## _cr15170 ## Source details **Canonical URL:** [_cr15170](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15170.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15170.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15170.pdf.json) --- ### FSAP team and scope - FSAP team led by Aditya Narain (mission chief); deputy mission chiefs Martin Čihák and Simon Gray; team members listed from IMFMCM, IMFWHD, IMFLEG, and external experts; team worked under guidance of Christopher Towe. - Report draws on three Detailed Assessment Reports published on April 2, 2015 (Basel Core Principles for Effective Banking Supervision, IOSCO Principles, and IAIS Core Principles for Effective Insurance Supervision) and three Technical Notes (Review of the Key Attributes of Effective Resolution Regimes for the Banking and Insurance Sectors; Stress Testing; and Systemic Risk Oversight and Management). - United States deemed by the Fund to have a systemically important financial sector (Press Release No. 14/08, January 13, 2014); stability assessment is part of bilateral surveillance under Article IV. - FSAP scope: assesses stability of the financial system as a whole; excludes certain categories of risk—operational, legal, or fraud. ### Executive summary: high-level findings - Welcome steps taken: FSOC providing coordination; regulatory perimeter expanded; improved information sharing; supervisory stress testing; new resolution powers. - Critical need: complete rulemaking under the Dodd-Frank Act (DFA) and implement agreed measures to avoid rollback of reforms. - Regulatory landscape: remains fragmented with gaps, overlaps, and potential for delayed responses to emerging risks. - System structure: dominated by large and interconnected banks; increased risks in non-bank sector (run and redemption risks due to leverage, maturity transformation, and interconnected wholesale funding chains). - Insurance sector: increased market risk exposure; insurers could face negative equity in a downside scenario. - Priority policy focus: micro- and macroprudential frameworks; data collection; independent insurance regulation; updated bank supervisory guidance (concentration, operational, interest rate risks); completion of securities and derivatives rulemaking; enhanced asset manager supervision; full implementation of risk management standards for FMIs. - Crisis preparedness: responsibility needs clear definition; FSOC identified as the natural candidate. ### Steps taken and macroeconomic context - Since 2010 FSAP, important steps taken to restore macroeconomic and financial stability. - By 2011, economy recovered from one of the deepest recessions in the post-war period. - Staff projections: economy returning to potential in 2017. - Bank and insurance capitalization stronger; household balance sheets healthier; regulatory fault lines narrowed. ### Emerging vulnerabilities and risks - Low-interest rate environment driving search for yield; indicators warrant close attention: - Credit risk: measures improved overall; corporate-sector indicators less encouraging. - Corporate debt: large increases in new issues, particularly speculative-grade. - Asset valuation: risk spreads suggest overvaluation in some asset-market segments. - Market liquidity: declined according to some metrics; trading liquidity could be severely constrained in market disruption. - Equity prices: approaching levels that may be hard to sustain given profit forecasts and eventual interest-rate normalization. - Spillover risks: elevated due to close U.S. interconnections and asset price co-movements well above pre-crisis levels. ### Key recommendations (excerpted) - Macroprudential framework and policy: - Provide an explicit financial stability mandate to all FSOC member agencies [para 32]. - Include in FSOC Annual Report specific follow-up actions for each material threat identified [para 32]. - Publish current U.S. macroprudential toolkit and prioritize further development [para 33]. - Expedite heightened prudential standards for designated non-bank SIFIs [para 34]. - Improve data collection and address impediments to inter-agency data sharing [para 34]. - Regulation and supervision: - Give primacy to safety and soundness in supervisory objectives of Federal Banking Agencies [para 38]. - Strengthen banking supervisory framework; limit related party lending and concentration risk; update guidance for operational and interest rate risk [para 39]. - Set up an independent insurance regulatory body with nationwide responsibilities and authority [para 45]. - Implement principle-based valuation standard for life insurers consistently across the states [para 43]. - Develop and implement group supervision and group-level capital requirements for insurance companies [paras 42-43]. - Provide needed resources to the SEC and CFTC and enhance their funding stability [para 49]. - Increase examination coverage of asset managers [para 49]; introduce explicit risk management and internal control requirements for asset managers and commodity pool operators [para 47]. - Complete assessment of equity market structure and address regulatory gaps [para 48]. - Stress testing: - Conduct liquidity stress testing for banks and nonbanks regularly; run regular network analyses; link liquidity, solvency, and network analyses [para 30]. - Develop and perform regular insurance stress tests on a consolidated group-level basis [para 27]. - Develop and perform regular liquidity stress tests for the asset management industry [para 28]. - Market-based finance and systemic liquidity: - Change redemption structures for MFs to lessen incentives to run; move all MMMFs to variable NAVs [paras 53-54]. - Complete triparty repo reforms and measures to reduce run-risk, including possible use of a CCP [para 52]. - Enhance disclosures and regulatory reporting of securities lending [paras 56]. - Strengthen broker-dealer regulation, particularly liquidity and leverage regulations [para 55]. - Improve data availability across bilateral repo/triparty repo and securities lending markets [para 57]. - Liquidity backstops, crisis preparedness, and resolution: - Revamp the Primary Credit Facility as a monetary instrument [para 68]. - Enable the Fed to lend to solvent non-banks designated as systemically important [para 69]. - Assign formal crisis preparedness and management coordinating role to FSOC [para 72]. - Extend Orderly Liquidation Authority powers to cover systemically-important insurance companies and U.S. branches of foreign-owned banks [para 75–76]. - Adopt powers to support foreign resolution measures; extend preference to overseas depositors [para 75]. - Finalize recovery and resolution plans for SIFIs and agree cooperation agreements with overseas authorities [para 74]. - FMIs and housing finance: - Identify and manage system-wide risks related to interdependencies among FMIs, banks, and markets [para 59]. - Offer Fed accounts to designated FMUs to reduce dependencies on commercial bank services [para 60]. - Reinvigorate momentum for comprehensive housing market reform [para 64]. ### Institutional and operational priorities - Strengthen FSOC governance and mandate; include specific follow-up actions in FSOC Annual Report. - Improve data collection and inter-agency sharing to build a comprehensive view of systemic risks and interconnections. - Create an independent national insurance regulator to address gaps with international standards, including valuation and solvency weaknesses, and ensure consistency in regulation and supervision. - Update bank supervisory guidance on concentration, operational, and interest rate risk. - Complete securities and derivatives rulemaking and address market-functioning issues. - Enhance supervision of asset managers: explicit risk management/internal control requirements and structured industry-wide stress testing. - Fully implement risk management standards for Financial Market Infrastructures. *Prepared by Aditya Narain, Martin Čihák, and Simon Gray; June 2015.* --- ### Nonbank financial sector: size and risk profile - Nonbanks account for more than 70 percent of U.S. financial sector assets. - Increasing maturity and liquidity transformation occurring via managed funds. - Insurance companies, hedge funds, and other managed funds contribute to systemic risk disproportionate to their size. - Opacity concerns: leverage and other risks embedded in securities lending and cash reinvestment. ### Households and nonfinancial firms: pockets of weakness - Household debt declining since crisis onset; household net worth rose as share of disposable income, improvement concentrated in top two deciles. - Housing price indicators aligned with long-term trends. - Delinquency rates dropped, but student loans and auto loans worsening concerns. - Student loan debt trebled over past 10 years to some $1.2 trillion. - High student-debt burdens can limit mortgage access. - Nonfinancial corporate balance sheets more leveraged; debt-service capacity a concern for smaller firms. - 2014: record issuance for U.S. investment-grade corporate bonds and CLOs; near-record for high-yield corporate bonds. - Covenant-lite loans account for two-thirds of new leveraged loan issuance. - Second-lien loans at near-record issuance rates. - Rising leveraged buyouts and M&A activity remain a concern. ### Banks: progress in balance sheet repair - Banks: stronger capital positions, more liquid assets, lower leverage vs pre-crisis. - Net income almost doubled in recent years due to lower provisions. - Nonperforming loan ratio fell to just over 2 percent, half the 2010 peak. - Coverage ratio improved. - Return on assets and return on equity strengthened but remain below pre-crisis. - Financial cycle and credit-to-GDP gap indicators do not signal excessive leverage. - Market-implied capital shortfall measures suggest systemic bank risk declining towards pre-crisis average. ### Insurance companies: new risks emerging - Low interest rates prompting insurers to take on greater risks. - Industry consolidation; some firm exits and failures. - Insurers invested more in private equity, hedge funds, longer duration and lower credit corporate bonds, and real estate-related assets. - Some life insurers increased securities-lending and cash collateral reinvestment activities. - Large life insurance groups expanded nontraditional business and provide complex guarantees; exposed to macroeconomic risks. - Regulatory RBC breaches declined, but capital adequacy ratios hard to interpret due to valuation rules, regulatory arbitrage via captives, and lack of group-level regulatory capital measures. ### Asset management and market-based financing: maturity and liquidity transformation - Significant maturity and liquidity transformation in short-term wholesale funding markets outside banks; hard to measure. - Funding primarily from MMMFs and securities lenders reinvesting cash collateral; borrowing demand mainly broker-dealers and short-term corporate finance; much intermediated through repo markets. - Assets under management for mutual funds increased, especially in corporate HY and EM bonds and debt funds. - Evidence of intensifying herding among U.S. mutual funds, particularly in smaller less liquid and retail markets. - Mutual funds could amplify shocks via asset liquidation and direct exposures. - Open-ended mutual funds required to meet redemption demand in cash within 7 days; may be unable to do so under stress. - Cash and liquidity buffers limited for passive mutual funds by need to minimize tracking error. - Some investments moving to regulatory perimeter edges (separate accounts and trusts). ### ETFs and pensions: liquidity and interconnectedness risks - Rapid growth in fixed income ETFs specializing in EM and HY corporate debt and bank loans despite lower liquidity of underlying assets and limited market maker arbitrage incentives. - Defined benefit plans remain almost half of pension industry; about 20 percent of multi-employer pension funds are underfunded. - Pressure to improve returns could spur undue risk taking (direct credit exposure or via securities lending and cash reinvestment). - Transfer of pension risk to insurance industry (e.g., ‘longevity swaps’) increases system interconnectedness. ### Financial markets: stretched valuations and volatility vulnerability - Stock prices reached all-time highs in early 2015; Shiller’s cyclically-adjusted P/E about 1 standard deviation above historical norms. - Margin borrowing as a percentage of market capitalization higher than during 1990s bubble. - Search for yield compressed risk premiums across most fixed income classes. - Banks and nonbanks hold substantial domestic securities that could be subject to heightened volatility as monetary policy tightens. - MMMFs and sponsors historically provided support by lending or purchasing fund assets during stress. - Critical data limitations remain for understanding interconnectedness. ### Cross-border interconnectedness and spillovers - U.S. GSIBs account for 22 percent of total GSIB assets. - U.S. insurance market largest in world; premium volume accounts for a third of global market; three U.S. G-SIIs account for a third of total G-SII assets. - U.S. derivatives market represents one third of world market. - U.S. financial system core of global networks for banks, equity, debt markets, and price correlations. - Market-price based calculations: distress in U.S. system may strongly affect foreign institutions; "spillback" limited. - Cross-border examples: U.S. MMMFs cut European bank exposures during European sovereign crisis causing dollar shortages; ECB QE announcement impacted long-term U.S. yields. - Cross-border cooperation: progress in banking and securities (SEC and CFTC MMOU signatories); insurance cross-border coordination and crisis management early stage. - Outstanding issues: coordinating cross-border resolution complicated by depositor preference rules and potential ring-fencing; mutual recognition of CCPs and common approach on margin requirements unresolved. ### Stress tests: illustrating the fault lines - Exercises: top-down solvency tests for BHCs and insurance sectors; liquidity risk analysis for BHCs and mutual funds; market-price based stress tests. - System can withstand moderate interest-rate increases; "low-for-long" scenario more troublesome for financial stability—particularly life insurance—than orderly rate increases. - "Disorderly" interest rate increases could materially affect managed funds and life insurance companies. - Cross-sector spillovers amplify shocks across banks, insurers, and nonbanks. - Markets less able to manage swings in interest rates and liquidity due to combined factors. --- ### Stress test headline results (DFAST and staff tests) - All 31 BHCs have sufficient capital to absorb losses under a “severely adverse” scenario resembling the 2008–09 crisis — first time since 2009 that no firm fell below any key capital threshold. - Staff solvency stress tests largely align with DFAST but indicate potential strains that could impact economic recovery. ### Bank solvency findings and dynamics - System-wide CET1 ratio would fall by 2½ percentage points in the first year under staff solvency stress tests. - No BHCs would fall below hurdle rates in the first year, reflecting high capital positions. - Two BHCs would breach minimum capital requirement in 2016 and an additional eleven BHCs thereafter. - Total capital shortfall peaks in 2019 at equivalent of 1 percent of 2019 GDP. - Shortfalls largely reflect staff assumption of continued loan growth under adverse shock and impending regulatory threshold breaches—illustrating difficulty banks would face in contributing to recovery rather than systemic failure. ### Network and contagion analysis - Focused on six large BHCs accounting for some 50 percent of the banking system’s total assets (data limitations). - Contagion risks contained because direct exposures not large relative to initial capital levels. - Risk transfer mechanisms (e.g., credit default swaps) materially alter institutions’ risk profiles; need to expand data on such exposures. ### Liquidity risk analysis - Most BHCs now have sufficient liquid assets to meet a shock similar to 2008/2009 event. - A few BHCs would face liquidity pressures from deposit outflows in short run and large unused commitments over longer horizon. - Analysis used historical run-off rates and quarterly published data in absence of supervisory data. - If run-off rates similar to those in the LCR are used, liquid assets for many BHCs would be insufficient due to large withdrawal of wholesale funding. ### Insurance sector and nonbank financial institutions (stress tests) - Analysis covered 43 insurance groups but handicapped by data limitations (fragmented oversight, lack of consolidated views, complex valuation and business practices, absence of group-level risk-based capital). - Under “fully market-consistent” valuation in adverse scenario, 16 life insurers and 1 credit insurer fell into “distressed” levels. - On statutory-accounting basis, results appear more benign and align with top-down NAIC stress tests, but may mask economic impact. - Authorities encouraged to develop and perform insurance stress tests on a consolidated, group-level basis. ### Mutual funds and market liquidity stress tests - Covered some 9,000 mutual funds representing around 80 percent of the industry. - Measured whether severe redemption pressures forcing open-ended mutual funds to liquidate positions could be absorbed by market trading liquidity (compared assets sold with dealer inventory position data). - Results suggest municipal bonds and corporate bonds markets may face significant stress under such shocks. - Exercise preliminary; authorities encouraged to conduct regular top-down analysis to form holistic view of industry contribution to systemic risk. ### Market equity-price based stress tests and cross-sector spillovers - Baseline: estimated distress probabilities expected to remain stable or trend slightly downward to pre-crisis levels. - Stressed scenario: estimated distress probabilities expected to rise broadly commensurate with—but milder than—the increase in the 2008 financial crisis. - Severely adverse macroeconomic shock would significantly increase probability of distress across all U.S. financial system sectors. - Spillovers from the United States to the rest of the world can be large; spillbacks appear relatively modest. ### Sensitivity to interest rate increases (highlights) - Orderly increases: relatively small overall impact, but parts of system could be substantially affected if rates rise rapidly. - Life insurance: materially affected if rate hikes are “disorderly”; market value of long-duration bond portfolios would decline; statutory accounting delays recognition of asset shock impacts. - IMF staff calculations for 31 BHCs: a 4.5 percentage point increase in the 3-month Treasury yields would have only marginal impact on CET1 because higher losses largely offset by retained earnings and reduced asset growth (calculations exclude broader macroeconomic effects). - Small banks: more exposed to interest rate risk due to longer asset maturities and shorter liability maturities; interest rate risk in the banking book needs updating. - Managed funds: could face difficulties; redemption demand could jump with disorderly rate rise; leveraged borrowers and funds exposed to longer-term bond yields could suffer major losses. - Fed’s balance sheet: would be impacted by sharp increase in short-term rates and normalization of term yields as QE unwinds; staff judges Fed’s balance sheet robust to yield curve changes and implementation of monetary policy would not be affected. ### Data and methodological constraints (identified) - Insurance sector data limited by fragmentation, lack of consolidated global views, complex valuation practices, business complexity, and absence of group-level risk-based capital. - Banking supervisors constrained in sharing confidential supervisory information, limiting assessment of interconnectedness and liquidity and interest rate risks. - Network analysis and liquidity stress testing limited by data availability (absence of broad interbank exposures, supervisory run-off data). - Mutual funds dealer inventory and position data used, but exercise is preliminary. ### Recommended enhancements to stress testing and macroprudential framework - Collect interbank exposures for fuller sample of banks. - Conduct regular network analysis. - Reexamine solvency stress test assumptions for consistency with historical evidence. - Implement both solvency and liquidity stress tests for nonbanks (insurance companies, mutual funds, pension funds) and banks. - Link liquidity, solvency, and network analysis within systemic risk stress testing framework. - Examine spillover risks between nonbanks and banks. - Develop and implement “time-varying” macroprudential tools to address build-ups of financial stability pressures, including tools to strengthen market resilience to run risks and fire sales. - Complete final steps to implement the countercyclical buffer (application triggers); examine scope to alter risk weights on particular lending; consider macroprudential tools for real estate (varying maximum LTVs and DTI ratios). - Strengthen FSOC governance: explicit financial stability mandate to all FSOC member agencies; publish specific follow-up actions with timelines and responsible agencies; reinforce collective ownership of FSOC (appoint Chairs for each supporting staff committee and consult FSOC on major regulatory rules affecting financial stability). - Sustain initiatives addressing TBTF; finalize heightened standards for designated nonbanks; accelerate responses where progress slow (e.g., MMMF reforms). - Reduce impediments to interagency data sharing and expand systemic risk oversight of FMIs. --- ### Banking supervision: progress and persistent coordination challenges - Federal banking agencies (FBAs) increased supervisory intensity and achieve a high degree of compliance with international standards. - Risk management and stress testing practices markedly improved; comprehensive stress testing integrated into supervisory toolkit. - Resolvability planning exercises influencing banking organization complexity. - Challenges from multi-agency framework: - Substantial duplication of supervisory effort; contradictory rules/guidance can create uncertainty. - Recommendation: redefine FBAs’ mandates so safety and soundness are given primacy, leaving consumer protection to the CFPB. - Charter shopping persists; dual banking structure complicates international cooperation. - Enforcement actions not always coordinated with home supervisors. ### Supervisory framework gaps and risk coverage - Governance and risk management clarity: clearer delineation of board and senior management roles needed. - Concentration risk and large exposures: framework needs strengthening to cover market and other risk concentrations; gaps in large exposures and related parties framework. - Operational risk and interest rate risk: supervisory guidance disparate; interest rate risk in banking book lacks specific capital charges or Pillar 2 limits. - Capital adequacy and compensation: differences vis-à-vis Basel III remain; interagency compensation reform proposal pending. - Proportionate supervision: enhanced focus on large banks should not overlook small deposit takers; small banks with higher risk activities should adopt stronger governance and contingency planning. ### Insurance supervision: strengthening, fragmentation, and recommendations - Progress: state regulators (NAIC) initiated solvency modernization; FIO provides mechanism for national priorities; FRB’s extension to consolidated supervision should strengthen systemic oversight. - Remaining gaps: - Transition to principles-based regulation at state level slow. - ORSA introduction imparts wide-ranging supervisory and resourcing implications. - Variations in independence, accountability and funding across states; staffing and expertise challenges. - Valuation and solvency approaches could lead to regulatory arbitrage. - Valuation and group-level capital: - Recommendation: change valuation standard to reflect product economics; extend solvency regulation to groups. - Principles-Based Reserving (PBR) part of SMI; implementation date uncertain. - No group-level capital standards in place, including for three insurance groups designated by FSOC. - Affiliate captive reinsurance use creates uncertainty about group-level capital adequacy. - Fragmentation and institutional reform: - Regulatory system complex and fragmented; NAIC cannot enforce convergence; FIO lacks powers to bring convergence. - Recommendation: create insurance regulatory body with nationwide remit, sufficient resources, accountability, independence, and powers to establish national standards and ensure supervisory consistency. ### Securities and derivatives: improvements, resource needs, and market structure risks - Coverage expanded to OTC derivatives, hedge fund managers, and municipal advisors. - SEC limited direct authority over municipal securities issuer disclosure. - CFTC advanced in implementing OTC derivatives framework; shortcomings in CPO/CPO advisor frameworks. - Asset management: - No explicit risk management/internal control requirements for asset managers in securities or commodities markets. - SEC should enhance mechanisms for a holistic view on emerging/systemic risks; CFTC should improve swaps data quality. - SEC needs to increase asset manager examination coverage from current ~10 percent of investment advisers per year. - Market structure and high-speed trading: - Fragmented equity market structure and high-speed trading pose challenges for price discovery and data-feed timeliness; Equity Market Structure Advisory Committee established. - Resourcing: - CFTC needs more resources to discharge expanded mandate; self-funding or multiyear budgeting recommended for SEC and CFTC. ### Market-based finance and systemic liquidity: structural weaknesses and policy options - Shadow banking reduced from pre-crisis peak but remains important. - Tri-party repo (TPR) market: - Infrastructure improved: intra-day credit largely eliminated; clearing banks limited to funding maximum of 10 percent of dealer’s notional tri-party book via pre-committed lines (incurring capital charge). - Remaining concerns: resilience needs enhancement; reliance on two clearing banks; non-government assets in TPR not covered by some CCP proposals. - Recommendation: authorities consider addressing remaining weaknesses; TPR central to short-term funding and Fed operations. - Money market funds (MMMFs) and run risk: - MMMFs must meet redemptions within 7 days at NAV when request made. - Proposal: change settlement price to sales-date NAV and actual sale price (bid price) to reduce run risk. - Introduce Variable NAVs across all MMMF categories with changes to investment and redemption rules. - Even after 2016, stable NAVs may apply to over half the funds managed by MMMFs. - Limit MMMF repo lending to securities MMMFs are allowed to hold outright to reduce post-default run-risk. - From 2016, MMMFs may impose fees and redemption gates in stress; unclear how widely used and potential to exacerbate runs. - Broker-dealers, securities lending, and disclosure: - Capital and liquidity rules for broker-dealers should be enhanced; assets of those outside BHC/FRB perimeter increasing. - Regulations governing all broker-dealers should be introduced to address leverage and liquidity weaknesses. - Comprehensive disclosure requirements needed for funds’ securities lending activities. - Data limitations and initiatives: - Authorities recognize data gaps prevent consolidated assessment across repo and securities lending. - OFR, FRB, and SEC working on pilot surveys for bi-lateral repo and securities lending covering selected broker-dealers and agent lenders. - Complementary publishing of more granular TPR repo data recommended. ### Financial Market Infrastructures (FMIs): systemic importance and concentration risks - U.S. FMIs among largest globally; many are globally systemically important. - Participants include major G-SIBs, thousands of customers, correspondent banks, investment companies, nonfinancial corporations, domestic and foreign. - Multiple CCP memberships by U.S. banks further interlink U.S. and global systems. - Disruption of a critical U.S. FMI operation could have serious systemic implications. - Regulation and identification of system-wide risks: - DFA helps reduce FMI systemic risks, but implementation ongoing; complete rules for designated FMUs and enforce them promptly. - System-wide risks to analyze: dependency on few G-SIBs for banking services; bank membership in multiple FMIs; pro-cyclicality of margin calls; cross-margining arrangements. - Inclusion of FMIs in OFR network analysis recommended. - Central bank settlement and concentration of service provision: - Provision of Fed accounts to designated FMUs could reduce dependency on commercial banks by allowing settlement in central bank money. - Concentration of service provision by few G-SIBs poses potential threat; default of one could have system-wide repercussions. - Recommendation: Fed encouraged to provide accounts to designated FMUs as permitted by DFA. --- ### Central Counterparties (CCPs) — risk mitigation priorities - Increased systemic importance of CCPs necessitates further risk mitigation work. - Authorities encouraged to increase CCP robustness. - Key issues warranting attention: cyber resilience; standardized stress testing; harmonized margin requirements; implementation of recovery and resolution regimes; adequacy of CCPs’ loss absorbing capacity in resolution; continued coordination between CCP supervisors and main clearing members. ### Housing finance — findings and recommended reforms - Mortgage markets continue to benefit from significant government support. - Important steps taken: QM and QRM rules. - Largest unfinished business: Government-Sponsored Enterprises reform—no clarity on when Fannie Mae and Freddie Mac will exit conservatorship or consensus on reformed housing finance system. - Federal government backs 80 percent of new single-family home loan originations. - One in five loans originated is insured by the FHA, which falls short of capital requirements, creating fiscal and financial risks due to moral hazard, distorted competitive landscape, and large subsidies. - Systemic importance: - Home mortgages amount to about $10 trillion, largest component of nonfinancial private sector debt. - Most mortgages securitized, creating strong domestic and international interconnections. - System facilitates 30-year fixed-rate mortgages with no prepayment penalty—unusual internationally, not typically needed by borrowers (who nearly all refinance in under 10 years), and imposing unnecessary risks and complexity on financial system. - Key features recommended for future housing finance system: - Wind down Fannie Mae and Freddie Mac investment portfolios within well-defined time period and supervise commensurate with systemic importance in interim. - Leverage government role to support standardization and computerization of mortgage data. - Introduce sizeable first-loss risk borne by private capital, with a public backstop strictly limited to catastrophic losses and funded by risk-based guarantee fees. - Ensure appropriate incentives for loan originators and securitization chain participants, including ‘skin in the game’. - Clear separation of regulatory roles for promoting access to credit and ensuring stability and safety. - Reduce cross-subsidization and market distortion by charging separately and appropriately for prepayment of fixed-rate mortgages. ### Financial and market integrity; inclusion and consumer protection - Authorities engaged in international review of financial benchmarks and pledged to fight market abuse, including benchmark manipulation. - Exploring options for strengthening major interest rate benchmarks with private sector, including rates incorporating bank credit risks and risk-free rates. - FATF-related measures progressing slowly; draft regulations and policy intentions to strengthen beneficial ownership identification and verification are in progress but may not fully address deficiencies identified in FATF mutual evaluation report of June 2006. - Financial inclusion: Global Findex ranks United States 27th out of 147 countries for adults with bank account; 2013 FDIC survey: some 20 percent of U.S. households “underbanked” and 8 percent “unbanked”. - Recommendations: promote financial inclusion, identify barriers, enhance consumer protection (CFPB), and improve financial literacy (Financial Literacy and Education Commission activities welcome). ### Reinforcing safety nets and the resolution framework — Liquidity backstops, crisis preparedness, resolution, deposit insurance - Liquidity backstops: - Repackage Primary Credit Facility to clarify monetary/payments-system role to remove stigma and distinguish from Secondary Credit Facility. - Consider relaxing DFA restrictions on Fed’s ability to provide liquidity to designated nonbank institutions; DFA limits Fed support to programs/facilities with “broad-based eligibility.” - Remove technical obstacles to Fed providing liquidity backstops to designated FMUs; Fed support to designated FMUs should be discretionary and only to solvent/viable institutions against good collateral. - FHLBs doubled to some $1 trillion during crisis; regulators should review liquidity and capital requirements imposed on FHLBs given increased interconnectedness. - Crisis preparedness and management: - Agencies have enhanced preparedness but need formal system-wide arrangements; assign FSOC responsibility for system-wide coordination. - Existing inter-agency arrangements informal; coordinating work could be undertaken by FSOC committees under Council oversight. - Resolution: - Title II OLA provides resolution regime for “covered financial companies” with FDIC resolution powers; OLA powers align broadly with best practice. - FDIC published single point of entry strategy as option for resolving covered financial companies; use of TLAC recommended. - Challenges: resolving large, complex, cross-border firms requires group-level planning; many resolution plans had significant shortcomings per FRB and FDIC reports (August 2014 and March 2015). - Cross-border improvements needed: statutory powers to give prompt effect to foreign resolution actions; depositor preference rules and ring-fencing complicate coordination. - Coverage gaps: U.S. insurance companies cannot be resolved using full OLA powers; fragmented state-based resolution regimes lack tools for systemic entities; asset managers not subject to Title I planning requirements and may not be resolvable using OLA powers; FMIs resolution under discussion. - Deposit insurance: - DFA increased minimum reserve ratio for FDIC fund and removed hard cap. - FDIC Board set higher target at 2 percent of insured deposits—may not be reached before end of next decade on current plans. - Consideration to raise assessments as bank profitability recovers to reach target sooner. - Credit unions: separate fund with much lower paid-in amount; hard cap of 1.5 percent remains; recommendations: remove cap; target significantly higher paid-in funds; make membership mandatory for all credit unions. ### Appendix I — selected figures and charts (reported) - Home mortgages: some $10 trillion. - Federal government backs 80 percent of new single-family home loan originations. - FHA-insured share of new originations: one in five loans. - FDIC Board target reserve ratio for FDIC fund: 2 percent of insured deposits. - FHLBs funding increased to some $1 trillion during the crisis. - Global Findex ranking: United States 27th out of 147 countries for adults with a bank account. - FDIC 2013 survey: some 20 percent of U.S. households “underbanked” and 8 percent “unbanked”. *International Monetary Fund — UNITED STATES (excerpt from the Financial Sector Assessment).* --- *Source: _cr15170 — Financial Sector Assessment Program materials, FSAP team and IMF staff analysis as presented in the provided content unit._* ### 2015. The FSAP findings were discussed with the authorities ### 2015. The FSAP findings were discussed with the authorities ### FSAP team and scope - The FSAP team was led by Aditya Narain (mission chief), and comprised Martin Čihák and Simon Gray (deputy mission chiefs), Ana Carvajal, Marc Dobler, Dale Gray, Eija Holttinen, Benjamin Huston, Nigel Jenkinson, Darryl King, Ivo Krznar, Fabiana Melo, Nobuyasu Sugimoto, Jay Surti, Constant Verkoren, and Froukelien Wendt (all IMFMCM); Deniz Igan and Juan Solé (IMFWHD); Ross Leckow, Steve Dawe, Gianluca Esposito, and Alessandro Gullo (IMFLEG); Timo Broszeit, Philipp Keller, John Laker, Göran Lind, Masakazu Masujima, Lyndon Nelson, Till Redenz, Malcolm Rodgers, Christine Sampic, and Ian Tower (all external experts). The team worked under the guidance of Christopher Towe. - The report draws on three Detailed Assessment Reports published on April 2, 2015 (Basel Core Principles for Effective Banking Supervision, IOSCO Principles, and IAIS Core Principles for Effective Insurance Supervision), and three Technical Notes (Review of the Key Attributes of Effective Resolution Regimes for the Banking and Insurance Sectors; Stress Testing; and Systemic Risk Oversight and Management). - The United States is deemed by the Fund to have a systemically important financial sector (Press Release No. 14/08, January 13, 2014), and the stability assessment under this FSAP is part of bilateral surveillance under Article IV of the Fund’s Articles of Agreement. - FSAPs assess the stability of the financial system as a whole and not that of individual institutions. Certain categories of risk—operational, legal, or fraud—are not covered. ### Executive summary: high-level findings - Welcome steps taken to strengthen the financial system: FSOC providing coordination; expansion of regulatory perimeter; improved information sharing; supervisory stress testing; new resolution powers. - Critical need to complete rulemaking under the Dodd-Frank Act (DFA) and implement agreed measures to avoid rollback of reforms. - Regulatory landscape remains fragmented with gaps, overlaps, and potential for delayed responses to emerging risks. - System dominated by large and interconnected banks; increased risks in the non-bank sector (run and redemption risks due to leverage, maturity transformation, and interconnected wholesale funding chains). - Insurers have taken on greater market risk and could be faced with negative equity in a downside scenario. - Continued focus needed on micro- and macroprudential frameworks, data collection, independent insurance regulation, updated bank supervisory guidance (concentration, operational, interest rate risks), completion of securities and derivatives rulemaking, enhanced asset manager supervision, and full implementation of risk management standards for FMIs. - Responsibility for system-wide crisis preparedness and management needs clear definition; FSOC is the natural candidate. ### Steps taken and macroeconomic context - Since the 2010 FSAP, important steps were taken to restore macroeconomic and financial stability. - By 2011, the economy had recovered from one of the deepest recessions in the post-war period. - Staff projections have the economy returning to potential in 2017. - Bank and insurance capitalization is stronger; household balance sheets are healthier; progress on regulatory fault lines. ### Emerging vulnerabilities and risks - Although systemic risks have eased since the crisis peak, several indicators warrant close attention in the low-interest rate environment that drives a search for yield: - Credit risk measures improved overall, driven by strengthened bank fundamentals and declining household delinquency; corporate-sector indicators are less encouraging. - Large increases in new issues of corporate debt—particularly speculative-grade—have occurred. - Risk spreads suggest overvaluation in some asset-market segments. - Market liquidity has declined according to some metrics, raising concerns that trading liquidity could be severely constrained in the event of a market disruption. - Equity prices are approaching levels that may be hard to sustain given profit forecasts and an eventual interest-rate normalization. - Spillover risks remain elevated due to close U.S. interconnections with the global financial system and asset price co-movements well above pre-crisis levels. ### Key recommendations (excerpted from Table 1) - Macroprudential framework and policy: - Provide an explicit financial stability mandate to all FSOC member agencies [para 32]. - Include in FSOC Annual Report specific follow-up actions for each material threat identified [para 32]. - Publish the current U.S. macroprudential toolkit and prioritize further development [para 33]. - Expedite heightened prudential standards for designated non-bank SIFIs [para 34]. - Improve data collection, and address impediments to inter-agency data sharing [para 34]. - Regulation and supervision: - Give primacy to safety and soundness in the supervisory objectives of Federal Banking Agencies [para 38]. - Strengthen banking supervisory framework; limit related party lending and concentration risk; update guidance for operational and interest rate risk [para 39]. - Set up an independent insurance regulatory body with nationwide responsibilities and authority [para 45]. - Implement principle-based valuation standard for life insurers consistently across the states [para 43]. - Develop and implement group supervision and group-level capital requirements for insurance companies [paras 42-43]. - Provide needed resources to the SEC and CFTC and enhance their funding stability [para 49]. - Increase examination coverage of asset managers [para 49]. - Introduce explicit requirements on risk management and internal controls for asset managers and commodity pool operators [para 47]. - Complete the assessment of equity market structure and address regulatory gaps [para 48]. - Stress testing: - Conduct liquidity stress testing for banks and nonbanks on a regular basis; run regular network analyses; and link liquidity, solvency, and network analyses [para 30]. - Develop and perform regular insurance stress tests on a consolidated group-level basis [para 27]. - Develop and perform regular liquidity stress tests for the asset management industry [para 28]. - Market-based finance and systemic liquidity: - Change redemption structures for MFs to lessen incentives to run; move all MMMFs to variable NAVs [paras 53-54]. - Complete triparty repo reforms and measures to reduce run-risk, including the possible use of a CCP [para 52]. - Enhance disclosures and regulatory reporting of securities lending [paras 56]. - Strengthen broker-dealer regulation, in particular liquidity and leverage regulations [para 55]. - Improve data availability across bilateral repo/triparty repo and securities lending markets [para 57]. - Liquidity backstops, crisis preparedness, and resolution: - Revamp the Primary Credit Facility as a monetary instrument [para 68]. - Enable the Fed to lend to solvent non-banks that are designated as systemically important [para 69]. - Assign formal crisis preparedness and management coordinating role to FSOC [para 72]. - Extend the Orderly Liquidation Authority powers to cover systemically-important insurance companies and U.S. branches of foreign-owned banks [para 75–76]. - Adopt powers to support foreign resolution measures; extend preference to overseas depositors [para 75]. - Finalize recovery and resolution plans for SIFIs, agree cooperation agreements with overseas authorities [para 74]. - Financial market infrastructures (FMIs): - Identify and manage system-wide risks related to interdependencies among FMIs, banks, and markets [para 59]. - Offer Fed accounts to designated FMUs to reduce dependencies on commercial bank services [para 60]. - Housing finance: - Reinvigorate the momentum for comprehensive housing market reform [para 64]. ### Institutional and operational priorities - Strengthen FSOC: give member agencies an explicit financial stability mandate and include specific follow-up actions in the FSOC Annual Report. - Improve data collection and inter-agency sharing to build a comprehensive view of systemic risks and interconnections. - Create an independent national insurance regulator to address gaps with international standards, including valuation and solvency weaknesses, and ensure consistency in regulation and supervision. - Update bank supervisory guidance on concentration, operational, and interest rate risk. - Complete outstanding rulemaking in securities and derivatives and tackle emerging market-functioning issues. - Enhance supervision of asset managers, including explicit risk management/internal control requirements and structured industry-wide stress testing. - Fully implement risk management standards for Financial Market Infrastructures. *Prepared by Aditya Narain, Martin Čihák, and Simon Gray; June 2015.* ### 3. The locus of financial stability risks has moved to nonbank financial institutions and ### 3. The locus of financial stability risks has moved to nonbank financial institutions and markets ### Nonbank financial sector: size and risk profile - Nonbanks now account for more than 70 percent of U.S. financial sector assets. - Increasing maturity and liquidity transformation is taking place via managed funds. - Insurance companies, hedge funds, and other managed funds contribute to systemic risk in an amount that is disproportionate to their size. - Concerns about opacity of leverage and other risks embedded in securities lending and cash reinvestment. ### Households and nonfinancial firms: pockets of weakness - Household debt has been falling since the beginning of the crisis; household net worth has risen as a share of disposable income, with improvement concentrated in the top two deciles of the income distribution. - Housing price indicators are in line with their long-term trends. - Delinquency rates have dropped amid a stronger economy and job growth, but student loans and auto loans are more of a concern. - Student loan debt has trebled over the past 10 years to some $1.2 trillion. - High student-debt burdens can limit access to other forms of credit, such as mortgages. - Nonfinancial corporate balance sheets have become more leveraged; ability to cover debt service is a concern, especially for smaller firms. - 2014 was a record year of issuance for U.S. investment-grade corporate bonds and collateralized loan obligations (CLOs) and a near-record year for high-yield corporate bonds. - Covenant-lite loans now account for two-thirds of new leveraged loan issuance. - Other lower-standard loans, such as second-lien loans, are also at near-record issuance rates. - Rising leveraged buyouts and mergers and acquisitions activity remain a concern. ### Banks: progress in balance sheet repair - Banks have strengthened capital positions, hold more liquid assets, and are less levered compared to the pre-crisis period. - Net income has almost doubled in recent years, helped by lower provisions. - Nonperforming loan ratio has fallen to just over 2 percent, half the level at its peak in 2010. - Coverage ratio has improved. - Return on assets and return on equity have strengthened but remain lower than pre-crisis. - Financial cycle and credit-to-GDP gap indicators do not signal excessive leverage. - Measures of the banking system’s market-implied capital shortfall suggest systemic risk posed by banks is declining towards its pre-crisis average. ### Insurance companies: new risks emerging - Insurance companies, hurt by the prolonged period of low interest rates, are taking on greater risks. - Industry consolidation continues; some firms have exited the market and a few firms have failed. - Insurers have invested more in private equity, hedge funds, longer duration and lower credit corporate bonds, and real estate related assets. - Some life insurers have increased securities-lending and cash collateral reinvestment activities. - Large life insurance groups have expanded nontraditional business, provide complex guarantees, and remain exposed to macroeconomic risks. - Regulatory risk-based capital (RBC) requirements: breaches have declined since the crisis, but capital adequacy ratios are hard to interpret because of valuation rules, regulatory arbitrage via captives, and lack of regulatory capital adequacy measures at group level. ### Asset management and market-based financing: maturity and liquidity transformation - Maturity and liquidity transformation in short-term wholesale funding markets outside banks is substantial but hard to measure. - Funding primarily comes from Money Market Mutual Funds (MMMFs) and securities lenders reinvesting cash collateral; borrowing demand comes mostly from broker-dealers and short-term corporate finance; much is intermediated through the repo markets. - Assets under management for mutual funds have increased, especially in corporate high-yield (HY) and emerging market (EM) bonds and debt funds. - Evidence of intensifying herding behavior among U.S. mutual funds, particularly in smaller less liquid markets and in retail markets. - Mutual funds could amplify shocks through asset liquidation and through direct exposures (funds exiting risky assets and limiting funding to other system participants). - Open-ended mutual funds have a regulatory obligation to meet redemption demand in cash within 7 days, which at times of stress they may be unable to meet. - Cash and other liquidity buffers are limited, at least for passive mutual funds, by their need to minimize tracking error. - Some investments are moving to the edges of the regulatory perimeter, e.g., into separate accounts and trusts. ### ETFs and pensions: rising liquidity and interconnectedness risks - Growth in fixed income ETFs specializing in EM and HY corporate debt and bank loans has been rapid despite lower liquidity of underlying assets and limited arbitrage incentives of market makers. - Defined benefit plans still remain almost half of the pension industry; about 20 percent of multi-employer pension funds are underfunded. - Pressure to improve returns could spur undue risk taking (direct credit exposure or via securities lending and cash reinvestment). - Transfer of pension risk to the insurance industry (e.g., ‘longevity swaps’) increases interconnectedness of the system. ### Financial markets: stretched valuations and vulnerability to volatility - Stock prices reached all-time highs in early 2015; Shiller’s cyclically-adjusted P/E ratio suggests the stock market is around 1 standard deviation above historical norms. - Margin borrowing as a percentage of market capitalization is higher than during the 1990s stock market bubble. - The search for yield has compressed risk premiums across most fixed income classes. - Banks and nonbanks hold substantial domestic securities that could be subject to heightened volatility as monetary policy tightens. - MMMFs and their sponsors have in the past provided support by lending or purchasing fund assets, even if not formally obliged to do so. - There remain critical data limitations that the authorities need to address to improve understanding of interconnectedness. ### Cross-border interconnectedness and spillovers - U.S. GSIBs account for 22 percent of total GSIB assets. - The U.S. insurance market is the largest in the world with premium volume accounting for a third of the global market; the three U.S. G-SIIs account for a third of total G-SII assets. - The U.S. derivatives market represents one third of the world market. - The U.S. financial system is at the core of global networks for banks, equity markets, debt markets, and price correlations. - Market-price based calculations indicate distress in the U.S. financial system may have strong effects on distress in foreign financial institutions, while “spillback” is limited. - Examples of cross-border spillovers: U.S. MMMFs cut exposures to European banks during the European sovereign crisis, contributing to dollar shortages; ECB announcement of QE measurably impacted long-term U.S. yields. - Cross-border cooperation: progress in banking, securities regulators (SEC and CFTC) as MMOU signatories, but insurance cross-border coordination and crisis management are at an early stage. - Further efforts needed in coordinating cross-border resolution (complicated by depositor preference rules and potential ring-fencing of foreign-owned uninsured bank branches). - A solution for mutual recognition of CCPs and a common approach on margin requirements and other risk management requirements remains outstanding. ### Stress tests: illustrating the fault lines - FSAP team used stress tests to quantify potential impacts of risks and vulnerabilities in banks and nonbanks. - Exercises included top-down solvency tests for bank holding companies (BHCs) and insurance sectors, liquidity risk analysis for BHCs and mutual funds, and market-price based stress tests. - The exercise was informed by top-down stress tests performed by supervisors for BHCs and insurance companies, and bottom-up stress tests run by BHCs. - The system appears able to withstand moderate increases in interest rates (as expected in interest-rate normalization), but a “low-for-long” scenario is more troublesome for financial stability—particularly the life insurance sector—than orderly interest rate increases. - “Disorderly” interest rate increases could materially affect parts of the system, such as some managed funds and life insurance companies. - Cross-sector spillovers amplify effects of shocks: U.S. banks, insurers, and other non-bank financial institutions tend to be adversely affected by credit risk shocks originating in other domestic sectors. - A combination of factors has left markets less able to manage swings in interest rates and liquidity. *Source: IMF staff analysis as presented in the chapter "The locus of financial stability risks has moved to nonbank financial institutions and markets."* ### 22. The results of the 2015 supervisory and company-run stress tests (DFAST) required by ### _cr15170 - 22. The results of the 2015 supervisory and company-run stress tests (DFAST) required by ### Stress test headline results - All 31 BHCs have sufficient capital to absorb losses under a “severely adverse” scenario resembling the 2008–09 crisis — the first time since annual stress tests began in 2009 that no firm fell below any key capital threshold. - Staff solvency stress tests are largely in line with DFAST but indicate potential strains that could impact the economic recovery. ### Bank solvency findings and dynamics - System-wide CET1 ratio would fall by 2½ percentage points in the first year under the staff’s solvency stress tests. - No BHCs would fall below the hurdle rates in the first year, reflecting already high capital positions. - Two BHCs would breach the minimum capital requirement in 2016 and an additional eleven BHCs thereafter. - Total capital shortfall peaks in 2019 at the equivalent of 1 percent of 2019 GDP. - Shortfalls largely reflect the staff’s assumption of continued loan growth even under the adverse shock and impending breaches of regulatory thresholds — results illustrate difficulty banks would face in contributing to a recovery rather than indicating systemic failure. ### Network and contagion analysis - Exercise focused on six large BHCs, accounting for some 50 percent of the banking system’s total assets (due to data limitations). - Contagion risks among these institutions are contained because direct exposures are not large relative to their initial capital levels. - Risk transfer mechanisms, such as credit default swaps, materially alter institutions’ risk profiles, underscoring the need to expand data on such exposures. ### Liquidity risk analysis - Staff analysis suggests most BHCs now have sufficient liquid assets to meet a shock similar to the 2008/2009 event. - A few BHCs would face liquidity pressures from deposit outflows in the short run and large unused commitments over a longer horizon. - Analysis used historical run-off rates and quarterly published data in the absence of supervisory data. - If run-off rates similar to those in the LCR are used, liquid assets for many BHCs would be insufficient to meet liquidity needs due to large withdrawal of wholesale funding. ### Insurance sector and nonbank financial institutions - Analysis covered 43 insurance groups but was handicapped by data limitations (fragmented oversight, lack of consolidated global views, complex valuation and business practices, and absence of group-level risk-based capital). - Under a “fully market-consistent” valuation in the adverse scenario, 16 life insurers and 1 credit insurer fell into “distressed” levels. - On a statutory-accounting basis, results appear more benign and broadly align with top-down NAIC stress tests, but this masks economic impact. - Authorities are encouraged to develop and perform insurance stress tests on a consolidated, group-level basis. ### Mutual funds and market liquidity - Analysis covered some 9,000 mutual funds representing around 80 percent of the industry. - Measured whether severe redemption pressures forcing open-ended mutual funds to liquidate positions could be absorbed by market trading liquidity (compared assets sold with dealer inventory position data). - Results suggest municipal bonds and corporate bonds markets may face significant stress under such shocks. - Exercise is preliminary; authorities are encouraged to conduct regular top-down analysis to form a more holistic view of industry contribution to systemic risk. ### Market equity-price based stress tests and cross-sector spillovers - In active markets such as the U.S., market equity price based stress tests complement accounting-data based tests. - Baseline scenario: estimated distress probabilities expected to remain stable or trend slightly downward to pre-crisis levels. - Stressed scenario: estimated distress probabilities expected to rise broadly commensurate with—but milder than—the increase in the 2008 financial crisis. - A severely adverse macroeconomic shock would significantly increase probability of distress across all U.S. financial system sectors. - Cross-sector spillovers amplify shock effects: U.S. banks, insurers, and other non-bank financial institutions tend to be adversely affected by credit risk shocks originating in other domestic sectors. - Spillovers from the United States to the rest of the world can be large; spillbacks from the rest of the world appear to be relatively modest. ### Sensitivity to interest rate increases (Box 1 highlights) - Orderly increases in interest rates likely have a relatively small overall impact, but parts of the financial system could be substantially affected if rates rise rapidly. - Life insurance: materially affected if rate hikes are “disorderly”; market value of bond portfolios would decline (especially longer duration instruments); statutory accounting delays recognition of asset shock impacts. - IMF staff calculations for 31 BHCs suggest a 4.5 percentage point increase in the 3-month Treasury yields would have only a marginal impact on CET1 because higher losses would be largely offset by retained earnings and reduced growth rates of assets (calculations do not incorporate broader macroeconomic effects). - Small banks: more exposed to interest rate risk due to longer asset maturities and shorter liability maturities; interest rate risk in the banking book needs updating (see Appendix V). - Some managed funds could face difficulties: redemption demand could jump with a disorderly rise in rates; leveraged borrowers and funds exposed to longer-term bond yields could suffer major losses. - The Fed’s balance sheet would be impacted by a sharp increase in short-term rates and normalization of term yields as QE unwinds, but staff judges the Fed’s balance sheet robust to yield curve changes and implementation of monetary policy would not be affected. ### Identified data and methodological constraints - Insurance sector data limited by fragmentation between state and federal oversight, lack of consolidated global views, complex U.S. valuation practices, complexity of insurance business, and absence of group-level risk-based capital. - Banking supervisors were constrained in sharing confidential supervisory information, limiting assessment of interconnectedness and liquidity and interest rate risks. - Network analysis and liquidity stress testing limited by data availability (e.g., absence of broad interbank exposures, supervisory run-off data). - Mutual funds dealer inventory and position data used, but exercise is preliminary. ### Recommended enhancements to stress testing and macroprudential framework - Address data gaps by collecting interbank exposures for a fuller sample of banks. - Conduct regular network analysis. - Reexamine solvency stress test assumptions to ensure consistency with historical evidence. - Implement both solvency and liquidity stress tests for nonbanks (insurance companies, mutual funds, pension funds) as well as banks. - Link liquidity, solvency, and network analysis within a systemic risk stress testing framework. - Examine spillover risks between nonbanks and banks. - Develop and implement “time-varying” macroprudential tools to address build-ups of financial stability pressures, including tools to strengthen market resilience to run risks and fire sales. - Complete final steps to implement the countercyclical buffer (application triggers); examine scope to alter risk weights on particular lending; consider macroprudential tools for real estate (varying maximum LTVs and DTI ratios). - Strengthen FSOC governance: provide explicit financial stability mandate to all FSOC member agencies; publish specific follow-up actions with timelines and responsible agencies; reinforce collective ownership of FSOC (appoint Chairs for each supporting staff committee and consult FSOC on major regulatory rules affecting financial stability). - Sustain initiatives addressing TBTF, finalize heightened standards for designated nonbanks, and accelerate responses where progress has been slow (e.g., MMMF reforms). - Reduce impediments to interagency data sharing and expand systemic risk oversight of FMIs (identify and manage interdependencies and interconnections; complete and consistently implement FMI regulations). *Source: _cr15170 - 22. The results of the 2015 supervisory and company-run stress tests (DFAST) required by* ### 37. The federal banking agencies have improved considerably in effectiveness, and ### The federal banking agencies have improved considerably in effectiveness, and ### Banking supervision: progress and persistent coordination challenges - The federal banking agencies have stepped up their supervisory intensity and achieve a high degree of compliance with international standards (Table 2). - Risk management practices of banking organizations, including stress testing practices, have markedly improved; comprehensive stress testing has been integrated as part of the supervisory toolkit. - Resolvability planning exercises are beginning to influence the complexity of banking organization. - Challenges remain from a complex, multi-agency framework: - Substantial duplication of supervisory effort can result in uncertainty when rules or guidance appear contradictory. - Recommendation: redefine the federal banking agencies’ mandates so that safety and soundness are given primacy in their supervisory objectives, leaving consumer protection to the CFPB. - Charter shopping has not been eliminated; the dual banking structure poses a challenge for international cooperation. - Enforcement actions are not always coordinated with home supervisors. ### Supervisory framework gaps and risk coverage - Governance and risk management clarity: - A clearer delineation of the contribution of boards and senior management in supervisory assessments would aid efforts to improve risk management. - Concentration risk and large exposures: - The concentration risk framework needs to be strengthened to cover market and other risk concentrations. - There remain gaps in the large exposures and related parties framework. - Operational risk and interest rate risk: - Supervisory guidance and reporting requirements in operational risk are very disparate. - The approach to interest rate risk in the banking book is in marked contrast to other risks, with no specific capital charges or limits being set under Pillar 2. - Capital adequacy and compensation: - Differences vis-à-vis Basel III remain in the capital adequacy regime as pointed out by the Basel Committee’s Regulatory Consistency Assessment Program. - An interagency proposal on compensation reform has yet to take shape to supplement supervisory guidance. - Proportionate supervision: - Enhanced supervisory focus on large banks is welcome, but should not result in overlooking small deposit takers. - Supervisory expectations are tailored to be less strict for smaller, non-systemic banks; small banks with higher risk activities should be encouraged to adopt better practices in corporate governance, risk management, and contingency planning commensurate with their risk profile. ### Insurance supervision: strengthening, fragmentation, and recommendations - Progress: - The U.S. insurance supervision framework has been strengthened. State regulators—under the aegis of the NAIC—have initiated solvency modernization and steps to strengthen group and international supervision. - The newly established Federal Insurance Office (FIO) provides a mechanism for identifying national priorities for reform and development under the umbrella of the FSOC. - Extension of the FRB’s responsibilities to cover consolidated supervision of certain insurance groups should strengthen oversight of systemic risks. - Remaining gaps and risks: - Reforms remain a work in progress; transition to more principles-based regulation and risk-focused supervision at the state level is taking time and faces obstacles. - Increased emphasis on risk management through the introduction of an Own Risk and Solvency Assessment (ORSA) with wide-ranging implications for supervisory work and resourcing. - Differences in independence, accountability and funding of insurance supervisors across states, and variations in regulations and supervisory approaches. - The FRB’s supervisory approach to insurance groups still needs to strike out in its own direction. - Staffing regulation and supervision with appropriate skills and expertise is a continuing challenge. - The approach to valuation and solvency regulation could lead to regulatory arbitrage. - Valuation and group-level capital: - Recommendation: the valuation standard should be changed to reflect the economics of the products better, and solvency regulation extended to groups. - Principles-Based Reserving, part of the solvency modernization initiative, would mitigate some issues, but its implementation date is uncertain. - There are no group-level capital standards in place, whether supervised by states or the FRB, including for the three insurance groups designated by FSOC. - Active usage of affiliate captive reinsurers creates uncertainty whether capital adequacy is sufficient at the group level. - Fragmentation and institutional reform: - The regulatory system for insurance remains complex and fragmented; the NAIC cannot enforce convergence and FIO lacks powers to bring about convergence. - The extension of the FRB’s powers to insurance supervision of designated nonbank financial companies has added to challenges of achieving regulatory consistency. - FSOC’s mandate is focused on system-wide stability and its membership does not provide for sector-wide coverage of insurance on the same basis as others. - Recommendation: an insurance regulatory body with nation-wide remit is needed to deliver enhancements and greater regulatory and supervisory consistency; this agency would require sufficient resources, accountability, and independence, and would have the mandate and powers to establish national standards, ensure regulatory consistency, and coordinate supervisory actions. ### Securities and derivatives: improvements, resource needs, and market structure risks - Progress and remaining shortcomings: - The securities and derivatives regulatory and supervisory framework has improved considerably; the regulatory perimeter now covers OTC derivatives markets, hedge fund managers, and advisors in the municipal securities markets. - The SEC continues to have limited direct authority over disclosure by issuers of municipal securities. - The CFTC is well advanced in implementing the new OTC derivatives framework, but shortcomings exist in the framework for commodity pool operators (CPOs) and advisors in commodity markets; protection of investors in commodity pools could be enhanced. - Asset management and systemic risk monitoring: - Explicit requirements on risk management and internal controls do not yet apply to asset managers in either securities or commodities markets. - Monitoring asset management risks requires continued work on improving data availability and risk identification tools. - The SEC would benefit from enhancing mechanisms to ensure a holistic view on emerging and systemic risks; the CFTC should continue to work on improving the quality of swaps data. - Market structure and high-speed trading: - The SEC faces challenges with a fragmented equity market structure and significant use of automated, high-speed trading technology. - Issues to analyze include whether the degree of dark trading negatively impacts price discovery and market efficiency, and risks from differences in timeliness of data feeds. - The SEC recently established an Equity Market Structure Advisory Committee to advise on these issues. - Resourcing and coordination recommendations: - SEC needs to be equipped to significantly increase the number of asset manager examinations from the current coverage of only around 10 percent of investment advisers per year. - CFTC needs more resources to effectively discharge its expanded mandate, including supervision of FMIs, responding to cybersecurity risks, and investments in technology. - Self-funding or multiyear budgeting within the current budget framework would enhance agencies’ ability to decide priorities and plan longer term. - Enhanced coordination with other agencies and self-regulatory organizations can improve efficiencies under the current complex regulatory and supervisory arrangements. ### Market-based finance and systemic liquidity: structural weaknesses and policy options - Continued importance and remaining vulnerabilities: - Market-based financing (“shadow banking”) has reduced from its pre-crisis peak but continues to play a very important role in U.S. funding markets. - Its components were both sources and transmitters of shocks in the GFC; liquidity of these markets could be adversely impacted through microstructure or infrastructure issues. - Entity-based regulatory system complicates identifying, managing and regulating risks, increasing the importance of FSOC oversight and coordination. - Tri-party repo (TPR) market: - Underlying infrastructure has been improved: intra-day credit extended to collateral providers has been largely eliminated by modifying the settlement cycle and improving collateral allocation processes. - Clearing banks are now limited to funding a maximum of 10 percent of a dealer’s notional tri-party book through pre-committed lines (incurring a capital charge). - Remaining concerns: resilience needs enhancement to reduce firesale risk and reliance on the two clearing banks; proposals to use some form of CCP service for government-guaranteed securities do not cover non-government assets used in TPR, where most risk is involved. - Recommendation: authorities should consider how best to address remaining weaknesses; TPR is central not only to short-term funding markets, but to the Fed’s own operations with the market. - Money market funds (MMMFs) and run risk: - Recommendation: measures should be taken to reduce vulnerabilities of open-ended MFs to runs. - MMMFs have a regulatory obligation to meet redemption requests within 7 days, and to do so at the NAV prevailing when the request is made, rather than at the price at which shares or assets are sold. - Proposal: change settlement price to sales-date NAV instead of redemption-date NAV, and to actual sale price (the bid price) instead of mid-price, to reduce run risk by placing the cost of exit onto those redeeming shares. - The introduction of Variable Net Asset Values (NAVs) across all MMMF categories, together with changes to investment and redemption rules, would help address important structural weaknesses. - Even after 2016, stable NAVs may apply to over half the funds managed by MMMFs, allowing investors to treat these investments as cash-equivalent despite greater liquidity risks. - Limiting MMMF repo lending to securities that MMMFs are allowed to hold outright could reduce post-default run-risk by allowing for a gradual and orderly liquidation of securities; currently MMMFs would be required to sell such assets immediately, unless a no action letter is issued by the SEC. - Other changes to take effect from 2016 will allow MMMFs to impose fees and redemption gates in the event of stress, but it is unclear how widely these will be used or whether their potential use could even exacerbate run risks. - Broker-dealers, securities lending, and disclosure: - Capital and liquidity rules covering broker-dealers should be enhanced; major broker-dealers fall under BHCs and FRB consolidated supervision, but assets of those outside this perimeter have been increasing. - Regulations governing all broker-dealers should be introduced soon to address weaknesses revealed during the GFC, including in leverage and liquidity. - More needs to be done in securities lending and cash collateral reinvestment to ensure risks are properly appreciated and managed; comprehensive disclosure requirements should be placed on funds’ securities lending activities. - Data limitations and initiatives: - U.S. authorities recognize data limitations prevent consolidated assessment of trends and risks across repo and securities lending markets. - The OFR, the FRB, and the SEC are working on pilot surveys for bi-lateral repo and securities lending activities that cover a selection of broker-dealers and agent lenders. - These initiatives could be complemented by publishing more granular data on TPR repos. ### Financial Market Infrastructures (FMIs): systemic importance and concentration risks - Systemic importance and interconnections: - U.S. FMIs are among the largest in the world and many are globally systemically important. - Most global systemically important financial institutions are among their participants, representing thousands of customers, including correspondent banks, investment companies, and nonfinancial corporations, domestic and foreign. - Multiple memberships of U.S. banks in CCPs around the world further interlink the U.S. and global financial systems. - Disruption of critical operations at one of the U.S. FMIs could have serious systemic implications. - Regulation and identification of system-wide risks: - The DFA helps reduce systemic risks related to U.S. FMIs, but implementation is still in progress; it is important to promptly complete the rules applicable to designated FMUs and ensure their enforcement. - System-wide risks to be analyzed include (i) dependency of FMIs on banking services of only a few G-SIBs; (ii) membership of banks in multiple FMIs; (iii) pro-cyclicality of margin calls; and (iv) cross-margining arrangements. - Inclusion of FMIs in OFR network analysis efforts would improve understanding of exposures among financial firms and potential channels of contagion. - Central bank settlement and concentration of service provision: - Provision of Fed accounts to designated FMUs could reduce their dependency on commercial banks’ services by allowing settlement in central bank money. - Concentration of service provision by G-SIBs poses a potential threat to FMI stability; authorities are increasing the number of service providers but current system-wide concentration by only a very few G-SIBs means the default of one could have system-wide repercussions. - Recommendation: the Fed is encouraged to provide accounts to designated FMUs, as permitted by the DFA. *Source: IMF staff assessment text provided in the content unit.* ### 61. Given the increased systemic importance of CCPs, it is crucial to pursue work on ### _cr15170 - 61. Given the increased systemic importance of CCPs, it is crucial to pursue work on ### Central Counterparties (CCPs) — risk mitigation priorities - Given the increased systemic importance of CCPs, it is crucial to pursue work on further risk mitigation. - U.S. authorities are encouraged to continue efforts to increase the robustness of CCPs. - Issues warranting further attention: - cyber resilience; - standardized stress testing; - harmonized margin requirements; - implementation of recovery and resolution regimes; - the adequacy of CCPs’ loss absorbing capacity in resolution; - continued coordination between the supervisors of CCPs and their main clearing members. ### E. Housing Finance — findings and recommended reforms - Mortgage markets continue to benefit from significant government support. - Important steps taken: the QM and QRM rules. - Largest unfinished business: Government-Sponsored Enterprises reform—no clarity on when Fannie Mae and Freddie Mac will exit conservatorship or consensus on the shape of a reformed housing finance system. - Federal government backs 80 percent of new single-family home loan originations. - One in five loans originated is insured by the FHA, although it falls short of its capital requirements, creating fiscal and financial risks due to moral hazard, the distorted competitive landscape, and large subsidies for debt-financed homeownership. - Systemic importance of mortgage markets: - Home mortgages amount to about $10 trillion, the largest component of nonfinancial private sector debt; - Most mortgages are securitized, creating strong interconnections domestically and internationally; - The system facilitates continued provision of 30-year fixed-rate mortgages with no prepayment penalty—unusual by international practice, not needed by borrowers (who nearly all refinance in under 10 years), and imposing unnecessary risks and complexity on the financial system. - Key features recommended for a future housing finance system, with an appropriate role for and supervision of the private sector (including the resumption of Private Label Securitization): - Winding down the Fannie Mae and Freddie Mac investment portfolios within a well-defined time period and supervising them commensurate with their systemic importance in the interim; - Leveraging the government’s role in the market to support standardization and computerization of mortgage data; - Introduction of a sizeable first-loss risk borne by private capital, with a public backstop that is strictly limited to catastrophic losses and is funded by risk-based guarantee fees; - Ensuring the maintenance of appropriate incentives for loan originators and those involved in the securitization chain, including ‘skin in the game’; - Clear separation of regulatory roles for promoting access to credit and ensuring the stability and safety of the mortgage market; - Reduction in cross-subsidization and market distortion by charging separately and appropriately for prepayment of fixed-rate mortgages. ### F. Financial and Market Integrity - U.S. authorities have played a key role in the ongoing international review of financial benchmarks to reinforce market integrity and pledged to fight market abuse, including benchmark manipulation. - They are exploring options for strengthening major interest rate benchmarks with the private sector, including both rates incorporating bank credit risks and risk-free rates. - Work to strengthen financial integrity is underway, but more rapid progress is needed to enhance transparency. - Draft regulations produced to strengthen financial institutions’ obligations to identify and verify the identity of beneficial owners; - Policy intentions announced to improve the authorities’ access to information on the beneficial ownership and control of U.S. companies. - These measures are progressing slowly and may not fully address all deficiencies identified in the last Financial Action Task Force (FATF) mutual evaluation report of June 2006. - The lack of sufficient transparency may impact authorities’ effectiveness in identifying and prosecuting persons who commit money laundering using U.S. companies and trusts, including laundering associated with taxes evaded in the United States and abroad, by U.S. citizens and foreigners respectively, and to cooperate effectively with foreign counterparts. ### G. Financial Inclusion, Literacy, and Consumer Protection - Promoting greater financial inclusion should feature more prominently on the policy agenda. - The Global Findex survey ranks the United States 27th out of 147 countries in terms of the percentage of adults with a bank account in a formal financial institution. - A 2013 FDIC survey finds that some 20 percent of U.S. households are “underbanked” and 8 percent are “unbanked”. - More work is needed to identify barriers to inclusion. - Enhanced focus on consumer protection, including the setting up of the CFPB, is an important part of the crisis response and is beneficial for both financial stability and financial inclusion. - Improving financial literacy will support these goals; the activities of the Financial Literacy and Education Commission are welcome steps. ### Reinforcing safety nets and the resolution framework — A. Liquidity Backstops - The Primary Credit Facility could be repackaged to clarify that it is a monetary policy/payments system facility to remove the risk of stigma and distinguish it from the Secondary Credit Facility. - Primary Credit Facility: serves primarily to cover unanticipated end-of-day liquidity shortfalls. - Secondary Credit Facility: remains a short-term lender of last resort facility for (solvent) banks, involving regulatory intervention and a more penal interest rate. - Consideration should be given to relaxing DFA restrictions on the Fed’s ability to provide liquidity to designated nonbank institutions. - DFA strictly limits Fed support to programs or facilities with “broad-based eligibility,” which could constrain action to avoid or minimize contagion. - Authorities are encouraged to consider enabling the Fed to provide liquidity support—subject to appropriate conditionality—to solvent non-banks designated as systemic by the FSOC. - DFA permits the Fed to provide liquidity backstopping to designated FMUs; any technical obstacles to this should be removed. - Private sector backstops should be the first line of defense for any FMI; - Fed support to designated FMUs should be at its discretion and only to solvent and viable institutions, against good collateral. - The Federal Home Loan Banks (FHLBs) doubled to some $1 trillion as an important source of funding during the crisis. - FHLBs benefit from an implicit government guarantee and a super lien over the assets of borrowers; - Regulators should review the liquidity and capital requirements imposed on FHLBs given an apparent increase in interconnectedness between FHLBs and their members. ### B. Crisis Preparedness and Management - Agencies have taken steps to enhance crisis preparedness and management, but more formal arrangements should be established and the FSOC assigned responsibility for system-wide coordination. - The 2008–2009 crisis response was flexible but suffered from a lack of preparation in some respects. - Agencies have developed strategies for handling failure of individual systemic institutions, but there are no formal system-wide arrangements. - Existing inter-agency crisis preparation arrangements remain informal, risking that inter-linkages and gaps may not be fully covered systematically. - Coordinating work could be undertaken by one of the FSOC committees under the oversight of the Council. ### C. Resolution — progress and remaining challenges - The resolution regime for financial institutions has been significantly strengthened. - Title II (“Orderly Liquidation Authority”, OLA) of the DFA provides a new resolution regime for “covered financial companies”, granting resolution powers to the FDIC. - OLA powers are extensive, align broadly with best international practice, and reflect FDIC experience resolving banks. - The FDIC has published a top down or “single point of entry strategy” as one option for resolving covered financial companies and their groups using these powers—loss absorbing creditors would be bailed-in to recapitalize a bridge bank and capital and liquidity streamed down to entities within the group, including overseas. - Effectively resolving large, complex, cross-border financial firms entails significant challenges that warrant further attention. - Effective planning and significant group-level efforts are required to implement orderly resolution. - DFA requires certain financial companies to prepare plans for their orderly resolution under ordinary insolvency law, but agency reviews of the largest domestic banking groups’ and FBOs’ plans highlighted significant shortcomings. - FRB and FDIC reported in August 2014 and March 2015, respectively, that the plans failed to address significant structural and organizational impediments to orderly resolution—prompting further actions to improve resolvability. - Minimum levels of total loss absorbing capital (TLAC) need to be put in place, at the right levels in systemic groups, to enable effective resolution. - Further improvements needed on cross-border issues: - Critical aspects not in place include statutory powers to give prompt effect to actions taken by foreign resolution authorities. - Deposit preference rules under the Federal Deposit Insurance Act and ring-fencing of foreign-owned uninsured bank branches can complicate coordination by typically ranking U.S. creditors above those abroad. - Ongoing efforts: enhance resolution preparedness, coordinate institution-specific resolution strategies on a cross-border basis, finalize agreements for information-sharing before and during a crisis, and progress on effective group-wide resolution plans and enhancing resolvability. ### D. Coverage gaps in resolution regimes - Not all potentially systemic financial firms are subject to effective resolution regimes or planning. - U.S. insurance companies cannot be resolved using the full OLA powers and fragmented state-based resolution regimes lack important tools for dealing effectively with a systemic entity. - Some potentially systemic firms such as asset managers are not yet subject to DFA’s Title I resolution planning requirements and may not be resolvable effectively using OLA powers. - U.S. agencies are discussing how FMIs would be resolved in the event of a failure. ### D. Deposit Insurance — recent measures and recommendations - Welcome measures have been enacted to strengthen deposit insurance for banks. - Deposit insurance funds were substantially depleted during the crisis. - DFA increased the minimum reserve ratio for the FDIC fund and removed its hard cap. - The FDIC Board set a higher target at 2 percent of insured deposits—although on current plans this may not be reached before the end of the next decade. - Consideration should be given to raising assessments, as bank profitability recovers, to reach the target sooner. - Strengthening funding and coverage of deposit insurance for credit unions is recommended. - Credit unions have a separate fund with a much lower amount paid-in (the first one percent is structured as deposits from members), a hard cap of 1.5 percent remains, and membership is not compulsory. - With some credit unions potentially becoming systemic, there is a need to: - remove the cap; - target a significantly higher level of paid-in funds; - make membership mandatory for all credit unions. ### Appendix I. Financial System Profile — selected figures and charts (as reported) - Home mortgages: some $10 trillion. - Federal government backs 80 percent of new single-family home loan originations. - FHA-insured share of new originations: one in five loans. - FDIC Board target reserve ratio for FDIC fund: 2 percent of insured deposits. - FHLBs funding increased to some $1 trillion during the crisis. - Global Findex ranking: United States 27th out of 147 countries for adults with a bank account. - FDIC 2013 survey: some 20 percent of U.S. households “underbanked” and 8 percent “unbanked”. - Note: Charts and figures include time series and cross-country comparisons (Flow of Funds; Haver Analytics; FDIC; SNL; IMF staff calculations) showing financial system size, pension funds structure, number and distribution of banks, banks’ balance sheets and income statements, bank funding, money market funds and mutual funds, and shadow banking system metrics. *International Monetary Fund — UNITED STATES (excerpt from the Financial Sector Assessment).* ### Appendix Figure 7. Market-Based Financing: Evolution and Components ### Appendix Figure 7. Market-Based Financing: Evolution and Components ### Market structure and instrument composition (Figures 7–10) - Financial markets structure, by instruments (2006–2014q3) — instrument shares shown across years: Other; Mortgages; Mutual Fund Shares; Equities; Corporate and Foreign Bonds; Agency & GSE-backed Securities; Treasury Issues; Open-Market Paper; Fed Funds & Security Repos; MMF Shares Outstanding. - Debt Securities Market (billion US$) — series by instrument (2006–2014q3): Commercial paper; Treasury securities; Agency and GSE-backed securities; Municipal securities; Corporate and foreign securities; Holding companies; ABS Issuers; State and local government; GSEs; Government; Other; Finance companies; ROW; Non-financial corporates. - Mortgage market (billion of $US) — components include: GSEs and agency and GSE backed mortgage pools; Other; ABS issuers; Banks. - Source data: Federal Reserve (Flow of Funds data). ### Financial soundness indicators (Appendix II) - Data coverage: 2008–2014, in percent. - Source: IMF staff based on country authorities data. - Note: Financial soundness indicators methodology as per http://fsi.imf.org/fsitables.aspx. ### Stress testing approach and scenarios (Appendix III) - General approach: - Combined three broad approaches: Bottom-up; Top-down cross-check using balance sheet data; Top-down calculations using market-based data. - Used publicly available data as of September 2014; constrained by lack of granular supervisory data (interdependencies, contagion). - Stress testing guided by Risk Assessment Matrix (Appendix Table 2) and Stress Testing Matrix (Appendix Table 3). - Scenario design: - Considered a baseline and a “stressed” scenario. - Severely adverse scenario comparable to DFA “severely adverse scenario” and characterized by a typical post-war U.S. recession. - Scenario shock magnitudes (severely adverse/DFA-based): - Unemployment rate rose by 4 percentage points over a two-year period. - Real GDP was 4.5 percent lower than the baseline by the end of 2015 (GDP growth rates were negative for 5 quarters). - Equity prices fell by 60 percent in one year. - House prices declined by 25 percent over the first two years. - Corporate spreads rose by 330 basis points. - Mortgage rates increased by 80 basis points. - Baseline scenario informed by the Blue Chip Economic Consensus and broadly reflected the IMF‘s World Economic Outlook projections as of January 2015. - Note: DFA scenarios extended over a five-year horizon. ### Banking, insurance, mutual fund, and market coverage in stress tests - Banking tests: - Coverage: largest 31 Bank Holding Companies (BHCs), covering 85 percent of sector assets. - Tests included credit and liquidity risks under a tail risk scenario. - Data cut-off: publicly available, consolidated data as of September 2014. - Solvency tests assessed Basel III Common Equity Tier 1 ratios against a hurdle rate: regulatory minimum consistent with the Basel III transition schedule augmented by the capital conservation buffer and a capital surcharge for Globally Systemically Important Banks (GSIBs) phased in over the forecast period. - Insurance stress testing: - Coverage: 43 insurance groups (20 life, 16 property & casualty, 5 health insurance, and 2 credit and mortgage insurance). - Tests included adverse shocks to assets, liability-side shock impacting variable annuity writers, and major insurance shocks (catastrophes and pandemics). - Macroeconomic parameters aligned with DFA tests; simplifications made due to lower granularity of public data. - Data cut-off: end-2014. - Mutual fund stress testing: - Coverage: 9,000 mutual funds. - Range of adverse scenarios considered. - Data frequency: 2014q3; quarterly. - Market equity price–based network analysis and stress testing: - Coverage: 210 institutions (U.S. banks, insurers, NBFIs, asset managers, nonfinancial firms; foreign banks and insurers). - Scenarios taken from DFAST, extended using WEO. - Data frequency: 2014q3; daily. - IMF top-down (solvency) test: - Coverage: 31 Bank Holding Companies (6 systemic BHCs for network stress testing, covering some 50 percent of total BHC assets). - Scenarios taken from DFAST, extended using WEO; sensitivity analysis and network analysis. - Cut-off date: 2014q3; quarterly. ### Key methodological notes - Top-down cross-check used publicly available balance-sheet data; modeled effects of macroeconomic developments on financial institutions’ health; included single-factor shocks; considered firm-specific differences. - Network analysis based on a matrix of exposures among six large banks. - Market-based top-down methods derived estimated probabilities of default from equity market data; used systemic macro-financial stress test framework and contingent claims analysis (CCA) building on the 2010 U.S. FSAP. ### Risk Assessment Matrix (Appendix Table 2) — Selected entries and quantified impacts - 1. A surge in financial volatility - Likelihood: High - Expected impacts: Stress in credit markets (especially cov-lite loans); impaired trading liquidity for high yield issues; bond repricing could lead to a run on mutual funds; runs intensified by increased retail holdings (over the past five years, the share of credit instruments held by retail funds has increased substantially, to 37 percent of total credit holdings). - Quantified impact: High — "A 50 bps permanent increase in 10-year interest rates could subtract about ½ percent of GDP after two years." Runs from mutual funds can cause vicious feedback loops. - 2. Financial imbalances from protracted period of low interest rates - Likelihood: Medium - Expected impacts: Excess leverage, weaker underwriting standards, mispricing of risk; increased intermediation outside banking; purchases of riskier assets by asset managers. - Quantified impact: High — If unaddressed, distortions could lead to financial instability with significant economic costs and large spillovers. - 3. Operational risk (cyber, hardware/software failure, natural disaster) - Likelihood: Medium - Expected impacts: Disruption/destruction of critical infrastructure leading to sizeable financial system impacts. - Illustration: An event similar to the 1859 solar storm (estimated 12 percent likelihood in the next 10 years) could have cost estimates of 2 trillion dollars with power and satellite outages lasting for months. - 4. Protracted period of slower growth and lower inflation in advanced and emerging economies - Likelihood: High - Expected impacts: Weak demand, persistently low inflation, "new mediocre" growth; slower growth could subtract about ½ percent of GDP after two years. - Impact classification: Medium - 5. Political fragmentation erodes globalization - Likelihood: Medium - Expected impacts: Geopolitical tensions, higher oil prices; a sustained 15 percent increase in oil prices above baseline would subtract about 0.2 percent of GDP after two years. - Impact classification: Low - 6. Bond market stress from a reassessment in sovereign risk - Likelihood: Low - Expected impacts: Interest rate spikes from budget or borrowing-limit impasses; protracted failure on fiscal sustainability could raise risk premium and have severe global spillovers. - Quantified impact: High — "A 200bps increase in the benchmark Treasury yields would subtract 2.5 and 1.5 percentage points from U.S. growth in 2015 and 2016, respectively." ### Key regulations where implementation is ongoing (Appendix IV) - G-SIB surcharge for capital — Global Systemically Important Banks — Phased in 2016–19. - Capital conservation buffer — All banks on advanced approaches — Phased in between 2016-2019. - Countercyclical capital buffer — All banks on advanced approaches — Phased in 2016–19. - Supplementary leverage ratio — All banks on advanced approaches — Jan 2016. - Enhanced Supplementary leverage ratio — Global Systemically Important Banks — Jan 2018. - Liquidity Coverage Ratio — Full for banks on advanced approach; modified for smaller banks — Phased in 2015–2017. - Enhanced single counterparty exposure rules for systemic banks — To be decided — TBD. - Higher prudential standards for designated nonbanks — Designated nonbanks — Proposed standards to be promulgated. - Principles based reserving for Insurance firms (PBR) — Implementation subject to at least 42 states with more than 75 % of total US premium adopting. Status: 17 states have adopted and another 13 are planning legislation by 2015; still will cover only 60% of premium. Targeted for December 2015; date unlikely to be met. - Insurance based capital standards — The Insurance Capital Standards Clarification Act of 2014 passed to clarify that FRB can apply insurance-based capital standards to the insurance portion — No deadline proposed for rulemaking or implementation. - NAV amendments and fees and gate amendments for MMMFs — NAV amendments (institutional prime MMMFs); Fees and gates (all MMMFs except government funds) — October 2016. - Implementation of the CPSS IOSCO Principles for FMIs: CFTC ICE Clear Credit and Chicago Mercantile Exchange — Final rules issued in 2011 and 2013 — Implementation ongoing. - Implementation of the CPSS IOSCO Principles for FMIs: FRB TCH/CHIPS and CLS — Final rule to amend Regulation HH and Payment System Risk policy issued in 2014 — From December 2014, with a one-year transition period for a subset of requirements. - Implementation of the CPSS IOSCO Principles for FMIs: SEC DTC, NSCC, FICC and OCC — Proposed rules issued in 2014; public consultation finished — No deadline proposed for final rule. *Source: Federal Reserve (Flow of Funds data); IMF staff and U.S. FSAP materials as presented in the source content.* ### Appendix V. Report on the Observance of Standards and Codes ### Appendix V. Report on the Observance of Standards and Codes ### A. Introduction - Summarizes assessments of implementation of the Basel Core Principles for Effective Banking Supervision (BCP); the IOSCO Principles of Securities Regulation; and the IAIS Principles of Insurance Supervision in the United States. - Assessments completed as part of an FSAP undertaken by the IMF and reflect the regulatory and supervisory framework in place as of the date of the completion of the assessment in November 2014. - The full Detailed Assessment Report (DAR) was published on April 2, 2015 and details the Overview of the Institutional Setting and Market Structure and the Preconditions for Effective Banking Supervision. ### B. Basel Core Principles for Effective Banking Supervision — Information and Methodology - Assessment required review of the legal framework and detailed examination of policies and practices of institutions responsible for banking regulation and supervision. - Focused on the three FBAs as the main supervisors of the banking system; did not cover local State regulators, supervision of credit unions, or activities of the CFPB. - Assessment carried out using the Revised BCP Methodology issued by the BCBS in September 2012. - U.S. authorities chose to be assessed and rated against both Essential Criteria and Additional Criteria. - Assessment team reviewed laws, rules, guidance; held extensive meetings with U.S. officials and sector participants; authorities provided a self-assessment, detailed questionnaire responses, supervisory documents, staff and systems access. - Assessment team comprised John Laker, Göran Lind, and Lyndon Nelson; Fabiana Melo (IMF) coordinated assessment and drafting. ### Main Findings — Overview - The U.S. federal banking agencies (FBAs) have improved considerably in effectiveness since the previous FSAP. - Dodd-Frank Act (DFA) and other reforms led FBAs to increase supervisory intensity, especially for large banking organizations, emphasizing capital planning, stress testing, and corporate governance. - FBAs significantly increased staffing numbers and skills; improvements reflected in a high degree of compliance with the BCP in this assessment. - DFA rationalized some supervisory responsibilities but did not fundamentally address fragmentation in the U.S. financial regulatory structure. - Substantial duplication of supervisory effort exists, particularly for entities in major banking groups, and risk of inconsistent messages from agencies remains. - U.S. prudential regulatory regime is complex (federal statutes, regulations, reporting requirements, policy statements, supervisory guidance) and tiers of prudential requirements have added complexity. - Many BCP requirements are implemented via a principles-based supervisory approach, providing flexibility but also resulting in a lack of specificity (e.g., absence of guidelines or supervisory “triggers” for various risks). ### Mandate, Independence, and Cooperation (CP 1-3) - Multiple FBAs with distinct but overlapping responsibilities heighten the need for effective cooperation and collaboration. - Improvements in collaboration need to become fully engrained in each agency’s modus operandi. - Establishment of supervisory colleges and crisis management groups (CMGs) increased urgency of information-sharing; no legal impediments to FBAs cooperating with foreign supervisors. - Dual banking structure poses challenges for international cooperation; state banking agencies with Foreign Banking Organization (FBO) presence do not always inform or coordinate enforcement actions with home supervisors. - FBAs are operationally independent and have clear mandates for safety and soundness, but also have other objectives; primacy of safety and soundness objective should be better enshrined in legislation or mission statements. - Creation of a stand-alone Consumer Financial Protection Bureau (CFPB) should help delineate consumer and prudential issues, but delineation is not yet sharp. - No evidence of direct interference by industry and government in supervisory priorities or decisions; high public and congressional scrutiny may indirectly create perception of “cyclical” supervisory responses. ### Licensing, Permissible Activities, Transfer Ownership, and Major Acquisitions (CP 3-6) - Dual banking structure and charter choice add to cooperation and collaboration challenges across multiple agencies. - Banks may choose federal or state charters; state-chartered banks may be supervised primarily by the FDIC or primarily by the Federal Reserve as a member bank, in addition to state supervision. - Concerns about “regime shopping” that could undermine regulatory integrity. - DFA restricted ability of weak and troubled banks to change charters; charter conversions of well-rated banks and savings associations continue on a modest scale. - FBAs need to guard against perceptions of regional differences in supervisory style or treatment influencing charter conversion choices. ### Supervisory Approach, Processes and Reporting, and Sanctioning Powers (CP 8-10) - FBAs increased resources and supervisory intensity for largest firms; articulated a tiered approach built on asset-based thresholds for proportionality. - Shift toward more stress testing, analysis, and horizontal reviews in addition to traditional on-site examinations. - Supervisory regime is effective and risk-based with increasing focus on resolution for larger firms. - Scope to better prioritize matters requiring attention and to align supervisory planning cycles across agencies. - Regulatory reporting framework is long-established and flexible; safeguards exist to guard against redundant data and information overreach. - Supervisory data is not collected from banks at the solo level (i.e., at the level of the bank excluding its subsidiaries), which may limit ability to test stand-alone bank capitalization. - In practice, omission has little prudential significance under current circumstances as bank subsidiaries tend to be small relative to parents; supervisors should monitor developments and consider introducing solo reporting if subsidiaries expand. - FBAs have a wide range of supervisory actions and use them, although follow-up needs to be stricter. - Prompt Corrective Action (PCA) framework is main early intervention framework and has clear triggers. - Authorities could consider implementing rules for promoting early action for other triggers than bank capital and introduce more explicit rules/processes to deal with ageing of MRAs/MRIAs. ### Consolidated and Cross-Border Supervision (CP 12-13) - Major improvements since the 2010 FSAP in FBAs’ ability to implement a comprehensive framework for consolidated supervision. - Outstanding work remains on regulatory and supervisory rules, guidance, and a formal rating system for SLHCs, and on developing a capital rule for corporate and insurance company SLHCs. - Comprehensive framework exists for cooperation and information exchange between FBAs and foreign supervisory authorities, strengthened by supervisory colleges and CMGs. - Authorities should continue establishing agreements with foreign counterparts on communication frameworks, especially for crisis situations. - Some specific rules apply only to foreign institutions (e.g., shorter run-off period for foreign branches in liquid asset requirements; requirements on FBOs to set up intermediate U.S. holding companies). - National treatment principle underlies framework but some distinctions for foreign institutions remain. ### Corporate Governance (CP 14) - Major changes in supervisory demands on banks’ corporate governance and in banks’ approaches following the crisis. - Laws and regulations have raised requirements; heightened focus by boards and management on corporate governance. - Demands on board involvement and skills have increased, leading to changes in board composition and calls for wider director skill sets. - Supervisory expectations are tailored to be less strict for smaller, non-systemic banks; assessors judged shortfalls not sufficiently material to alter overall conclusions. - Supervisors encourage medium- and small-sized banks with higher risk activities to adopt better corporate governance and risk management practices appropriate to their risk profiles. ### Risk Management, Capital Adequacy, and Prudential Framework (CP 15-25) - Substantial improvements in banks’ risk management and in risk aggregation facilitated by stress testing requirements. - Achieving meaningful risk aggregation across Global Systemically Important Banks (GSIBs) remains work in progress and may take years. - Need better delineation in supervisory guidance of board vs. management responsibilities and more emphasis on contingency planning for smaller banks. - Strong commitment to stress testing; supervisory and firm-led stress testing still need improvements in scenario severity determination and data granularity. - Robust and comprehensive approach to capital adequacy, though U.S. capital regime is in transition. - FBAs implemented major elements of the Basel II advanced approaches from January 1, 2014. - U.S. standardized approach based on Basel II began to come into effect from January 1, 2015. - Broad adoption of the Basel III definition of capital, when applicable to most banks from January 1, 2015, will improve capital quality by limiting inclusion of certain intangibles. - Stress testing promotes a forward-looking approach to capital planning and board/senior management engagement. - Introduction of risk-based capital rules based on Basel standards for most savings and loan holding companies removes a prior anomaly, although a comprehensive capital framework for all savings and loan holding companies is not in place. - Differences remain between the new U.S. capital regime and Basel framework, notably absence of capital charge for operational risk and for Credit Value Adjustment (CVA) risk in the U.S. standardized approach. - Supervisory process for problem assets and provisions/reserves is long-established and rigorous; constrained historically by “incurred loss” approach of U.S. GAAP. - Introduction of FASB’s proposed Current Expected Loss Model (CELM) will permit more forward-looking provisioning. - Supervisory framework to guard against concentration risk and large exposures needs strengthening: - Effective supervisory framework for credit concentration risk exists; guidance issued and followed up in supervisory reviews. - New BCP methodology expands Core Principle to include market and other risk concentrations (asset classes, products, collateral, currencies); detailed supervisory framework for these other risk concentrations is not well developed. - Widening of large exposures definition under DFA brought thresholds more into line with BCP requirements, but anomalies and omissions remain (separate/additional limits for money market investments and security holdings; 50 percent limit on exposures to a corporate group is problematic). - Authorities encouraged to finalize the large exposures framework, with legal limits, for large bank holding companies and foreign banking organizations. - Gaps in related party exposure framework may heighten concentration risk: - No formal requirements for prior board approval of transactions with affiliates or write-offs of related party exposures exceeding specified amounts, or for ongoing board oversight of related party transactions and exceptions. - In practice, FBAs expect high board oversight and monitor affiliate/insider transactions in offsite and onsite examinations. - Statutes impose limits on bank exposures to affiliates and insiders that, with one exception, are at least as strict as single counterparty/group limits. - Exception: aggregate limit for lending to insiders of 100 percent of a bank’s capital and surplus (and 200 percent for smaller banks) — higher than prudent practices and a potential risk for depletion of own funds by insiders. - No formal limit framework for holding company transactions with affiliates or insiders; needed for comprehensive related-party regime. - U.S. “related party” regime does not appear as broad as required by this CP. - Interest Rate Risk in the Banking Book (IRRBB): - IRRBB approach contrasts with other key risks and could usefully be updated. - Market and liquidity risk regimes are tiered, comprehensive and robust; market risk would benefit from a de-minimis regime for all banks and liquidity risk from more granular and frequent reporting. - IRRBB has no tiering and is principles-based; no specific capital set aside and no supervisory limits. - Given the stage of the U.S. economic cycle, inherent interest rate exposure is high with particular concentrations in the small bank sector. - Updating 1996 guidance to include more quantitative guidance is merited to reduce inconsistency across the sector and over time. - Operational Risk: - Overall regime for operational risk outside AMA banks has not reached sufficient maturity. - No overall definition of operational risk or structured guidance on identification, management, mitigation for non-AMA banks. - Guidance for AMA banks (8 banks at time of assessment) is well specified; for others operational risk management is within general risk management and guidance is disparate. - Absence of a comprehensive reporting regime and no standardized capital charge for operational risk. - FBAs coordinating additional inter-agency guidance and identifying mitigation in vertical/horizontal reviews. - Cyber risk is a top priority across agencies and poses coordination and operational challenges. ### Controls, Audit, Accounting, Disclosure and Abuse of Financial Services (CP 26-29) - Internal audit function subject to greater supervisory attention and expectations significantly raised. - Little mention of the compliance function except in the context of Bank Secrecy Act (BSA) and Anti-Money Laundering (AML) regime. - Significant resources deployed by authorities and firms to meet BSA/AML standards; attention to other criminal abuse vulnerabilities (e.g., theft, burglary) is more disparate. - Regulatory framework did not include adequate identification of ultimate beneficiary owner of legal entity clients, or processes for dealing with domestic Politically Exposed Persons (PEPs) at the time of assessment. - No requirement for external auditors to report immediately directly to the supervisor if they identify matters of significant importance; mitigated by frequent contact between supervisors and auditors during planning and examinations. - Disclosure regime is best practice in some respects; public disclosure of supervisory call reports promotes market discipline. - Gaps remain: not all banks required to issue full financial standards reviewed by an independent accountant in accordance with independent audit requirements. - U.S. definition of “reporting on a solo basis” differs as it does not collect or disclose data on a “bank stand-alone basis.” *Source: Appendix V. Report on the Observance of Standards and Codes (assessment reflecting framework in place as of November 2014).* ### Appendix Table 4. Summary Compliance with the Basel Core Principles—ROSC ### Appendix Table 4. Summary Compliance with the Basel Core Principles—ROSC ### 1. Responsibilities, objectives and powers - DFA reforms rationalized responsibilities: dissolution of the OTS and establishment of a specialized, stand-alone consumer protection regulator. - Multiple regulators with distinct but overlapping mandates remain. - Further clarification needed in FBAs’ mission statements and division of responsibilities between the FBAs and the CFPB at the working level. - Assessors view: further work required to make the new supervisory structure more focused and effective. ### 2. Independence, accountability, resourcing and legal protection for supervisors - Since the crisis, FBAs strengthened accountability, transparency, and internal decision-making processes. - Further steps could be taken to assure the independence of the Federal Reserve’s supervisory role. - FBAs strengthened capacities through active hiring and training programs. - Challenge: retaining capacities as U.S. economic conditions improve and specialist skills become more attractive to industry. - Assessors encourage: keep hiring programs flexible and responsive, and keep training programs fully funded. ### 3. Cooperation and collaboration - Substantial effort since the crisis to improve cooperation and collaboration for targeted, comprehensive, timely consolidated supervision. - International cooperation could be further strengthened if state supervisory agencies consulted fully, in all cases, with the FBAs and foreign supervisors on impending enforcement actions. ### 4. Permissible activities - Well-established framework for defining permissible activities of banks and protecting the integrity of the term “bank”. - Not a specific FBA responsibility, but important that U.S. authorities monitor disclosure practices of “bank-like” institutions to ensure the community is well informed about the security of their savings. ### 5. Licensing criteria - Evaluation processes for banks seeking a national charter and access to the deposit insurance fund appear thorough and testing. - DFA gave statutory force to interagency initiatives addressing inappropriate regime shopping, but further guidance could be provided. - FBAs need to guard against perceptions of differences in supervisory style or intensity in regional offices that could sway banks’ choices on charter conversions. ### 6. Transfer of significant ownership - Comprehensive definitions for “controlling interest” consider quantitative and qualitative factors. - Clear rules for prior approval or notifications of changes in ownership; supervisors may deny improper changes or require reversal/remedial actions. - In practice, international practice of a five percent threshold for reporting significant shareholders is applied. - No explicit regulatory requirement for a bank to immediately report if a major shareholder is no longer suitable; assessors recommend introducing such a supervisory requirement (shortcoming to be addressed under CP 9). ### 7. Major acquisitions - Laws and regulations define acquisitions and investments requiring prior approval, after-the-fact notification, or general consent. - Clear criteria exist for authorities’ assessments; restrictions on scope of permissible investments and acquisitions (e.g., non-bank related activities). - Assessors saw evidence these rules and policies are applied in practice. ### 8. Supervisory approach - Regulatory system changing rapidly with broadened supervisory role and greater tiering (e.g. Banking Institutions with at least $50bn of Assets). - Net effect viewed as positive: supervisory regime is effective and risk-based with increasing focus on resolution for larger firms. - Agencies need to review communication approach with firms; system of supervisory issues requiring action (e.g. MRAs) needs simplification and ideally a common interagency approach. - Agencies should continue efforts on long-outstanding MRAs. ### 9. Supervisory techniques and tools - Agencies have an array of tools and are developing new techniques such as stress testing and horizontal reviews, altering balance of supervisory work. - Absence of formal reporting requirements for banks to inform supervisors of key changes is a weakness that could undermine monitoring and delay action. - Agencies should ensure clarity of objectives for horizontal reviews (absolute vs relative standards). - Communication with banks needs improvement: clarify key messages; avoid conflating roles and expectations of boards and senior management; balance feedback to avoid excessive praise or excessive historical reporting. - Agencies should align planning cycles to maximize joint working opportunities. ### 10. Supervisory reporting requirements and tools - FBAs have a long-established and effective regulatory reporting framework, with flexibility to expand reporting in response to supervisory needs. - With the crisis passed, FBAs encouraged to review granularity of data collected, particularly for stress testing and liquidity analysis. - FBAs do not collect data from banks at the solo level (i.e. at the level of the bank excluding its subsidiaries); assessors understand omission is not sufficiently material to warrant a lower rating for CP 12 under current circumstances. ### 11. Corrective and sanctioning powers of supervisors - Authorities recommended to consider implementing rules promoting early action for issues beyond capital and liquidity. - U.S. legislation, regulations, and processes for supervisory action are robust and have been strengthened. - Historically, escalation of supervisory measures sometimes took longer than appropriate; recent reduction in such cases due to clearer rules and stricter implementation. - Assessors recommend: continue progress, set more explicit rules for the ageing of MRAs and MRIAs, set timelines for completion of remedial actions, require regular reporting of progress. - Assessors encourage implementation of planned OCC guidance on supervisory practices relating to MRAs. ### 12. Consolidated supervision - Lack of full compliance based on: regulatory and supervisory rules, guidance, and a formal rating system for SLHCs have not been adopted; absence of a capital rule for corporate and insurance company SLHCs. - Capital standards not required at diversified financial group level under Basel capital framework (calculated at banking holding group and banking group levels). - Lack of an established supervisory assessment framework may hamper supervisors reviewing and taking action at SHLC level. - As noted in CP 10, FBAs do not collect data at the solo level; assessors satisfied omission has no prudential significance under current circumstances because U.S. bank subsidiaries tend to be small relative to the parent and can only undertake activities the bank could undertake in its own name. ### 13. Home-host relationships - Comprehensive framework for co-operation and information exchange between FBAs and foreign supervisory authorities, reflecting large cross-border activities. - Strengthening underway via supervisory colleges and CMGs. - Assessors encourage establishment of agreements with foreign counterparts on communication strategies, especially for crisis situations. - International cooperation could be strengthened if state supervisory agencies consulted fully, in all cases, with the FBAs and foreign supervisors on impending enforcement actions; assessors were made aware of circumstances where this did not occur. - Some specific rules apply to foreign institutions (e.g., shorter run-off period for foreign branches in liquidity, asset maintenance requirements for branches, requirements on large FBOs to set up intermediate U.S. holding companies). - BCP assessment mandate limited to prudential rules and supervision to ensure minimum safety and soundness; assessors find these rules aim to obtain that effect and do not assess level playing field issues. ### 14. Corporate governance - Major changes since 2008-09 in supervisors’ demands and banks’ approaches to corporate governance; laws and regulations have gradually raised requirements from a low level. - Strengthened expectations in: (i) Board involvement in setting risk appetite; (ii) establishment of Risk Management Committees; (iii) increased frequency of Board meetings. - Evidence seen in supervisory examination reports and supervisory actions. - Distinction between roles of boards and senior management was often unclear historically; many instances where “board and senior management” used where international practice would assign responsibility to only one. - Demands on board involvement and skills have increased, prompting changes in board composition and skill sets. - Stricter requirements primarily apply to large banks; “trickling down” to midsize and smaller banks expected but will take time. - Some key regulations (e.g., SR 12-17 by the FRB and Heightened Standards by the OCC) have only recently come into force and are not yet fully implemented; primarily refer to large banks. - Remaining shortfalls in requirements on roles and responsibilities of boards relative to international standards (see comments on CP 20 on Lending to related parties). - Requirements that banks inform supervisors promptly about material developments affecting fitness and propriety of Board directors or senior management are defined only for a narrow scope of events and should be broadened. ### 15. Risk management process - Substantial improvement observed in risk management processes, though from a low starting point. - Changes brought U.S. up to standard practice in other jurisdictions in areas such as frequency of board meetings, board composition, and existence of risk committees. - Risk aggregation has improved. - Risk oversight remains work in progress with much guidance new or yet to be implemented. - Guidance needed for Banking Institutions with less than $10bn of Assets as supervision of these fails to meet many aspects of essential criteria (but not sufficient to warrant material non-compliance). - Communication should place greater weight on the Board’s role and delineate it from senior management. - Aspects of Chief Risk Officer role, particularly regarding departures, need clarification. - Further work needed on firm-led stress tests where firms tend to stretch scenarios beyond credibility rather than examine appropriate loss levels for given shock severity. ### 16. Capital adequacy - FBAs have a robust and comprehensive approach to capital adequacy for banks and most holding companies; approach strengthened in response to Basel and DFA reforms. - Stress testing essential for capital adequacy assessments for banking organizations with more than $10 billion of assets. - Concerns from the 2010 DAO about quality of capital and coverage of most savings and loan holding companies addressed in the new regulatory capital rule; however, savings and loan holding companies with substantial insurance or commercial activities are excluded from the new rule. - Differences exist between the new capital rule and the Basel framework in definitions of capital, risk coverage, and calculation methods, warranting a “Largely Compliant” rating for this CP. - Risk-based capital requirements for internationally active banks under advanced approaches differ in a number of respects from the Basel framework. - U.S. standardized approach (the “floor”) does not impose a capital charge for operational risk or for CVA risk (and has divergences regarding standardized approach to market risk). - Omission in risk coverage may be significant for a broad segment of the banking system and makes the “standardized” floor less binding than it may appear. ### 17. Credit risk - U.S. approach to credit risk is exceptionally codified in regulation and guidance, reflecting supervisors’ emphasis on this risk. - Agencies do not set limits, but assessors found evidence that such limits exist within banks and that agencies would require limits and escalation criteria if absent. - Recommendation: consider the use of limits when guidelines are next reviewed. ### 18. Problem assets, provisions, and reserves - FBAs have a long-established and rigorous process for evaluating banks’ approaches to problem assets and maintenance of an adequate ALLL. - FBAs consistently challenge unrealistic bank ALLL estimates and secure necessary increases, taking enforcement action if required. - This approach will be tested as the U.S. economy improves. - Supervisory judgments are constrained by “incurred loss” requirements of U.S. GAAP, but proposed reforms will permit more forward-looking provisioning. ### 19. Concentration risk and large exposure limits - FBAs have a sound supervisory framework for dealing with credit concentration risk; guidance issued on specific areas and followed up in supervisory reviews. - Some reassessment warranted of supervisory force of thresholds for commercial real estate exposures. - Little evidence of a comparable supervisory framework and guidance for other risk concentrations, as EC 1 requires. - DFA widened definition of large exposures to include counterparty credit risk from derivatives and securities financing transactions, bringing large exposure thresholds more into line with BCP requirements. - Separate and additional limits for money market investments and security holdings available to banks (but not federal savings associations) leave open possibility of excessive risk concentrations. - The 50 per cent limit on exposures to a corporate group appears out of line with standard and the Federal Reserve’s proposed large exposures framework for large bank holding companies and foreign banking organizations. *IMF assessment: Appendix Table 4. Summary Compliance with the Basel Core Principles—ROSC* ### 20. Transactions with ### 20. Transactions with related parties ### Related party regime — findings - The “related party” regime in the U.S. regulatory framework does not appear as broad as required by this CP, in terms of the definition of covered transactions, affiliates and insiders. - The CP requires a higher degree of board involvement and oversight than presently required by U.S. laws and supervisory guidance. - There are no formal requirements for prior board approval of transactions with affiliated parties or the write-off of related party exposures exceeding specified amounts (as per EC3). - There are no formal requirements for board oversight of related party transactions and exceptions to policies, processes and limits on an ongoing basis (as per EC6). - The FBAs expect banks to apply a high degree of board oversight and monitoring of affiliate and insider transactions and review this as a matter of practice. - The aggregate limit for lending to insiders of 100 per cent of a bank’s capital and surplus (and 200 per cent for smaller banks) does not appear consistent with the general intent of this CP and creates the risk that a small group of insiders could deplete the own funds of a bank. - There are no regulated limits for holding company transactions with their affiliates or insiders. ### Country and transfer risks — findings and recommendation - A robust framework exists for regulation and assessment of country and transfer risks and for the allocation of loan loss reserves reflecting country and transfer risks. - The rules do not cover savings associations (noted as due to their tradition of having limited international exposures); assessors recommend introduction of a de minimis regime being applied to all categories of banks. - U.S. affiliates of foreign banks are not covered since they are expected to be under consolidated supervision from the home authorities; assessors find this acceptable provided there is good cooperation and information-sharing between the FBAs and relevant foreign supervisory authorities on country risk matters as well as consolidated supervision. - Country risk has not yet been specifically tested in the stress tests mandated by the FBAs. While covered on a case by case basis by banks’ internal stress testing, assessors recommend that guidance and rules on stress tests specifically include country risk. ### Market risk — findings - The Market Risk regime is comprehensive and understood. - Supervisors show very active engagement in implementing the regime and in dealing with material market risk issues such as valuation allowances and profit and loss attributions. - Appropriate use is made of peer-group comparison such as through Hypothetical Portfolio Exercises. - Material weaknesses identified in the 2009 BCP—such as market risk monitoring and management—have been significantly improved. - Supervisors have implemented much of the Basel II approach and supplemented that for banks subject to the Market Risk Rule, improving market risk measurement and monitoring processes and models at certain major firms. - The Stress Test Regime mandated under DFA has improved the completeness and use of market stress testing. ### Interest rate risk in the banking book — findings and recommendation - The assessors find the U.S. compliant. - The principles-based approach appears backed by adequate supervision proportionate to the size and complexity of the bank and the risk being run. - Assessors saw examples of supervisors applying guidance. - Given concentrations in small and community banks, the agencies’ approach would benefit from some tiering and should include quantitative guidelines to serve as a preventative indicator of supervisory risk appetite and a point of escalation. ### Liquidity risk — findings and recommendation - The Liquidity Risk Regime for banks below $50bn of Assets is quite high level; assessors saw numerous examples of supervisory action supporting the overall principle. - Current levels of reporting for these banks (for example in respect of encumbered assets) are inadequate with only one line in the Call Report. - Authorities recognize this deficiency and have proposed greater reporting depth as part of the implementation of the Liquidity Coverage Ratio. - Assessors did not see evidence of encumbrance being a particular concern, but liquidity issues were prominent in supervisory actions. - For Banking Institutions with at least $50bn of Assets and for those of Global Systemic Importance, the regime (mostly in Regulation YY) is comprehensive and robust and supported by extensive reporting. - Recommendation: extend efforts to develop an interagency approach to the implementation of LCR. ### Operational risk — findings and recommendations - Federal Agencies are placing increasing emphasis on operational risk, co-coordinating additional inter-agency guidance and identifying mitigation for vertical and horizontal issues. - Agencies are alert to changing threat landscape, including escalation of fines and cyber risks. - The overall regime has not reached a maturity level equivalent to market and credit risk. - Guidance for banks under AMA (only 8 banks at the time of assessment) is well specified; for other banks operational risk management falls within “general” risk management (see CP 15). - Guidance for other banks is disparate and compounded by the absence of a comprehensive reporting regime—only certain operational risks are covered by GLBA 501(b). - There is no standardized capital charge for operational risk. - The absence of a comprehensive reporting regime is a weakness given the scenario-based nature of operational risk assessment. - Agencies prioritize Cyber Risk and have FFIEC working groups, but coordination challenges remain across agencies and beyond. - Recommendations: introduce guidance on operational risk management and supervisory expectations applicable to non-AMA banks; introduce an appropriate reporting regime regarding operational risk. ### Internal control and audit — findings and recommendation - Federal Banking Agencies are raising the bar for control functions, notably Internal Audit. - Supervisors are finding Internal Audit issues classified as Matters Requiring Attention—at the OCC there were 405 outstanding at the time of this report. - Very little mention of Compliance except regarding the BSA and Anti-Money Laundering regime; vulnerabilities to other criminal abuse forms (e.g., fraud) are more disparate and risk being deemphasized. - Recommendation: authorities should seek an appropriate balance in surveillance and guidance, possibly by consolidating related guidance into fewer places. ### Financial reporting and external audit — findings and recommendations - Not all banks are required to issue full financial statements reviewed by an independent accountant in accordance with independent audit requirements. - There is no requirement for an external auditor to report immediately directly to the supervisor; reporting is through the bank should they identify matters of significant importance. - There is no comprehensive requirement (only an expectation) for non-public banks to rotate their external auditors. - The supervisor cannot set the scope of the external audit but could encourage the auditor, after the preliminary audit but before finalization, to include new issues. - Assessors recommend FBAs be given legal powers to add issues to the scope of the external audit in specific cases. - Recommendations: require all banks to issue full financial statements reviewed by an independent accountant; require external auditor to report immediately and directly to the supervisor on matters of significant importance; review supervisory powers to allow setting the scope of external audits; require non-public banks to rotate their external auditors. ### Disclosure and transparency — findings - No examples of disclosures covering ongoing developments during a financial reporting period, except for occasional analytical papers; most comprehensive published report periodicity is quarterly (call reports). - Authorities are encouraged to promote disclosure of such information where relevant. - FBAs do not collect data from banks at the solo level (i.e., at the level of the bank excluding its subsidiaries), meaning Basel III capital intended to be imposed on a bank both stand-alone and consolidated can only be tracked on the latter basis. - Assessors are satisfied in practice this omission has no prudential significance given U.S. bank subsidiaries tend to be small relative to the parent and limited in activities. ### Abuse of financial services / BSA/AML — findings and recommendations - Rules and supervisory expectations on BSA/AML issues are comprehensive; strong political and supervisory focus and significant resources deployed within authorities and banks. - For CP 29, further improvements recommended as assessors did not see evidence that legislative deficiencies were fully compensated in supervisory practice. - Supervisors should explicitly require (rather than “expect”) that a bank’s decision to enter into relationships with high-risk accounts and countries, including with foreign and domestic PEPs, be escalated to senior management. - Current legal and regulatory framework does not require identification of the ultimate beneficial owner of legal entity clients; proposed amendments open for public consultation will introduce requirements to address this deficiency and assessors welcome the proposed rule. ### Selected recommended actions (extracts relevant to this chapter) - Principle 20: - Introduce formal requirements for prior board approval of transactions with affiliated parties and the write-off of related party exposures exceeding specified amounts. - Introduce formal requirements for board oversight of related party transactions and exceptions to policies, processes and limits on an ongoing basis. - Review the aggregate limit for lending to insiders of 100 per cent of a bank’s capital and surplus (and 200 per cent for smaller banks). - Introduce limits for holding company transactions with their affiliates or insiders. - Amend the coverage and details of the “related party” regime to bring it into line with this CP. - Principle 21: - Introduce de minimis regime to be applied to all categories of banks, and include savings associations. - Introduce explicit reference to country risk in guidance and rules on stress tests guided by the authorities. - Principle 23: - Revise the 1996 guidance to include more quantitative guidelines regarding interest rate risk in the banking book. - Principle 25: - Introduce guidance on operational risk management and supervisory expectations applicable to non-AMA banks. - Introduce appropriate reporting regime regarding operational risk. - Principle 27: - Introduce requirements for all banks to issue full financial statements in accordance with agreed accounting standards that are reviewed by an independent accountant. - Introduce requirement for external auditor to report immediately directly to the supervisor on matters of significant importance. - Review supervisory powers to allow the supervisor to set the scope of the external audit. - Introduce a requirement for non-public banks to rotate their external auditors. - Principle 29: - Supervisors should explicitly require escalation to senior management for relationships with high-risk accounts and countries, including foreign and domestic PEPs. - Proposed amendments to require identification of the ultimate beneficiary owner of legal entity clients are welcomed. *Source: _cr15170 - 20. Transactions with (IMF FSAP assessment excerpt).* ### 2010. This is particularly noteworthy since, compared to the 2010 assessment, the federal banking ### _cr15170 - 2010. This is particularly noteworthy since, compared to the 2010 assessment, the federal banking ### Banking supervision assessment (comparison with 2010) - The federal banking agencies were assessed against four additional Core Principles for Effective Banking Supervision (29 total) and significantly more Essential Criteria and Additional Criteria compared to the 2010 assessment. - The revised Core Principles have a heightened focus on risk management, making the 2015 assessment more rigorous than the one completed in 2010. - The IMF’s assessment of the U.S. system broadly indicates compliance with the Core Principles even under the more stringent principles and a higher standard. - The Report notes the federal agencies’ approach is principles-based, while the assessment regime places a premium on specificity in regulations. - The Report recognizes global and domestic reforms since 2010, particularly the Dodd-Frank Act (DFA), have increased the intensity of supervisory programs and improved risk management and oversight of large bank organizations, including enhanced emphasis on capital planning, stress testing, and corporate governance. - The U.S. authorities acknowledge that some reforms are still pending and will take time to fully implement; additional implementation will further improve compliance with the Core Principles. ### Institutional mandate, mission clarity, and interagency coordination - The Report acknowledges federal banking agencies are operationally independent and have clear mandates for safety and soundness, but identifies: - duplicative efforts by the federal banking agencies, and - a lack of delineation between safety and soundness and other missions. - There is no formal statement that safety and soundness is the sole or primary mission of a federal banking agency, but no confusion exists among agencies, the public, or the industry that supervision and regulation focus on safety and soundness. - The U.S. authorities state responsibilities such as assuring compliance with consumer laws and accounting for financial stability considerations do not conflict with safety and soundness assessments; consumer compliance weaknesses present operational and reputational risk and are part of overall safety and soundness risk assessment. - In practice, clarity of mission exists; distinctions between prudential safety and soundness responsibilities and consumer protection responsibilities are shared between the Consumer Financial Protection Bureau (CFPB) and federal banking agencies. - Federal banking agencies have met DFA collaboration requirements and addressed duplicative efforts through coordination with each other and the CFPB, evidenced by interagency Memoranda of Understanding. ### Substantive supervisory actions by federal banking agencies (not fully reflected in the Report) - Establishing forward-looking stress testing requirements for banks with less than $10 billion in assets: - Banks with assets less than $10 billion are not required to complete formal DFA capital stress tests, but federal banking agencies require stress testing on certain high-risk and volatile activities, and all banks are expected to have appropriate capital planning processes. - Publishing federal banking agencies’ examination manuals and directors’ guides, and conducting outreach and training initiatives that articulate the responsibilities of boards of directors. - Issuing extensive guidance on business resumption planning, included in the Federal Financial Institutions Examinations Council’s booklets. - Requiring institutions with total assets of less than $500 million in certain instances to have an independent audit of their financial statements. - Applying stricter regime standards for affiliate transactions, including: - tighter U.S. quantitative limits of 10 percent of bank capital for transactions with a single affiliate and 20 percent of capital for the aggregate transactions with all bank affiliates, instead of 25 percent of the bank’s capital, - inclusion of asset purchases by a bank from affiliates in the 10/20 limit structure noted above, - prohibition on a bank having any unsecured credit exposure to an affiliate, - prohibition on a bank purchasing low-quality assets from an affiliate. ### Basel III and capital/liquidity standards (U.S. stance vs. Basel) - U.S. authorities meet many Basel III international standards and significantly exceed some, especially related to capital and liquidity: - Requiring the largest U.S. bank holding companies to have risk-based capital ratios that exceed Basel minimum capital requirements via the Federal Reserve’s Comprehensive Capital Analysis and Review and annual stress tests programs. - Utilizing a Global Systemic Important Bank surcharge to reflect short term wholesale funding, which increases banks’ capital conservation buffer. - Exceeding the Basel standard, the largest, most global, systemic U.S. bank holding companies must maintain a supplementary leverage ratio buffer greater than 2 percentage points above the 3 percent minimum, for a total of more than 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments. - Insured depository institution subsidiaries of these firms must maintain at least a 6 percent supplementary leverage ratio to be considered “well capitalized.” ### Dialogue and follow-up - U.S. authorities look forward to continuing dialogue with the IMF and global counterparts to promote the FSAP mission of enhancing global financial sector stability and supervisory practices. - The U.S. authorities will review the Report’s recommendations carefully and will take action, where permissible, on items that enhance communication and information sharing among the agencies and ensure more effective oversight of systemic risk. ### IOSCO Objectives and Principles of Securities Regulation — assessment basis and scope - Assessment conducted on the basis of the IOSCO Principles approved in 2010 and the Assessment Methodology adopted in 2011. - Principle 38 was not assessed due to separate standards for securities settlement systems and central counterparties. - A review of state-level regulatory and supervisory frameworks was outside the scope; given the relatively limited role of state regulation this did not materially affect the overall judgment of the U.S. regime. - The IOSCO Principles and Methodology do not specifically address over-the-counter (OTC) derivatives; adoption and implementation status of the U.S. OTC derivatives framework did not impact grades. ### IOSCO — institutional setting and supervisory architecture - Regulatory arrangements are complex, involving two federal agencies and several important SROs: - Two federal agencies: the SEC and the CFTC share primary responsibility for regulation and supervision of U.S. securities and derivatives markets: - The SEC: regulation and supervision of securities markets and single security based options, futures and swaps markets. - The CFTC: regulation and supervision of futures, options and swaps markets (except for narrow-based security indices). - The SEC’s and CFTC’s mandates significantly expanded as a result of DFA, including shared responsibility over swaps markets and bringing HF managers and municipal advisors under SEC jurisdiction. - State securities regulators retain responsibility for issuances conducted at the state level only; the role of state regulators has recently increased for smaller IAs. - SRO reliance and roles: - The CFTC and SEC rely significantly on SROs: exchanges, clearing organizations, and securities and futures associations. - Two registered associations with SRO functions: the Financial Industry Regulatory Authority (FINRA) and the National Futures Association (NFA). - FINRA has authority over BDs; NFA has authority over intermediaries in futures and swaps markets. - Membership in an SRO is mandatory for corresponding intermediaries, except IAs are not required to be members of any SRO. - FINRA has roles in market surveillance due to agreements with exchanges and for OTC trading; NFA is developing a similar role for some SEFs. - Enforcement: - Criminal enforcement is the responsibility of federal, state and local authorities. - The SEC and CFTC have significant administrative and civil enforcement powers. - Criminal prosecution is available by other U.S. authorities to pursue securities and derivatives market violations; federal, state and local prosecutorial authorities play active roles. ### IOSCO — main findings and challenges - Post-crisis, mandates of SEC and CFTC have significantly expanded; agencies have improved prudential requirements for some regulated entities, adopted increasingly forward-looking risk-based supervision, enhanced risk identification processes, and improved use of enforcement functions; improvements also observed at SROs. - Key challenge: the level of funding for both the SEC and CFTC affects their ability to deliver mandates and provide confidence to markets and investors: - Funding limitations have impacted timely delivery of new rules and implementation of registration programs for new categories of participants. - Number of expert staff in the SEC and CFTC is insufficient for robust hands-on supervision, notably for investment advisers (IAs). - Leveraging technology can mitigate but not replace the need for additional human resources. - Consideration recommended to make both agencies self-funded and allow multi-year budgeting. - Fragmented equity markets remain a key challenge for the SEC: - The SEC framework enhanced competition and best execution, but needs updating for evolved markets to ensure operational transparency and fair, objective access. - The SEC should be vigilant about the impact of dark trading on price formation; the Equity Market Structure Advisory Committee is an important step. - Agencies should strengthen ability to identify emerging and systemic risks; recommended increased involvement of the respective Commission (as a whole) in assessing and monitoring responses to risks to ensure a holistic view and enhance contribution to FSOC. ### IOSCO — principles assessments (summary) - Principles for the regulator: - SEC and CFTC are independent with clear mandates and sufficient powers (rulemaking, registration, examination, enforcement) and operate under high accountability with public transparency and strong ethics rules. - Agencies are increasingly forward-looking and risk-based, aiding FSOC contributions; however, resource constraints challenge effective discharge of expanded mandates. - Principles for self-regulation: - Strong reliance on SROs (FINRA, NFA) results in complex arrangements; SROs are subject to oversight including rule approval/notification and ongoing monitoring via reporting and examinations. - Principles for enforcement: - SEC and CFTC possess broad inspection and enforcement powers; extensive use of enforcement powers by agencies, SROs, and criminal authorities. - Robust supervisory programs are in place; programs are risk-based and generally ensure no entity goes without inspection for a long period, except for IAs where coverage is more limited. - Market surveillance primarily relies on SROs’ automated tools. - Principles for cooperation: - SEC and CFTC can share information and cooperate domestically and internationally; signatories to many MOUs including IOSCO (MMOU) and bilateral MOUs; no outside permission required to share or obtain information; access to financial records of individuals and small partnerships requires notifying the customer, with possible delay in certain circumstances. - Principles for issuers: - Public offering issuers, including asset-backed securities (ABS), are subject to strong disclosure at registration and periodically; municipal securities are exempt from registration and reporting requirements and SEC lacks authority to ensure compliance. - Reporting companies have significant freedom in structure and share classes but face strong disclosure obligations; limitations to shareholders’ rights must be disclosed. - Federal laws allow acquisition of control without a tender offer obligation; state corporate law features can create disincentives. - Reporting of insiders’ holdings, substantial holdings, and beneficial ownership is required; SEC actively monitors and enforces issuers’ disclosure obligations. - High quality accounting standards (U.S. GAAP) are set through an open, transparent process. - Principles for auditors, CRAs, and information service providers: - Auditors of reporting companies must be registered with the PCAOB; PCAOB has a credible examination program and audit standards are high quality. - PCAOB enforces compliance with audit standards; SEC can also exercise enforcement over auditors. - CRAs wishing their ratings used for regulatory purposes must register with the SEC as NRSROs; ratings are used for regulatory purposes by the SEC in limited cases, mainly MMMFs. - The SEC conducts NRSRO examinations on an annual basis. - BDs (securities) and FCMs, IBs, SDs and MSPs (derivatives) are subject to obligations on research analysis to manage conflicts of interest. - Principles for collective investment schemes: - IAs to MFs, and CPOs, are subject to registration with the SEC and CFTC focusing on integrity and disclosure rather than on human resources, financial capacity, and internal control/compliance arrangements. - MFs and commodity pools (CPs) subject to disclosure at registration and periodically. - Self-custody and related party custody of MF and CP assets allowed with additional safeguards for MFs. - MF and CP assets must be valued according to U.S. GAAP; MF and CP shares/units must be valued at net asset value (NAV), except MMMFs. - IAs to HFs are subject to registration requirements based on disclosure; organizational and operational conduct standards apply. - SEC conducts only limited examinations of IAs to MFs, though a presence examination program exists for newly registered IAs, including those managing HFs. - Principles for market intermediaries: - Registration regimes combined with SRO membership subject all categories of participants—except IAs and CTAs—to comprehensive eligibility criteria including integrity, capital requirements, and adequacy of internal controls. - All categories of intermediaries except IAs and CTAs are subject to capital requirements and periodic reporting of financial position and capital adequacy. - IAs and CTAs’ registration regimes are based on integrity criteria and disclosure; they are not permitted to hold client assets nor deal on behalf of customers, but may have discretion to make investment decisions. - Authorities are encouraged to consider more comprehensive internal control and risk management requirements for IAs due to their typically substantial assets under management. - Well-developed processes exist to deal with failure of intermediaries and have been applied in practice. - Principles for secondary markets: - Exchanges and Designated Contract Markets (DCMs) subject to detailed registration requirements. - Alternative Trading Systems (ATSs) are subject to SEC broker-dealer registration and FINRA membership processes plus SEC disclosure obligations; public information on ATS operations, subscribers and market models is limited. - Pre-and post-trade transparency requirements apply in securities and derivatives markets, but certain derogations may lead to suboptimal pre-trade transparency. - Authorities should review regulatory framework for bilateral trading systems, enhance ATS disclosure requirements, and analyze risks that pre-trade transparency of certain order types (including dark order types) may adversely impact price discovery. - Market abuse addressed by the Exchange Act and CEA with administrative, civil and criminal sanctions. - Open positions in commodity futures and options closely monitored by SROs and CFTC; position information in securities markets available through a DTCC service. - Default procedures apply in both clearing agencies and DCOs and are disclosed through their rules. - Short selling subject to disclosure and “locate” requirements; SEC and SROs monitor compliance. *Italic: Source — UNITED STATES, INTERNATIONAL MONETARY FUND (excerpts from the provided document).* ### Appendix Table 6. Summary Implementation of the IOSCO Principles ### Appendix Table 6. Summary Implementation of the IOSCO Principles ### Regulatory mandates, independence, powers and processes (Principles 1–4) - Principle 1: Mandates of the SEC and CFTC are stated by law; agencies interpret laws and publicly disclose interpretations, guidance and no action letters. CPO and CTA regimes may lead to different investor protection consequences than those applied to IAs. Agencies are legally required to consult and coordinate in specific areas and communicate regularly. In some areas single reporting or substituted compliance mechanisms and joint inspections have been established. - Principle 2: The SEC and CFTC are independent agencies separate from any office of the Government. Commissioners can be removed only for cause per judicial precedents. The Congressional budget approval process can materially affect agencies’ ability to decide priorities and long term planning. Agencies generally do not require approval or consultation to exercise functions. Strong accountability to Congress and the public, and judicial review of rules and regulatory decisions, exist. - Principle 3: The SEC and CFTC have powers for rulemaking, registration, examination, investigation and enforcement. Agencies have recruited staff with diverse skill-sets. Current funding levels pose challenges for proper discharge of functions given expanded mandates. - Principle 4: Requirements for provision of regulated activities are available on agencies’ websites. Rulemaking requires public consultation and cost analysis. Agencies also use roundtables. Regulatory decisions are subject to due process, including notice of proposed decisions, opportunity to be heard, and judicial review. ### Professional standards, confidentiality, and ethics (Principle 5) - Principle 5: SEC and CFTC staff bound by general government ethics rules and agency-specific ethics rules addressing holding and trading securities and commodities. Both agencies subject to strict confidentiality rules and have mechanisms to monitor potential breaches. ### Monitoring systemic risk and regulatory perimeter (Principles 6–7) - Principle 6: Supervisory programs across divisions monitor entities, products and markets to identify emerging and systemic risks. SEC holds regular division and Commissioner meetings; CFTC staff hold informal and weekly closed door surveillance meetings with the Commission. Both agencies have improved data collection and analysis, but enhancements are needed, particularly on asset management and swaps data. Chairs participate as voting members at the FSOC and staff in subcommittees. - Principle 7: Processes exist to review the regulatory perimeter—both sector/product-specific reviews driven by supervisory findings, market events or law, and holistic reviews via five year strategic plans. Actions include supervisory actions, guidance or new rules, and proposals to change legal frameworks. ### Conflicts of interest, SRO oversight, and supervision (Principles 8–12) - Principle 8: Issuer conflicts addressed by strong disclosure obligations, including related party transactions; extensive disclosure for ABS. New asset level disclosure and retention requirements will become effective over the next two years. Regulated entities’ regime relies on prohibitions, management and disclosure of conflicts. Compliance monitored primarily through supervisory programs. - Principle 9: Extensive reliance on SROs (exchanges, DCMs, FINRA, NFA) for supervision of intermediaries and market surveillance. All SROs subject to SEC or CFTC ongoing oversight including rule approval/notification, reporting requirements, and risk-based on-site examinations. - Principle 10: SEC and CFTC have broad inspection, information and investigative powers and conduct market surveillance. CFTC and NFA conduct front line surveillance for markets under their jurisdiction; for securities markets the SEC and SROs cooperate on surveillance. - Principle 11: Robust enforcement powers including subpoena powers, administrative and civil proceedings, referral to criminal authorities. Sanctions include monetary penalties and disgorgement; for the CFTC, restitution is also available. - Principle 12: Robust supervisory programs and risk-based examinations; most entities covered so none goes unexamined for long, but IA examination coverage is limited. Market surveillance for derivatives is by DCMs and CFTC; for securities, exchanges and FINRA are front line. SEC has improved enforcement (case management, admissions in settlements, specialized units and task forces). ### Information sharing and international cooperation (Principles 13–15) - Principle 13: Subject to legal requirements, SEC and CFTC can share information with domestic and foreign authorities without external approval. RFPA-covered financial records require customer notification; delaying notice possible in certain circumstances. IOSCO MMOU requirement on prior consultation before notifying customer is followed. - Principle 14: SEC and CFTC are signatories to the IOSCO MMOU, have domestic MOUs, bilateral MOUs, and use ad hoc arrangements and access request letters when MOUs are insufficient. Both have responded to significant numbers of information requests from foreign authorities. - Principle 15: Agencies have assisted foreign authorities by using powers to obtain and compel documents and testimony. ### Issuer disclosure, shareholder rights, accounting and auditor oversight (Principles 16–21) - Principle 16: Issuers subject to strong initial and periodic disclosure obligations: annual reports with audited statements, quarterly reports, and material event disclosure. Municipal securities are exempt from registration and reporting; SEC lacks direct authority to ensure municipal issuer compliance except via antifraud enforcement. Statutory thresholds for suspension of periodic reporting are high. SEC actively monitors issuer disclosure compliance. - Principle 17: Companies have freedom in corporate structure and classes of shares; reporting issuers must disclose shareholder rights in prospectus. Strong fiduciary duties and private rights in courts. Federal laws allow acquisition of control without triggering tender offer obligations. Reporting of insiders’ holdings, substantial holdings (over 10 percent), and most beneficial owners is required within stipulated deadlines. - Principle 18: Reporting issuers must prepare financial statements under U.S. GAAP (considered high quality). Foreign issuers can use IFRS or other standards with reconciliation. FASB sets U.S. GAAP, overseen by FAF. FASB funding via fees assessed against issuers. Standard-setting process is open and actively monitored by SEC. SEC examines financial statements for U.S. GAAP compliance and has a specialized accounting/financial fraud task force. - Principle 19: Auditors of reporting companies must register with the PCAOB, created by law as a non-profit corporation under SEC oversight. PCAOB composed of five members selected by the SEC, including two CPAs, all full time and independent from the audit profession. PCAOB funded by fees assessed to issuers, BDs, and other registrants. PCAOB inspection program frequency depends on number of issuers audited; PCAOB can remediate deficiencies and impose enforcement actions; SEC enforcement complements PCAOB. - Principle 20: SEC rules on auditor independence address financial relations, self-interest, advocacy, familiarity, intimidation, non-audit services, and rotation of lead auditor every five years. PCAOB requires audit firms to have quality control systems assuring independence in fact and appearance. Audit committees oversee selection and work of audit firms. PCAOB inspections and enforcement, plus SEC actions, monitor compliance. - Principle 21: Audit standards set by PCAOB are of high quality; standard setting involves public consultation. PCAOB inspection and enforcement programs, with SEC enforcement, monitor compliance. ### Oversight of credit rating agencies and analytical services (Principles 22–23) - Principle 22: U.S. or foreign CRAs wishing their ratings to be used for regulatory purposes must register with the SEC. Credit ratings are used for limited regulatory purposes (notably MMFs). Registration and annual SEC examinations of each NRSRO (at least annually) address integrity, transparency, timeliness, confidentiality and conflict management. SEC can recommend remedial action or bring enforcement actions; sanctions range from fines to suspension or revocation. In practice the SEC has sanctioned at least one CRA. - Principle 23: Equity research by BDs subject to comprehensive SRO rules to increase analyst independence and manage conflicts. A 2003-2004 settlement required large BDs (accounting for approximately 80 to 90 percent of the U.S. equity underwriting business) to strengthen research independence; settlement remains in effect. SEC rules require analysts to certify reports and disclose certain conflicts; antifraud provisions apply. CFTC rules impose information barriers and disclosure for commodities research by FCMs, IBs, SDs and MSPs. ### Collective investment schemes, valuation, hedge funds and investor information (Principles 24–28) - Principle 24: IAs to MFs and CPOs are subject to SEC and CFTC registration (CFTC function delegated to NFA). Registration focuses on statutory disqualifications and extensive disclosure to regulator and investors. Ongoing organizational and conduct obligations include compliance programs. NFA monitors CPOs via risk-based supervisory program. SEC has a risk-based supervisory program for IAs to MFs, but coverage is limited given sector importance. - Principle 25: MFs and CPs may adopt different legal structures disclosed in prospectus. MF assets must be segregated. Custody by an IA or related entity allowed with additional safeguards including two unannounced additional auditor inspections; few MFs self-custody. CFTC regime requires CP asset segregation but not custodian/depository; no additional safeguards if assets held by CPO or related custodian. In practice most CPs have separate custodians often related entities. - Principle 26: Publicly offered MFs and CPs subject to Securities Act prospectus obligations (MFs also subject to ICA). Prospectus issuers must provide periodic annual and semiannual reports. CEA requires CPOs to provide detailed disclosure documents to prospective participants, annual audited financial statements, an annual report to participants and regulator, and quarterly or monthly reporting. Delegation of activities allowed only to entities registered with SEC and/or CFTC. - Principle 27: MFs and CPs required to value portfolios according to U.S. GAAP. Prospectus/disclosure documents must state frequency, timing and manner of redemptions. Sales/redemptions must be at current NAV. MMFs may use fixed prices (not required to price at market value) subject to strict eligible asset and duration rules. Federal laws do not require periodic disclosure of NAV, but prices are generally available via financial publications and websites. No specific statutory requirements for pricing errors; market practices address compensation in certain circumstances. Suspensions/deferrals of redemptions handled via disclosure and specific ICA rules; SEC and CFTC have authority to act. - Principle 28: No federal HF definition; HF managers required to register as IAs or CPOs depending on asset type. Registration focuses on disqualifications and disclosure. Ongoing organization and conduct standards apply. HF managers with RAUM above a certain threshold face additional periodic reporting to SEC and CFTC on funds’ assets, exposures and leverage; reports can be shared with domestic authorities including FSOC and foreign regulators under Principles 13–15 frameworks. Capital or prudential requirements for IAs/CPOs managing HFs could be established if FSOC designates such entities as systemically important. ### Market entry, prudential requirements and internal controls (Principles 29–31) - Principle 29: Statutory registration plus SRO membership subject most participants (except IAs and CTAs) to eligibility criteria including integrity, capital requirements, and internal controls. IAs and CTAs are not permitted to hold customer assets or deal for customers; registration for them focuses on disqualifications and disclosure. Organizational and conduct obligations including compliance programs apply to IAs and CTAs. - Principle 30: All intermediaries except IAs and CTAs are subject to capital requirements based on a net capital formula with deductions for liquidity and market risks and additional charges for concentration. Some large BDs use an alternative net capital (ANC) framework allowing model-based haircuts; ANC firms have higher minimum capital and SEC approval for models. ANC uses value-at-risk for concentration risk and lacks separate concentration charges. Intermediaries report financial position including net capital periodically with frequency varying by activities and must notify authorities if capital falls below specified thresholds. SEC, CFTC and SROs monitor firms’ financial positions. - Principle 31: Except IAs and CTAs, intermediaries required to have adequate internal controls and risk management systems. Segregation obligations apply to all intermediaries. Know-your-customer requirements apply in both securities and commodity futures. Intermediaries must manage conflicts of interest; commodity futures framework relies more on disclosure. IA examination program coverage is limited despite sector importance. ### Failure management, trading systems, transparency, surveillance and market integrity (Principles 32–37) - Principle 32: CFTC has a plan for market disruption including firm failure; SEC has a defined process for failures of regulated entities. Early warning systems exist for intermediaries with minimum capital requirements including reporting when capital falls below thresholds. Agencies and SROs actively monitor firms’ financial positions. SEC staff informs SIPC if a BD is in or approaching financial difficulty so SIPC can assess SIPA proceedings. If SIPA initiated, a SIPA trustee can transfer client accounts; SIPC Fund compensates up to a limit if BD assets insufficient. For failed FCMs customers compensated on a pro rata basis; there is no SIPC equivalent for FCMs. Under Dodd-Frank, systemically important intermediaries may be placed into a Title II receivership with FDIC as receiver. - Principle 33: Exchanges and boards of trade must register; registration criteria/processes set out in Exchange Act, CEA and rules. ATS must register as a broker-dealer, join an SRO (in practice FINRA), and file Form ATS with SEC. Fair access requirements apply after ATS market share exceeds a five percent threshold; currently there are no such ATS. Limited public information on ATS order execution rules, subscribers and market models is available via voluntary disclosures. - Principle 34: National securities exchanges and FINRA share market surveillance and member supervision for securities; DCMs and NFA for commodity futures and options. Most SEFs outsource surveillance to NFA. SEC and CFTC can investigate improper conduct referred by SROs or on initiative. Supervision of exchanges primarily through rule approval/review and on-site examinations of self-regulatory functions. Examining exchange technological systems and system safeguards is an increased focus. - Principle 35: Equity market pre- and post-trade transparency based on Regulation NMS. Exchanges’ proprietary feeds available to subscribers; pre-trade transparency absent for dark order types and dark pool ATS trading. Post-trade information must be disclosed as soon as practicable but within a maximum delay of 10/90 seconds; in practice information is disclosed within milliseconds. In commodity futures/options, block trades and bona fide exchanges for related positions are exempted from pre-trade transparency via DCM rules. Block trade thresholds set by DCM rules have decreased. CFTC harmonized block trade rule not finalized. - Principle 36: Fraudulent and manipulative practices prohibited under Exchange Act, CEA and SRO rules. Insider trading prohibition applies in securities markets. Trading in commodity futures/options on material nonpublic information breaching pre-existing duty may violate CEA. Market abuse subject to administrative, civil and criminal sanctions. SROs monitor potential abuse and may act under their rules or refer to SEC, CFTC and criminal authorities. A range of sanctions has been imposed. - Principle 37: DCMs and DCOs monitor open positions in commodity futures and options; CFTC complements this monitoring. Actions can be taken if a clearing member cannot meet obligations or post margin. Individual clearing agencies monitor member exposures in securities markets. Cross-market post-trade monitoring facilitated by DTCC Limit Monitoring system. Default procedures exist and are disclosed in clearing agency and DCO rules. Short selling subject to disclosure and locate requirements; SEC and SROs monitor compliance. ### Securities settlement systems and CCPs (Principle 38) - Principle 38: Not assessed. *International Monetary Fund — Appendix Table 6. Summary Implementation of the IOSCO Principles* ### Appendix Table 7. Recommended Action Plan to Improve Implementation of the IOSCO ### Appendix Table 7. Recommended Action Plan to Improve Implementation of the IOSCO Principles ### Recommended actions by IOSCO Principle - Principle 1 - The SEC and CFTC should continue their efforts to coordinate via joint regulations, unified reporting and/or use of substituted compliance as appropriate. - All regulatory authorities with mandates impacting securities and derivatives markets should continue to enhance coordination. - The CFTC is encouraged to review whether legal changes should be pursued in order to subject CPOs and CTAs to a similar standard of care as IAs and to a more comprehensive framework to address conflicts of interest. - Principle 2 - Consideration should be given to mechanisms to make both the SEC and CFTC’s funding more stable, for example by the agencies’ becoming self-funded and/or providing for multiyear budgeting. - Principle 3 - Additional resources should be provided for the SEC and CFTC commensurate to their expanded mandates. - Principle 6 - The SEC should continue to work on improving data availability and automated tools to identify risks, in particular in connection with asset managers. - The SEC should consider enhancing mechanisms to ensure a holistic view of emerging and systemic risk, for example by making more formal arrangements for discussions on risk, ensuring participation of the Commission as a whole, and establishing a more formal accountability framework. - The CFTC should continue to work on improving the quality of swaps data and expanding current mechanisms to monitor the swaps markets. - Principle 8 - The SEC is encouraged to review conflicts of interest arising from the participation of BD affiliates in an ATS managed by the BD. - The SEC is encouraged to review the impact of order types, order routing, and related fee structures in equity markets on conflicts of interest. - The SEC is encouraged to continue its review of the BD and IA models to determine whether harmonization of the standards of care is needed, and whether additional actions are needed in connection with conflicts of interest, including those arising from compensation arrangements for different types of accounts, products or services. - Principles 12, 24 and 31 - The SEC should increase the intensity of its examination coverage of IAs. - Principle 16 - Consideration should be given to making amendments to the federal securities laws to grant the SEC direct authority to impose disclosure requirements on issuers of municipal securities and to remove the exemption available to non-municipal conduit borrowers. - Consideration should be given to reviewing the thresholds that trigger a suspension in reporting obligations, in particular for banks and bank holding companies. - Principle 17 - The SEC is encouraged to consider reducing the deadline for beneficial ownership disclosure as well as for the first report that insiders need to file. - Principle 19 - The PCAOB should take forward the implementation of actions to ensure the timeliness of its enforcement proceedings. - The SEC and PCAOB are encouraged to further analyze whether PCAOB proceedings should be made public. - Principle 21 - The PCAOB should work on ensuring timely advancement of its standard setting agenda. - Principle 23 - FINRA is encouraged to finalize its rules for research analysis in debt securities, as well as rules for research analysis in equity securities to eliminate, where appropriate, potential asymmetries between the regime applicable to the firms covered by the Global Settlement and the regime applicable to the rest of the industry. - Principle 24 - The authorities should consider to explicitly require IAs to MFs and CPOs to implement internal controls and risk management. - Principle 25 - Consideration should be given to amending the CEA to enable the CFTC to require additional safeguards where a CPO or a related entity has possession of pool assets. - Principle 27 - The CFTC or the NFA should adopt a rule providing for the way investors are to be treated, if adversely affected by errors in the pricing of interests in a CP. - Principle 28 - As the authorities continue to analyze the risks posed by HFs, they are encouraged to review whether a comprehensive risk management framework is warranted. - Principle 29 - The authorities are encouraged to consider whether to explicitly require internal controls and risk management for IAs and CTAs that conduct portfolio management. - Principle 30 - The SEC is encouraged to continue its review of the capital and liquidity framework for ANC firms. - More broadly, the SEC is encouraged to continue reviewing the adequacy of liquidity requirements for the larger BDs. - Principle 33 - The SEC should continue to follow the development of bilateral trading systems and, if needed, adjust the regulatory framework as appropriate. - The SEC should require the ATSs to disclose their order execution rules and procedures. - The SEC should ensure that the regulatory framework enhances the requirement for fair access to ATS, including by removing or at least lowering the current five percent threshold. - The SEC and FINRA are encouraged to further ensure that their respective processes provide a sufficiently in-depth analysis of the order execution procedures of a new ATS, in particular for fairness, and provide specific evidence of a BD’s operational and other competence to operate an ATS. - The SEC is encouraged to consider whether additional requirements could be applied to exchanges themselves to further enhance their ability to manage the risks arising from direct electronic access. - Principle 35 - The SEC is encouraged to continue to deepen its analysis of the pre-trade transparency impact of various order types and the reference prices dark order types are permitted to use to ensure that current derogations do not adversely impact the price discovery process. - The CFTC should promptly finalize its block trade rules to provide a regulatory basis for assessing pre-trade transparency waivers for block trades. - Principle 37 - The authorities are encouraged to review whether the current mechanisms are sufficient to provide them with a comprehensive view of the total exposures of market participants that are active across various markets (equity, fixed income, commodity futures and options). ### Authorities’ response to the assessment - Chairs of the SEC and the CFTC: - Appreciate the IMF’s commitment to the Financial Sector Assessment Program and expressed gratitude for the IMF assessment team's professionalism. - Recognize and welcome that the United States is held to the highest and most stringent grading standard and value the objective assessment. - Note that in the aftermath of the financial crisis agencies were given new powers and responsibilities to strengthen the regulatory system. - Highlight that the Report reflects recognition that over the past five years the SEC and CFTC have harnessed new powers to implement more robust rulemaking, supervision and enforcement programs, including comprehensive regulatory reform of the OTC derivatives marketplace, improved supervisory programs for registered entities, and extensive use of enforcement powers. - State that while staff disagree with certain conclusions, recommendations, ratings and interpretations of the IOSCO Principles, the assessment process was comprehensive and fair. - Indicate SEC and CFTC staffs will continue to evaluate the Report to enhance regulatory programs and improve cooperation and coordination in rulemaking and oversight, and look forward to continuing dialogue with the IMF. ### IAIS Core Principles assessment: information, methodology and institutional setting - Assessment methodology and scope - Assessment made against the Insurance Core Principles (ICPs) issued by the IAIS in October 2011, as revised in October 2013. - Previous assessment in 2010 used an earlier version of the ICPs issued in 2003. - Assessment based solely on laws, regulations and supervisory practices in place at the time of the assessment in November 2014. - Assessment addresses national-level insurance regulation and does not assess individual state authorities. - Principal regulatory responsibilities are shared by the 50 states, the District of Colombia and five U.S. territories (hereinafter “states” includes the 50 states, the District of Colombia and five U.S. territories, unless the latter two are specifically mentioned), the Federal Reserve Board (in respect of consolidated supervision only) and the FIO. - The assessment team comprised Ian Tower, Philipp Keller and Nobuyasu Sugimoto in October–November, 2014. - Institutional roles and coordination - States are responsible for licensing, supervision and examination of all insurance companies and intermediaries (“producers”). - The FRB’s responsibilities for consolidated supervision extended to relevant designated NBFCs and SLHCs; its responsibilities now cover around 30 percent of total premium income in the United States. - The Federal Insurance Office (FIO) has a broad monitoring role for the insurance sector and its regulation. - Other federal bodies with roles include FSOC, state securities regulators and the SEC (and FINRA), the Department of Labor, FinCEN and the IRS. - State insurance departments are typically headed by a commissioner; funding is usually raised from the insurance markets via fees and levies and subject to state budgeting processes; departments also collect premium taxes for the states. - The National Association of Insurance Commissioners (NAIC) provides model laws and regulations (now totaling over 200), manages the Financial Regulation Standards and Accreditation Program, operates a centralized financial analysis process via the Financial Analysis Working Group (FAWG), and provides multiple databases and technical support. - NAIC’s Financial Analysis Working Group discusses reports covering all “nationally significant companies” (around 1,600 companies representing 85 percent of the market). - FRB and FIO developments - FRB supervises certain groups (17 in total) containing insurance companies, including 15 SLHC groups at present and two insurance groups designated for FRB supervision (AIG and Prudential Financial). - FRB is growing its insurance-area staff and developing a supervisory regime; it has not yet defined a group level capital requirement for insurance groups it regulates. - FIO, established in the Treasury Department, has a broad monitoring role and lead role in international aspects of insurance regulation and systemic risk responsibilities, but has no authority to license or regulate individual insurance companies or undertake consolidated supervision. ### Main findings and observance summary - Overall assessment - U.S. insurance supervision has been significantly strengthened in recent years and many recommendations of the 2010 FSAP are being addressed. - Insurance has been brought within the scope of system-wide oversight. - Establishment of the FIO created a mechanism for identifying national priorities for reform. - FRB consolidated supervision now covers around 30 percent of total premium income in the United States. - State regulators have been adjusting to the new architecture while progressing reforms such as the Solvency Modernization Initiative (SMI). - Strengths - Powerful state-level capacity for financial analysis with peer group review through NAIC processes. - Development of lead state regulation and a network of international supervisory colleges. - Sophisticated approach to legal entity capital adequacy via the Risk-Based Capital approach. - High degree of transparency and accountability in regulation and supervision. - FRB supervision has strengthened focus on group-wide governance and risk management. - Cooperation between state and federal regulators is developing, based on complementarity. - Areas still in progress or concern - Transition from rules-based to principles-based regulation and risk-focused supervision at the state level is progressing but slow. - Introduction from 2015 of an ORSA with wide-ranging implications for supervisory work and resourcing. - FRB regulatory development is proceeding slowly; staffing with appropriate skills and expertise is ongoing. - Overall, the assessment finds a reasonable level of observance of the Insurance Core Principles, but key gaps remain. ### Key areas for development and specific gaps - Valuation and capital - Valuation standard of state regulators, especially for life insurance, requires review; current prescriptive, formula-based standards vary in conservatism and lack transparency. - Principles-Based Reserving (part of SMI) would mitigate issues, but its implementation date is uncertain. - No group-level capital standards in place for groups supervised by states or the FRB. - States should have the ability to set group-wide valuation and capital requirements; the FRB should develop a valuation and capital standard speedily. - RBC should be extended to financial guaranty companies. - Governance, risk management and market conduct - Gaps exist in governance and risk management requirements; no insurance-specific governance requirements that hold boards responsible for policyholder interests. - No requirements for risk management and compliance functions; state regulators will require larger companies to have internal audit functions from next year. - State examinations normally occur only every five years; consideration should be given to more frequent examinations of larger companies and reduced reliance on outsourcing in some states. - Market conduct supervision (state-run) should be strengthened through a risk-focused supervisory framework and enhanced analysis of risks from complex products and commission-based sales. - Governance, funding and objectives of state regulators - Appointment and dismissal arrangements for commissioners in many states expose supervision to potential political influence. - High dependence on state legislatures for legislation and resources exposes supervisors to political influence and budgetary pressures, partially mitigated by NAIC processes. - Need to review levels of skills and expertise as technical demands change with reforms like ORSA and possible Principles-Based Reserving. - State regulators’ objectives are not clearly and consistently defined in law. - FRB objectives for consolidated supervision do not include insurance policyholder protection, creating potential conflict with policyholder interests in times of stress. - Systemic complexity and fragmentation - Regulatory system remains complex and fragmented, with differences between state regulators and between state and federal regulators. - Risks from lack of consistency include opportunities for unhealthy arbitrage (e.g., use of affiliated captive reinsurers) and failure to act on sector- or system-wide regulatory gaps. - Recommendation for national-level body - A national-level insurance regulatory body is needed to deliver enhancements and greater consistency across states in regulation and supervision. - Options to consider include strengthening FIO’s capacity to bring about convergence on uniform high standards and comprehensive market oversight. - Alternatively, an agency at the national level with appropriate independence and expertise should be given a mandate and powers to establish national standards, ensure regulatory consistency and supervisory coordination. - Such an agency would require sufficient resources, accountability and independence, in line with the expectations of the Insurance Core Principles. *Appendix Table 7. Recommended Action Plan to Improve Implementation of the IOSCO Principles* ### Appendix Table 8. Summary of Observance with the ICPs ### Appendix Table 8. Summary of Observance with the ICPs — Insurance ### Institutional framework, objectives and powers - Insurance regulators are clearly identified in law and have adequate powers, the more so when 2010 changes to the holding company system powers are adopted in all states. - The FIO has significant powers in relation to oversight of the sector and regulation, but only the states and FRB have powers over insurance companies and/or their groups. - States’ insurance law and state regulators’ expression of objectives are consistent with promotion of a fair, safe and stable insurance sector for the benefit and protection of policyholders. - States should ensure that "the promotion of insurance business and excessive focus on affordability of insurance rather than fair treatment of policyholders, are not a part of regulatory objectives." - The establishment of the FIO and extension of the FRB’s mandate introduced a new objective: consideration of the impact on U.S. financial stability. - The objectives of the FRB do not explicitly include insurance policyholder protection; potential conflicts may arise between financial stability objectives and policyholder interests. ### Independence, governance and resourcing of supervisors - State insurance regulators generally have a high degree of day-to-day operational independence and accountability and operate within a highly transparent framework, while protecting confidential information. - Risks to independence exist via state governance: appointment and dismissal arrangements for commissioners expose supervision to potential political influence; elected commissioners may face electoral pressures. - High dependence on state legislatures for principal legislation and budgetary resources exposes departments to political and budgetary pressures; NAIC processes (including accreditation) mitigate but do not eliminate these risks. - States’ financial resources appear broadly adequate for current work programs, but levels of skills and expertise require development as supervisory demands change; some departments rely on contractual staff. - Statewide remuneration policies constrain hiring of specialist skills. - The NAIC accreditation program has served state regulation well; NAIC could extend scope (e.g., captives, market conduct, intermediary regulation) and increase focus on the quality of supervisory judgments. - The FRB needs more staff with understanding of insurance issues at senior levels. ### Information exchange, licensing and suitability - Information exchange has increased through NAIC processes, MoUs and international supervisory colleges; seven states are signatories to the IAIS MMoU with many more applying or considering applying. - UCAA process and accreditation standard for licensing cover core requirements and contribute to consistency across states, but inconsistency remains (e.g., absolute minimum capital requirements, exemptions of certain activities). - Once a company writes business, RBC becomes more relevant than absolute minimum capital. - Business model assessment guidance exists, but documentation (e.g., peer comparison of cost structures) may be insufficient for consistent accreditation validation. - States rely heavily on onsite examinations to assess suitability of key individuals; focus tends to be on compliance/fitness rather than competence and integrity, and assessments are not always sufficiently documented. - Lack of powers (e.g., ongoing approval of Board, Senior Management and Key Persons in Control Functions) makes it difficult for state regulators to take formal regulatory action; moral suasion is often used. ### Governance, risk management, internal controls and ERM/ORSA - Neither states nor the FRB have formal broad-based, insurance-specific governance requirements at legal entity or group level; supervision relies on assessing risks of individual companies and groups through oversight and onsite supervision. - State evaluation work on governance is highly structured and exams are thorough, but governance requirements tailored to insurance (engaging boards in overseeing insurance risks and recognizing policyholders’ interests) are needed. - The FRB applies an approach developed for banking groups and should develop specific requirements for insurance groups to focus on insurer-specific risks. - Neither states nor the FRB have a comprehensive set of risk-management and controls requirements tailored to insurance business. - Examination thoroughness, examiners’ guidance and recent financial controls framework mitigate some risks; imminent state requirements for internal audit functions at larger firms and ORSA requirements will extend the framework. - ORSA requirements are not yet in force; when in force, ORSA will be mandatory for larger companies that cover "over 90 percent of the market by premium income." - State regulators rely on high-level principles and handbook expectations for qualitative requirements; FRB needs to make rules more specific to insurers given differences in insurer vs bank risks and behavior. ### Valuation, capital adequacy and solvency framework - Current valuation standard for life insurers is prescriptive and often formula-based; algorithms and formulae have grown more complex as products have become more complex. - Reserving assumptions are often static and set at product sale; the valuation standard has varying levels of conservatism, leading to lack of transparency. - Valuation standard uses amortized cost for specific assets under a hold-to-maturity argument; this breaks down where dynamic rebalancing is required. - The valuation standard does not necessarily give appropriate incentives for dynamic hedging. - Shortcomings are mitigated by complex structures (e.g., affiliated captives); captives can hold fewer assets to back reserves and allow differences between full formulaic reserve and economic reserve to be backed by other assets (including letters of credit). - Principle-Based Reserving (PBR) would reduce many shortcomings and reduce regulatory arbitrage via affiliated captive transactions; supervisory review of PBR will require sufficient state regulator expertise. - Allowing conservatism explicitly as a margin over current estimate would increase transparency by decomposing reserves into current estimate and margin over current estimate. - Any capital requirement the FRB develops must be based on a valuation standard; the FRB should consider a valuation standard useful to capture risk exposures of SLHCs and NBFCs. - The RBC framework is a sophisticated, risk-based capital framework improved since the early 1990s; its reliance on an amortized cost valuation standard and rules-based approach makes RBC formulae increasingly complicated. - Documentation of RBC methodology, parameterization, assumptions and implementation would be useful. - Financial guaranty insurers and mortgage insurers are not subject to RBC; they remain required to hold minimum capital and surplus requirements that were insufficient during the financial crisis; reliance on external ratings is not advisable. - For groups and conglomerates, focus on legal entity capital alone is insufficient; NAIC has qualitative requirements but quantitative group-level capital requirements would enhance transparency and reduce regulatory arbitrage. - The FRB should develop and formulate its preferred approach to: underlying valuation standard, time horizon for capital, risk measure of capital, and the legal entities within the group to which capital requirements would be imposed. ### Supervisory review, preventive measures, enforcement and exit - State regulators have a highly developed offsite analysis approach drawing on comprehensive legal entity reporting and NAIC-led analytical and peer review frameworks. - Holding company system analysis and enhanced lead state regulator role have strengthened supervision; proposed corporate governance reporting would strengthen further. - Financial condition examinations have become more risk-focused and more often coordinated as group examinations; market regulation examinations need further development. - Publication of factual examination reports on a legal entity basis absorbs significant resources and risks misleading readers where confidential supervisory issues exist; states are considering format modifications to reflect risk-focused exams. - A five years maximum examination cycle is long relative to other regulators and could be shortened or supplemented with targeted exams for larger/higher-risk firms. - States have a full range of powers to intervene and use them in practice; RBC-related company and regulatory action levels and associated triggers provide for automatic intervention ahead of stress, supplemented by extensive financial reporting, financial analysis tools and RBC forward simulations to support discretionary intervention and early discussions with senior management. - States and the FRB have a wide range of enforcement measures and use them actively and effectively. - States have appropriate tools to wind-up insurance legal entities while protecting policyholders; insolvencies have been low, though 136 companies had entered into run-off "as of the end 2013." - The prescribed system of indicators and procedures (including the FAWG process) has led to early-stage interventions. ### Reinsurance, investments and intermediaries - Regulation and supervision of reinsurance is comprehensive; handbooks give detailed guidance on best practices and evaluation of reinsurance programs. - State regulators analyze material intra-group reinsurance contracts; complex webs of retrocessions can interact and impact potential performance of retrocessions. - Investment limits in model acts plus detailed expectations in handbooks create a sophisticated framework focused on security, liquidity and diversification; regulators strengthened requirements on securities lending and liquidity focus. - Low-interest environment has increased hunt for yield; if insurers invest in more exotic asset classes, NAIC might consider adapting investment definitions to ensure proper asset-class assignment. - Risk of regulatory arbitrage exists as investment limits across states are inconsistent and there is no group-wide investment requirement. - Producer regulation is less uniform than company regulation but all states have key ICP18 expectations: licensing, producer skills/competence requirements, and powers to examine and act on misconduct. - Safeguards for client money exist where intermediaries act as agents; less uniformity exists for money held by brokers, but premiums generally must be held in a fiduciary capacity. - Contingent commission requirements have been strengthened via disclosure and New York action, but requirements vary across states. - All insurance producers, including major brokers, are subject to supervision and must comply with state laws; closer oversight of major brokers would be appropriate given their high impact on policyholders and market integrity. ### Public disclosure, fraud, AML/CFT and market conduct - Publicly disclosed information is extensive and sufficient for sophisticated users; financial statements are filed electronically except for small companies; off-balance-sheet items must be disclosed in notes. - Transfer of business to affiliated captives can move business off-balance sheet and reduce transparency; specialist analysis can address this. - Insurance groups and holding systems should be required to submit consolidated financial filings and make them publicly available; statutory accounting would be useful for public and regulatory analysis. - Public disclosure usefulness is hampered by the valuation standard (see ICP14). - State regulators use market conduct examinations and expect Antifraud Plans; fraud data availability has improved via databases leading to enforcement actions. - AML/CFT: key aspects set out in the Bank Secrecy Act; FinCEN is responsible federal authority, IRS has delegated examination authority. FinCEN plans to rely more on state regulators’ AML/CFT examinations over time; currently 11 MoUs between FinCEN and state regulators exist and FinCEN plans to expand MoU network. Exchange of information can take place without a MoU. ### Group-wide supervision, macroprudential surveillance and stress testing - Group supervision has been improved; Insurance Holding Company System Model Act allows state regulators to supervise insurance groups; FRB exercises consolidated supervision over SLHCs and NBFCs. - U.S. states can demand information from any insurer or affiliate and take action if non-insurance entities or holding companies create risk to the insurer. - There are no capital standards in place for groups supervised by state regulators or for SLHCs and NBFCs supervised by the FRB; absence of a group-wide valuation and capital standard limits ability to evaluate intra-group transactions and failure modes. - Resolution planning might be workable without a sound capital framework because states can request any information they believe necessary; but a policyholder-protection regulatory framework needs to consider catastrophic events for insurance legal entities. - A stress-testing regime for insurance groups and holding companies would support state regulators; in absence of group-wide valuation and capital standard, stress testing—if defined appropriately—would help assess exposures. - There are no group-wide investment, market conduct and disclosure requirements in place. - Macroprudential surveillance is not yet congruent with the complexity of the U.S. financial sector; further scope exists to analyze interlinkages, systemic exposures and interactions between regulatory systems. - The FIO, FSOC, the FRB and the NAIC combined constitute a framework for macroprudential surveillance and insurance supervision, but macroprudential work relevant to insurance is still developing. - Cooperation among authorities on macroprudential issues can be improved; pooling resources might increase overall quality. FRB’s insurance-specific stress test development could benefit from closer cooperation with states and the NAIC. - Delivering appropriate representation for insurance at the FSOC is complicated by fragmentation of supervisory responsibilities. - The concept of systemic relevance for NBFCs should be clearly defined by the FSOC to support FSOC and OFR analysis of emerging threats and systemic risk identification. - States and the NAIC might consider introducing a stress testing regime; ideally, for financial market stresses, it would be aligned "as far as feasible to the FRB CCAR framework" to give insights into cross-sector interlinkages. ### Supervisory cooperation, cross-border crisis management and resolution - Significant strengthening of domestic and international supervisory coordination has occurred through holding company analysis, supervisory colleges and FRB group-wide supervision of SLHCs/NBFCs. - Lead state concept is embedded and delivers stronger coordination, but limitations on cooperation between states remain due to lack of regulatory uniformity. - State regulators’ cooperation with FRB supervisors is developing based on complementary approaches, though FRB’s role is still relatively new for some groups. - Absence of U.S. or global group-wide capital standards constrains lead state processes, FRB group supervision and college work, but U.S. regulators have established effective supervisory colleges for information-sharing and coordination. - Cross-border crisis management and coordination are at an early stage; supervisory colleges and CMGs are recent developments. Dodd-Frank frameworks applied to NBFCs have brought early progress to resolution planning ("living wills"). - Outside colleges, U.S. supervisors have coordinated across foreign and multiple state jurisdictions in troubled-company management, though no company failures resulted. - Colleges or CMGs could be used more for crisis preparedness, including sharing information on group structures, intra-group transactions and barriers to effective crisis management. - Resolution capacity for cross-border insurance groups requires further development. *Appendix Table 8. Summary of Observance with the ICPs — Insurance.* ### Appendix Table 9. Recommendations to Improve Observance of the ICPs ### Appendix Table 9. Recommendations to Improve Observance of the ICPs ### ICP 1 — Objectives, Powers and Responsibilities of the Supervisor - It is recommended that: - all states adopt the joint statement of the objectives of insurance regulation and review their legislation to ensure that it is consistent with the statement (for example, that any mandate to promote or develop the insurance sector that could conflict with the statement is eliminated); and - regulators undertake analysis of potential conflicts between the objectives of the SLHC regime and the objectives of insurance supervision, as set out in the ICPs, and recommend changes in the legislation as appropriate, which may include more explicit recognition of the objective of insurance policyholder protection. ### ICP 2 — Supervisor - It is recommended that: - states reform arrangements for the appointment and dismissal of commissioners, providing for fixed terms for all, with dismissal only for prescribed causes and with publication of reasons; - state governments increase the independence of insurance departments in relation to resourcing, enabling them to determine budgets, set and retain relevant fees and assessment income to finance their work and employ appropriate staff as necessary to meet their objectives, subject to continued accountability to state legislatures; - the NAIC review the scope and operation of the accreditation program, including the potential value of an element of external assessment and a quality assurance element to accreditation work; and - the FRB continue to increase its insurance expertise (particularly in the area of actuarial methods, insurance accounting and underwriting risk), including in senior positions, to ensure the effectiveness of its insurance group supervisory work. ### ICP 3 — Information Exchange and Confidentiality Requirements - It is recommended that states and the FRB review their internal processes and procedures, including staff training, to ensure that supervisors understand the importance of sharing information, including proactive sharing, taking into account the need to ensure confidentiality. ### ICP 4 — Licensing - It is recommended that states improve consistency of the licensing requirements among the states both at high level (such as the absolute minimum capital level and the scope of exemption from licensing) and practical interpretation level (through better documentation of analysis and more detailed accreditation review work). ### ICP 5 — Suitability of Persons - It is recommended that: - state regulators adopt and implement the Corporate Governance Annual Disclosure Model Act and related regulation and handbooks promptly; and - state regulators require examiners and supervisors to state more clearly their observations of properness of key individuals at least in their internal documentations, so that appropriate regulatory actions can be followed up. ### ICP 7 — Corporate Governance - It is recommended that states and the FRB develop appropriate standards for insurance company governance, to be applied at legal entity and/or group level and implement these through the model law process or FRB requirements. ### ICP 8 — Risk Management and Internal Controls - It is recommended that: - after the introduction of the ORSA regime and requirement for an internal audit function, the states review the range of their standards on risk management and control functions, assessing whether standards embedded in the ORSA requirement should be applied to a wider population of firms and whether to require at least the larger firms to have risk management, compliance and actuarial functions; and - the FRB develop and communicate a set of expectations in relation to risk management and internal controls for insurance NBFCs and SLHCs. ### ICP 9 — Supervisory Review and Reporting - It is recommended that: - the states review the adequacy of reporting on qualitative issues such as material outsourcing and adopt the proposed new framework for corporate governance reporting; - the states review the scope for a higher frequency of examinations or increased targeted examinations between the regular full scope examinations, for the larger groups; and consult on whether they should remove the requirement for examination reports to be published; - the states review the scope for more coordinated multistate market conduct examinations; and - the FRB develop and publish a tailored supervisory framework and appropriate tools addressing insurance risks for the supervision of the SLHC and NBFC insurance groups, including stress tests that that include insurance risk scenarios such as a major pandemic. ### ICP 12 — Winding-up and Exit from the Market - It is recommended that the states work closely with federal and International regulators, and resolution authorities to improve resolvability of large and complex insurance groups. ### ICP 13 — Reinsurance and Other Forms of Risk Transfer - It is recommended that: - state regulators analyze the interaction of the web of retrocessions and the group’s or holding’s structure in more depth; and - the FRB analyze the interaction of the web of retrocessions in particular for systemically important insurance groups. ### ICP 14 — Valuation - It is recommended that: - the NAIC continues to pursue the update of the valuation methodology for life insurers based on principles-based reserving; - captives and insurers have to use the same valuation requirements; - the valuation standard is applied consistently across all states; - the valuation standard is consistently defined taking into account how assets that cover liabilities are actually managed; - the valuation standard is adapted such that it captures conservatism explicitly in a margin over current estimate; - state regulators authorities ensure that they have sufficient expertise in-house to cope with principles-based approaches to reserving; and - the FRB defines a valuation standard for their regulated insurance entities. ### ICP 15 — Investment - It is recommended that: - identical investment rules and limits are imposed on affiliated captives to which insurance liabilities are ceded to; and - state regulators with cooperation with the NAIC, FRB and FIO to continue to analyze investment activities both at legal entity level and group level and address any regulatory arbitrage by improving consistency of investment requirements among states and federal regulations. ### ICP 16 — Enterprise Risk Management for Solvency Purposes - It is recommended that: - the FRB continues to enhance their expertise in insurance risk and business models; - the FRB adapts its rules and regulation and approaches to take into account the specifics of insurers, where warranted; and - the state regulators and the NAIC consider requiring the ORSA for all insurers, proportionate to the size and complexity of the firms. ### ICP 17 — Capital Adequacy - It is recommended that: - state regulators and the NAIC develop an RBC requirement for financial guaranty insurers, taking into account their specific exposures to risk; - state regulators and the NAIC develop an approach that would allow RBC to capture intra-group transactions (IGTs); - the FRB develops a capital standard for NBFCs and SLHC, with due consideration of accounting and actuarial standards, developing its methodology in cooperation with state regulators and the NAIC; and - state regulators, the NAIC and the FRB coordinate to develop common or consistent capital requirements to avoid regulatory arbitrage between the two capital requirements. ### ICP 18 — Intermediaries - It is recommended that: - a uniform approach to the regulation of larger business entities, including major commercial lines brokers be developed; and - producers in all states be required to make disclosures to customers of the status under which they are doing business, including which insurance companies have appointed them. ### ICP 19 — Conduct of Business - It is recommended that: - states further develop market conduct requirements that address the risks of unfair policyholder treatment across the range of insurance products and including requirements to treat customers fairly, to act with due skill and diligence, give suitable advice and to manage conflicts of interest; - states develop a risk-focused surveillance framework specifically for market conduct to support proactive, risk-based supervision of market conduct, covering both the supervision of individual firms and of issues that arise across the market; - states review staffing and resourcing models for market conduct regulation of insurers and producers, including scope to undertake more examination work using employees rather than consultants (see also ICP2 on resources); and - states continue to give consideration to developing an accreditation program for market conduct work (initial discussions have already been held), building on the work of the MAWG and on the comprehensive Market Regulation Handbook. ### ICP 20 — Public Disclosure - It is recommended that insurance groups and insurance holding systems are required to submit financial filings also on a consolidated level. ### ICP 22 — Anti-Money Laundering and Combating the Financing of Terrorism - It is recommended that to facilitate active and effective information sharing on AML/CFT, FinCEN, state regulators and the NAIC continue to expand the network of MOUs and speedily implement the ongoing project for electronic information exchange. ### ICP 23 — Group-wide Supervision - It is recommended that: - state regulators obtain direct legal authority over the insurance holding company (although this is beyond the current ICP); - capital standards are put in place in a consistent manner, for groups supervised by state regulators and by the FRB; - potential conflicts between the objectives of different supervisory authorities are addressed; - a stress testing regime for insurance groups and holding companies be implemented; - consolidated financial statements are published by all insurance groups; and - investment activities at the group level are carefully monitored to address potential regulatory arbitrage and search for yield at the group level. ### ICP 24 — Macroprudential Surveillance and Insurance Supervision - It is recommended that: - different authorities and offices work closer together on macroprudential issues; - the FSOC encourage the FRB to develop stress testing and crisis management exercises which are meaningful for the insurance sector; and - the representation of the insurance sector is brought into line with that for other sectors on FSOC. ### ICP 25 — Supervisory Cooperation and Coordination - It is recommended that: - states and the FRB review how to develop stronger cooperation between U.S. insurance supervisors, which could include increased joint working (e.g., on-site work), secondments and appropriate training; and the FIO and NAIC work more closely together, for example to develop a shared view on priorities for modernization of insurance regulation; - state regulators and FRB set objectives for colleges to move to the next level of cooperation, including potentially the development of a shared group risk assessment and joint working; and consider whether this may require sub-groups of members or colleges to meet in a core group format to promote efficient working; and - states fully and effectively incorporate the state regulators’ collective expectations on international supervisory colleges into the accreditation program. ### ICP 26 — Cross-border Cooperation and Coordination on Crisis Management - It is recommended that the authorities continue their work in relation to crisis preparedness, giving priority to building on the work of the CMGs (and current work at the FSB and the IAIS) to develop their planning for a crisis and resolution of a major cross-border group. Supervisors should ensure that all internationally-active groups have developed contingency plans and are able to deliver information that may be required in a crisis in a timely fashion. ### Authorities’ Responses to the Assessment - The Federal Reserve Board (FRB), the NAIC, and the FIO (collectively, the “U.S. authorities”) welcomed the opportunity to take part in the second U.S. FSAP and support the objectives of the IMF’s FSAP more generally. - The current Insurance Core Principles (ICPs), as amended by the IAIS in 2013, are more rigorous and comprehensive than the prior version used for the first U.S. FSAP conducted in 2010. The U.S. authorities are therefore pleased that the IMF’s current assessment of the U.S. system broadly indicates compliance with such principles; that insurance supervision in the United States has been significantly strengthened in recent years; that lessons have been learned from the financial crisis; and that many of the recommendations of the 2010 FSAP are being addressed. - The Report recognizes that the implementation of global and domestic reforms, particularly the DFA and ongoing enhancements at the state level, has increased the supervisory scope and intensity of insurance supervision and oversight. Some state and federal reforms are pending and will take time to fully implement, including at the federal level those related to enhanced prudential standards for non-bank financial companies. The Report acknowledges that additional implementation of the reform programs will further improve compliance with the ICPs in the United States. - The U.S. authorities are pleased with the Report’s overall evaluation, which concludes as follows: - Overall, the assessment finds a reasonable level of observance of the Insurance Core Principles. There are many areas of strength, including at state level the powerful capacity for financial analysis with peer group review and challenge through the processes of the NAIC. Lead state regulation is developing and a network of international supervisory colleges has been put in place. Regulation benefits from a sophisticated approach to legal entity capital adequacy (the Risk-Based Capital approach). Regulation and supervision continue to be conducted with a high degree of transparency and accountability. FRB supervision is bringing an enhanced supervisory focus to group-wide governance and risk management. Cooperation between state and federal regulators is developing, based on the complementarity of their approaches, although it has further to go. - The Report makes numerous recommendations to increase U.S. compliance with the ICPs. The U.S. authorities acknowledge that some continued reforms are worth considering to further strengthen certain aspects of the system of regulation and supervision in the United States. However, the state regulators disagree with a few of the ratings ascribed to certain ICPs and the U.S. authorities do not believe that each of the proposed regulatory reforms recommended in the Report is warranted, or would necessarily result in more effective supervision, reduced cost and complexity of insurance supervision, or successfully address perceived regulatory gaps, especially when compared to functional outcomes. For example, the Report expresses concern that the objectives of the respective agencies could come into conflict in a crisis situation. In practice, there is clarity of mission among the U.S. authorities and, to date, they have resolved potential conflicts through regulatory and supervisory cooperation. - The U.S. authorities appreciate the work of the assessors and look forward to continuing dialogue with the IMF as the authorities consider the recommendations. *Source: Appendix Table 9. Recommendations to Improve Observance of the ICPs.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15170.pdf_