|
INSTITUTE OF INTERNATIONAL BANKERS
July 19, 2004
Jennifer J. Johnson
Secretary
Board of Governors of the Federal
Reserve System
20th Street and Constitution Avenue, NW
Washington, DC 20551
Public Reference Room
Mail Stop 1-5
Office of the Comptroller of the Currency
250 E Street, SW
Washington, DC 20219
Regulation Comments
Chief Counsel’s Office
Office of Thrift Supervision
1700 G Street, NW
Washington, DC 20552
Attention: No. 2004-27
Robert E. Feldman
Executive Secretary
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
Attention: Comments/OES
Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: Proposed Interagency Statement on Sound Practices Regarding
Complex Structured Finance Activities (Federal Reserve Board Docket No.
OP-1189; Office of the Comptroller of the Currency Docket No. 04-12;
Office of Thrift Supervision File No. 2004-27; Securities and Exchange
Commission
File No. S7-22-04)
Ladies and Gentlemen:
We are submitting this letter in response to the request of the
Federal Reserve Board (the “FRB”), the Office of the Comptroller of the
Currency (the “OCC”), the Federal Deposit Insurance Corporation (the
“FDIC”), the Securities and Exchange Commission and the Office of Thrift
Supervision (collectively, the “Agencies”) for comment on the Agencies’
proposed interagency statement (the “Proposed Statement”) regarding
sound internal controls and risk management practices relating to
complex structured finance transactions (“CSFTs”).1 The
Institute of International Bankers represents internationally
headquartered financial institutions from over 40 countries, and our
members include international banks that operate branches and agencies,
bank subsidiaries and broker-dealer subsidiaries in the United States.
Introduction and Executive Summary
As the Proposed Statement recognizes, CSFTs can play an important and
beneficial role in the U.S. and international financial markets and
economy. Many of the Institute’s largest members are among the most
significant providers of complex structured finance products, and many
have developed and implemented leading risk management practices
specifically designed to identify and address the legal, reputational
and other risks which some such activities present. The Institute thus
supports the Agencies’ effort to develop uniform guidance in this area
on an interagency basis and to promulgate meaningful guidance for
institutions that are subject to examination and supervision by multiple
federal regulators.
At the same time, the Institute has a number of concerns regarding
the Proposed Statement. The principal focus of this letter is on the
implications for international banks of the Proposed Statement, taking
into account the unique manner in which international banks operate in
the United States.
• International banks’ U.S. operations include branches and
agencies, subsidiary banks and subsidiary broker-dealers, all of which
are “financial institutions” as defined in the Proposed Statement (and
all of which thus would be subject to the proposed interagency
guidance to the extent they engage in complex structured finance
activities).
• Specifically in relation to U.S. branches and agencies of
international banks, risk management guidance like that reflected in
the Proposed Statement should reflect the fact that such U.S.
operations are not separately incorporated and do not, for example,
have a separate board of directors.
• More broadly, the Institute strongly urges the Agencies to
recognize that an international bank’s U.S. risk management policies
and procedures necessarily will need to be adapted to the bank’s
global policies and procedures, as informed by home country legal,
regulatory and supervisory requirements. As a result, international
banks may implement guidance regarding CSFTs in ways that differ in
certain respects from the ways U.S.-headquartered institutions would
implement the same guidance, without any material difference in the
effectiveness of that implementation.
In addition, this letter identifies several other concerns regarding
the proposal that we share with domestically headquartered institutions
and offers a number of suggestions to address these concerns.
• The Institute respectfully recommends that the Proposed Statement
be revised to make clear that the listed examples of characteristics
of CSFTs, or transactions warranting additional scrutiny by financial
institutions, are simply indicators of types of transactions that
could, depending on the context of the transaction or other factors,
qualify for the relevant procedures. For international banks, this is
especially important in view of the fact that cross-border structures
are listed as an example of types of transactions that could warrant
additional scrutiny.
• The Agencies should avoid implications in the Proposed Statement
that particular procedures or structures for implementing the
Agencies’ guidance are required, or even presumptively superior, for
all financial institutions. More broadly, the wording of the Proposed
Statement should be changed to make the guidance less prescriptive and
more flexible and adaptable to the range of different types of
institutions, different governance structures and oversight
mechanisms, and different types and levels of structured finance
activity.
• The Proposed Statement should be revised to avoid the creation of
new legal duties on the part of financial institutions to review and
evaluate their customers’ and counterparties’ legal, compliance,
accounting or disclosure treatment of proposed transactions. The
Institute believes it would be inappropriate and fundamentally
contrary to the stated objectives of the Proposed Statement to
establish new legal duties or standards, even by implication, through
Agency guidance in this area.
Importance of Taking Into Account the Unique Structure of
International Bank’s U.S. Operations
The Institute believes it is critical that the Agencies take into
account the nature of U.S. operations of international banks in applying
risk management guidance to such offices. For example, as offices of an
international bank headquartered in another country, U.S. branches and
agencies are not separate corporate entities and do not have boards of
directors. Thus, when the Proposed Statement describes the important
role that a financial institution’s board of directors plays in
establishing the financial institution’s risk management framework, the
Agencies should recognize that, for U.S. branches and agencies, there
necessarily will be a distinction between (1) the global risk management
oversight role of an international bank’s board of directors (or
comparable governing board), which will reside at the international
bank’s head office, which is supervised by the international bank’s home
country supervisor, and (2) the local risk management role of a U.S.
branch or agency’s senior management. The Proposed Statement is drafted
largely with U.S.-incorporated and U.S.-headquartered financial
institutions in mind, and we would respectfully request that the
Agencies more explicitly recognize in the final version of the
interagency guidance (and in other related guidance, such as additions
to examination manuals) that special considerations should be taken into
account when assessing the internal control framework of U.S. branches
and agencies of international banks. Thereafter, we would encourage the
FRB and the OCC (and, in the case of insured branches, the FDIC) to
apply the guidance flexibly to such branches and agencies when
evaluating the scope and nature of their internal control framework,
taking into account the fact that they are offices of
internationally-headquartered institutions.2
U.S. branches and agencies typically implement their own internal
controls and risk management systems, reflecting the nature of the
activities they conduct in the United States and particular U.S. legal,
regulatory and supervisory considerations. At the same time, it will be
important to recognize that U.S. branches and agencies also operate
under the international bank’s global internal controls and risk
management systems.3 In supervising international banks’
compliance with the Agencies’ final guidance, the Agencies should take
into consideration the fact that internal controls and risk management
systems for cross-border establishments involve resource allocation and
coordination between the internal controls and risk management systems
applicable to the local U.S. operations and those applicable to the
global operations of the institution. In some cases, this will require
that the U.S. risk management procedures and internal controls be
adapted to the institution’s global infrastructure and thus may not
mirror the procedures and controls or evidence the same level of
resources located in the United States that a U.S.-headquartered
institution would implement. These considerations apply not only to U.S.
branches and agencies of international banks but also to separately
incorporated U.S. financial institutions operated by international
banks, such as U.S. bank and broker-dealer subsidiaries.
The Institute appreciates the fact that the scope of the Proposed
Statement is expressly limited to the U.S. branches and agencies
of internationally headquartered banks and does not purport to apply to
their non-U.S. banking offices.4 This territorial limitation
is appropriate in the Institute’s view, and any extension to the non-U.S.
branches and agencies of international banks would have posed
significant problems and potential conflicts with non-U.S. risk
management practices, corporate procedures, legal and regulatory
requirements and supervisory standards.
General Concerns Regarding the Proposed Statement
As noted above, the Institute also shares many of the concerns raised
by domestically headquartered commenters and their associations
regarding the Proposed Statement.
The Scope of Transactions Covered by the Proposed Statement
An issue of particular concern to the Institute’s members relates to
the scope of the transactions covered by the Proposed Statement. The
Institute believes the Agencies should revise the Proposed Statement to
avoid any implication that the many types of routine and
well-established structured transactions, which may appear complex by
some criteria but which do not raise the types of legal and reputational
risks to which the guidance is directed, should be subject to enhanced
scrutiny by financial institutions. For example, the Proposed Statement
helpfully identifies a non-exclusive list of characteristics of CSFTs
that could warrant review under the risk management procedures
described in the Proposed Statement.5 Elsewhere, the Proposed
Statement lists examples of characteristics that should be considered in
determining whether a transaction warrants additional scrutiny.6
Given the tendency for such lists of examples to become “checklists” in
the examination process, or to be misused as disjunctive criteria for a
“definition” of a CSFT, we would recommend that the Proposed Statement
be revised to make clear that any one or more examples of
characteristics of CSFTs (e.g., the creation or use of SPEs
designed to address the economic, legal, tax or accounting objectives of
the customer), standing alone, do not necessarily indicate that a
structured finance transaction should be considered “complex.”
From the perspective of internationally headquartered institutions,
this point is particularly important in view of the fact that one of the
identified examples of characteristics of transactions that could
warrant additional scrutiny is “transactions that cross multiple
geographic or regulatory jurisdictions.” The U.S. operations of
international banks routinely structure and engage in cross-border
transactions, including many transactions that are entered into on a
cross-border basis using multiple branches or affiliates of the
international bank. The vast majority of such transactions do not raise
issues that would warrant additional scrutiny pursuant to a procedure
aimed at managing the legal, reputational and other risks associated
with CSFTs. Without discounting the general relevance of that particular
characteristic to a framework of structured finance risk management, we
would respectfully suggest that its presence in the Agencies’ list of
examples underscores the need to clarify that the complexity of any one
transaction will necessarily depend on the overall context of the
transaction and the parties involved.
The Importance of Flexibility and Accommodation of Tailored,
Risk-Based Practices
The Proposed Statement generally suggests a degree of deference to
financial institutions’ own judgments regarding the nature and structure
of the scrutiny that should apply to CSFTs. In our experience, this
deference is critical in areas of risk management that are as
sophisticated and as rapidly evolving as structured finance. As new
products and structures are introduced into the marketplace, new risk
management techniques are adapted, especially in the area of structured
finance where many products themselves are (or contain) tools for
mitigation of risks. The financial institutions that develop the
products and risk management techniques typically are in the best
position to tailor their procedures to the risks presented. As a result,
overly prescriptive standards in this area could present difficult
problems for financial institutions seeking to comply with Agency
guidance. Guidance that is too rigid and unable to evolve with new
practices, or that adopts a “one size fits all” approach without
allowing institutions to tailor their practices to their circumstances
or types of structured finance activities, risks undercutting financial
institutions’ efforts to develop effective risk management.
While the Proposed Statement appears intended, consistent with
risk-management guidance issued by the banking Agencies in other areas,
to permit institutions to tailor their policies and procedures to their
individual circumstances, types of transactions, etc., in the
Institute’s view there are several areas in which the Proposed Statement
implies an unduly prescriptive approach. For example, the Proposed
Statement implies that some risk management structures, such as a
senior-level review committee, are favored means of managing the risks
presented by CSFTs.7 Many financial institutions have
implemented such review committees; however, the appropriateness of
relying on such a committee necessarily will depend on the scope and
nature of the financial institution’s activities. We would recommend
that the Proposed Statement be revised to clarify that the
appropriateness of implementing a senior-level review committee will
depend on the nature of the institution’s complex structured finance
activities and its overall internal controls and risk management
framework.
Similarly, the Proposed Statement indicates in places that a
financial institution’s own legal department should review CSFTs as part
of the approval process and should be involved throughout a product’s
development, implying a need to have significant involvement of in house
legal staff. The Proposed Statement also calls for a delineation of the
roles of other in-house internal control groups, such as tax and
accounting. At many international banks, however, the U.S.-based
internal control groups commonly seek assistance from outside
professionals in assessing the legal, tax, accounting and compliance
risks presented by CSFTs (either professionals advising the bank in the
transaction or the bank’s regular outside advisors). This is frequently
the case at international banks whose U.S.-based legal, tax and
accounting departments are smaller than those of comparable domestically
headquartered institutions. The Institute believes that the Proposed
Statement should be made sufficiently flexible to allow international
banks to develop procedures to ensure adequate review using an
appropriate combination of (1) in-house resources in their U.S. and non-U.S.
operations and (2) assistance from outside advisors.8
The Importance of Not Creating New Legal Duties for Financial
Institutions
The Institute also believes it is important that the Proposed
Statement not create new duties on the part of financial institutions to
monitor the compliance by their customers and other counterparties with
applicable laws, regulations and accounting standards. The Institute
recognizes that financial institutions, in order to manage their own
legal and reputational risks, should be attentive to types of
transactions that could be subject to abuse by counterparties. Agency
guidance can usefully underscore the importance of having procedures to
make informed, risk-based judgments regarding the circumstances under
which an inquiry regarding a customer’s legal compliance, disclosure or
accounting treatment may be appropriate. That guidance should not, in
the Institute’s view, go so far as to create new duties on the part of
financial institutions to undertake such a review in particular
circumstances.
The Institute believes it would be inappropriate for the Proposed
Statement to create such legal duties beyond the existing standards
embodied in relevant statutes and common law relating to secondary and
vicarious liability. The Institute would respectfully submit that the
development of such legal duties is not within the competency of the
Agencies. Furthermore, even the inadvertent creation of new legal
standards in this area would be contrary to the objectives of the
Proposed Statement to assist financial institutions in the management of
legal risks presented by CSFTs. The Agencies’ guidance should not become
an instrument for litigants seeking to obtain from financial
institutions damages that could not be obtained from the financial
institution’s customer or counterparty. It would be unfortunate indeed
if the Agencies’ guidance had the unintended effect of increasing the
liability of financial institutions in disputes concerning CSFTs and
deterring financial institutions from engaging in transactions whose
value to the liquidity and stability of U.S. financial markets the
Agencies recognize in the Proposed Statement.
Even beyond these considerations, however, the Institute would
respectfully submit that the Proposed Statement overstates the role that
financial institutions reasonably can be expected to perform in policing
the marketplace for CSFTs. At the most practical level, it is
fundamentally unrealistic to expect financial institutions to “obtain
and document complete and accurate information regarding a customer’s
accounting treatment of the transaction [and] financial disclosures,”
“assess[] the customer’s business objectives for entering into a
transaction,” or “ensure that the customer understands the risk and
return profile of the transaction.” Even if as a policy matter it were
considered appropriate for financial institutions to undertake these
measures (and in our view it is not), a financial institution generally
will not have access to complete information necessary to make the types
of judgments they imply. Rather, only the customer/counterparty will be
able to make these judgments, with the advice of the advisors it retains
for this purpose.
To avoid any doubt regarding the intended effect of the Proposed
Statement, the Agencies should add an explicit statement to the Proposed
Statement when it is finalized to the effect that the guidance is
intended to assist financial institutions in the development of
appropriate risk management procedures and not to imply what legal
standards or duties apply to a financial institution’s transactions with
its customers and other counterparties.
In addition, we would encourage the Agencies to revisit their
approach to describing appropriate measures a financial institution
should take vis-à-vis its customers. In view of the fact that there may
be different sources for, and degrees of, elevated risk, and consistent
with the overall risk-focused approach of the Proposed Statement, we
would recommend that prescriptive statements such as “should ensure,”
“should assess,” and “should obtain and document” be revised to suggest
that financial institutions’ procedures identify when such review and
documentation will be required, as opposed to suggesting that it should
be required in all instances of elevated risk.9
At a minimum, we believe that the Proposed Statement should be
revised to make clear that the types of review and other risk management
procedures that a financial institution should use for CSFTs will
necessarily depend not only on the type of transaction involved but also
on the nature and circumstances of the financial institution’s role in
the transaction. For example, appropriate risk management procedures may
vary depending on whether the financial institution is the agent or
arranger in a syndicated transaction or is instead a participating
institution. A participating institution often serves as a “Liquidity
Provider” or “Credit Enhancer,” which contractually obligates it to
replace the market investors in certain specified situations. In such
situations, these participants are more akin to the investing public for
whom the draft guidance is offering protection. Also, participants
rarely, if ever, are afforded the in-depth and continuing access to the
structuring customer that the arranging institution enjoys. Similarly,
appropriate risk management procedures may vary depending on whether the
particular structured finance product is one developed by the financial
institution itself or presented to the financial institution by a
customer of the financial institution or by one of the financial
institution’s outside advisors. While the relevance of these types of
considerations is implicit in the Proposed Statement, we believe they
should be explicitly identified in the final version of the Proposed
Statement.
Lastly, we would encourage the Agencies to take into account the fact
that many customers and other counterparties of financial institutions
covered by the proposal (both domestically headquartered financial
institutions and U.S. operations of international banks) are non-U.S.
entities. These non-U.S. counterparties operate under a variety of home
country laws and regulations that could impact the ability of U.S.
financial institutions to obtain information regarding their legal and
regulatory compliance, accounting treatment, disclosure practices, etc.
Concomitantly, the types of risk management procedures called for by the
Proposed Statement could impose unique burdens on non-U.S.
counterparties. We respectfully submit that such extraterritorial
effects should be minimized where possible, consistent with the
Agencies’ objective of guiding the industry’s development of sound risk
management practices for CSFTs.
Please do not hesitate to contact the Institute if we can be of
further assistance.
Sincerely,
Lawrence R. Uhlick
Executive Director and
General Counsel
299 Park Avenue
New York, NY 10171
1 69 Fed. Reg. 28980 (May 19, 2004).
2 For example, the Proposed Statement indicates that
financial institutions “should define the complex structured finance
transaction reporting requirements appropriate for various levels of
management and the Board.” 69 Fed. Reg. at 28989 (emphasis
added). In the case of a U.S. branch or agency, reporting requirements
relating to complex structured finance activities in the United States
will in most cases appropriately apply to various levels of management.
The extent to which reports are made to the international bank’s home
country governing board depends on separate considerations relating to
the international bank’s global framework for risk management and
internal controls.
3 See 69 Fed. Reg. at 28986 (“In the case of U.S.
branches and agencies of foreign banks, these policies should be
coordinated with the group-wide policies developed in accordance with
rules of the foreign bank’s home supervisor.”)
4 See, e.g., id.
5 See 69 Fed. Reg. at 28985.
6 See 69 Fed. Reg. at 28988.
7 See 69 Fed. Reg. at 28986 (“The [A]gencies believe
that such a senior-level committee can serve as an important part of an
effective control infrastructure for complex structured finance
activities.”).
8 For example, the flexibility reflected in the statement to
the effect that “[f]inancial institutions should ensure that any legal
reviews are conducted by qualified in-house or outside counsel and that
these professionals are provided the documentation and other information
needed to properly evaluate the transaction,” see 69 Fed. Reg. at 28987
(emphasis added), should be expanded and applied throughout the
discussion of internal review procedures to avoid any implication (which
arises at other places in the discussion) that the professional
resources devoted to the review need to be located in-house.
9 Compare, e.g., 69 Fed. Reg. at 28988 (“The financial
institution’s policies also should address when third party accounting
professionals should be engaged to review transactions.” (emphasis
added)).
|
