Regulator Open Session – OCC - FIRMA

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Nov 18, 2013 (3 years and 4 months ago)

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1

Regulator Open
Session
-

OCC



Joel Miller

Asset Management Group Leader

Office of the Comptroller of the Currency

April 29, 2009

2


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 (CA
ME
LS)


FFIEC: Uniform Interagency Trust Ratings System
(UITRS)


OCC focus: Composite Rating



6

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


7

Asset Management
Risks

8

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.

11

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






13

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.

14

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
$ Billions
0
200
400
600
800
1,000
1,200
1,400
1,600
S & P 500
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.

15

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
Trillion
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
Trillion
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.





22



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
$ trillion
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.




25

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.


32

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

39

OCC Asset Management

Handbooks & 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



41

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


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QUESTIONS?



Contact:



Joel Miller, (202) 874
-
4493



Joel.Miller@occ.treas.gov