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THE NEW YORK CLEARING
HOUSE ASSOCIATION
Ms. Jennifer J. Johnson, Secretary
Board of Governors of the
Federal Reserve System
20th & Constitution Avenue, N.W.
Washington, D.C. 20551
Attention: Docket Nos. R-1156, R-1162
Robert E. Feldman, Executive Secretary
Federal Deposit Insurance Corporation
550 17th Street, N.W.
Washington, D.C. 20429
Attention: Comments/OES
Public Information Room
Office of the Comptroller of the Currency
Mailstop 1-5
250 E Street, S.W.
Washington, D.C. 20219
Attention: Docket Nos. 03-21, 03-22
Regulation Comments
Chief Counsel’s Office
Office of Thrift Supervision
1700 G Street, N.W.
Washington, D.C. 20552
Attention: Nos. 2003-47, 2003-48
Re: Interim Capital Treatment of Consolidated Asset-Backed Commercial
Paper (“ABCP”) Program Assets and Notice of Proposed Rulemaking
Regarding ABCP Programs and Early Amortization Provisions
Ladies and Gentlemen:
The New York Clearing House Association L.L.C. (“The Clearing
House”), an association of major commercial banks1, appreciates the
opportunity to comment on the interim final rule (“Interim Final Rule”)
regarding the capital treatment of ABCP program assets and the notice of
proposed rulemaking (“NPR”) regarding ABCP programs and early
amortization provisions recently published by the Board of Governors of
the Federal Reserve System (the “Board”), the Federal Deposit Insurance
Corporation (the “FDIC”), the Office of the Comptroller of the Currency
(the “OCC”) and the Office of Thrift Supervision (the “OTS”) (together,
the “Agencies”).
We commend the Agencies for their swift response to the
implementation of the Financial Accounting Standards Board’s
Interpretation No. 46 (“FIN 46”) on banking organizations’ risk-based
capital calculations. The ramifications of FIN 46 for banking
organizations’ Tier 1 and total capital ratios, if left unaddressed,
would be inappropriate and significant. This is a critical area of
concern for all banking organizations and we applaud the Agencies’
efforts to address the consequences of the change in the accounting
treatment of variable interest entities (“VIEs”) resulting from FIN 46.
We also generally support both the Agencies’ view that regulatory
capital should in many circumstances be maintained against 364-day or
less ABCP liquidity facilities and the substance of the NPR’s approach
to an early amortization capital charge for securitizations of retail
credit exposures. However, we believe the substance of the ABCP
liquidity proposal requires revision. As to the early amortization
capital charge for securitizations of retail credit exposures, we urge
the Agencies to coordinate their proposal, as to substance and timing,
with the implementation of the new capital accord of the Basel Committee
on Banking Supervision (“BIS II”).
We have set forth below our specific comments on the Interim Final
Rule and on the NPR.
I. Interim Final Rule
While the interim final rule appropriately affords banking
organizations at least temporary risk-based capital relief against ABCP
program assets that may be required to be consolidated under FIN 46,
there is a lack of clarity and an apparent unintended inconsistency
among the Agencies’ regulations as to the types of commercial paper
vehicles covered by the rule.
More specifically, the Agencies have not defined an “asset-backed
commercial paper program” in exactly the same way in their respective
regulations, as implemented on an interim basis in the Interim Final
Rule and as proposed to be made permanent in the NPR. We understand,
however, that the Agencies intend for structured investment vehicles (“SIVs”)
to be eligible for the risk-based capital relief applicable to “ABCP
programs.” Unfortunately, the definitions of “asset-backed commercial
paper program” proposed by the Board and the FDIC are ambiguous and
could be read to exclude SIVs. We therefore urge the Agencies to remedy
this inconsistency and uncertainty, in order to prevent possible future
misinterpretations.
SIVs are entities that issue long-term capital notes and short-term
funding instruments (e.g., commercial paper and medium-term
notes) and use the proceeds to purchase investments in highly-rated debt
securities. SIVs are required to operate within a number of prescribed
limits and tests specified by rating agencies. Although SIVs typically
have more funding alternatives available to them than traditional ABCP
programs, SIVs are conduits that present, for a banking organization
holding an SIV’s capital notes and/or acting as the portfolio/investment
manager or sponsor of an SIV, a similar risk profile as for a banking
organization acting as sponsor of an ABCP program. That is, the risks
associated with an SIV are dispersed among its capital noteholders based
upon their ownership amounts. Consequently, SIVs consolidated by a
banking organization as a result of the application of FIN 46 should be
subject to the same regulatory capital treatment as other ABCP programs.
We suggest the following definition of “asset-backed commercial paper
program” to address this issue:
“Asset-backed commercial paper program” means a commercial
paper conduit, structured investment vehicle or other program that, in
each case, issues commercial paper backed by assets or other exposures
held in a bankruptcy-remote special purpose entity.
II. Notice of Proposed Rulemaking
A. ABCP Programs – Treatment of Liquidity Facilities
The Agencies have proposed to require that liquidity facilities to
ABCP programs meet certain tests in order for the liquidity facility not
to be considered a recourse obligation or direct credit substitute, and
to be eligible for the 20% (proposed for facilities with original
maturities of one year or less) or 50% (already in effect for facilities
with original maturities of more than one year) credit conversion
factors for determining the facility’s on-balance sheet credit
equivalent amount. Such an “eligible liquidity facility” is defined by
the NPR as being one in which draws under the facility are subject to a
reasonable asset quality test that precludes funding of assets 60 days
or more past due or in default.
Given the continuing consideration and revision of BIS II and its
framework, we recommend that the Agencies re-consider the conversion
factors proposed in the NPR to make them consistent with the BIS II
requirements. Based upon the strength of the credit risk profile of the
liquidity facilities, we believe a lower conversion factor than 20%
would be appropriate in most cases. In addition, we do not believe that
the asset quality test proposed for liquidity facility draws for
transactions with rated assets is appropriate.
Specifically, while The Clearing House members believe that it is
appropriate to maintain some regulatory capital against ABCP liquidity
facilities having an original maturity of one year or less, mandating a
20% credit conversion factor for such facilities would result in a
risk-based capital charge which is excessive relative to the historical
credit loss experience of banking organizations with these facilities.
We note that others in the industry have proposed a 5% – 10% credit
conversion factor for such short-term liquidity facilities as a more
risk sensitive and appropriately calibrated proxy for the credit risk
truly inherent in these exposures. We strongly support this view.
Moreover, it is important to note that adoption of the proposed 20%
credit conversion factor for short-term liquidity facilities would
create competitive inequities for U.S. banking organizations, not only
with non-U.S. competitors but also with other non-bank providers of
corporate funding within the U.S.
Additionally, apart from the proper credit conversion factor to be
applied to short-term ABCP liquidity facilities, we believe that the
definition of an “eligible liquidity facility” should be more flexible
and incorporate asset quality tests that vary based upon the specific
transaction structures or underlying asset types. In our view, the
generic “reasonable asset quality test” established in the NPR’s
proposed definition of “eligible liquidity facility” would not
appropriately assess credit risk or set appropriate risk-based capital
requirements for liquidity facilities. Instead, we recommend that the
Agencies replace the NPR’s proposed definition of “eligible liquidity
facility” with a requirement that each bank seek approval from its
primary regulator for reasonable asset quality tests specific to the
ABCP programs sponsored by that bank. This is essentially an “internal
models” approach similar (i) to that applied by the Agencies in the
market risk capital requirements and in some circumstances involving
recourse obligations and direct credit substitutes for ABCP programs and
(ii) to the internal ratings based approach for credit risk contemplated
by BIS II.
We believe the characteristics of the ABCP program market support our
proposal. There are significant variations in the underlying terms and
characteristics of various ABCP programs. These differences are driven
primarily by asset type and transaction type, and, in certain cases, by
the practices and policies followed by the sponsoring bank with respect
to its ABCP program liquidity facilities. Generally, under ABCP program
liquidity facility agreements, the liquidity provider purchases specific
underlying ABCP conduit assets at a set price upon the occurrence of
defined events. The purchase price to be paid is determined by reference
to certain credit-related terms or “triggers” set forth in the liquidity
facility agreement.
Credit-related triggers that are used to determine the purchase price
for a particular ABCP conduit asset vary according to the specific
transactions and the underlying asset pool characteristics. Generally,
credit-related triggers can be classified as one of two types: ratings
based triggers or cash flow/financial benchmark triggers. Each of these
types of credit-related triggers has unique characteristics, and both
exist in industry practice.
Ratings based purchase price adjustment triggers in liquidity
facility agreements can be based on the credit rating of the underlying
seller, the transaction itself 2 (if externally rated), or
the transaction guarantor. Cash flow/financial benchmark purchase price
adjustment triggers in liquidity facility agreements are based on key
financial performance benchmarks of the underlying asset pool, including
cash flow performance measures such as days past due or delinquent
payments.
For cash flow/financial benchmark triggers, where delinquent cash
flow benchmarks are used, different underlying asset types have very
different charge off/delinquency standards. For example, trade
receivable pool transactions may have a 60-day or 90-day charge
off/delinquency standard, and credit card receivable pool transactions
generally have a charge off/delinquency standard of between 120 and 180
days.3
Regarding the asset quality test set forth in the NPR, we do not
believe that the limitation that prohibits liquidity facility draws for
transactions where the rating of the assets falls below investment grade
is appropriate. Such a requirement is irrelevant for non-ratings-based
triggered transactions where the asset quality is determined using cash
flow or other benchmarks. Further, we note that all cash flow and
ratings based purchase price triggers are in place to adjust the
purchase price of the asset pool underlying the liquidity facility to
ensure that any credit risk of the underlying asset pool is incorporated
into the amount of the draw, thereby making the investment grade
requirement unnecessary. We therefore suggest that the Agencies delete
this limitation.
Consequently, instead of the standardized requirements proposed in
the NPR, we recommend that the final rule allow each bank to establish
with its primary regulator an asset- and structure-specific reasonable
asset quality test for determining whether that bank’s liquidity
facilities are “eligible liquidity facilities.” Such a bank-specific
test would be based on that bank’s ABCP program liquidity facility
programs and would incorporate industry practice for assessing credit
quality in ABCP program liquidity facilities. We believe that this
method of evaluating risks to banks related to their particular
liquidity facilities would more accurately assess the banks’ exposure
and better achieve the Agencies’ goal of implementing a risk-sensitive
approach to the exposures arising from ABCP programs.
B. Liquidity Facilities Held in Trading Accounts
The Clearing House member banks understand that the Agencies’ are
concerned about potential arbitrage of the risk-based capital rules in
connection with the proposed credit conversion factor for short-term
liquidity facilities related to ABCP programs. The Agencies have
explicitly addressed this concern in the NPR by proposing to amend their
respective market risk capital rules to require generally that liquidity
facilities in favor of ABCP programs held in the trading account be
excluded from coverage under the market risk capital rules and instead
be subject to capital requirements under the credit risk capital rules.
This change poses several serious concerns, and The Clearing House
member banks believe it is inappropriate and unwarranted. First, the
Agencies’ proposal ignores U.S. GAAP accounting decisions with respect
to the trading book classification of individual transactions by
prohibiting application of the market risk capital rules and mandating
use of the credit risk capital rules. The proposed approach would
effectively reclassify these transactions to the banking book,
notwithstanding that the Call Report instructions typically require that
they be carried in the trading book. Accordingly, implementation of this
proposal would establish a precedent whereby in the future the Agencies
could incrementally revise for certain products their risk-based capital
treatment, which derives from the accounting decisions made with respect
to those products, and thus potentially undermine business decisions
related to other products carried in the trading book.
Second, we note that there already exists a well-defined mechanism
for assessing capital in the trading book. Namely, the market risk
capital rules distinguish the capital (the specific risk component)
required for liquid/rated as opposed to illiquid/unrated exposures held
in the trading book. The specific risk component capital charge for an
illiquid/unrated exposure is the same as under the credit risk capital
rules, whereas rated exposures are appropriately analyzed in a more
risk-sensitive calibration than under the credit risk capital rules.
Additionally, the mark-to-market accounting discipline applied to
trading positions (cash or synthetic), combined with individual banking
organizations’ market value adjustment process (the component that
addresses illiquidity or pricing uncertainty), assures that capital is
adequately reserved on a “real-time” basis. To not use all of these
regulatory and conventional mechanisms for assessing the appropriate
amount of capital for market pricing risk, and instead to arbitrarily
default to the credit risk capital rules, is not justified as an
analytic matter or by the low level of risk that providers assume in
connection with these products and in practice could dissuade U.S.
banking organizations from offering products such as deep
out-of-the-money liquidity options, which embody positive risk/return
features.
Additionally, the Agencies’ apparent focus on ABCP programs in which
the underlying assets consist of unrated corporate trade receivables is
much too narrow. Although the Agencies acknowledge that some programs
may hold marketable assets such as rated asset-backed securities, we
believe that the risk profile of programs that hold rated corporate
bonds has not been adequately considered. We are very concerned about
the anomaly this will create: the Agencies’ example would lead to the
conclusion that a very small capital charge will result if the assets
are highly rated when, in fact, a liquidity facility for a program whose
underlying assets are AAA-rated corporate bonds would be assigned the
highest credit risk weighting as if the underlying assets were unrated
and illiquid.
Finally, the NPR does not include a definition of “liquidity
facilities.” The Board and the FDIC each provide in the proposed
amendments to their respective market risk capital rules that positions
in the bank’s trading account that “in form or in substance” act as
eligible liquidity facilities to ABCP programs would be subject to the
credit risk capital rules. We believe that this creates a framework that
is too broad and will be impractical to implement. We strongly urge that
each of the Agencies remove the prohibition against use of the market
risk capital rules for derivatives and other similar arrangements with
ABCP programs that may be “deemed” eligible liquidity facilities, and
that are appropriately held in the trading book under U.S. GAAP
accounting. We respectfully submit that regulatory capital should be
determined in the same way for the same risks in the trading book
whether the transaction is a cash position (funded) or a derivative with
a single counterparty or a commercial paper issuer (unfunded). That is,
there should not be significantly different regulatory capital results
simply by indirectly assuming the same risks that could be assumed
directly.
However, if the Agencies determine that the approach proposed in the
NPR is appropriate, the exclusions from covered positions under the
market risk capital rules should be narrowed. At a minimum, we strongly
urge the Agencies to adopt a uniform standard that conforms to the
standard proposed by the OCC. We understand that the Agencies may wish
to prevent “plain vanilla” liquidity facilities traditionally present in
ABCP programs from being treated as trading positions. We note, however,
that there can be other, highly-structured derivative products related
to various types of ABCP programs that may be appropriately treated as
trading positions. We are very concerned that the treatment proposed in
the NPR will too readily prescribe an unjustified credit risk capital
treatment for such products.
Specifically, we propose that banking organizations be permitted to
leave in the trading book for regulatory capital purposes (and apply the
market risk capital rules to) liquidity facilities or arrangements that
satisfy the following criteria:
1. The arrangement with the ABCP program must be documented in
legal form as a derivative, part of a documented trading strategy,
treated for risk management purposes as a trading position and treated
as a trading account transaction for U.S. GAAP accounting purposes.4
2. The purpose of the derivative or other arrangement must be to
provide (i) interest rate hedging, (ii) foreign exchange rate hedging,
and/or (iii) market price protection on issued commercial paper which
requires funding only upon remote price movements caused by a general
disruption in the commercial paper markets.
3. There must be an independent credit support, either direct or
indirect, in the overall arrangement.
4. The underlying assets and/or the related liabilities (i.e., the
commercial paper) must be eligible for inclusion in the trading book.
We do not expect to achieve a zero regulatory capital charge in the
trading book for these derivatives positions, but we believe it is
inappropriate to take a full credit risk capital charge given that
structural elements of the transactions make potential risk of credit
losses a remote possibility. We believe that this would be more than
adequately achieved by the mark-to-market, the trading book risk
management and the market risk capital processes.
C. Early Amortization Capital Charge
The Clearing House members recognize and support the Agencies’
efforts to take a more risk-sensitive approach by tiering the risk-based
capital charges in the NPR’s proposal with respect to an early
amortization charge for securitizations of retail credit exposures. This
is superior to the past proposals on this topic. For banking
organizations with significant securitized retail credit exposures, this
is a critically important issue, the scope of which is not limited to
operations in the United States. Therefore, although we agree with the
direction the Agencies have taken in the NPR, we strongly urge the
Agencies not to address this issue in regulations adopted pursuant to
the NPR but instead to coordinate their requirements for an early
amortization capital charge with the implementation of BIS II, both as
to substance and timing of implementation. The risk of inconsistent or
contradictory guidance in this area is too great, and the effects too
far reaching, to justify adopting any new regime in this area in advance
of the implementation of BIS II. Furthermore, we do not understand the
urgency of adding risk-based capital requirements to the existing
charges on these transactions given that these securitization structures
generally are assessed risk-based capital currently under the Agencies’
recent securitization and recourse rules.
* * *
Thank you for considering the views expressed in this letter. We
would welcome the opportunity to meet with you in person if you would
find that to be useful. If you have any questions, please contact Norman
R. Nelson, General Counsel of The Clearing House, at 212-612-9205.
Sincerely yours,
Jeffrey P. Neubert
President and CEO
The Clearing House
100 Broad Street
New York, NY 10004
1 The members of The Clearing House are Bank of America,
National Association, The Bank of New York, Bank One, National
Association, Citibank, N.A., Deutsche Bank Trust Company Americas, Fleet
National Bank, HSBC Bank USA, JPMorgan Chase Bank, LaSalle Bank National
Association, Wachovia Bank, National Association, and Wells Fargo Bank,
National Association.
2 For example, certain types of conduits often purchase
investment securities that are externally rated on a transaction basis.
3 We
note our view that an arbitrary cut-off at the 60-day delinquency level
in the case of credit card receivable pool transactions would
significantly overstate the risk of default, as the amount of credit
cards that ultimately charge-off between 120 and 180 days is typically
far less than the amount that are 60 days delinquent.
4 This would require that changes
in value be marked-to-market through P&L and therefore be reflected
immediately in regulatory capital.
cc:
Norah Barger
Deputy Associate Director
Board of Governors of the
Federal Reserve System
George French
Deputy Director
Division of Supervision and Consumer Protection
Federal Deposit Insurance Corporation
Tommy Snow
Director, Capital Policy
Office of the Comptroller of the Currency
John C. Price
Director, Supervision Policy
Office of Thrift Supervision
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