scope on-site examinations at least once every year or 18 months. - Substantial continuous supervision program exists at major banks. - Mechanisms constrained when an agency is not supervisor of the entire group or parts of the group are under another functional regulator. - Consistency and supervisory techniques: - Each FBA employs standard supervisory techniques broadly consistently; agencies provide supervisory staff with extensive manuals, guidance, and assessment mechanisms embedded in practices. - Opportunities exist to improve consistency between agencies’ operating processes and to develop a “best of breed” model for supervision. - The CAMELS-based rating system used by U.S. supervisors is somewhat outdated compared to those used by overseas peers. Accounting and disclosure (CP 22) - Extensive disclosure by regulated banks and holding companies founded on U.S. GAAP. - Alignment of regulatory reporting with U.S. GAAP (particularly allowance for loan losses) criticized for not permitting consideration of future events when estimating loan losses. - The current framework undermines efficacy of the PCA regime because regulatory intervention thresholds are aligned to U.S. GAAP reporting. Corrective and remedial powers of supervisors (CP 23) - Supervisory options and penalties: - FBAs have a range of supervisory options when entities do not comply with laws/regulations or engage in unsafe and unsound practices; options include prompt remedial action and penalties. - Remedial penalties and sanctions may be applied to banks, holding companies, management, board members, employees, controlling shareholders, other participants in a bank’s affairs, and independent contractors (attorneys, appraisers, accountants). - Prompt Corrective Action (PCA) regime: - A PCA regime applies when a bank’s capital falls below prescribed minimum ratios/levels and provides a backstop against regulatory forbearance. - Agencies can intervene before minimum capital ratios are breached. - Tension exists where supervisors, while adhering to regulations, may assess a bank as capital deficient and require capital infusion while the bank could be defined as “well capitalized” under PCA definitions. - Dichotomy arises from inconsistency between U.S. GAAP-based PCA regime and supervisory risk assessment systems and could weaken credibility of enforcement actions. *Source: Summary of the Detailed Assessment Report on U.S. compliance with the Basel Core Principles (DAR completed October/November 2009; ROSC summary published May 2010).* ### 24. The existing legislation for consolidated supervision needs to be strengthened. ### _cr10250 - 24. The existing legislation for consolidated supervision needs to be strengthened. ### Consolidated supervision: principal findings - "The existing legislation for consolidated supervision needs to be strengthened." - "Restrictions, both statutory and practical, on access to information on various parts of a group make it difficult to assess risks from a group-wide perspective." - Some remedial steps have been taken: "FBAs have ramped up their consolidated supervision efforts including for the former investment banks that are now BHCs." - A legal regime providing "clear, ready, and direct access, legally supported, for whichever agency is responsible for consolidated supervision is desirable." - Current legislative language permitting supervisors to circumvent restrictions only when there is "a material risk to the bank" is described as "not workable." - Conclusion: "The legislative restrictions need to be repealed." ### Information sharing and cross-border cooperation - "The FBAs have clear authority to share confidential supervisory information with foreign banking and other sector supervisors." - Such sharing "facilitates global consolidated supervision and implementation of the underlying home-host relationship framework," but is subject to the limitation of not impinging on "U.S. interests". - Conditions on shared information: "The information must be used for lawful supervisory purposes, and the recipients must keep the information confidential." - Operational practice: "FBAs provide adequate data and information to host country supervisors about U.S. banks and holding companies, to enable the host country to supervise the overseas operations of the U.S. banks." - Ongoing engagement: "The FBAs have ongoing contact with supervisors in other countries in which U.S. banks or holding companies have material operations, including periodic visits to discuss supervisory issues." ### Basel Core Principles—selected assessments relevant to consolidated/group supervision - From Table 1, CP 1 (Objectives, independence, powers, transparency, and cooperation): authorities "comply" with subcomponents but need "Greater clarity" on mandates where bank and holding company supervisors are different agencies. - CP 6 (Capital adequacy): "important shortcomings exist in the definition of Tier 1 capital for holding companies with regard to innovative instruments, in the absence of capital rules for SLHCs, and in allowing intangibles (especially mortgage servicing rights) to count for a very high portion of a bank or thrift’s Tier 1 capital." - CP 7 (Risk management process): "Severe shortcomings in enterprise-wide risk monitoring and management at banks, were revealed in the recent crisis." - CP 19 (Supervisory approach): "Authorities need to improve their approach to the group-wide oversight of financial groups, including unregulated entities." - CP 24 (Consolidated supervision): "Present legislation and practices hinder effective conduct of consolidated supervision of financial groups although supervisors work around this by changing their interpretation of the GLB Act." Additional issues: "gaps in regulatory limits and reporting of large exposures, related lending, and capital on a consolidated basis at the holding company level." "De facto practices of applying and monitoring large exposure and related lending limits should be expressly mandated." "Lacking a fixed rule, SLHC capital is supervised on a case-by-case basis." - Specific numeric limits noted under CP 11 (Exposure to related parties): "The limit for aggregate lending to a single related party or to a connected group of related parties is set at 15 percent of the bank's own fund plus surplus funds (i.e., excess provisions for loan losses) ... The overall limit for lending to all related parties in aggregate is set at 100 percent of own funds plus surplus funds." ### Recommended action plan—selected recommendations related to consolidated/group supervision - "Consider formally setting out the mandate and objectives of the FBAs in legislation. Ensure core safety and soundness mandates and individual accountability for each FBA are clear. Clarify expectations and accountability for the primary federal bank regulator and the holding company regulator..." - "Strengthen inter-agency coordination of supervisory processes, pursue opportunities for: more integrated supervision planning; more commonality of forward-looking risk rating systems, more sharing of off-site surveillance methodology and results, and more joint reviews." - "Make changes in legislation and practices to ensure effective conduct of consolidated supervision of financial groups." - "Also, regulatory limits and reporting of adherence to those should be introduced on the consolidated group level, including at the holding company level, for large exposures, and related lending." - CP 6 related recommendation: "Work with the BCBS and domestically to strengthen the definition of what counts as Tier 1/core capital especially for holding companies. Revisit ability for banks and thrifts to have a large part of their Tier 1 capital composed of intangibles by capping the percentage allowed at a lower level. Put in place formal capital rules for SLHCs." - CP 7 related recommendation: "Conduct regular inter-agency horizontal detailed assessment of all risk monitoring, management and risk governance improvements at major complex banking groups. Include detailed testing of the robustness of improvements. Include all large complex banking organizations in these regular assessments." - CP 19 related recommendation: "Improve the capacity for group-wide oversight of financial groups, including unregulated entities. Introducing domestic 'supervisory colleges' involving all main regulators (not just the FBAs) of major banking groups may assist..." ### Contextual and procedural notes from authorities’ response - The U.S. authorities "strongly support the Financial Sector Assessment Program" and note the assessment comes "in the wake of a severe financial crisis and economic downturn." - The assessment applies the Core Principles updated in 2006 and "places a greater emphasis on risk management." - Authorities observe that "the IMF’s assessment of the U.S. system is that it is broadly in compliance with the Core Principles" while acknowledging the "few areas that are identified for improvement." *Source: _cr10250 - 24. The existing legislation for consolidated supervision needs to be strengthened.* ### 28. The Report acknowledges that, while many of the identified weaknesses are being ### _cr10250 - 28. The Report acknowledges that, while many of the identified weaknesses are being ### Acknowledgement of limitations of the assessment - The Report acknowledges that, while many of the identified weaknesses are being addressed by the U.S. federal banking agencies and by legislative reforms, it was not possible for the assessment to incorporate, or give credit for, these actions or reforms. (para. 28) - Examples cited: - A number of firms that experienced major problems (i.e., the government sponsored enterprises and various investment banks before they became BHCs) were not subject to oversight by any of the federal banking agencies and failures in risk management at these companies were a major contributor to the financial crisis. (para. 28) - U.S. federal banking agencies have expressed their desire to move forward expeditiously with legislative changes to address identified concerns. (para. 28) ### Supervisory actions and oversight progress - The U.S. federal banking agencies are making substantial progress in oversight of risk management practices, including initiatives related to credit, market, and liquidity risk, and consolidated supervision recognized in the Report. (para. 29) - The Report notes that supervisors’ actions taken as the magnitude of the crisis became clear, and actions continued since the crisis, are at least as important in judging supervisors’ effectiveness as assumptions about oversight based on supervised institutions’ risk management weaknesses. (para. 29) ### Statutory and organizational mandates of federal banking agencies - The authorities state each FBA has both statutory and organizational mandates and objectives which are clear and provide specific roles and authority for supervision of regulated entities. (para. 30) - Each agency has specific authority to compel organizations to make improvements in risk management and other processes; agencies are actively working with institutions to improve these processes and regulatory policy. (para. 30) ### Assessment of CP 6 (Capital Adequacy) and U.S. bank capital standards - IMF’s assessment of CP 6 does not fully reflect aspects of U.S. bank supervision immediately before the crisis and once the crisis emerged. (para. 31) - Key U.S. capital standards and outcomes cited: - U.S. banks are held to a higher capital standard than international standards because of U.S. Prompt Corrective Action law and regulation. (para. 31) - Currently, approximately 96 percent of U.S. banks, representing approximately 99 percent of total bank assets, hold 50 percent or more capital than international minimums. (para. 31) - Prior to the crisis most U.S. banks, including the largest, had Tier 1 capital composed mostly of common equity (80–90 percent or higher). (para. 31) - In contrast, banks in other countries had common equity levels closer to the Basel predominance standard of 50 percent common shareholders’ equity with the remaining component of Tier 1 capital generally consisting of tax-deductible hybrid securities. (para. 31) - As a result of the Supervisory Capital Assessment Program (SCAP), the largest U.S. banks now have risk-based ratios of Tier 1 capital and Tier 1 common equity that far exceed Basel minimum capital requirements. (para. 31) ### Substantive supervisory actions not fully reflected in the Report - The federal banking agencies have taken a number of substantive actions that the authorities contend are not fully reflected in the Report, including: (para. 32) - The SCAP stress assessment on the 19 largest bank holding companies, which together hold two-thirds of the assets and more than one-half of the loans in the U.S. banking system. The SCAP was notable in scope, rigor, intensity, breadth, and transparency, and resulted in large banks raising a substantial amount of common equity capital which strengthened the level and quality of bank capital in the United States. (para. 32) - Joining international efforts to initiate supervisory colleges for large, globally active U.S. banks. (para. 32) - Directing large banks to improve their ability to aggregate risks across legal entities and product lines to identify potential risk concentrations and correlations, and requiring improved contingency funding plans. (para. 32) - Conducting targeted, leveraged lending reviews at the largest syndication banks, focusing on syndicated pipeline management, stress testing, and limit setting. (para. 32) - Conducting high quality implementation of Basel II. (para. 32) - Issuing and implementing interagency guidance on subprime and non-traditional mortgages. (para. 32) - Initiating new data gathering, e.g., a project that provides data on over 60 percent of residential mortgages serviced in the United States. (para. 32) ### Authorities’ intended follow-up and priorities - The U.S. authorities appreciate the Report’s recommendations and will review them carefully. They will take action where they have authority, including in the areas of: (para. 33) - enhancing communication and information-sharing among the agencies; - ensuring more effective oversight of systemic risks; - requiring increased liquidity buffers at systemically important institutions. - The authorities look forward to a continuing dialogue as they jointly seek to improve the stability and effective supervision of the global financial services sector. (para. 33) *Source: FINANCIAL SECTOR ASSESSMENT PROGRAM, UNITED STATES OF AMERICA — THE IOSCO OBJECTIVES AND PRINCIPLES OF SECURITIES REGULATION, REPORT ON STANDARDS AND CODES (ROSC), JULY 2010.* ### 14. Principles for issuers (Principles 14–16): Companies that issue securities in the ### _cr10250 - 14. Principles for issuers (Principles 14–16): Companies that issue securities in the ### Principles for issuers (Principles 14–16) - Companies that issue securities in the public market must provide extensive financial information and other disclosure on initial offerings. - Most issuers are subject to detailed continuing disclosure obligations in line with IOSCO standards. - Liability provisions ensure issuers are held responsible for all disclosure provided. - Enforcement mechanisms: - SEC - The exchanges - Civil suits by investors - Limitations: - There is limited authority over municipal government issuers. - Market fairness: - Holders of voting securities of a public issuer are generally treated fairly. ### Principles for collective investment schemes (Principles 17–20) - Registration and eligibility: - Operators and marketers of CIS offered to the public are subject to registration requirements. - The initial eligibility criteria for CIS and their operators should be more extensive, and should be demonstrated prior to registration. - Disclosure and reporting: - The initial and ongoing disclosure requirements for CIS are comprehensive. - Update requirements under the Commodity Exchange Act (CEA) are not timely. - Valuation and verification: - Assets of CIS are valued in accordance with U.S. generally accepted accounting principles (GAAP). - Assets are verified by an independent auditor at least annually. - Custody: - The custodian of CIS assets is not required to be an arm’s length party. ### Principles for market intermediaries (Principles 21–24) - Entry and integrity: - There are minimum entry standards for all market intermediaries that include criteria relating to integrity. - Capital and controls: - Capital and internal control requirements apply to futures commission merchants and broker dealers. - These requirements are assessed prior to licensing by the SROs. - Advisers are not subject to capital requirements or to operational capacity assessments prior to licensing. - Risk sensitivity: - The applicable capital requirements vary by the chief risks undertaken by the intermediary (largely market and credit risk). - The ability of the prudential requirements (capital formulae and risk management requirements) to address the full range of risks present in some business models (funding, liquidity, reputational, and affiliate risks) appears to need improvement. - Structural developments: - The crisis brought to light weaknesses in the framework governing investment bank holding companies. - The conversion of the remaining entities into bank holding companies has eliminated the practical need for the securities regulators to address these problems immediately. - Failure management: - There are procedures in place at both agencies to address failures of intermediaries, and these have been tested in practice. ### Principles for the secondary market (Principles 25–30) - Authorization and oversight: - Securities and futures exchanges are subject to authorization and oversight. - Under the CEA, there are categories of futures trading systems that are exempt from authorization. - Recent legislative amendments have enabled the CFTC to strengthen oversight of operational Exempt Commercial Markets (ECMs) where appropriate. - Transparency: - In the securities markets, post-trade transparency (details of completed transactions) is comprehensive. - Publicly displayed liquidity or pre-trade transparency (best bids and offers) is comprehensive. - However, roughly a quarter of liquidity is not publicly displayed (i.e., dark pool Alternative Trading Systems (ATSs) and broker dealer internalization of trading on behalf of clients). - Market structure risk: - The SEC’s concern that a two-tier market may be emerging—that provides valuable order information on the best prices for National Market System (NMS) stocks only to selected market participants—is justified. - Any proposed rule changes should be supported by independent factual evidence. *Source: IMF country report excerpt (chapter content provided).* ### 18. Market surveillance by the securities and futures exchanges and Financial ### 18. Market surveillance by the securities and futures exchanges and Financial Industry Regulatory Authority (FINRA) ### Market surveillance — overview and key findings - Market surveillance by the securities and futures exchanges and FINRA is effective and has kept pace with technological developments in markets. - A comprehensive surveillance system for securities trading to be used by the exchanges, ATS, and the SEC (such as exists in the futures markets) would be beneficial for: - detection of market abuse, and - identifying indicators of developing stress points. - Market manipulation is generally well policed in both markets. - Insider trading legislation should be more comprehensive in futures markets, although the approach to insider trading for securities and futures should be different given the differences in the nature of the markets. Whether additional expansion of coverage is warranted should be studied. - The opacity of the over-the-counter (OTC) derivatives market contrasts with the relative transparency of OTC securities markets for equities and bonds. ### Table 1 — Summary implementation of the IOSCO Principles (selected assessments) - Principle 1. Responsibilities of the regulator: - The responsibilities of the CFTC and SEC are clearly stated in the laws. However, there are gaps in coverage of products and services in the market, differences in treatment of similar products, and gaps in the scope of each agency’s authority. - Principle 2. Operational independence and accountability: - The CFTC and SEC are operationally independent. There is a strong system of accountability to Congress. The funding method for the authorities does not provide funding sufficient to meet their regulatory and operational needs on a long-term basis. - Principle 3. Adequate powers, resources, and capacity: - Both authorities have extensive powers over their areas of responsibility, but there are gaps. The CFTC and SEC need additional resources in order to supervise the very large and complex U.S. securities and futures markets. - Principle 4. Clear and consistent regulatory processes: - The CFTC and SEC are subject to a high degree of transparency including public consultation regarding their regulations. They are active on investor education. - Principle 5. Staff professional standards: - The CFTC and SEC have developed codes of ethics, including investment limitations on staff and, in the case of the SEC, reporting obligations. There are mechanisms to monitor compliance. - Principle 6–7. Use of SROs and SRO oversight: - Effectiveness depends to a large degree on the skills and resources of the SROs. Exchanges and clearing agencies perform important self-regulatory functions as do registered associations. - Following the coming into force of the CFMA, the CFTC has had insufficient authority over exchanges; this deficiency is being addressed via recommendations for legislative change. - Principle 8. Inspection, investigation, and surveillance powers: - The CFTC and SEC have broad investigative and surveillance powers; they can conduct on-site inspections without prior notice and obtain books and records without a court order. - Principle 9. Enforcement powers: - The CFTC and SEC have broad enforcement powers, including injunctions, civil proceedings, compelling information, administrative sanctions, and referrals to criminal authorities. - Principle 10. Effective use of enforcement and compliance: - Significant shortcomings were identified in the SEC enforcement program. A current extensive and wide-ranging program of change is beginning to generate improvements; important elements remain “work in progress.” - Resources for the examination of registered IAs by the SEC are insufficient. - Resources for criminal prosecution of securities fraud are too limited. - Principle 11–13. Information sharing and assistance: - The CFTC and SEC have broad authority to share information domestically and internationally and are signatories of the IOSCO MMOU and have bilateral MOUs. - Principle 14. Disclosure for issuers: - Extensive initial and ongoing disclosure for most public issuers exists. There is limited direct authority over municipal government. On-going disclosure requirements do not apply to all public issuers. - Principle 15. Fair and equitable treatment of holders: - Holders of voting securities of a public issuer generally are treated fairly. - Principle 16. Accounting and auditing standards: - U.S. GAAP is widely recognized as acceptable; GAAS of the PCAOB are widely accepted globally. - Principle 17–20. Collective investment schemes (CIS): - Operators and marketers of CIS are subject to registration requirements but eligibility criteria are not comprehensive. - Resources do not allow routine examination of operators with sufficient frequency. - Notice of changes affecting investor rights should be given prior to the effective date; material change requirements set out in the CEA are not timely. - Assets of CIS are valued in accordance with U.S. GAAP and verified by an independent auditor at least annually; no guidance on addressing pricing errors in commodity pools. - Principle 21–24. Market intermediaries and prudential requirements: - Minimum entry standards exist but only some intermediaries are subject to full assessment of financial capacity and internal controls before licensing. - Capital requirements apply to FCMs, non-guaranteed IBs, and BDs and vary by certain risks; capital formulae do not address the complete range of risks. - Standards of conduct and internal control requirements exist; risk management expectations for BDs and FCMs should be reexamined (liquidity, funding, reputational risk under stress). - Procedures for dealing with failure of a market intermediary are in place and have been tested. - Principle 25–27. Trading systems, authorization, oversight, and transparency: - Securities and futures exchanges and trading system operators are subject to authorization and oversight, but categories of trading systems are exempt from authorization under the CEA. - The authorization of “dark pool” ATSs under Regulation ATS does not provide for adequate pre-trade transparency; 25 percent of liquidity is not publicly displayed (i.e., dark pool ATSs and broker dealer internalization). - The CEA and CFTC regulations have not been updated to reflect modern concepts of transparency; futures markets practice real time publication. - Principle 28. Detecting and deterring manipulation: - Insider dealing law is too narrowly focused in the derivatives markets. Market surveillance is carried out to a high standard by exchanges and FINRA and is particularly comprehensive in the futures markets. The SEC and CFTC are constrained by technology limitations. - Principle 29. Large exposures, default risk, and market disruption: - Timely and comprehensive information flows in futures markets provide effective early warnings. In securities markets, tracking large exposures and potential sources of market disruption is more difficult. - Principle 30. Clearing and settlement oversight: - A separate CPSS-IOSCO assessment was conducted for the securities markets. Arrangements in the futures markets were not assessed. ### Table 2 — Recommended action plan (grouped by principle clusters) - Principles relating to the regulator (Principles 1–5): - Decisions should be taken promptly on the recommendations of the Joint Report to enhance investor protection and improve cooperation between the CFTC and SEC. Legislative and regulatory gaps identified in the Joint Report should be closed. - Funding of both authorities needs to be increased and the method of funding should be reviewed. The annual appropriations process seems inadequate to meet the needs for funding necessary long term projects. - Consideration should be given to moving to direct self-funding (i.e., ability to capture fee income for own funding rather than remitting it to general government revenue and relying on a government budget). The total fee income at the SEC presently generated from its activities far exceeds the combined budgets of the SEC and the CFTC. - Both agencies need more resources—human, informational and technological—to fulfill their regulatory functions efficiently and effectively. - Principles relating to self-regulation (Principles 6–7): - Amend the CEA to provide the CFTC with greater powers over product and rules approval of the futures exchanges and to provide greater scope for public consultation prior to their introduction, balancing prior approval with exchange innovation. - The CFTC should remain aware of industry concerns regarding retention of member regulation by demutualized DCMs. - The SEC should consider delegating sole registration authority for BDs to FINRA. - Principles relating to enforcement (Principles 8–10): - Complete the SEC Enforcement Division and OCIE program to implement the 21 recommendations set out in the 2009 report of the OIG and other improvements as a high priority. - Consider adding enforcement staff with more accounting and economics backgrounds; mixed teams could enhance Enforcement Division performance. - Increase the number of staff dedicated to periodic examination of registered IAs so the percentage of IAs examined annually matches the percentage of BDs examined by the SEC and FINRA. - The enforcement division of the CFTC would benefit from more resources; this becomes more pressing if remit expands (e.g., to include OTC derivatives). - The securities unit of the fraud section in the criminal division of the DOJ should be given additional resources to prosecute securities fraud. - Principles for issuers (Principles 14–16): - Continuous disclosure requirements should apply to all public issuers. - The SEC should have the power to mandate both initial disclosure requirements and on-going obligations directly on municipal government issuers. - Principles for collective investment schemes (Principles 17–20): - Eligibility criteria for CIS and their operators should include human and technical resources, appropriate financial capacity, and adequate internal management and controls, assessed before operations begin. - Increase resources at relevant regulators for routine examinations of operators and CIS. - Require CPOs to have policies to avoid or mitigate conflicts. - Require notice of changes affecting investor rights prior to the effective date; prompt changes to commodity pool disclosure documents should be required when material changes occur. - Consider requiring the custodian of a CIS’s assets to be an arm’s length party and consider requiring auditors to have relevant prior experience. - The CFTC should provide guidance on how to address pricing errors in valuation of commodity pools. - Principles for market intermediaries (Principles 21–24): - Adopt the lower 10 percent threshold for review of the fitness of control persons of an intermediary under both the CEA and Exchange Act. - Assess back-office capabilities, internal controls, and policies and procedures of all futures intermediaries and IAs prior to registration. - FINRA should have clear authority to examine and address all securities-related activities of members, including registered IA activities. - Consider requiring that the custodian be at arm’s length to the IA. - Implement proposed changes to the futures capital rules to address gaps relating to cleared OTC derivatives and improve sensitivity of the formula to actual risks. - Reexamine capital rules and prudential requirements to ensure all risks (funding, reputational, liquidity, affiliate) are addressed fully, and ensure adequacy under stress. Consider reviewing rules governing BD custody of client assets. - The CFTC should have authority to review and approve/disapprove margin requirements set by the DCMs. - Principles for the secondary market (Principles 25–30): - Pursue legislative change to secure enhanced powers as set out in the Joint Report; the CFTC should consider seeking an authorization power over entities seeking to set up ECMs and EBOTs, noting ongoing initiatives considering abolition of ECM and EBOT categories. - Prioritize the SEC’s broad review of equity market structure to determine whether rules have kept pace with changes in trading technology and practices, encouraging broad public debate while reaching actionable outcomes. *Source: _cr10250 - 18. Market surveillance by the securities and futures exchanges and Financial Industry Regulatory Authority (FINRA).* ### conclusions promptly. It will be essential that the review be conducted ### _cr10250 - conclusions promptly. It will be essential that the review be conducted ### Market integrity and regulatory recommendations (derivatives, insider trading, surveillance) - Implement the recommendations in the Joint Report regarding insider dealing and Chinese Walls in derivatives markets. - The CFTC should undertake a study to consider whether expansion of the insider trading prohibition in the futures markets beyond the recommendation in the Joint Report is warranted given the current state of the markets, contracts and investors. - The SEC should review the extent to which the absence of additional offences of insider trading is a limiting factor in the SEC’s enforcement effort in this area. - Current discussions among the securities exchanges and FINRA on creating a consolidated surveillance structure to oversee the consolidated market should be given greater priority with a view to reaching a positive conclusion in a timely manner. - Consideration should be given to amending the regulations to provide the SEC and the securities exchanges with accurate and timely information on large holders of and traders in securities as the CFTC and the futures exchanges have in their markets. This would support surveillance and identify emerging market stress points in a timely fashion. - The SEC should join the CFTC in considering the introduction of an explicit and comprehensive financial resource requirement for exchanges. ### Authorities’ response to the IMF FSAP assessment — overarching views - The U.S. authorities appreciate the effort, time, and resources committed by the IMF to prepare the FSAP, and recognize the FSAP’s role to promote the soundness of financial systems and improve supervisory practices. - Given the financial crisis and the maturity, complexity and significance of the U.S. financial system, the U.S. regulatory system was subject to a more stringent standard than in previous IMF assessments. - U.S. authorities acknowledge many of the IMF-identified areas for improvement but take exception to a number of the Report’s findings and overall ratings. ### Views on regulatory reform and resource needs - The U.S. authorities agree that comprehensive regulatory reform of the OTC derivatives marketplace is essential. - The U.S. authorities agree with the Report’s strong recommendation for increased resources for the CFTC and the SEC should the U.S. Congress expand the agencies’ missions to include the regulation of OTC derivatives. - The CFTC and SEC additionally need greater resources to keep up with the growth of securities and futures markets in the United States. - The U.S. authorities agree that the CFTC and SEC should enhance cooperation and coordination and already have taken steps to do so. ### Defensive arguments on regulation and enforcement effectiveness - The U.S. regulatory system helped ensure that the world’s largest and most complex exchange-listed equity, commodity futures, and options markets continued to function properly and withstood the ultimate stress test during the financial crisis. - Some proposed reforms for OTC derivatives mirror long-standing elements of the U.S. regulatory approach (e.g., requiring standardized products to trade on regulated trading platforms and to be cleared by central counterparties). - U.S. regulators have taken action under existing authority to remedy problems and make improvements: - SEC proposed new rules to improve the quality and timeliness of disclosure in municipal markets. - SEC adopted new custody control rules that include surprise inspections to verify assets held by money managers. - SEC launched a robust review of equity market structure, including issues such as dark pools. - CFTC is requiring large trader reporting in the cleared OTC markets to extend risk surveillance consistent with its existing risk program for on-exchange trading. ### Criticisms of the Report’s methodology and specific findings - The Commissions strongly disagree with many of the ratings in the Report, arguing that some ratings reflect misunderstandings of the U.S. regulatory system. - The Report’s rating on market intermediaries is criticized for assuming that every intermediary must be regulated the same way (e.g., undergo an extensive review prior to registration), a requirement the Commissions assert cannot be found in the IOSCO Principles or the assessment Methodology. - The Report is said to reject a legitimate risk-based approach to registration and oversight of futures and securities intermediaries without evidence the approach is ineffective. - The Report states capital requirements for futures and securities firms do not fully address risk, yet provides no evidence that the CFTC’s and SEC’s current requirements do not already exceed recognized international best practice as reflected in the Principles. - The Report’s finding that the U.S. system fails to address adequacy of CIS operators’ human and technical resources, financial capacity and internal management and controls overlooks U.S. features: - The U.S. system mandates disclosure by CIS operators and relies on oversight by a separate entity, a CIS board, which generally consists of a majority of independent directors. - CIS boards and operators are subject to fiduciary duties enforced by the SEC and private litigants, offering ongoing review rather than a one-time fit-and-proper check. - The IOSCO Principles apply to futures markets “where the context permits”; CIS Principles were written for publicly offered funds and were not intended to cover privately-offered funds, such as the vast majority of CFTC-regulated commodity pools. Publicly offered pools represent a small percentage of total pools regulated by the CFTC. ### Assessment of enforcement effectiveness and data cited - The Report’s adverse conclusions about the U.S. regulatory system are said to be in some cases not based on objective criteria and, for Principle 10, appear to rely heavily on an SEC OIG Report issued in August 2009 about a specific investigation. - SEC enforcement performance in fiscal year 2009 (cited to counter the Report’s conclusions): - Orders that required wrongdoers to disgorge ill-gotten gains in the amount of approximately US$2.09 billion. - Orders that imposed money penalties on wrongdoers in the amount of approximately US$345 million, a 35 percent increase over the previous fiscal year. - The filing of 664 cases against 1,787 persons. - SEC distributed approximately US$2.1 billion to harmed investors from both disgorgement funds and Fair Funds during fiscal year 2009. - The U.S. authorities argue these metrics demonstrate the credibility and effectiveness of the SEC enforcement program and that the Report fails to articulate objective metrics underpinning its rating. ### Steps taken in response to identified failures - In response to the OIG Report and other issues, the SEC has: - Restructured the Enforcement Division and streamlined procedures. - Taken steps to improve its inspection program and place greater reliance on risk assessment. - Worked to improve technology and modernize handling of the large number of tips and complaints received each year. - The Report’s ratings are argued to insufficiently credit these improvements. ### Concluding stance and commitment to dialogue - The U.S. authorities acknowledge many IMF-identified areas for improvement and note much is already underway to address these concerns. - The U.S. authorities firmly believe the overall ratings are not reflective of the U.S. regulated marketplace but will continue to evaluate and, as appropriate, enhance their regulatory programs. - The CFTC and SEC look forward to continuing dialogue with the IMF to strengthen financial regulation and enhance supervision of the global financial services sector. ### Insurance sector assessment — overview and key statistics - Insurance regulation in the United States is mostly carried out by states and is generally thorough and effective, although areas require significant development. - Strong regulation contributed to the overall resilience of the insurance sector during the financial crisis. - There is generally a high level of observance of the Insurance Core Principles; aspects of regulatory work such as data collection and analysis in relation to individual insurance companies are world-leading. - Needs identified: development of the policy framework in relation to insurance and financial stability and international issues; extensive reform to laws governing state insurance departments (including on appointment and dismissal of commissioners) to secure independence of regulatory work; significant development of the approach to supervision of groups. - Assessment context: - Assessment based on information available in November 2009 and the 2003 version of the IAIS Insurance Core Principles and Methodology. - Assessment carried out by Tom Karp and Ian Tower, Monetary and Capital Markets Department, IMF. - The NAIC contributed a self-assessment and further material. - Market size and structure (end-2008 figures and rankings): - There were 7,948 licensed insurance companies at the end of 2008. - Total premium volume in 2008 of US$1.24 trillion accounted for 29 percent of the global market. - Insurance density (premiums per capita) in 2008: US$4,078, ranking ninth. - Insurance penetration (premiums as a percentage of GDP) in 2008: 8.7 percent, ranking thirteenth. - Three main sectors: life, property and casualty, and health insurance. - Key specialist insurance lines that must be written in separate companies: financial guaranty (bond insurance—the “monoline insurers”); mortgage insurance; and title insurance. *Source: Financial Sector Assessment Program — United States of America, IMF Monetary and Capital Markets Department (excerpts from the FSAP/ROSC content provided).* ### 7. Most U.S. insurers write primary insurance on U.S. risks. The U.S. market is ### 7. Most U.S. insurers write primary insurance on U.S. risks. The U.S. market is ### Market structure and capacity - Low market concentration in most sectors, indicating a high degree of competition. - Limited private sector capacity in certain “hard to insure” risks, such as natural catastrophes, which has led to the creation of programs provided by government. - Limited international insurance business and a relatively small reinsurance capacity: 58 percent of all premium ceded to reinsurers by U.S. insurers is to markets in Europe and Bermuda. - Relatively few groups offering insurance as well as other financial services: only 17 groups are headed by a bank holding company and regulated by the Federal Reserve. ### Distribution of insurance products - Distribution is mainly through agents and brokers. - Intermediaries are generally referred to as “producers.” - Producers may act as captive agents, independent agents, or brokers (acting on behalf of the customer). ### Sector performance through the financial crisis - Capital and surplus fell by 6.7 percent in life and 8.5 percent in property and casualty between end-2007 and mid-2009. - Companies whose capital adequacy, measured by the regulators’ risk-based capital (RBC) requirements, fell to regulatory intervention levels accounted for only 3 percent of the total in 2008. - The property and casualty sector suffered from investment falls; losses from natural catastrophes in 2009 were not as high as in some recent years. - Note: All data from Swiss Re: World Insurance in 2008. ### Significant stresses and notable cases - Writers of financial guaranty business (the monoline insurers) lost their high ratings after serious losses related to impair structured finance products. - The American International Group (AIG) was supported by the federal authorities after major losses at its capital markets affiliate. - Two other insurance groups with federally regulated banking or thrift subsidiaries were granted federal government capital support under the Troubled Asset Relief Program (TARP); others had applied for funds. - Life insurance was particularly affected by the crisis, with many strains related to growth in non-traditional savings products such as variable annuities with generous guarantees. ### Ongoing challenges and exposures - Pressures have eased, but challenges remain, especially for life companies if economic recovery continues to be modest. - As life companies have shifted to savings products, insurance risks (mortality and longevity) have become less significant. - Health insurers face significant uncertainty arising from the federal government reforms to health insurance. - Property and casualty risks are more dispersed; while the United States is exposed to major natural catastrophes, their impact is regional and the largest risks are carried by foreign reinsurers. ### Regulatory framework: federal and state roles - Insurance is predominantly state-regulated in the United States. - The 1945 McCarran-Ferguson Act reinstated the regulatory authority of the states “on matters of the business of insurance” and exempted the “business of insurance” as regulated by the states from federal anti-trust laws. - The federal government has enacted measures affecting insurance, including the Gramm-Leach-Bliley Act of 1999 and the 2002 U.S.A. PATRIOT Act, which gave examination powers in relation to anti-money laundering and specified insurance business to federal authorities. ### State regulatory functions and operations - States carry out insurance regulatory functions within the state administration via insurance departments or similar units. - Functions include licensing and oversight of insurance companies and intermediaries, reserving and capital requirements, financial analysis, onsite examinations, and, in most states, some review or approval authority over policy forms and premium rates (for property and casualty insurers). - A commissioner heads each department, exercising formal powers; some commissioners are elected, most are appointed by the state governor. - Funding is usually raised from the insurance markets via fees and levies. - Insurance departments also collect premium taxes for the states, a significant part of state governments’ total revenues. - Departments respond directly to consumers’ complaints and requests for information and license and oversee insurance intermediaries. ### Role of the NAIC - The NAIC is a not-for-profit organization established by state insurance commissioners to centralize functions for economies and greater uniformity. - The NAIC employs some 430 staff, compared with nearly 12,000 employed by the states. - Key functions include: - Development of model laws and regulations (now totaling over 200). - The Financial Regulation Standards and Accreditation Program (the accreditation program), aimed at ensuring that states meet certain minimum standards in respect to financial regulation. - The centralized financial analysis process operated through the NAIC’s Financial Analysis Working Group (FAWG). ### Policyholder protection - Insurance policyholders are protected against the insolvency of insurance companies by guaranty associations in each state. - All U.S. insurance companies are required to be members of associations covering life and health insurance and, through separate organizations, property and casualty. - Payments are triggered by the insolvency of an insurer. - Laws differ by state on the extent of coverage and maximum payable per policyholder. *IMF staff report excerpt* ### 17. Insurance regulation in the United States is generally thorough and effective, ### 17. Insurance regulation in the United States is generally thorough and effective, although there are areas where development is needed ### Key findings - The preconditions for effective insurance supervision are generally met; but there is a need for development of the framework in relation to insurance and financial stability and international issues. - There is a need for reform of the laws governing state insurance departments, including on appointment and dismissal of commissioners, the budgetary framework and remuneration policies, in order to secure the independence of regulatory work. - While regulation is carried out transparently, there is a need for measures to foster improved stakeholder understanding of the regulatory approach. - There is a comprehensive set of requirements and processes for insurance company licensing, but some gaps in the requirements relating to suitability of persons. - Requirements in relation to governance, internal controls, and risk management are limited and should be extended. - NAIC data collection and analysis capabilities are world-leading, although the absence of complete group-wide consolidated data for groups hinders the ability of supervisors to analyze and monitor important market-wide events. - Examinations (i.e., onsite supervision) are generally thorough and well documented. - The approach to enforcement is comprehensive and applied in practice as necessary; there is no explicit authority for supervisors to fine directors or senior managers of insurers, or to bar them from acting in responsible capacities in the future. - The approach to supervision of groups needs significant development. Supervisors do not currently make a comprehensive and consistent assessment of the financial condition of the whole group of which a licensed insurance company is a member. - The liability reserving methods and bases generally lead to conservative estimates and, in combination with capital requirements, provide a sizable buffer against adverse experience. - Consideration should be given to specifying a target safety level for reserving and an associated target safety level for capital for general transparency and for international comparison. - Producer (i.e., intermediary) regulation is less uniform than for insurance companies, but states have the core requirements; there is a need to extend broker trust fund arrangements across states, develop a uniform approach to the regulation of major brokers and finalize a consistent approach to commission disclosure. - Consumer protection work is moving to a more proactive approach; this transition has further to go. Core consumer protection requirements are apparently in place in most states. - Requirements on fraud are in place across states, and the capacity of departments to address fraud-related issues is increasing as market conduct exams are undertaken and the availability of fraud data increases. - The authorities have only recently brought relevant insurance business within the scope of federal anti-money laundering regulatory requirements. There were significant gaps in the framework when the most recent Financial Action Task Force (FATF) work was undertaken in 2006. ### Summary of Observance of the Insurance Core Principles (selected ICP assessments) - ICP 1 – Conditions for effective insurance supervision: The preconditions are generally met; need development on insurance and financial stability and international issues. - ICP 2 – Supervisory objectives: Objectives of departments are generally not established explicitly by law; differences in departmental objectives and scope for conflict. - ICP 3 – Supervisory authority: Vesting of regulatory powers in the commissioner ensures operational independence in principle; however, governors in most states can dismiss commissioners at any time without public reasons; elected commissioners face electoral pressures; departments depend on state legislatures for principal legislation and budgetary resources. - ICP 4 – Supervisory process: Regulation is open and transparent with clear accountability and rights of appeal; need measures to foster stakeholder understanding of the state-based regulatory approach. - ICP 5 – Supervisory cooperation and information sharing: Information exchange traditionally focused on other insurance departments; regulators can share information with relevant federal authorities and with regulators abroad; need to continue developing the network of MoUs. - ICP 6 – Licensing: Core requirements adopted by all states represent a comprehensive set of requirements and processes for insurance company licensing, though approaches vary. - ICP 7 – Suitability of persons: Departments assess significant owners, Board members, senior management, auditors, and actuaries at application and via examinations; approach is assessment-based rather than formal approval of individuals. - ICP 8 – Changes in control and portfolio transfers: There are extensive requirements and related reporting. - ICP 9 – Corporate governance: SEC sets and enforces standards for publicly-traded companies; requirements for all insurance companies will be introduced from January 2010; departments increasing focus on governance. - ICP 10 – Internal controls: Few requirements relating to internal controls other than financial reporting; Sarbanes-Oxley applies to publicly-traded companies and will be extended from January 1, 2010, to most other insurers. - ICP 11 – Market analysis: Absence of complete group-wide consolidated data hinders supervisors; NAIC data sources and analysis capabilities are world-leading. - ICP 12 – Reporting to supervisors and off-site monitoring: NAIC data collection and analysis capabilities in relation to authorized insurance companies are world-leading; no formal reporting requirements for complete group-wide consolidated data. - ICP 13 – On-site inspection: Financial examinations are generally thorough and well documented; rollout of risk-focused examination approach will require more qualitative judgments by examiners and be challenging to implement. - ICP 14 – Preventive and corrective measures: Prompt corrective action triggers and required actions are thorough and rigorously applied; reduce insurer shortfall in any failure. - ICP 15 – Enforcement or sanctions: No clear authority for supervisors to fine directors or senior managers or to bar them from future responsible capacities. - ICP 16 – Winding-up or exit from the market: Strong supervisory focus on ensuring individual policyholder obligations are met; arrangements for insurer wind-up and exit are clear and have worked effectively in conjunction with guaranty fund arrangements. - ICP 17 – Group-wide supervision: U.S. approach focuses on individual insurance companies; supervisors do not assess the financial condition of the whole group; risk-focused examinations are not yet focusing on group issues; supervisory colleges are not meeting for all U.S.-based international groups. - ICP 18 – Risk assessment and management: Desired outcomes essentially achieved in practice due to comprehensive examinations, but no requirement that an insurer have comprehensive risk management policies and systems. - ICP 19 – Insurance activity: Laws or regulations do not explicitly require strategic underwriting and pricing policies approved and reviewed regularly by the Board; Boards are not required to set strategic limits on these functions. - ICP 20 – Liabilities: Reserving methods and bases generally lead to conservative estimates consistent with statutory accounting; no specified safety level targeted for reserving or capital. - ICP 21 – Investments: Regulatory requirements for investments are robust; as insurers move to principles-based approach, ensure investment risk and asset/liability mismatching are covered in reserving and capital requirements. - ICP 22 – Derivatives and similar commitments: Requirements relating to derivatives use are robust and sensible, allowing derivatives for enhancing investment management without undue risk. - ICP 23 – Capital adequacy and solvency: No requirements to address inflation of capital through multiple gearing; reserves are conservative and regulatory capital is required in addition, providing a sizable buffer; absence of specified safety level makes it difficult to determine covered adversity, but buffer appears commensurate with or higher than in many other jurisdictions. - ICP 24 – Intermediaries: Producer regulation is much less uniform than for insurance companies; most states have core requirements; less uniformity on safeguards for money held by brokers. - ICP 25 – Consumer protection: Departments moving to a more proactive approach to market conduct; transition has further to go, particularly in identifying and responding quickly to wider market issues; lack of uniformity across states in market conduct area though core consumer protection requirements are apparently in place in most states. - ICP 26 – Information, disclosure and transparency toward markets: No regulatory requirements in relation to disclosure, but full financial information including actuarial opinion and auditor’s statement are readily available to stakeholders via NAIC submissions; scope to improve availability of information to policyholders without access to databases, ratings, etc. - ICP 27 – Fraud: Approaches vary by state but core requirements (such as making insurance fraud a crime) are in place across states; capacity to address fraud-related issues is increasing as market conduct exams are undertaken. - ICP 28 – Anti-money-laundering, combating the financing of terrorism: Relevant insurance business only recently brought within the scope of (federal) anti-money laundering regulatory requirements; implementing the approach has taken time; significant gaps existed in the framework when the most recent FATF work was undertaken in 2006; effectiveness of cooperation between state and federal regulators is limited pending consideration of legal issues and agreement of new procedures and information sharing arrangements. ### Recommended actions (selected, mapped to ICPs) - ICP 1: Increase information-sharing and coordination between state regulators and federal authorities; agree policies and procedures for regulation of systemically important institutions, markets and instruments in the insurance sector; make new arrangements to increase the authority of federal authorities in relation to implementation of international agreements. - ICP 2: Insurance departments, the NAIC and state legislatures should develop a clear, joint statement of the objectives of insurance regulation and align individual state department objectives with these. - ICP 3: NAIC and state legislatures should reform commissioner appointments to provide fixed terms as standard, permit mid-term dismissal only for prescribed causes with publication of reasons, and make departments fully self-funding. - ICP 4: NAIC should make publicly available some information currently available only on payment of a fee or by subscription; publish summary information on their assessment of states’ compliance with accreditation standards. - ICP 5: States and NAIC should continue developing the network of MoUs; all state insurance departments should ensure laws are updated to protect information received from foreign regulators. - ICP 7: Adopt specific requirements in relation to individuals’ fitness and propriety and fill gaps in department requirements. - ICP 9: As examiners gain experience, NAIC and/or departments should consider issuing more guidance on good and bad practices in corporate governance for insurers. - ICP 10: As examiners gain experience, NAIC and/or departments should consider issuing guidance on internal control practices and make it a formal requirement for insurers to have an internal audit function. - ICP 11: Regulators should collect more complete group-wide consolidated data for insurance groups and broader financial conglomerates; develop further analysis of developments outside the U.S. markets. - ICP 12: Introduce collection of group-wide consolidated data for insurance groups and broader financial conglomerate groups. - ICP 15: Change insurance laws to provide supervisory authority powers to fine individual directors and senior managers and to bar them from acting in responsible capacities in the future. - ICP 17: U.S. supervisors should include fuller assessment of the financial condition of the whole group, extend the risk-focused examination approach to groups, and ensure colleges of supervisors for U.S. groups with major international operations are established and effectively led by U.S. regulators with appropriate insurance expertise. - ICP 18: Change laws, regulations or standards to require insurers to have comprehensive risk management policies and systems capable of promptly identifying, measuring, assessing, reporting and controlling risks. - ICP 19: Laws or regulation should explicitly require insurers to have strategic underwriting and pricing policies approved and reviewed regularly by the Board. - ICP 23: Consider specifying a target safety level for reserving and an associated target safety level for capital; include requirements to address inflation of capital through multiple gearing in law, regulation or rules. - ICP 24: Strengthen producer regulation by extending broker trust fund arrangements across states, developing a uniform approach to regulation of major brokers, and completing work on a consistent approach to commission disclosure. - ICP 28: Set a timetable for agreement and implementation of new arrangements between state insurance departments and federal authorities to deliver greater resourcing of supervisory activities and necessary information exchange. ### Authorities’ response - The U.S. authorities welcomed participation in the U.S. FSAP and the IMF’s assessment of a high level of observance of the IAIS Insurance Core Principles (ICPs). - The FSAP provided insurance regulators in the United States with a timely opportunity to undertake a comprehensive self-assessment of the U.S. insurance regulatory system against international standards and has contributed to ongoing internal reviews and assessments of regulatory practices. - The FSAP served as a useful platform for providing an overview of the U.S. insurance regulatory system and its multi-jurisdictional structure. - The authorities appreciate the recognition by the IMF of the strengths in the regulatory system including areas that the IMF itself has coined as “world leading.” *IMF Financial Sector Assessment Program — U.S. insurance regulatory assessment (chapter content provided).* ### 19. As recognized by the Report, it is important to consider the U.S. assessment in ### 19. As recognized by the Report, it is important to consider the U.S. assessment in ### Context and scope of the U.S. ICP assessment - The assessment of the U.S. supervisory framework was undertaken in the wake of a severe financial crisis. - Movements toward significant changes in supervisory practices have gained momentum as a result of the financial crisis and circumstances emanating from the crisis, including with respect to group-wide supervision. - The IMF’s assessment of U.S. compliance with ICP 17, the group-wide supervision standard, goes beyond the scope of the current ICP assessment by assessing compliance with a group supervision structure that is still under discussion and development in most jurisdictions and within the IAIS. - Revision of the insurance ICPs that may reflect these changes may not be finalized until 2011. ### International cooperation and ongoing initiatives - Insurance regulators in the United States are working with regulators around the world on initiatives to enhance group supervision. - Inter-regulatory cooperation processes in place include: - the use of lead state supervisory structures; and - the Financial Analysis Working Group of the National Association of Insurance Commissioners (NAIC). - The Report acknowledges the comprehensive review underway with the Solvency Modernization Initiative, which takes into account international and cross-sectoral practices in analyzing possible additions or modifications to current insurance regulatory practices. ### Prudential regulatory independence and accountability - U.S. authorities remain strongly committed to prudential regulatory independence and accountability, including continually striving to improve ways to effectively balance these two objectives. - Transparent rulemaking with opportunity for stakeholder involvement has proven an effective way to provide accountability and improve the regulatory environment while respecting regulatory independence. - As reflected in the assessment of ICP 3, the Supervisory Authority standard, the assessment appears to rely on structural characteristics while failing to fully recognize the effective operational independence of state insurance regulators. - In practice, the U.S. multijurisdictional approach to insurance regulation holds regulators accountable to each other in a peer review process that includes: - on-going nation-wide monitoring through the NAIC, - regular dialogue among all regulators, and - the ability of states to question the actions of fellow state insurance regulators. ### Regulatory approach: principles-based versus rules-based - The assessment indicates philosophical preferences for a principles-based, rather than rules-based, approach to regulation. - Assessment recommendations inconsistently apply those preferences by variously seeking more, as well as fewer, rules. - There appears to be no empirical evidence in the assessment to suggest that one approach is superior to the other or that the choice of approach affects the U.S. regulators’ ability to meet the standards set out in the various ICPs. - U.S. authorities fully support a regulatory environment based on principles and made operational by rules that can: - provide consistent standards throughout the marketplace, and - remain flexible enough to adapt to new developments. ### AML and CFT assessment (ICP 28) - The IMF’s assessment of ICP 28 identified some areas where U.S. AML requirements may be improved upon. - The assessment fails to fully recognize the robust protection provided U.S. citizens against money laundering activities. - The United States has a bifurcated regulatory scheme regarding AML regulation: - the federal government has primary jurisdiction of AML statutes; and - regulation of insurance and expertise in financial examination of insurance is the responsibility of the states. - Both state and federal authorities have agreed to work together to review the current examination process. - An in-depth legal analysis on this subject has yet to be undertaken. ### Authorities’ response and next steps - U.S. Authorities appreciate the assessment and will thoroughly review the Report’s recommendations. - They will take the recommendations into account when initiating and implementing any insurance regulatory reforms. - U.S. Authorities look forward to continuing ongoing dialogues with the IMF on how to best collectively improve international financial stability and supervision of the global financial services sector. --- ### Extracted key findings and statistics from the FICC-GSD ROSC (selected) - The Fixed Income Clearing Corporation–Government Securities Division (FICC-GSD) observes the majority of the CPSS-IOSCO Recommendations for central counterparties (RCCPs) and broadly observes the others. - It is important that FICC-GSD effectively takes additional steps to properly address financial risks. - It would be beneficial that the Securities and Exchange Commission (SEC) requires FICC-GSD compliance with RCCPs, and the Federal Reserve is provided with a legal mandate to oversee FICC. Key statistics of FICC-GSD, 2007–09 (as presented) - 1. Number of contracts and transactions cleared (millions): 30.4 34.4 28.7 - 2. Value of contracts and transaction cleared (USD billions): 1,006,100 1,014,500 905,100 - 3. Average daily value of transactions (USD billions): 44 3,6 - 4. Peak value of transactions (USD trillions): 5.9 7.0 5.8 - 5. Total number of clearing members, of which: 103 97 98 - 5.1. Foreign clearing members: 11 11 13 - 6. Clearing fund (USD millions) 1/: 13,701.7 18,896.8 14,141.4 - 1/ Includes the value of cash and securities. Selected FICC-GSD observations and assessments - Legal Framework (Rec. 1): FICC’s activities are governed by a consistent set of laws, regulations, and contractual arrangements forming a sound legal foundation; information is publicly available. - Participation requirements (Rec. 2): Access and exit criteria are publicly disclosed; requirements for participants’ financial resources and credit worthiness are based on legal nature and services used; operational reliability is assessed. - Financial risk management (Rec. 3–6): Daily exposure measurement; contributions to the clearing fund; intraday calls for additional clearing funds possible; clearing fund composed of cash and securities; repo arrangements for collateral liquidation are not committed facilities. - Custody and investment risks (Rec. 7): Clearing fund assets held in dedicated accounts with two major clearing banks; cash investments authorized under an Audit Committee policy that establishes credit limits by counterparties. - Operational risk (Rec. 8): Business continuity arrangements developed at DTCC holding company level; contingency plans and back-up facilities regularly tested and maintained. - Money settlements (Rec. 9): End-of-day funds settlement uses central bank money with a tiered settlement arrangement relying on DTC as settlement agent; settlement via Federal Reserve’s National Settlement Service (NSS). - Physical deliveries (Rec. 10): Rules set forth obligations for securities deliveries; continuous monitoring of participants’ exposures and collection of margin against failed items. - Risks in links between CCPs (Rec. 11): Cross-margining arrangement with the Chicago Mercantile Exchange (CME); cooperative framework between CFTC and SEC in place. - Efficiency (Rec. 12): Pricing levels regularly reviewed and cost-based; cost allocation methodology reviewed by internal and external auditors; benchmark studies conducted. - Governance (Rec. 13): Single governance structure for DTCC subsidiaries; not all relevant information publicly available; DTCC reviewing governance arrangements; public interest considered through SEC rule filing and notice processes. - Transparency (Rec. 14): Regulations, rules, and procedures publicly available; annual audited financial statements published; non-audited quarterly financial statements provided; completed and published RCCPs self-assessment. - Regulation and oversight (Rec. 15): Responsibilities and objectives of public authorities clearly defined and publicly disclosed; SEC supervises FICC-GSD as a registered clearing agency; Federal Reserve has legal power to examine FICC; SEC and Federal Reserve have signed exam-specific information sharing arrangements regarding oversight of FICC-GSD. *Source: Excerpts from the IMF Financial Sector Assessment Program ROSC for the United States (selected sections of the provided content).* ### 5. A CCP should maintain sufficient financial ### _cr10250 - 5. A CCP should maintain sufficient financial ### Financial resources and liquidity - A CCP should maintain sufficient financial resources to withstand, at a minimum, a default by the participant to which it has the largest exposure in extreme but plausible market conditions. - FICC-GSD’s liquidity need is highly concentrated to the two major clearing banks. - FICC-GSD’s liquidity can be increased by repoing the securities in the clearing fund; however, this arrangement cannot be considered as a committed line, since there is no complete assurance that the repo markets would be effective in extreme market situations. - Table 3 — Recommendation 5: Financial resources — Recommended Action: - Consider an additional liquidity buffer to deal with extreme situations where repo arrangements cannot be used. - Minimize FICC-GSD’s exposure and concentration risk vis-à-vis the two clearing banks. - Consider conducting more frequent stress testing than once a month, in particular, in times of unusual market volatility. - Disclose stress testing assumptions to participants. ### Default procedures - A CCP’s default procedures should be clearly stated, and they should ensure that the CCP can take timely action to contain losses and liquidity pressures and to continue meeting its obligations. - Key aspects of the default procedures should be publicly available. - FICC-GSD’s default procedures are clearly stated in the system’s rules and procedures, which would allow FICC-GSD to suspend or terminate a member from any service, should it become subject to insolvency proceedings or fail to perform its obligations to the system. - The U.S. legal framework provides a high degree of assurance with regard to the enforceability of default procedures. ### Custody and investment risk - A CCP should hold assets in a manner whereby risk of loss or of delay in its access to them is minimized. Assets invested by a CCP should be held in instruments with minimal credit, market, and liquidity risks. - FICC-GSD’s assets are highly concentrated to the two major clearing banks, and not all FICC-GSD investments are secured. - Table 3 — Recommendation 7: Custody and investment risk — Recommended Action: - Continue to monitor and mitigate the potential risks, which result from holding assets at only two commercial banks. - Avoid unsecured investments to the largest extent possible. ### Operational risk - A CCP should identify sources of operational risk and minimize them through the development of appropriate systems, controls, and procedures. Systems should be reliable and secure, and have adequate, scalable capacity. Business continuity plans should allow for timely recovery of operations and fulfillment of a CCP’s obligations. - Contingency plans and backup facilities for the failure of key systems are not tested and reviewed with participants (only connectivity is tested with the critical participants). - Table 3 — Recommendation 8: Operational risk — Recommended Action: - Test and review FICC-GSD backup sites to critical participants’ backup sites. ### Money settlements - A CCP should employ money settlement arrangements that eliminate or strictly limit its settlement bank risks, that is, its credit and liquidity risks from the use of banks to effect money settlements with its participants. Funds transfers to a CCP should be final when effected. - FICC-GSD uses the central bank model with a tiered settlement arrangement relying on DTC as settlement agent, for its end-of-day funds settlement. - From the broader DTC assessment: For cash settlement, DTC relies on settling banks—settling for their own and other participants—making the payments from and to DTC’s account at the FRBNY. There is a high concentration of payment flows at the top five settling banks in DTC. This concentration is currently not monitored by DTC. ### Physical deliveries - A CCP should clearly state its obligations with respect to physical deliveries. The risks from these obligations should be identified and managed. - FICC-GSD does not have direct access to Fedwire Securities and Fedwire Funds services. Such access would allow FICC-GSD to settle DVP in central bank money and reduce the settlement concentration to the two clearing banks. - Table 3 — Recommendations 10: Physical deliveries — Recommended Action: - Provide FICC-GSD direct access to Fedwire Securities and Fedwire Funds services to settle DVP transactions in central bank money. ### Risks in links between CCPs - CCPs that establish links either cross-border or domestically to clear trades should evaluate the potential sources of risks that can arise, and ensure that the risks are managed prudently on an ongoing basis. There should be a framework for cooperation and coordination between the relevant regulators and overseers. - FICC-GSD has appropriate risk management procedures in place to identify and evaluate the risks from the links, and there is a supervisory coordination between CFTC and SEC for the links to CME. ### Efficiency - While maintaining safe and secure operations, CCPs should be cost-effective in meeting the requirements of participants. - FICC-GSD regularly reviews its pricing levels, which are cost-based. It also conducts benchmark studies to assess cost effectiveness in the market. ### Governance - Governance arrangements for a CCP should be clear and transparent to fulfill public interest requirements and to support the objectives of owners and participants. In particular, they should promote the effectiveness of a CCP’s risk management procedures. - FICC-GSD’s governance arrangements are not sufficiently specified and transparent, including criteria for the composition and selection of Board members. - Table 3 — Recommendation 13: Governance — Recommended Action: - FICC-GSD’s governance arrangements should be more clearly specified and transparent, including criteria for the composition and selection of Board members. ### Transparency - A CCP should provide market participants with sufficient information for them to identify and evaluate accurately the risks and costs associated with using its services. - The regulations, rules, and procedures governing FICC-GSD are publicly available, as are audited annual financial statements, and participants receive non audited quarterly financial statements. ### Regulation and oversight - A CCP should be subject to transparent and effective regulation and oversight. In both a domestic and an international context, central banks and securities regulators should cooperate with each other and with other relevant authorities. - The SEC has not formally required FICC-GSD to perform a self-assessment based on the RCCPs, but compliance with SEC rules ensures compliance with most of the recommendations. - Table 3 — Recommendation 15: Regulation and oversight — Recommended Action: - SEC should formally require FICC-GSD to perform a self-assessment based on the RCCPs. - Ensure the compliance of the SEC rules with the RCCPs. - Provide legal mandate to the Federal Reserve to oversee FICC-GSD, which is systemically important system, as a complementary function to the SEC regulation and supervision. ### Actions to Improve Compliance (selected from Table 3) - Recommendation 3: Credit exposures management — Align the definitions of margins and clearing funds with international standards. - Recommendation 5: Financial resources — (see Financial resources and liquidity section for the four listed actions). - Recommendation 7: Custody and investment risk — (see Custody and investment risk section for the two listed actions). - Recommendation 8: Operational risk — Test and review FICC-GSD backup sites to critical participants’ backup sites. - Recommendation 10: Physical deliveries — Provide FICC-GSD direct access to Fedwire Securities and Fedwire Funds services to settle DVP transactions in central bank money. - Recommendation 13: Governance — (see Governance section for the listed action). - Recommendation 15: Regulation and oversight — (see Regulation and oversight section for the three listed actions). ### Authorities’ response to the assessment - The U.S. authorities welcome the IMF’s assessment of the FICC-GSD against the RCCPs. - Authorities note the IMF’s assessment reflects the high degree of compliance of FICC-GSD with the RCCPs, and will work with FICC-GSD in considering the assessment’s specific comments and recommendations. - Authorities appreciate the contribution that the assessment process makes to the stability and effective regulation and oversight of systemically-important payment, clearing and settlement systems. *International Monetary Fund — Report on the Depository Trust Company’s observance of the CPSS-IOSCO Recommendations for Securities Settlement Systems (ROSC), July 2010* ### 11. DTC operates an indirect holding system where securities (or interest in securities) ### _cr10250 - 11. DTC operates an indirect holding system where securities (or interest in securities) ### System structure and operational controls - DTC operates an indirect holding system where securities (or interest in securities) are registered in the name of the direct participants through nominee accounts rather than in the name of the end beneficiary. - Physical and technical controls as well as periodic audits are performed by DTC’s regulators and Internal Audit Department. - DTC operates a DVP Model 2 settlement system, where securities settle on a gross basis intraday and associated funds settle on a net basis at the end of the day. - DTC does not provide intraday finality for cash transfers; securities are delivered during the day while finality of cash takes place at the end of day. - Contingency plans and backup facilities for the failure of key systems are not tested and reviewed with participants (only connectivity is tested with the critical participants). - DTC has adequate procedures and measures in place to ensure the protection of customers’ securities. ### Governance, access, pricing, and transparency - DTCC’s Board is composed of 18 members. Members of the Board are elected by the shareholders annually. - There is a single governance structure for all the subsidiaries of DTCC. - DTC’s access and exit criteria are publicly disclosed and the same eligibility rules apply to all participants depending on the scope of the service used regardless of the type, identity and location of the participant. - DTC reviews in the annual budget process its pricing levels which are cost-based; the cost allocation methodology is part of a regular review by both internal and external auditors. - DTCC ensured that each service of the DTCC group does not cross-subsidise the cost and expenses of the others. - The laws, regulations, rules and procedures governing DTC are publicly available, but governance arrangements for DTC could be more transparent and only limited information is available to the public (including criteria for composition and selection of Board members). ### Regulation, oversight, and authorities - DTC is regulated and overseen by the SEC, the Federal Reserve and the NYSBD. - The responsibilities and objectives of relevant public authorities with regard to DTC activities are clearly defined and publicly disclosed. - The SEC has entered into memoranda of understanding with foreign regulators to facilitate the exchange of information with authorities of all the countries with which DTC has developed links, except for Peru. - The Fed’s oversight of DTC is not based on a general statutory payment systems oversight authority, but rather on DTC’s status as a State Member Bank of the Fed and the Fed’s consequent role as banking supervisor; the banking supervision and the oversight functions have two different objectives and use different tools. - The SEC has not yet required DTC to perform a self assessment with respect to RSSSs, but SEC staff would consider recommending to the Commission to require such a self-assessment. - The self-assessment of the Federal Reserve’s NSS against the CPSIPS has not been reviewed by the relevant authorities and is not public. ### Links and cross-border arrangements - DTC maintains links with 13 foreign CSDs, of which two are bilateral (both inbound and outbound). - For inbound links, linked CSDs are treated as other participants in DTC; for outbound links DTC conducts an assessment of the risks associated with the establishment of the link before allowing its participants to process transactions with a foreign CSD’s participants. - DTC uses ISO 15022 for cross-border linkages with CSDs; messages (ISO-based and Message Queuing) are sent and received over DTC’s proprietary system as well as SWIFT. - DTC has adequate measures and procedures to handle the risk associated with links, but DTC should update the information on links on DTCC’s website to reflect the current status. - Formal co-operation with Authorities in Peru needs to be established. ### Risk areas highlighted in the CPSS-IOSCO assessment (selected findings) - Pre-settlement risk: - DTC does not fully offer trade confirmation services, and does not match settlement instructions prior to settlement. - To enhance risk management procedures, DTC should explore the possibility to introduce an instructions matching mechanism prior to settlement. - Central counterparty assessment: - No cost-benefit analysis of the introduction of a CCP for transactions settled through DTC but not cleared by NSCC has been conducted. - Settlement risk and liquidity concentration: - There is a high concentration of payment flows at the top five settling banks, which increases credit risk exposures of the settlement banks. - DTC relies on a single bank for the cash settlement for Canadian dollar. - Although DTC currently has sufficient liquidity resources to protect against the failure of the largest affiliated family of participants, more extreme cases of multiple failures could test DTC’s liquidity resources. - Operational risk: - Contingency plans and backup facilities for the failure of key systems are not tested and reviewed with participants (only connectivity is tested with the critical participants). - Custody risk: - DTC has adequate procedures and measures in place to ensure the protection of customers’ securities. - Efficiency and standards: - DTC's fees are cost based and DTC returns to its users excess net revenues not needed to fund its operations via rebates or other refunds; DTCC performs periodic benchmarking studies to assess cost effectiveness in the market place. ### Table 3: Recommended actions to improve compliance (selected) - Recommendation 2: Trade confirmation - DTC should explore the possibility introducing an instructions matching mechanism prior to settlement. - Recommendation 4: CCPs - A cost-benefit analysis of the introduction of a CCP for transactions not cleared by NSCC should be conducted. - Recommendation 8: Intraday finality for cash - DTC should consider conducting additional net funds settlement batches during the day in order to provide intraday finality for cash transfers. - Recommendation 9: Risk controls - DTC should be given access to central bank liquidity facilities. - Recommendation 10: Cash settlement - DTC should continue to monitor the financial conditions and should begin monitoring the exposures of the settlement banks. - DTC needs to reduce the concentration of settlement cash for Canadian dollar. - DTC may explore the possibility of becoming a direct participant of the Canadian RTGS system. - The self-assessment of the Federal Reserve’s NSS against the CPSIPS should be reviewed by the relevant authorities and made public. - Recommendation 11: Operational risk - DTCC should test its back-up sites to critical participants’ backup sites. - Recommendation 13: Governance - DTC’s governance arrangements should be more clearly specified and transparent, including criteria for the composition and selection of Board members. - Recommendation 18: Oversight and regulation - Formal co-operation with Authorities in Peru needs to be established. - It would be more effective and transparent to legally entrust the Fed the role of overseer of financial market infrastructure, and to separate between the banking supervision and the oversight functions. - SEC is encouraged to require clearing agencies to perform self-assessments against the CPSS-IOSCO recommendations by rules or in a policy statement. - Recommendation 19: Risks in links - DTC should update the information on links on DTCC’s website to reflect the current status. ### Authorities’ response (summary) - The U.S. authorities welcome the IMF’s assessment of DTC against the RSSSs and note the high degree of compliance of DTC with the RSSSs. - The authorities are largely in agreement with the assessment’s comments and recommendations and will share them with DTC. - The authorities appreciate the contribution of the assessment process to the stability and effective regulation and oversight of systemically important payment, clearing and settlement systems. *Source: IMF staff assessment text (excerpt) from the DTC/DTCC CPSS-IOSCO assessment.* ### 4. The NSCC is registered as a clearing agency with the Securities and Exchange ### 4. The NSCC is registered as a clearing agency with the Securities and Exchange ### Background and role - NSCC is registered as a clearing agency with the Securities and Exchange Commission (SEC) and subject to the SEC’s oversight. - Established in 1976 as a New York business corporation; since 1999 a wholly-owned subsidiary of the Depository Trust & Clearing Corporation (DTCC). - Provides central counterparty services for the vast majority of broker-to-broker trades involving equities, corporate and municipal bonds. - Also provides wealth management and insurance services, automated customer account transfer services and risk management. - As of December 2009, NSCC had 206 clearing members, including 3 foreign institutions. ### Key statistics of NSCC (2007–09) - 1. Number of contracts and transactions cleared (millions): 2007: 13,537; 2008: 21,877; 2009: 23,254 - 2. Value of contracts and transaction cleared (USD billions): 2007: 283,200; 2008: 315,100; 2009: 209,690 - 3. Average daily value of transactions (USD billions): 2007: 1,137; 2008: 1,255; 2009: 835 - 4. Peak value of transactions (USD billions): 2007: 2,230; 2008: 3,373; 2009: 1,091 - 5. Total number of clearing members, of which: 2007: 226; 2008: 221; 2009: 206 - 5.1 Foreign clearing members: 2007: 3; 2008: 4; 2009: 3 - 6. Clearing fund (USD millions)1: 2007: 4,866.6; 2008: 6,620.4; 2009: 2,941.0 - 1. Includes the value of cash and securities. - Source: DTCC. ### Main findings — summary by theme Legal Framework (Rec. 1) - NSCC’s activities are governed by a consistent set of laws, regulations and contractual arrangements that form a sound legal foundation for clearing, settlement and custody activities, which are publicly available and readily accessible to system participants. Participation requirements (Rec. 2) - NSCC’s access and exit criteria are publicly disclosed. - Requirements for participants’ financial resources and credit worthiness are based on legal nature of entities and services to be used. - NSCC assesses participants’ financial strength and operational reliability. Financial risk management (Rec. 3–6) - NSCC measures exposures to participants daily and requires payment of contributions to the clearing fund; can conduct intraday calls for additional clearing funds when appropriate. - Mitigates credit exposures via clearing fund requirements, cross-guarantee and cross-margining arrangements. - Conducts stress testing monthly using scenarios from the past ten years and specific historic events. - Liquidity resources composed of cash and securities and committed credit facility by some banks; in case of insufficient cash, seeks to liquidate collateral via repo arrangements. - Default procedures clearly stated in rules and procedures. Custody and investment risks (Rec. 7) - Securities and cash of the clearing fund are held in dedicated accounts with the two major clearing banks. - Cash investments authorized under a policy approved by DTC’s Audit Committee, outlining principles to mitigate loss risk from unsecured investments. - Assets held under tri-party custodial arrangements. - When repos not available, assets invested in overnight commercial paper in bank sweep accounts. Operational risk (Rec. 8) - Business continuity arrangements developed at DTCC holding company level covering all sites, networks control centres, and back-up sites as a unified complex. - DTCC has procedures to identify and mitigate operational risk sources; contingency plans and back-up facilities regularly tested and maintained. Money settlements (Rec. 9) - NSCC settles its money obligations in commercial bank money. Physical deliveries (Rec. 10) - Rules clearly set forth obligations with respect to securities deliveries. - Uses a “modified” DVP mechanism: securities delivered with finality to participants only if NSCC has received the cash or is in a credit position vis-à-vis the relevant clearing member. - Continuously monitors participants’ exposures and collects margins when required. Risks in links between CCPs (Rec. 11) - NSCC has established three links to the Option Clearing Corporation (OCC) and the Canadian Clearing and Depository Services Inc (CDS). - NSCC reports an assessment of associated risks with these links has been conducted. - A cooperation framework (MoU) between the SEC and the Canadian authorities has been set for the supervision of the links; no such arrangement with the Monetary Authority in Singapore (MAS). Efficiency (Rec. 12) - NSCC regularly reviews pricing levels based on cost recovery. - Cost allocation methodology reviewed by internal and external auditors. - Conducts benchmark studies to assess market cost-effectiveness. - DTCC internal auditors ensure services do not cross-subsidise other services and financial resources for risk management are not commingled. Governance (Rec. 13) - Single governance structure for all DTCC subsidiaries, including NSCC. - Governance arrangements are made public but not all relevant information is publicly available. - DTCC is reviewing governance arrangements. - Public interest considered via SEC filing and public comment requirement for proposed NSCC rule changes and industry discussions. Transparency (Rec. 14) - Regulations, rules and procedures governing NSCC publicly available. - Audited annual financial statements published; participants receive unaudited quarterly financial statements. - NSCC completed and publishes on its website a self assessment following the RCCPs assessment methodology. Regulation and oversight (Rec. 15) - Responsibilities and objectives of relevant public authorities regarding securities clearing and settlement clearly defined and publicly disclosed. - SEC supervises NSCC as a registered clearing agency; SEC applies standards other than the RCCPs, though some RCCP issues are addressed under securities laws applied by the SEC. - Federal Reserve has authority to examine NSCC as an affiliate of DTC. - SEC and Federal Reserve have signed exam-specific information sharing arrangements regarding NSCC oversight. - MoU between SEC and Canadian authorities exists for link supervision; no MoU with MAS. - The SEC has not formally required NSCC to perform self-assessment based on the RCCPs. - The Federal Reserve does not have a legal mandate to oversee the NSCC, other than authority to examine NSCC as an affiliate of DTC. ### Summary of observance against CPSS-IOSCO Recommendations (high-level points) - Legal risk: NSCC activities governed by a consistent and transparent legal basis. - Participation requirement: Adequate financial requirements; net capital requirement above SEC minimum; all members contribute to Clearing Fund. - Measurement and management of credit exposures: Definitions of margins and clearing funds not consistent with international usage/practice and RCCPs glossary. - Margin requirements: NSCC relies on margins and clearing fund contributions; regular testing of participant exposures. - Financial resources: Liquidity can be increased by repoing securities in clearing fund, but repo arrangement is not a committed line in extreme markets. - Default procedures: Clearly stated in rules; U.S. legal framework provides high degree of assurance on enforceability. - Custody and investment risk: Assets highly concentrated in two major commercial banks; not all investments secured. - Operational risk: Contingency plans and backup facilities not tested and reviewed with participants (only connectivity tested with critical participants). - Money settlements: Relies on settlement agent to settle end-of-day funds in central bank money; does not have direct access to Federal Reserve accounts unless chartered as a bank or statutory changes occur. - Physical deliveries: Securities promptly redelivered through allocation algorithm. - Risks in links: Appropriate risk management procedures for links; MoU with Canadian authorities for the Canadian link. - Efficiency: Pricing cost-based and regularly reviewed; benchmark studies conducted. - Governance: Governance arrangements not sufficiently specified and transparent, including board composition and selection criteria. - Transparency: Regulations, rules, procedures, and annual audited financial statements publicly available; unaudited quarterly financials provided to participants. - Regulation and oversight: SEC has not formally required RCCP self-assessment; Federal Reserve lacks explicit legal mandate to oversee NSCC beyond affiliate examination. ### Actions to improve compliance (Table 3 — recommended actions) - Recommendation 3 (Credit exposures management): Align the definitions of margins and clearing funds with international standards. - Recommendation 5 (Financial resources): - Consider additional liquidity buffer to deal with extreme situations where repo arrangements cannot be used. - Consider conducting more frequently stress testing than once a month, in particular, in times of unusual market volatility. - Disclose stress testing assumptions to participants. - Recommendation 7 (Custody and investment risk): - Continue to monitor and mitigate potential risks from holding assets at only two commercial banks. - Avoid to the largest extent possible unsecured investments. - Recommendation 8 (Operational risk): Test and review NSCC’s backup sites to critical participants’ backup sites. - Recommendation 9 (Money settlements): Give NSCC access to central bank accounts and Fedwire Securities Services. - Recommendation 13 (Governance): NSCC’s governance arrangements should be more clearly specified and transparent, including criteria for the composition and selection of board members. - Recommendation 15 (Regulation and oversight): - SEC should formally require NSCC to perform a self-assessment based on RCCPs. - Ensure the compliance of the SEC rules with the RCCPs. - Provide legal mandate to the Federal Reserve to oversee NSCC, as a complement to the SEC regulation and supervision. ### Authorities’ response - U.S. authorities welcome the IMF’s assessment of the NSCC against the RCCP. - Authorities note the high degree of compliance of the NSCC with the RCCPs and will work with NSCC in considering the assessment’s specific comments and recommendations. *International Monetary Fund, FINANCIAL SECTOR ASSESSMENT PROGRAM, July 2010.* ### 1. The assessment of the Fedwire Securities Service (FSS), ### The assessment of the Fedwire Securities Service (FSS) ### Institutional and market structure — Overview - The Reserve Banks operate FSS on a consolidated basis through the Federal Reserve Bank of New York’s Wholesale Product Office (WPO). - The Reserve Banks, through FSS, act as the central securities depositories (CSD) for securities issued by the Treasury, federal agencies, government sponsored entities (GSE), and certain institutional organizations. - FSS is the key interbank settlement system for Fedwire-eligible securities. - FSS participants include depository institutions and certain other institutions, including U.S. branches and agencies of foreign banks. - Clearance and settlement functions are also performed by the FICC and the two clearing banks, JP Morgan Chase (JPMC) and Bank of New York Mellon (BoNY). - A large share of settlement of Government securities is internalized in the two clearing banks; no official figure is available on internalization. - The FSS is overseen by the Federal Reserve Board; the SEC and the Treasury provide relevant market perspectives. The SEC regulates many participants and the central counterparty (CCP). ### Key statistics of FSS (2007–09) - 1. Turnover (USD trillions): 435.6 (2007), 419.3 (2008), 295.7 (2009) - 2. Instructions processed (millions, total for the year): 24.2 (2007), 25.0 (2008), 21.1 (2009) - 3. Average daily value of transfers (USD trillions): 1.73 (2007), 1.66 (2008), 1.17 (2009) - 4. Peak daily value of securities settled (USD trillions): 2.60 (2007), 2.81 (2008), 2.55 (2009) - 5. Total value of securities held (USD trillions), of which: 43.18 (2007), 47.27 (2008), 52.58 (2009) - 5.1 Treasury securities: 4.54 (2007), 5.80 (2008), 7.27 (2009) - 5.2 Securities issues by federal agencies: 2.78 (2007), 3.12 (2008), 3.82 (2009) - 5.3 Securities issued by GSE: 35.81 (2007), 38.28 (2008), 40.41 (2009) - 6. Number of new issues (thousands): 98.4 (2007), 100.8 (2008), 74.5 (2009) - 7. Number of participants, of which: 7,500 (2007), 6,700 (2008), 6,300 (2009) - 7.1 Number of active participants: 2,645 (2007), 2,558 (2008), 2,566 (2009) ### Main findings — Legal framework (Rec. 1) - FSS activities are governed by a consistent set of laws, regulations, and contractual arrangements that form a sound legal foundation for clearing, settlement, and custody activities. - This legal framework is public and readily accessible to system participants. ### Main findings — Pre-settlement risk (Rec. 2–5) - Confirmation services for FSS eligible securities to direct participants that are cleared by CCP are provided by FICC. - FSS does not require settlement instructions to be matched prior to settlement. - Settlement cycle for FSS eligible securities is generally shorter than T+3, except mortgage backed securities (MBS) that settle on a monthly basis. - Costs/benefits of reducing the settlement cycle have been assessed; market participants considered establishing the CCP more appropriate than reducing the settlement cycle. ### Main findings — Settlement risk (Rec. 6–10) - Securities settled in FSS are issued on a dematerialized basis (except for a limited number that can be immobilized). - Transfer of ownership occurs when securities are transferred between participants within the system. - FSS enables delivery versus payment (DVP) on a real time basis. - Transfer of securities and cash occurs simultaneously and is final when securities and cash accounts are credited and debited. ### Main findings — Operational risk (Rec. 11) - FSS has procedures to identify and minimize operational risk in the settlement process. - Contingency plans and back-up facilities are regularly tested and maintained; business continuity plan accounts for dependence between FSS and Fedwire Funds. - A risk-based review of the IT system is conducted by independent external auditors. - Senior management regularly monitors operational reliability issues. ### Main findings — Custody risk (Rec. 12) - FSS operates an indirect holding system where securities (or interest in securities) are held for the sole benefit of the direct participants whose account has been credited. - Physical and technical controls and periodic audits ensure Reserve Banks records are accurate and customers’ securities are adequately managed. ### Main findings — Other issues (Rec. 13–19) - FSS access and exit criteria are publicly disclosed. - Some key market participants such as nonbank broker-dealers are not allowed access to FSS on the basis of non-risk related criteria. - Entities not physically present in the United States cannot access FSS, as they are not covered by U.S. banking supervision authorities. - Under the Monetary Control Act (1980), Federal Reserve Banks must recover direct and imputed costs as if a private firm offered the service. - FSS uses a proprietary message format translatable to/from international message standards; no switch to SWIFT or ISO standards is currently envisaged. - Participants are provided with sufficient information on FSS, including laws, regulations, rules, and procedures; self-assessments following RSSSs methodology are disclosed on the Federal Reserve website. - The Federal Reserve Board exercises oversight based on its supervisory responsibility for the Reserve Banks; the Government Accountability Office has legal power to audit FSS as a Treasury Agent. ### Summary of observance with CPSS-IOSCO recommendations (selected points) - Recommendation 2 (trade confirmation): FSS should explore an instructions matching mechanism prior to settlement. - Recommendation 3 (settlement cycles): Government bonds settle on T+1; MBS settle on fixed monthly dates — for compliance MBS should be settled no later than T+3. - Recommendation 4 (CCP): FICC-GSD acts as CCP for all FSS eligible securities except agency MBS; FICC has filed a proposed rule change with the SEC to allow FICC-MBSD to act as CCP for agency MBS. - Recommendation 5 (securities lending): FSS does not provide securities lending facility though a well-functioning market for securities lending exists in the United States. - Recommendation 6–8 (dematerialization and DVP): Vast majority are dematerialized; FSS enables DVP and real-time finality. - Recommendation 9 (risk controls): The Fed’s net debit caps set limits on intraday credit; the Fed provides uncollateralized intraday credit to expedite DVP settlement. - Recommendation 10 (settlement asset risk): High concentration in JPMC and BoNY; dealers heavily rely on intraday credit from these clearing banks; intraday credit is uncommitted but collateralized — failures could disrupt tri-party repo market and settlements. - Recommendation 11 (operational): FSS has adequate operational risk controls and contingency arrangements. - Recommendation 12 (custody): Physical/technical controls and audits minimize custody risk. - Recommendation 13 (governance): WPO advisory does not include smaller and midsize participant representatives; relies on feedback via the financial services website. - Recommendation 14 (access): Nonbank broker-dealers are ineligible to maintain Reserve Bank accounts, preventing settlement in central bank money; some infrastructures not chartered as banks cannot directly use FSS. - Recommendation 15 (efficiency): FSS operating hours are relatively short compared to other CSDs. - Recommendation 16 (communication): International communication procedures less relevant given participation restrictions; could become relevant if remote access allowed. - Recommendation 17 (information): Laws, regulations, system rules, and fees are part of contractual agreements and available on the Fed website. - Recommendation 18 (regulation and oversight): Legal basis for Federal Reserve Board’s supervision exists but is based on banking supervisory responsibility rather than explicit legal responsibility for clearing and settlement. - Recommendation 19 (cross-border links): No cross-border link in place because foreign CSDs without U.S. presence and banking license cannot open Fed accounts; Fed does not monitor indirect links involving major custodians in cross-border transfers of FSS eligible securities. ### Recommended action plan (selected recommendations and actions) - Recommendation 2: The FSS should explore the possibility of introducing an instructions matching mechanism prior to settlement. - Recommendation 3: MBS should be settled no later than T+3. - Recommendation 9: The Fed should continue to monitor residual risks from uncollateralized intraday credit and assess whether additional mitigation tools such as collateral are needed. - Recommendation 13: WPO should include representatives of smaller and midsize participants in its advisory group to ensure their needs and interests are taken into account. - Recommendation 14: The Federal Reserve should be given the legal authority to open accounts and provide services, at a minimum, for other payment, clearing and settlement infrastructures. - Recommendation 15: The Fed should re-assess the operating hours of FSS. - Recommendation 16: International standards could become relevant should remote access of other infrastructure be allowed; global co-operation calls for adoption of (or compatibility with) common global standards for major infrastructures. - Recommendation 18: The Fed should be provided the legal basis to oversee systemically important payment, clearing, and settlement infrastructures. - Recommendation 19: The Fed should consider monitoring the functioning of indirect links where major custodians are involved in cross-border transfers of FSS eligible securities between FSS and foreign CSDs. ### Authorities’ response to the assessment - U.S. authorities strongly support the FSAP program and welcome the independent review. - Authorities note high degree of compliance of the Fedwire securities service with the RSSSs and largely agree with the assessment’s comments and recommendations. - Authorities will explore introducing settlement instruction matching in the Fedwire securities service, considering associated costs and benefits. - Authorities will reassess the business case for extending FSS operating hours and seek ways to ensure needs of smaller and midsize participants are considered. - On rolling settlement for MBS, authorities agree in principle that reducing settlement period reduces settlement risk but emphasize careful study and consultation with market participants given instrument characteristics and trading practices; near-term risk reduction should focus on industry proposal to implement a CCP for MBS. - Regarding residual risks from intraday credit, authorities state a rigorous program for assessing, monitoring, and mitigating intraday credit risks is in place; they are strengthening the program and plan implementation of an explicit collateralization policy in late 2010 or early 2011. *Source: The assessment of the Fedwire Securities Service (FSS).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10250.pdf_