On December 23, 2011, the federal agencies extended the comment period on a proposal to implement the Dodd-Frank Volcker Rule until February 13, 2012. The Volcker Rule requires regulators to implement certain prohibitions and restrictions on the ability of a bank or nonbank financial company to engage in proprietary trading and have certain interests in, or relationships with, a hedge fund or private equity fund.
As noted in the November LRA, the proposal explicitly provided that a bank’s acquisition, retention and/or sponsorship of separate account BOLI are permitted activities under certain conditions. Industry groups and lawmakers cited the complexity of the proposal and the lack of coordination with the Commodity Futures Trading Commission (CFTC) in seeking the comment-period extension. There is also a bank lobbying effort that focuses on the definition of “illiquid” so more funds will be accorded the five year compliance period instead of the two year period which is applicable to most bank holdings in hedge and private equity funds. Originally, comments were due by January 13, 2012.
On December 20, the Federal Reserve Board (FRB) issued a proposal to implement Sections 165 and 166 of the Dodd-Frank Act. The proposal generally applies to all U.S. bank holding companies (BHCs) with consolidated assets of $50 billion or more and any nonbank financial firms that may be designated by the Financial Stability Oversight Council (FSOC) as systemically important companies. The proposal includes a wide range of measures addressing issues such as capital, liquidity, credit exposure, stress testing, risk management and early remediation requirements. The proposal has a gradual or phased-in approach to implementation. In fact, in several areas the initial phase uses or enhances requirements already imposed on large BHCs. For example, the first phase of enhanced risk-based capital and leverage requirements is to require compliance with the FRB’s capital plan rule issued in November 2011. Later implementation phases will be addressed in subsequent rulemakings. The FRB is proposing that covered firms would need to comply with many of the enhanced standards a year after they are finalized. One exception is related to stress testing which would take effect shortly after the rule is finalized. Comments are due on the proposal by March 31, 2012.
As noted in our November LRA, the Financial Stability Oversight Council (FSOC) proposed a rule that would establish a three-part test to identify nonbank systemically important financial institutions (non-bank SIFIs). Dodd-Frank Section 113 authorizes the Financial Stability Oversight Council (FSOC) to require a nonbank financial company to be supervised by the Federal Reserve if the FSOC determines that the company could pose a threat to the financial stability of the United States. A few comments were submitted by law firms purporting to represent the interest of a number of nonbank financial companies. Those comments largely focused on technical aspects of the rulemaking process including questioning the authority of the FSOC to even promulgate substantive rules under the requisite Dodd-Frank section and the FSOC’s bifurcation of its prior proposed rule into a Proposed Rule and an Appendix. Another recurring comment urged the FSOC to wait to issue a final rule until after other regulatory actions related to the designation process are finalized – namely the definition of the phrase “predominately engaged in financial services,” the Section 170 safe harbor for exempting certain nonbank financial companies from being designated as a SIFI, and the Freedom of Information Act (FOIA) regulations that will govern data and other information supplied to the FSOC in connection with the designation process.
The American Council of Life Insurers (ACLI) in its comment letter reiterated its position that the traditional, core activities of life insurance companies do not present systemic risk. Additionally the ACLI also requested that the final rule be amended to explicitly provide that confidential notice be given to a firm before any designation announcement is made public. MetLife submitted a separate comment letter although the company noted that it contributed to the ACLI comment submission. The MetLife letter discussed “nontraditional” insurance activities and noninsurance activities conducted by insurance groups. Stating that in their view, the central point should be an analysis of what is regulated and what regulatory gaps exist. They also asserted that the current system of oversight of regulated insurance entities is adequate. The industry generally believes that MetLife, Prudential Life and American International Group are the most likely insurers to receive the SIFI designation.
As noted in our December 7th Ad Hoc LRA, the federal banking agencies issued a notice of proposed rulemaking (NPR) to further comply with Dodd-Frank Section 939A, which requires all federal agencies to remove references to and requirements of reliance on credit ratings from their regulations and replace them with appropriate alternatives for evaluating creditworthiness. This NPR amends the January 2011 NPR and solicits comment on proposed methodologies for calculating the specific risk capital requirements that will directly impact market risk capital rules.
While this NPR is concerned with the market risk capital rules, the agencies stated that it is important to align the methodologies for calculating specific risk-weighting factors for debt positions and securitization positions in the market risk capital rules with methodologies for assigning risk weights under the agencies’ other capital rules. Accordingly, the agencies intend to propose, at a later date, to revise their general risk-based capital rules by incorporating creditworthiness standards for debt and securitization positions similar to the standards included in this proposal. The comment period ends on February 3, 2012.
On December 9, 2011, the Federal Insurance Office (FIO) held a conference entitled “Insurance Regulation in the United States: Modernization and Improvement.” The purpose of the conference was to allow the FIO to continue its outreach process to key industry figures and to discuss certain aspects of the insurance industry, including the assessment of industry opinions on the study and the report on the modernization and improvement of the U.S. insurance regulation required by the Dodd-Frank Act. The FIO report is due January 2012, 18 months from Dodd-Frank’s enactment. FIO Director Michael McRaith stated that the FIO anticipates meeting the January deadline for the report, but that the initial report will discuss only the FIO’s most important findings and points.
In November 2011, the Treasury Department made appointments to positions on the Federal Advisory Committee on Insurance (FACI), an advisory body that was established to provide advice, recommendations, analysis and information directly to the FIO. The FACI is comprised of 15 individuals, largely from state insurance regulators, but it also includes industry executives from the Chubb Corporation, Liberty Mutual Group, Lloyd’s North America, Marsh & McLennan Companies and New York Life Insurance.
On December 30, 2011, the IRS publicly disclosed private letter ruling (PLR) 145159-10 (issued on September 22, 2011). PLR 2011-52014 is particularly noteworthy because it issued less than one year after the Service published Revenue Ruling (“RR”) 2011-9. In RR 2011-9, the IRS reaffirmed a position it expressed earlier in PLR 2006-27021, issued July 7, 2006; namely, that an employer owned life insurance (EOLI) policy is “newly issued” (i.e., not carried over) at the time of a 1035 Exchange, requiring re-testing under IRC §264(f). In contrast to when Congress was promulgating IRC §101(j), when it was enacting IRC §264(f), Congress neglected to state whether it intended for the issue date to carryover at the time of exchange. Not surprisingly, in the absence of any record of Congressional intent, the IRS took the position that a policyholder would suffer ongoing interest disallowance for all policies covering former employees at the time of exchange. With PLR 2011-52014, the IRS acknowledges an avenue through which taxpayers might avoid the bulk of economic consequence implied by RR 2011-9 (i.e., the impact of permanently forfeiting loan interest deductions commensurate with policies covering former employees at the time of exchange).
Despite the favorable implications of PLR 2011-52014, there are a number of complex issues (e.g., state laws and bank regulatory considerations) which must first be traversed before structures like those described in the PLR can be consummated. We have been researching this area for over two years and think that in addition to helping to minimize the impact of Section 264(f), there are numerous, compelling business reasons for banks to participate in such structures (e.g., securing stable earnings in a cost efficient manner, obtaining better terms and pricing through combined purchasing power).
The Dodd-Frank Act granted broad subpoena power to the Federal Insurance Office (FIO) and the Office of Financial Research (OFR). Introduced last month, H.R. 3559 would revoke the subpoena authority granted to the FIO and OFR to collect data directly from insurers. Instead, the bill requires that such data be obtained by “advance coordination” with the insurance company’s state regulator, another federal agency, or from a public source. The bill also requires that the FIO and OFR, as well as state regulators, maintain the confidentiality of nonpublic data obtained from or shared with other federal and state regulators. The bill was referred to the House Financial Services Committee and the Committee on Agriculture. The House Financial Services insurance subcommittee approved the bill with a 7-5 vote along party lines. Reportedly, Moody’s commented on the bill in a Weekly Credit Outlook stating that the bill would limit the free flow of essential insurance data to the parties responsible for overseeing the industry and added that the bill would prevent sharing non-publicly available information from both the general public and other government agencies, even those charged with analyzing systemic risk.
On December 29, 2011, the federal district judge ordered final approval of the settlement agreement which was preliminarily approved on August 11, 2011. The settlement class consists of 233 individuals and the settlement amount is $2.02 million. From that settlement amount, one-third will go to plaintiffs’ counsel and the two named plaintiffs will each receive a $10 thousand compensatory award.
This matter began in Florida state court in March 2008. In May 2009, Wal-Mart Stores gained a favorable decision from the Middle District of Florida court which dismissed the matter, ruling that the plaintiffs lacked standing to recover damages; however, the plaintiffs appealed to the 11th Circuit. The appellate court certified a question to the Florida Supreme Court to determine whether a July 2008 statute amendment allowing an insured party to sue for benefits wrongly obtained by a third party could be applied retroactively. As a result of the settlement negotiations, the 11th Circuit case was closed and the question was left unanswered.
On December 5, 2011, the New York Department of Financial Services (DFS) released its interim report relating to its investigation of claims and locating beneficiaries owed death benefits under life insurance policies, annuity contracts and retained asset accounts. The report stated that as of the release date, life insurers had already made $52.6 million in payments to almost 8,000 beneficiaries as a result of the DFS’s investigation into the industry’s failure to match life insurance policies against a master file of deaths to find benefits that were due but had not been paid. Some life insurers use the U.S. Social Security Administration’s Death Master File (DMF), an up-to-date list of recent deaths, to promptly stop annuity payments once a contract holder dies. However, many life insurers had not been using the same DMF data to determine if any death benefit payments were due under life insurance policies, annuity contracts or retained asset accounts. The DFS recently began requiring all life insurers doing business in New York to use reliable, available data to identify when policyholders have died and benefits are due.
On December 12, 2011, Sun Life Financial announced the completion of a major strategic review of its businesses. As a result of that review, the company announced that it will close its domestic U.S. variable annuity and individual life products to new sales effective December 30, 2011 and its corporate-owned life insurance will be closed to new sales effective January 31, 2012. According to Sun Life, their Experience-Rated BOLI business will continue to be serviced by a dedicated team within their Corporate Markets Department and they will continue to support all policy administration, including all in force policy transactions.
On December 27, 2011, MetLife announced that GE Capital Financial will acquire most of the depository business of MetLife Bank. GE Capital will acquire approximately $7.5 billion in MetLife Bank deposits, including certificates of deposit and money market accounts. Approximately $3 billion in custodial deposits associated with MetLife’s forward mortgage business and certain other deposits are not included in the transaction, but will be transferred out of MetLife Bank over the next six months. This was a significant step towards MetLife’s goal of no longer being a bank holding company. Financial terms of the transaction, which is expected to close in the second quarter of 2012, were not disclosed.
On December 7, the federal banking agencies issued a notice of proposed rulemaking (NPR) to further comply with Dodd-Frank Section 939A which requires all federal agencies to remove references to and requirements of reliance on credit ratings from their regulations and replace them with appropriate alternatives for evaluating creditworthiness. This NPR amends the January 2011 NPR and solicits comment on proposed methodologies for calculating the specific risk capital requirements that will directly impact market risk capital rules and eventually will impact the general risk-based capital guidelines. The proposal sets forth methodologies to be broadly consistent with the Basel Committee on Banking Supervision (BCBS) standardized measurement method for specific risk. Of course the two methods are not fully aligned without references to credit ratings, but the agencies believe them to be comparable.
While this NPR is concerned with the market risk capital rules, the agencies stated that it is important to align the methodologies for calculating specific risk-weighting factors for debt positions and securitization positions in the market risk capital rules with methodologies for assigning risk weights under the agencies’ other capital rules. Accordingly, the agencies intend to propose, at a later date, to revise their general risk-based capital rules by incorporating creditworthiness standards for debt and securitization positions similar to the standards included in this proposal. The comment period ends on February 3, 2012.
The NPR includes updated definitions, methodologies and other creditworthiness alternatives that are still under evaluation by the agencies. Below is a brief highlight of the treatment of certain debt and securitization positions under the proposal.
Sovereign Debt Position
Under this NPR, “sovereign debt position” would be defined as a direct exposure to a sovereign entity. A sovereign entity would not include commercial enterprises owned by the central government that are engaged in activities involving trade, commerce, or profit, which are generally conducted or performed in the private sector. The agencies are proposing that a bank determine its specific risk-weighting factors for sovereign debt positions based on Organization for Economic Co-operation and Development (OECD) Country Risk Classifications (CRCs). The agencies believe that section 939A was not intended to apply to assessments of creditworthiness of organizations such as the OECD. The OECD is not subject to the sorts of conflicts of interest that affected NRSROs because the OECD is not a commercial entity that produces credit assessments for fee-paying clients, nor does it provide the sort of evaluative and analytical services as credit rating agencies.
Exposures to Government Sponsored Entities (GSE)
For the purposes of this proposal, a “GSE” would be defined as an agency or corporation originally established or chartered by the U.S. Government to serve public purposes specified by the U.S. Congress, but whose obligations are not explicitly guaranteed by the full faith and credit of the U.S. government. In this proposal, and consistent with the treatment of these positions in the current market risk capital rules, the agencies propose to apply specific risk-weighting factors ranging from 0.25 percent to 1.6 percent to debt positions that are exposures to GSEs based on maturity. GSE equity exposures, including preferred stock, would be assigned a specific risk-weighting factor of 8.0 percent.
Exposures to Depository Institutions, Foreign Banks, and Credit Unions
Under the current market risk capital rules, debt positions that are exposures to banks incorporated in OECD countries generally are assigned a specific risk-weighting factor ranging from 0.25 percent to 1.6 percent based on remaining maturity of the position. Banks that are not incorporated in an OECD country are assigned similar specific risk-weighting factors if certain conditions are met. This proposal would eliminate the distinction based on OECD membership for the purpose of the market risk capital rules and instead apply specific risk-weighting factors to debt positions that are exposures to depository institutions, foreign banks, or credit unions based on the applicable specific risk-weighting factor of the entity’s sovereign of incorporation. For example, debt positions that are exposure to a bank incorporated in a country with a CRC of 1 would be assigned a specific risk-weighting factor ranging from 0.25 percent to 1.6 percent depending on the remaining maturity of the position. If an entity’s sovereign of incorporation is assigned to the 8.0 percent specific risk-weighting factor because of a lack of CRC rating, then the debt position that is an exposure to that entity would also be assigned an 8.0 percent specific risk-weighting factor.
Corporate Debt Positions
The agencies are proposing to permit a bank to use a methodology that uses market-based information and historical accounting information (indicator-based methodology) to assign specific risk-weighting factors to corporate debt positions that are exposures to a publicly traded, non-financial institution, and to assign a specific risk-weighting factor of 8.0 percent to all other corporate debt positions excluding those that are exposures to a depository institution, foreign bank, or credit union.
Financial Institution Debt Positions
The agencies are proposing that all corporate debt positions issued by financial institutions be assigned a specific risk-weighting factor of 8.0 percent. The agencies intend to continue working to develop and evaluate alternative methodologies to the use of credit ratings for financial institution debt positions.
Securitization
Under this NPR, the agencies have developed a simplified version of the Basel II advanced approaches supervisory formula approach (SFA) to assign specific risk-weighting factors to securitization positions including re-securitization positions. In this proposal, the simplified version is referred to as the simplified supervisory formula approach (SSFA). If a bank cannot, or chooses not to, use the SSFA, a securitization position would be subject to a specific risk-weighting factor of 100 percent, which is roughly the equivalent of a 1,250% risk weight. The SSFA is designed to apply relatively higher capital requirements to the more risky junior tranches of a securitization that are the first to absorb losses and relatively lower requirements to the most senior positions. The agencies are proposing to apply a specific risk-weight factor floor that will increase as cumulative losses on the pool increase over time.