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HSBC NORTH AMERICA HOLDINGS INC.
July 16, 2004
Office of the Comptroller of the Currency
250 E Street, SW
Attn: Public Reference Room
Mail Stop 1-5
Washington, DC 20219
Regulation Comments
Chief Counsel’s Office
Office of Thrift Supervision
1700 G Street, NW
Washington, DC 20552
Attention: No. 2004-27
Jennifer J. Johnson
Secretary
Board of Governors of the
Federal Reserve System
20th Street and Constitution Av., NW
Washington, DC 20551
Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Robert E. Feldman
Executive Secretary
Attention: Comments/OES
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
Re: Proposed Interagency Statement on Sound Practices Regarding
Complex Structured Finance Transactions (Office of the Comptroller of
the Currency Docket No. 04-12; Office of Thrift Supervision No. 2004-27;
Federal Reserve Board Docket No. OP-1189; Securities and Exchange
Commission File No. S7-22-04)
Ladies and Gentlemen:
HSBC North America Holdings Inc. (“HSBC North America”) appreciates
the opportunity to comment on the proposed Interagency Statement on
Sound Practices Concerning Complex Structured Finance Transactions (the
“Statement”) issued by the Office of the Comptroller of the Currency,
the Office of Thrift Supervision, the Board of Governors of the Federal
Reserve System, and the Securities and Exchange Commission
(collectively, the “Agencies”). HSBC North America is a wholly-owned
subsidiary of HSBC Holdings plc (“HSBC Holdings”), and is the holding
company through which HSBC Holdings conducts its operations in the
United States. HSBC Holdings is the largest banking organization
headquartered in the United Kingdom and is the second largest banking
organization in the world by market capitalization.
As a bank holding company, HSBC North America operates various
subsidiaries in the United States. Its principal banking subsidiary,
HSBC Bank USA, N.A., has more than 400 branches in New York, Florida,
Pennsylvania, California, Washington, and Oregon. Its consumer finance
subsidiary, Household International, Inc., is one of the country’s
largest credit card issuers and offers consumer and mortgage loans to 50
million customers through offices throughout in the United States. Other
subsidiaries of HSBC North America, including HSBC Securities (USA)
Inc., an investment bank registered with the Securities and Exchange
Commission, engage in a broad range of permissible nonbanking activities
in the United States. As financial institutions supervised by the
Agencies, HSBC North America and its subsidiaries would be directly
affected by the guidance provided by the Statement.
HSBC North America strongly supports the Agencies’ effort to provide
guidance on strengthening safeguards for the legal, reputational and
other risks that may be associated with some complex structured finance
transactions (“CSFTs”). As a leader in providing a wide array of
financial services to clients, HSBC North America believes that
financial institutions have a vital role to play in the responsible use
of CSFTs and related financial products and applauds the Agencies’
recognition of the important role played by CSFTs and the institutions
structuring or participating in them in serving “the legitimate business
purposes of customers.” Moreover, HSBC North America appreciates the
Agencies’ observation that “many financial institutions have already
taken meaningful steps to improve their control infrastructures relating
to [CSFTs] in light of control weaknesses evidenced by recent events.”
Both HSBC North America and HSBC Holdings have long-standing,
sophisticated risk-management policies and procedures in place that
account for all components of risk, including legal and reputational
risk and we are consistently seeking to improve the safeguards in those
policies and procedures.
While it may be true that some financial institutions may need to
adopt legal and reputational risk-mitigation systems that have not been
taken seriously in the past, we respectfully urge the Agencies not to
impose unnecessary additional burdens on us and on other financial
institutions that for a long time have incorporated a thorough
evaluation of legal and reputational risk into our financial structuring
and advisory capabilities. In particular, the Agencies should avoid
imposing a “one-size-fits-all” approach as a solution for financial
institutions. The degree of exposure of these institutions to the risks
posed by CSFTs depends significantly on numerous variables, such as the
type of role played by the institution, the type of transaction
contemplated by the customer, and the jurisdictions in which both
operate. Of more importance is that such an approach threatens to expose
these institutions to the very liability from which the Agencies seek to
protect them. We therefore respectfully urge the Agencies to issue a
final version of the Statement that allows financial institutions
considerable flexibility in determining which transactions require
heightened scrutiny and how best to apply that scrutiny. The Statement
should allow a financial institutions to set its own standards with
respect to each of the areas for which policies and controls are
suggested so that it can account for the different roles and
responsibilities that it assumes and the types of CSFTs in which it is
involved.
Set forth below are our two principal comments on the Statement.
Following these comments we briefly list several other points of concern
to HSBC North America that we understand will be covered at greater
length in the comments of various financial trade associations of which
we are a member.
1. The Statement should not impose a new framework that imposes
liability on financial institutions for the failures of customers or
other participants in CSFTs.
The Statement as drafted threatens to increase the risk to the safety
and soundness of the banking industry by providing grounds for the
imposition of liability on financial institutions beyond those that
exist under current law. In some cases, language in the Statement could
serve as a basis on which to impose liability on financial institutions
for fraudulent activities independently conducted by customers or other
parties to a CSFT. This language includes the repeated call for
financial institutions to “ensure” that certain steps are taken and
results are obtained and the detailed and extensive review that the
Statement contemplates for what the Statement considers to be high-risk
CSFTs regardless of a financial institution’s own assessment of that
risk. We respectfully request that the Agencies reconsider the use of
terms in the Statement that may inadvertently convert its supervisory
guidance into a mandate or requirement for purposes of compliance. We
suggest that the Agencies replace the phrase “should ensure” with a less
prescriptive term such as “should consider,” “should strive” or “should
evaluate the need for.”
To avoid the unintended consequence of expanding rather than reducing
the exposure of the U.S. banking industry to legal risk, HSBC North
America asks that the Statement clarify that its guidance creates no
duty or any other ground on which to impose liability on a financial
institution or its directors and officers either for a failure to follow
the Statement’s guidance or for the actions of any customer or other
party to a CSFT, beyond those that exist under current law. The
Statement should also make clear that it does not shift the customer’s
obligation to comply with securities disclosure requirements to the
financial institution. We are concerned that unless these points are
clarified, the Statement will discourage financial institutions from
participating in legitimate, economically sound CSFTs and, at worst,
expose them to significant liability for the acts of others over which
they have no control and for which they should have no responsibility.
Two more ways in which the Statement implies additional grounds for
liability are of particular concern to us. First, the Statement places
on a financial institution’s board of directors the burden for the
implementation of the controls and policies recommended by the
Statement. The Statement states, among other things, that the directors
are “ultimately responsible for the financial well being of the
institutions they oversee” and “should establish the financial
institution’s threshold for the risks associated with [CSFTs].” We agree
that a financial institution’s board should oversee its risk-control
framework and regularly make efforts to strengthen it; however, to
impose responsibility on the board for any shortcoming in that framework
would be a mistake. To do so would discourage qualified individuals from
serving as a director of a financial institution and, at a minimum,
would threaten their active participation and frank discussion in board
meetings.
Second, the Statement asks financial institutions to obtain
information and assurances from other parties, implying that the failure
to do so is a failure to comply with the guidelines. The Statement says
that, in the case of CSFTs that “pose higher levels of legal and
reputational risk,” a financial institution “should ensure that staff
approving the transactions obtain and document complete and accurate
information about the customer’s proposed accounting treatment of the
transaction, financial disclosures related to the transaction as well as
the customer’s objectives for entering into the transaction.” The
Statement calls for financial institutions to “consider seeking
representations and warranties from the customer stating the purpose of
the transaction, how the customer will account for the transaction, and
that the customer will account for the transaction in accordance with
applicable accounting standards, consistently applied.” Finally, the
Statement contemplates not only that third-party accountants be retained
to review transactions but that those accountants discuss the CSFT
transaction with the customer’s independent auditor.
The realities of the financial marketplace make compliance with these
guidelines impractical. A financial institution may find that its
customer simply refuses to comply with requests for these types of
information and assurances and that it has defensible reasons for doing
so. A customer’s outside auditor would typically have every reason not
to provide its client’s counterparty with information on which that
counterparty could later claim to have relied. A financial institution
may responsibly choose not to pursue certain of the approaches suggested
in the Statement for entirely legitimate business reasons, particularly
in circumstances in which it has relied on outside counsel and other
traditional resources for fully sufficient protection on these points.
2. The Statement needs to allow a financial institution that operates
in a multi-jurisdictional environment the flexibility to adopt policies
and procedures that reflect foreign regulations and global
risk-management practices.
The Statement should make clear that it does not apply to non-U.S.
bank holding companies such as HSBC Holdings with respect to the CSFT
activities of their non-U.S. subsidiaries. In the case of a non-U.S.
bank, the Statement limits its application to that bank’s U.S. agencies,
branches or subsidiaries, clearly deferring to the non-U.S. bank’s
home-country regulator on the question of how CSFTs entered into by its
non-U.S. offices and subsidiaries should be regulated. The same should
be true for non-U.S. holding companies. In the case of the HSBC Group,
the Statement should apply to HSBC North America and its subsidiaries,
including HSBC Bank USA, N.A. and HSBC Securities (USA) Inc., but the
Agencies should defer to the Financial Services Authority and other non-U.S.
regulators on how CSFTs entered into to HSBC Holdings’ non-U.S.
subsidiaries should be supervised.
HSBC North America’s status as a subsidiary of a non-U.S. holding
company and member of a global organization that does business in 79
countries and territories prompts two related points. First, the
Statement needs to recognize that a financial institution such as HSBC
North America will be more likely to be involved in CSFTs to which a
non-U.S. affiliate or other non-U.S. entity will be a party simply by
virtue of its membership in a global organization. The Statement should
provide these institutions with the flexibility to tailor their internal
policies and procedures with respect to CSFTs in a way that reflects the
fact that these non-U.S. parties will be subject to non-U.S. regulatory
regimes. HSBC Holdings has decades of experience managing operations in
numerous jurisdictions, which requires it to integrate and reconcile
different regulatory regimes on a continuous and highly sophisticated
basis. HSBC North America and similarly situated financial institutions
should be allowed to rely on this unusual expertise and experience in
evaluating and monitoring its participation in CSFTs.
Second, the statement lists “[t]ransactions that cross multiple
geographic or regulatory jurisdictions” as an example of a
characteristic “that should be considered in determining whether or not
a transaction or several transactions might need additional scrutiny.”
Either this characteristic should be removed from the list or the
Statement should make clear that it is a characteristic that needs to be
considered only for institutions without significant direct or
affiliated foreign operations. HSBC North America is a financial
institution a principal strategic advantage of which is its ability to
structure cross-border transactions and serve customers and
counterparties in more than one geographic region. This admonition thus
applies to a substantial portion of its business. We respectfully
dispute the implication that such a transaction is per se likely to need
additional scrutiny on the ground that “processing and oversight” is
made more difficult. HSBC North America and its non-U.S. affiliates
distinguish themselves from their competitors on the basis that
“processing and oversight” is not more difficult for them, i.e. on the
basis that their expertise in these transactions enable them to evaluate
these transactions without the difficulties encountered by financial
institutions that do not enjoy the benefits HSBC Group’s global
risk-management infrastructure.
3. Additional Comments
We have summarized below three additional concerns that we have about
the Statement and that we share with a broader range of financial
institutions. We understand that they will be discussed in more detail
by other interested parties who plan to comment on the Statement.
a. The Statement should allow a financial institution to tailor its
CSFT policies not only to the type of transaction but to the scope of
the institution’s involvement in any CSFT. The Statement should make
clear (i) that different roles played by financial institutions in the
development or structure of CSFTs present different types and degrees of
risk, (ii) that heightened scrutiny may not be necessary in
circumstances in which financial institutions play a limited role in a
CSFT transation, and (iii) that financial institutions should exercise
the discretion and flexibility to apply the Statement’s guidance
differently when roles or responsibilities vary.
b. The requirement that a financial institution establish a special
SPE-approval process and monitor the use of SPEs is redundant and
unnecessary. The continuous review and monitoring of an institution’s
use of an SPE will be unnecessary in many instances in which an SPE is
formed and should properly be folded in to the heightened scrutiny
imposed on CSFTs that the institution has identified as requiring this
treatment. For example, an SPE created by a customer may well call for a
different level of scrutiny than an SPE structured by the financial
institution. Whether the use of a particular SPE needs to be
continuously monitored should be left to the discretion of the financial
institution, based on the type of transaction in question and the scope
of the institution’s role and responsibilities in that transaction.
c. Terminology throughout the Statement should be revised to avoid
the perception of vagueness. For example, the Statement urges financial
institutions to implement recommended policies and controls for
evaluating “the appropriateness of the transaction(s)” and “preventing
the financial institution from participating in inappropriate
transactions.” The terms “appropriateness” or “inappropriate” are not
defined by the Statement. We suggest that references to
“appropriateness” or “inappropriate transactions” be replaced with
“transactions that, in the determination of the financial institution,
pose an unacceptably high level of legal or reputational risk.” Also,
the statement that “[t]he more complex variations of selected structured
finance transactions have . . . placed pressure on the interpretations
of the accounting and tax rules” unnecessarily risks discouraging
innovation, and should be removed from the final Statement.
* * *
We hope that this letter is helpful to the Agencies as they begin to
finalize the Statement. We would be more than happy to discuss any of
the matters raised in this letter at greater length. Please do not
hesitate to call or e-mail me at (212) 525-6533 or janet.l.burak@us.hsbc.com,
if you have any questions about our comments.
Sincerely,
Janet L. Burak
HSBC North America Holdings, Inc.
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