1 regulator open session - occ joel miller asset management group leader office of the comptroller...
TRANSCRIPT
1
Regulator Open Session - OCC
Joel Miller
Asset Management Group Leader
Office of the Comptroller of the Currency
April 29, 2009
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OCC – Asset Management Supervision Asset Management Risks
Focus on Market Disruption Issues Managing Asset Management Risk Asset Management Examination Focus Conclusions Appendix I: OCC Guidance
Presentation Overview
3
OCC - Asset Management Supervision
4
OCC Asset Mgt. Supervision OCC regulates 1600 national banks and 70
limited purpose trust companies Range from large complex banks with global
operations to community banks Approximately half of all national banks have
fiduciary, retail brokerage, investment banking or advisory activities.
About 150 OCC examiners with AM expertise perform on and off-site supervision.
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OCC Asset Mgt. Supervision
Supervision by Risk Objective: Assess a bank’s ability to identify,
measure and monitor risk Risk Assessment System (RAS) – For nine risk
categories, determine: Quantity of risk Quality level of risk management Direction
FFIEC: Uniform Ratings System (CAMELS) FFIEC: Uniform Interagency Trust Ratings System
(UITRS) – OCC focus: Composite Rating
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OCC Asset Mgt. Supervision Integrated risk-based supervision Large Banks: EIC/AM Team Leader Mid-size Banks: EIC/Functional EIC-AM Community Banks: Portfolio Manager/AM
Examiner Supported by five AM Lead Experts and
Washington based AM Policy Group
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Asset Management Risks
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Asset Management Risk Areas Broad Risk Categories - Asset Management
Activities Reputation Strategic Compliance Transaction (Operational)
CAMELS: Management & Earnings Market Disruption – Has highlighted these
risks, especially in certain products and activities
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Asset Management Risk Areas
Reputation and Litigation Risks Market disruption resulted in a substantial
decline in the market value of fiduciary assets across almost all asset classes. Discretionary (managed) accounts and employee
benefit accounts (e.g., 401-k), pose the greatest reputation and litigation risk to bank fiduciaries.
Clients reassessing which asset managers best weathered the storm and moving assets accordingly. Client retention a key focus.
10
Asset Management Risk Areas
Valuation of assets in illiquid markets Accounting guidance (FAS 157) requires fair
value to represent current market conditions, but not the price that would be received in a forced or distressed sale.
Pricing services dropped coverage of illiquid securities and bank asset managers and custodians had to seek other pricing sources.
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Asset Management Earnings
Why Focus on AM Earnings? Effects Earnings/CAMELS Significant losses can erode Capital Market disruption
Firmwide high risk initiatives may be driven by earnings pressure
Effective risk management in AM needed to avoid taking on excessive risk to compensate for lost earnings
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Asset Management Risk Areas
Market Sensitive Earnings Decline Asset base and administrative fees contract as market
value of assets declines. Performance fees decline as many alternative
investment strategies have turned negative. Flight to quality – investor movement away from higher
profit margin business (equities) to lower margin cash/cash equivalents (MMMFs) – reduces management fees.
EB Defined Contribution Plans Fees effected by: Reductions in employer match reductions Reductions in employee contributions as a result of layoffs or
uncertainty
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Asset Management Revenue
AM revenue of $6.36 billion in 4Q08 comprised 25% of national banks’ non-interest income and 7% of operating income.
National Bank AM revenue by Call Report category: Fiduciary Revenue $3.6 billion Securities Brokerage Revenue $1.3 billion Annuity Sales Revenue $95 million Investment Banking, Advisory and Underwriting
Revenue $1.4 billion
Source: Call Report. Includes full-service national banks and limited-purpose national trust banks as of 12/31/08.
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Fiduciary Income Linked to Assets under Management Positive correlation between Fiduciary income
and S&P 500. Decline in equity markets = decrease in bank’s
AUM and income.
$2.00$2.50$3.00$3.50$4.00$4.50$5.00$5.50$6.00$6.50$7.00$7.50$8.00$8.50$9.00$9.50
$ B
illi
on
s
0
200
400
600
800
1,000
1,200
1,400
1,600
S &
P 5
00
Income $4.91 $5.25 $5.52 $5.63 $5.92 $6.19 $6.03 $5.87 $6.55 $6.43 $6.51 $6.63 $7.20 $6.78 $7.35 $6.84 $7.18 $7.50 $7.90 $7.40 $8.50 $8.50 $9.00 $8.20 $7.40
S&P 500 885 875 909 994 1,044 1,114 1,124 1,111 1,148 1,192 1,186 1,217 1,228 1,276 1,284 1,278 1,366 1,420 1,471 1,497 1,493 1,388 1,359 1,280 1,003
Dec-02
Mar-03
Jun-03
Sep-03
Dec-03
Mar-04
Jun-04
Sep-04
Dec-04
Mar-05
Jun-05
Sep-05
Dec-05
Mar-06
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Source: Call Report. Includes all full-service commercial banks and limited-purpose national trust banks as of 12/31/08.
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Total Fiduciary & Custody Assets All Banks (2004 – 2008)
Total Fiduciary Assets - All Banks
$15.5 $16.1$17.3 $18.3
$20.0$21.8 $22.6 $22.9
$18.2
$0.0
$5.0
$10.0
$15.0
$20.0
$25.0
Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08
Trilli
on
Total Custody Assets - All Banks
$35.7 $36.5$42.3
$47.4 $50.4$57.8 $57.1
$50.3
$33.2
$0.0
$10.0
$20.0
$30.0
$40.0
$50.0
$60.0
$70.0
Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08
Trilli
on
Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.
Growth in both fiduciary and custody assets leveled off by mid-year 2008, then dropped significantly by end of year.
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Asset Management Risk Areas
AM products and services impacted by ongoing Market Disruption Hedge Funds Securities Lending Auction Rate Securities Collective Investment Funds Money Market Mutual Funds/STIFs
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Asset Management Risk Areas Hedge Fund Issues
Most strategies performing poorly in current market Performance and client liquidity needs lead to increasing
redemption requests Which leads to gates raised/fund lock-ups Risks to bank fund managers.
Decline in earnings potential due to industry contraction Litigation risk Reputation risk
Banks are particularly vulnerable where they placed discretionary client assets in hedge funds and funds-of-funds that are now frozen or in liquidation.
Bank custodians also vulnerable as clients seek out deep pockets to indemnify their hedge fund losses.
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Madoff Fraud Direct and Indirect Exposures
Investments by individuals, foundations, endowments, and pension plans in Madoff “fund” – bank may be acting in a fiduciary capacity
Indirect investments in fund-of-funds that invest a percentage of their assets in a Madoff “fund”
Custodial relationships in which bank holds Madoff “fund” assets
Lending exposure to clients who invested in Madoff “fund.”
Asset Management Risk Areas
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Securities Lending Issues Once viewed as low risk by clients and banks Decline in value of sec-lending pools (e.g. Lehman,
AIG assets) holding reinvested cash collateral: Litigation and settlements Restrictions imposed on customers’ ability to withdraw
assets Many customers now unwilling to take on additional
risk and sec-lending opportunities dry up. For some banks, contraction has substantial decreased
sec-lending business and earnings Banks perceived to be stronger in sec-lending have
prospered in “flight to quality”.
Asset Management Risk Areas
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Asset Management Risk Areas Auction Rate Securities Issues
Regulatory actions - settlements with SEC, FINRA and state regulators that include buy-back schedules and CMPs.
Voluntary ARS buybacks undertaken to preempt litigation. Both voluntary and involuntary buy-backs can be costly
and saddle banks with illiquid securities with corresponding impact on bank earnings, capital and liquidity.
Capital support agreements extended to affiliated funds holding these illiquid securities to buy time and keep ARS off the bank’s books.
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Asset Management Risk Areas
Collective Investment Fund Issues Funds holding illiquid assets such as RE
facing flurry of redemption requests. Industry seeks to avoid liquidating fund assets at fire sale prices.
Expect issuance of new Labor Department regulation, or Congressional action, that will compel substantial new fee and conflict disclosures for employee benefit assets.
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National banks continue to be major players in offering collective investment funds. •66 NBs offer over 1,600 collective investment funds totaling $1.3 trillion.
Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.
Market Value of Collective Investment & Common Trust Funds Decline
$0.85 $0.90
$1.33
$1.51
$1.74
$2.01 $2.02
$1.30
$1.75$1.67
$2.29
$2.51
$2.68
$2.94 $3.00
$2.00
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
2001 2002 2003 2004 2005 2006 2007 2008
$ t
rill
ion
National Banks
All Banks
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Asset Management Risk Areas
MMMFs and Short Term CIF Issues Sponsors provide support to stabilize NAVs
or unit values. (SIVs, Lehman…) “Flight to safety” from Prime funds to
Treasury and Government funds. Low rates – waived fees Some funds closed or restricted
Government Support Programs
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Pledge Requirements – Reg 9.10
Enhanced FDIC insurance reduces trust pledge requirements: Coverage to $250,000 for certain retirement
accounts Coverage expanded for irrevocable trusts Temporary coverage increase from $100K to $250K
(through 12/31/09) for other accounts Temporary (through 12 /31/09) FDIC guarantee of
certain non-interest bearing accounts FDIC insurance pass-through guidance applies to
individual accounts held in covered non-interest bearing omnibus account.
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Employee Benefits Deposit Prohibition – Problem Banks Banks that are no longer “well capitalized”
or “adequately capitalized” are prohibited from accepting any employee benefit plan deposits. Federal Deposit Insurance Act as amended
in 2006 (12 USC 1821(a)(1)(D)(ii)) imposes this prohibition.
EB depositors still receive pass through coverage, but bank is in violation if it accepts EB deposits, including additions to existing accounts
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Managing Asset Management Risk
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Managing AM Risk Investment Management:
Adhere to prudent investment standards Maintain effective and ongoing due diligence
over external investment managers Maintain effective and ongoing due diligence
over complex and alternative investments Properly conduct and document investment
reviews
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Managing AM Risk Effective valuation policies and
oversight - Valuation of assets in illiquid markets Market disruption has made it difficult to
value suddenly illiquid assets Pricing services dropped coverage of
illiquid securities Accounting guidance (FAS 157) requires
fair value on audited financial statements Improper valuations have been a key
factor in disruption related litigation
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Managing AM Risk Operational Focus:
Potential increase in operating losses and trade errors associated with market volatility
Potential stress on bank controls, operations, and risk management resulting from expense reduction
Impact of loss of key personnel resulting from corporate-wide downsizing
Need for due diligence over sub-custodians as highlighted by recent fraud disclosures
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Asset Management Examination Focus
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Asset Management Risk Areas GLBA/Regulation R
Effective date for most banks - 1/1/09. Must ensure all securities activities conducted by a bank department, including the Treasury desk, comply with broker/dealer requirements.
Bankers need to look across all lines within the bank (e.g., asset management, capital markets and commercial) to ensure compliance with the new regulatory requirements.
Failure to comply could result in securities law violations and rescission of trades to the detriment of the bank.
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Recent OCC Issuances
Conflicts of Interest Associated with Divestiture of Asset Mgt. Affiliates OCC Bulletin 2008-5
Annual Reg 9 Reviews OCC Bulletin 2008-10 Expectations Automated vs. Manual Reviews Unique Assets
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AM Examination Observations Investments
Effective annual reviews Process/oversight Documentation/Exceptions
Understanding, due diligence and oversight of alternative investments (hedge funds)
Oversight of third party investment advisors Proper authorization for use of affiliated funds or
brokers Oversight of pricing for illiquid or thinly traded
assets
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AM Examination Observations
Account Administration and Compliance Inadequate Compliance/Risk Management
programs - testing Accepting direction from authorized parties EB administration/expertise Adequate/current policies and procedures Oversight of account overdrafts
35
AM Examination Observations Operations/Internal Controls/Audit
Segregation of duties & dual control Controls over system access Corporate action processing automation BSA audit scope/trust activities Monitor 9.10 pledge requirements
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Conclusions
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Conclusions
Earnings Pressures/Effective Risk Management
Investment Management Due diligence/risks of complex investments
Back to Basics Investment oversight Account Administration Operations
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Appendix I:OCC Guidance
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OCC Asset ManagementHandbooks & Guidance Retirement Plan Services Collective Investment Funds Asset Management Conflicts of Interest Custody Services Investment Management Services Personal Fiduciary Services Retail Nondeposit Investment Sales Insurance Activities A Guide to the National Banking System
http://www.occ.treas.gov/nb/nbguide.pdf
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OCC Handbooks & Guidance OCC 2008–10, Fiduciary Activities of National Banks: Annual
Reviews of Fiduciary Accounts Pursuant to 12 CFR 9.6(c)
OCC 2008-5, Conflicts of Interest: Risk Management Guidance – Divestiture of Certain Asset Management Businesses
OCC 2007–42, Bank Securities Activities: SEC's and Federal Reserve's Final Regulation R
OCC 2007-21, Supervision of National Trust Banks: Revised Guidance: Capital and Liquidity
OCC 2007-7, Soft Dollar Guidance: Use of Commission Payments by Fiduciaries
OCC 2007-6, Registered Transfer Agents: Transfer Agent Registration, Annual Reporting, and Withdrawal from Registration
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OCC Handbooks & Guidance OCC 2006-24, Interagency Agreement on ERISA Referrals
OCC 2004-2, Banks/Thrifts Providing Financial Support to Funds Advised by the Banking Organization or its Affiliates