U.S. Office of Public Policy
First Quarter 2016
Connecting the columns
What the latest in Washington means for Wall Street
Contents
2
Introduction
2
Regulatory Relief
Legislation
3
Fiduciary Standards
3
Prudential Measures
5
Market Liquidity
5
Derivatives
6
Asset Management
6
Insurance Regulation
7
GSE Reform
Executive Summary
The following considers the current state of play of certain major financial policy issues and
assesses how they will be addressed in 2016 and beyond. The issues covered include:
–– Regulatory relief legislation: Ongoing efforts to pass significant financial regulatory
relief legislation into law are likely to continue to stall.
–– Fiduciary standards: The Department of Labor has a clear path to finalize its fiduciary
rule, which will go into effect later this year and have significant consequences on the
retirement savings industry.
–– Prudential measures for banking institutions: The Federal Reserve will finalize its TLAC
proposal with likely only minor changes.
John Nolan
U.S. Office of Public Policy
UBS Americas Inc.
Desk +1-202-585-8986
john-a.nolan@ubs.com
–– Market liquidity: The Treasury and other regulators will begin a long process to enhance
the transparency and regulatory oversight of the Treasury market.
–– Derivatives: With most of its Dodd-Frank regulatory architecture in place, the CFTC will
continue its shift towards implementational issues
–– Asset management: Contending with significant industry pushback, the SEC will make
a concerted effort to put in place key pieces of its agenda to update its regulatory regime
for asset managers.
–– Insurance regulation: As insurance companies take or consider actions to restructure
their businesses to avoid regulatory requirements, the progress on those regulatory
requirements remains slow.
–– GSE reform: With comprehensive housing finance legislation currently moribund, this will
be another year of the status quo for Fannie and Freddie.
Connecting the Columns, First Quarter 2016: Inaugural Issue l 1
Introduction
Chaotic Presidential and Congressional elections will
have broad implications for what gets done in Washington
this year.
advance anytime soon. The standoff, which has effectively
put banking and financial nominations in a holding pattern,
is unlikely to be resolved this year.
In Congress, a short schedule and a hyper-partisan
political environment mean that there will be very limited
opportunities to make headway legislatively. One possible
exception is the lame-duck period, which will occur after
the dust settles on election night. The lame-duck dynamics
(an outgoing President and many outgoing members of
Congress) can sometimes create a propitious environment
for political compromise, although a lot will depend on
who ends up controlling what. For example, a Democratic
presidential win combined with a divided Congress
augurs a more productive lame duck than a Republican
presidential win combined with full control of Congress.
Regulatory Relief Legislation
The elections will affect the pace of regulatory efforts,
but the effect will be less pronounced than the legislative
impact. In some cases, the administration will be working
hard against the clock to complete and implement rules on
priority legacy issues. The Department of Labor’s fiduciary
rule is a prime example of this in the financial regulatory
context. In others, regulators will try to complete or at least
make significant progress on major initiatives—like the
Federal Reserve’s TLAC proposal or the SEC’s regulatory
agenda on asset management—that already are underway.
Finally, with the sixth year anniversary of the Dodd-Frank
Act approaching this summer, some important mandated
rules (such as the SEC’s rules on security based swaps) still
remain uncompleted even if the lion’s share of the most
consequential Dodd-Frank rules have been finalized.
However, that momentum also came with a decided
crosscurrent. One Dodd-Frank amendment concerning
derivatives hitched a ride on a must-pass funding bill. It
narrowed the scope of the swaps push-out requirement,
which required federally-insured depository institutions to
discontinue certain swaps activities or “push out” these
activities to separately capitalized affiliates. Although
the push-out fix had previously passed the House with
bipartisan support, its inclusion in the funding bill was
criticized by many Democrats and became a lightning
rod for populist outrage. That blowback created a serious
headwind for further Dodd-Frank reforms going into 2015.
Many agencies will be constrained by vacancies in highlevel positions. Regulators are unlikely to receive much
relief from the Senate, where many nominations are
caught in a bottleneck. Senate Banking Committee
Chairman Shelby has signaled that he has little interest in
moving on nominations before his committee until the
administration nominates an individual for the role of
Vice Chairman for Supervision at the Federal Reserve.
This has not occurred, although the role is performed on
a de facto basis by Governor Tarullo. Of all the pending
nominees, the ones for the two open spots on the SEC
have the best chance of moving since one of those
nominees is a former staffer for the Banking Committee
Chairman. However, even these two are unlikely to
Through most of the years following the passage of the
Dodd-Frank Act in 2010, financial reform legislation
followed a similar path. The Republican-controlled
House would pass proposed changes to the law, which
inevitably would fail in the Senate given the President’s
and Democrats’ resistance to reopen the law. That pattern
broke in late 2014, when the first trickle of Dodd-Frank
changes made their way into law. Going into last year,
full Republican control of Congress also meant that DoddFrank reform efforts would be redoubled.
In the Senate, Banking Committee Chairman Shelby still
managed last year to push a comprehensive regulatory
relief package through his panel. But he did so only on a
party-line vote. Democrats, who wanted to focus
on anodyne regulatory relief for community banks,
objected to the broad scope of the legislation. The bill’s
centerpiece is a large effective increase in the threshold
(from $50 billion in assets to $500 billion) at which banks
become subject to heightened regulatory requirements.
In addition to this contentious provision, the bill contains
others, such as reforms of FSOC and the Fed as well as
a broader safe harbor for mortgage loans retained by
banks. The House passed individually many bills that were
similar to provisions included within the Shelby legislation.
Throughout last year, there were ongoing efforts in the
Senate to reach a bipartisan compromise on a pared down
version of regulatory reform, but that never materialized.
Connecting the Columns, First Quarter 2016: Inaugural Issue l 2
There was some room to cut a deal (for example,
community bank relief paired with a more modest
increase in the threshold at which banks become subject
to enhanced requirements). However, Shelby’s more
expansive version of financial reform could not be squared
with the more narrow focus of moderate Democrats.
With the foundering of these bipartisan efforts, we expect
Republicans instead to push for more sweeping and
dramatic changes to the Dodd-Frank Act, to include an
outright repeal of the process for designating nonbank
financial companies as systemically important and a repeal
of Title II resolution authority. While these bills will have
no chance of advancing beyond the House floor, they will
give Republicans an opportunity to highlight their vision for
financial reform in the run-up to the elections. Depending
on those election results, the lame duck session at the end
of this year may see a revival of efforts to reach a more
modest bipartisan compromise.
Fiduciary Standards
After its first proposal (issued in 2010) was withdrawn
after facing serious criticism from both industry
and Congress, the Department of Labor (DOL) took
another crack last spring at a proposed rule to expand
the application of fiduciary standards and prohibited
transaction rules under ERISA. This time, the DOL issued
it with the imprimatur of the President, who has made this
issue a top domestic policy priority in his remaining tenure
in the White House.
The DOL proposal would broadly apply ERISA
fiduciary standards to anyone providing an investment
recommendation (to include recommendations regarding
rollovers or distributions) to retirement accounts. The
resulting application of fiduciary standards (for the first
time) to brokerage relationships with retail retirement
investors is significant since ERISA rules prohibit
commissions and other transaction-based compensation.
While the DOL has proposed an exemption to allow the
brokerage model to continue to serve retail retirement
investors, many view that exemption as unworkable since
it is so laden with complex and ambiguous conditions
and restrictions.
During its comment periods on the proposal, the DOL
received a record number of letters. The DOL also heard
from many members of Congress in both parties who
expressed concern about the proposal’s potential
negative impact on retirement savers’ access to and
choice regarding investment advice. This concern
culminated in efforts in Congress to include a provision in
the year-end funding bill that would have pushed back
final action by the DOL, but that provision never
materialized, in large part because of the White House’s
stiff opposition to it.
Without any such action by Congress, the DOL has a clear
path to move ahead. The administration’s goal is to have
the rule implemented before it leaves office. Given that,
we expect that the DOL will come out with a final rule
over the next few months (either the end of the first
quarter or the beginning of the second quarter) and then
implement it by the end of the year. While there will
remain rumblings in Congress on the DOL rule, we see
little likelihood of any legislative action altering this basic
timetable. Although the DOL has signaled a willingness to
make changes to address some concerns with the
proposal, we expect that the final rule will be substantially
similar to the proposal. As such, it will have a dramatic
impact on the retail retirement marketplace. Among other
effects, the rule has the potential to act as a catalyst for
greater movement to fee-based advsiory relationships and
for the increased use of index and other passive
investment vehicles.
Finally, the SEC continues to work on a proposal to apply
a single fiduciary standard to brokers and investment
advisors. While the SEC has indicated that it intends to
propose a rule in the fall, we don’t expect such a proposal
to see the light of day this year. The potential for an SEC
rule to layer upon additional and potentially conflicting
requirements to those of the DOL rule will be a key
concern as these efforts move forward.
Prudential measures
Total Loss Absorbing Capital (TLAC) Proposal
The Federal Reserve in October issued its proposed rule
setting Total Loss Absorbing Capital (TLAC) and long
term debt (LTD) requirements for certain U.S. banking
institutions, namely U.S. global systemically important
banks (G-SIBs) and intermediate holding companies
(IHCs) of foreign bank organizations (FBOs) that are GSIBs.
Connecting the Columns, First Quarter 2016: Inaugural Issue l 3
The TLAC requirements are designed to ensure that
these institutions have sufficient loss-absorbing capital
in resolution (similar standards were issued by the
Financial Stability Board and similar requirements are
being promulgated by other jurisdictions).
TLAC is essentially a combination of common equity Tier
1 and eligible long-term debt (LTD). The U.S. G-SIBs and
IHCs subject to TLAC requirements would need to have a
clean holding company, meaning that the holding
company issuing TLAC couldn’t engage in transactions
(e.g., short-term debt issued to external entities) that
could be a barrier to orderly resolution.
The proposed TLAC requirements for U.S. G-SIBs were set
at 18% on the basis of risk weighted assets and 9.5% on
the basis of leverage, with the risk-weighted requirements
also including a 2.5% capital buffer plus a G-SIB capital
surcharge. A significant component of TLAC must be in
the form of LTD (e.g., 6% plus a G-SIB capital surcharge
on the risk-weighted basis), which is defined as debt that
is issued by the holding company, is unsecured, has a
maturity of at least one year, and is governed by U.S. law.
The TLAC requirements for covered IHCs generally are
calibrated lower than the requirements for U.S. G-SIBs,
but still at the upper bound of the range called for in the
international standard for TLAC. IHCs that are not
themselves resolution entities (i.e., where the parent will
be resolved under a single point of entry resolution
strategy) will have a lower 16% TLAC requirement (riskweighted basis), while IHCs that are resolution entities
(i.e., where there is a multiple point of entry resolution
strategy) will face the same 18% requirement (riskweighted basis) to which U.S. G-SIBs are subject. IHCs
also would be subject to the 2.5% capital buffer, but not
any G-SIB surcharge. As with U.S. G-SIBs, a significant
portion of an IHC’s TLAC will need to be in the form of
long-term debt. To preserve parent company ownership
in resolution, an IHC’s TLAC would need to be issued
internally to its parent or an affiliate owned by the
ultimate parent, whereas U.S. G-SIBs will issue their TLAC
to external entities.
The proposed rules would become effective in 2019, with
a phase-in period that would make the requirements fully
applicable in 2022. We expect that the Fed will try to
finalize the TLAC rule by end of the year. While the Fed is
unlikely to make major changes to the calibration of the
requirements, it may grandfather certain existing long-term
debt and provide other transitional relief. The Fed estimates
that U.S. G-SIBs will need to issue $90 billion of new longterm debt to meet the new requirements. However, the
banks may need to issue a multiple of that amount if their
existing long-term debt is not grandfathered.
After the Fed finalizes the TLAC rule, there will be a number
of remaining questions regarding the scope of TLAC’s
application and the way in which it is fully applied. We
expect that similar requirements eventually will be applied
to both larger regional bank holding companies and FBOs
that are not G-SIBs but that have significant U.S. operations
(the TLAC proposal already gives the Fed some flexibility to
capture IHCs that are part of FBOs that are not G-SIBs). We
also expect that the Fed will require further pre-positioning
of capital at major U.S. subsidiaries to allow for the effective
transfer of loss from those subsidiaries to their parent.
While this will raise costs and potentially reduce flexibility in
resolution, the Fed ostensibly views pre-positioning at this
level as an important mechanism through which losses in
major subsidiaries roll up to the holding company.
Other Prudential Rules
In addition to TLAC, the Fed and the banking regulators will
have other prudential rulemakings on their agenda.
Over the next few months, the Fed will propose a rule
requiring banks to meet a net stable funding ratio (NSFR).
The NSFR is one of two new quantitative liquidity rules
introduced as part of the Basel III framework; the other is
the liquidity coverage ratio (LCR), which the U.S. banking
regulators finalized in the fall of 2014. Whereas the LCR
requires banks to have enough cash and high-quality liquid
assets to meet stressed cash outflows, the NSFR requires
banks to have a minimum amount of stable funding
for illiquid assets. The liquidity rules, as well as other
recent bank regulatory measures (e.g., the supplemental
leverage ratio, the G-SIB capital surcharge), raise the
cost of repo borrowing and other short-term funding,
which will continue to constrain the marketmaking and
prime brokerage capabilities of dealer banks. The LCR is
scheduled to be fully implemented in 2017, while the NSFR
is supposed to go into effect in 2018.
The banking regulators will begin work on a proposal to
implement another Basel initiative that would significantly
increase capital requirements on assets held in banks’
trading books. The Basel Committee’s Fundamental Review
of the Trading Book was finalized this year and is scheduled
to take effect in 2019.
Connecting the Columns, First Quarter 2016: Inaugural Issue l 4
Market Liquidity
Industry and Congress have buffeted regulators with
complaints about the potential negative impact of
regulatory capital and liquidity requirements on the
inventories of dealer banks and, by extension, bond
market liquidity. Hitherto, these complaints have largely
fallen on deaf ears.
Instead of treating the bond market generically,
regulators have chosen to focus on the evolution of a
particular market, the Treasury market. Last summer,
the Treasury, Federal Reserve, the SEC and the CFTC
issued a joint report on the causes of the October 2014
turmoil in the Treasury market, which saw a dramatic
drop and then quick reversion in Treasury yields with
no obvious exogenous catalyst (such as market-moving
news). Regulators identified changes in market structure
(including increased automated trading), not regulatory
requirements, as the primary factor.
These regulators just issued a request for information on
the Treasury market. The request asks market participants
and other participants to provide data and feedback on
the evolution and current state of the Treasury market,
current risk management practices, the need for greater
government access to market data, and the need for more
public reporting of market data. Towards the end of the
year, the Treasury plans to announce planned actions on
improving government access to data on Treasury market
transactions. Beyond that, the regulators will be looking
to update the current regulatory structure for a market
where many of the biggest and most active firms in the
Treasury market are subject to limited oversight.
This interagency review of Treasury market structure
is occurring as the SEC is conducting its own ongoing
comprehensive review of equity market structure and
as the CFTC proposes an enhancement of risk control
requirements for algorithmic trading in the futures,
options and swaps markets.
Derivatives
The prudential regulators and the CFTC late last year
separately finalized rules putting in place one of the
key remaining pieces of swaps regulations—margin
requirements for uncleared swaps. The complex rules,
which set initial and variation margin requirements for
uncleared swaps, will further incentivize clearing at a
point when there’s already been a dramatic movement
towards clearing of swaps through central clearinghouses
over the past several years. That being said, the final
rules were less harsh than the initial proposals and
dealer banks were able to secure relief regarding initial
margin requirements for swaps transactions between
affiliates. CFTC Chairman Massad had to push through
its margin rule over the objection of his fellow
Democratic Commissioner, who had concerns about the
relief provided to inter-affiliate transactions.
With the finalization of the margin rule, the CFTC now has
built out much of the regulatory architecture underpinned
by its authority under Title VII of the Dodd-Frank Act. This
will mean a greater focus on implementation of existing
rules in the coming year.
That being said, the CFTC still has some outstanding
Title VII rules. For example, it is looking to repropose its
rule to set capital requirements for swap dealers and
major participants that are not already subject to capital
requirements by prudential regulators. Its controversial rule
on position limits (which was finalized, but then struck
down by the courts) is also outstanding, but is unlikely to
be addressed this year. Finally, it is looking to make progress
on other initiatives, such as cybersecurity and risk controls
on automated trading.
With the aforementioned move to more central clearing
concentrating risk in large central clearinghouses, the
CFTC and other regulators (domestic and international)
will continue to focus on how these entities could be
orderly resolved in a crisis. Over the next few weeks,
CFTC Chairman Massad also will try to resolve a
longrunning dispute with the EU over the equivalence
of US and EU clearinghouses. Without EU recognition
of US clearinghouses, banks with exposures to US
clearinghouses will face punitive capital requirements
under EU capital rules.
While the CFTC has regulatory authority over the
lion’s share of the swaps market, the SEC’s regulatory
purview is still significant, covering single-name CDS
and other securities-based swaps. The SEC still has many
outstanding rules under its Title VII authority, and it is
uncertain whether the agency will be able to finalize
the preponderance of them by the end of the year.
Connecting the Columns, First Quarter 2016: Inaugural Issue l 5
Asset Management
The asset management industry has been the subject of
close scrutiny by the Financial Stability Oversight Council
(FSOC) over the past few years. In 2014, FSOC signaled
that it would be pivoting away from considering the
potential designation of individual asset management
firms as systemically important to conducting a broad
and holistic review and analysis of asset management
products and activities. That review has been overtaken
by regulatory actions of the SEC, which is both a member
of the FSOC and the primary regulator of the asset
management industry. The SEC has successfully defended
its turf by putting forward several rule proposals that
address areas of inquiry by the FSOC. Over the course
of 2015, the SEC proposed individual rules covering the
following issues:
– enhanced mutual fund disclosure: The SEC is trying
to address gaps in the current reporting regime by
improving fund disclosure of derivatives usage and
borrowing through securities lending and increasing
advisor disclosure of separately managed accounts;
– liquidity risk management: The SEC has proposed
that funds institute a board-approved comprehensive
liquidity risk management program and a codification
of its existing guidance that funds maintain a
15 percent limit on illiquid assets. Under the risk
management program, a fund would need to assess its
ability to meet redemptions under normal and stressed
conditions, classify the liquidity of its portfolio assets
(by the amount of days an asset is convertible to cash),
and determine a minimum percentage of net assets
that are cash and equivalent assets (i.e., assets that
can be converted to cash within three business days
without material price changes); and
– leverage limits: The SEC has proposed severely limiting
funds’ ability to use derivatives to synthetically leverage
their portfolios. The proposal limits derivatives risk
(defined by gross notional value) to 150 percent of net
assets (or 300 percent if a fund can demonstrate its
use of derivatives is for hedging purposes).
The SEC will look to finalize these rules in the coming year.
The industry will try to poke holes in the broad proposal
on liquidity risk management, but the recent suspension
of redemptions by a major high-yield bond fund gives the
Commission a lot of momentum to push ahead (the FSOC
also will be closely monitoring the SEC’s follow-through).
The fight over the proposed limit on fund leverage and
derivatives usage may even be more contentious and
protracted given its devastating, albeit more concentrated,
impact. Through this proposal, the SEC essentially would
regulate out of business popular ETFs that use swaps
to gain leveraged exposure to equity market and other
indices. But given recent issues with levered exchangetraded products, the SEC will have momentum here too.
The SEC also will propose two remaining rules impinging
upon the asset management industry. One will require
resolution planning, while the other will require stress
testing.
Insurance Regulation
In the wake of the Dodd-Frank Act, the Federal
Reserve became the consolidated regulator of a group
of insurance companies. It currently supervises three
insurance companies designated as systemically important
by the FSOC and a diverse set of insurance companies
that are savings and loan holding companies. Out of
concern that the Fed would use its regulatory mandate to
apply inappropriate, bank-like capital standards to these
companies, Congress passed in 2014 a legislative fix to
Dodd-Frank that clearly directed the Fed to tailor its capital
standards to the business model of insurance companies.
While there was some anticipation that the Fed would
come out with its initial proposal on insurance capital
standards last year, we expect that the Fed will continue
to move slowly and deliberately.
The Fed has never evinced much excitement about
regulating insurance companies and has little interest in
expending precious political capital at this point on such
a controversial rule. There are a number of reasons for the
lack of urgency. One of the major insurance companies the
Fed regulates is legally contesting its designation by the
FSOC. The international process for developing insurance
capital standards continues to stall. The Fed is also still in
an early stage at building out its insurance expertise.
The Fed is embarking on a long journey to create out of
whole cloth a capital regime reflective of the liability risks
across a diverse set of companies. While the Fed views
most insurance liabilities as being fairly stable, it
is concerned about annuity/retirement products that
offer short-term redemption features and capital
markets activities (e.g., repo borrowing, securities
lending) that
Connecting the Columns, First Quarter 2016: Inaugural Issue l 6
pose liquidity risks and generate linkages to the broader
financial system. The Fed detects flaws in existing insurance
regulatory capital frameworks, like state-based regulatory
capital requirements and the European regulatory capital
regime of Solvency II. It sees the state-based requirements
as not capturing some of the aforementioned risks of
certain retirement products and capital markets activities,
while it believes Solvency II’s basis of valuation on market
prices is inappropriate given the stability of traditional
insurance liabilities. With European regulators trying to
shape global insurance capital standards in the likeness of
Solvency II, the international standards are unlikely to be
a compelling model for the Fed.
While the Fed will not feel obliged to closely follow an
international standard that likely will resemble Solvency
II, the timeline of the international process does have
relevance. The current timeline, which looks overly
ambitious, is finalization of a global insurance capital
standard in 2017 and implementation in 2020. There is
little reason for the Fed to front-run these slow-moving
international efforts. Industry and investors are right to
assume that the Fed’s capital requirements for the largest
and most complex insurance companies will have bite.
However, as some companies take or consider preemptive
steps to dramatically restructure their businesses, it’s
worth noting that that bite likely will not be felt for quite
some time.
GSE Reform
This will be another status quo year for the two
government sponsored enterprises (GSEs), Fannie Mae
and Freddie Mac. Fannie and Freddie have been under
effective government control since being bailed out (the
government injected a total of $187.5 billion) and placed
in conservatorship in the fall of 2008. Since that time,
various attempts in Congress at comprehensive housing
finance reform have come and gone. The government
also amended the bailout terms, and, beginning in
2013, started to sweep all of the companies’ profits.
This has left Fannie and Freddie with very weak capital
positions, making a future credit drawdown from the
government likely, if not inevitable. In that context,
investors have called for the government to allow the
two entities to rebuild their capital positions and emerge
from conservatorship. This notion of “recap and release”
has never had any traction with the administration, and
is now officially dead after Congress passed a provision
in the year-end funding bill restricting the government’s
ability to sell its stakes in Fannie Mae and Freddie Mac.
With few big cards to play, the administration is left with
a few small-ball measures over its last year. For example,
the Federal Housing Finance Administration (FHFA), the
GSEs’ conservator, will continue to prod Fannie and
Freddie to lay off more and more of their risks to private
investors through credit risk transfer (CRT) transactions.
These efforts remain largely aspirational. While much
has been made of the GSEs’ use of structured credit
transactions that resemble pre-bubble trades, these
transactions still represent a drop in the overall ocean of
mortgage credit. Increased capital requirements
significantly dampen banks’ interest in CRT transactions,
a dynamic that is likely to only worsen as U.S. banking
regulators look to implement the Basel Committee’s
proposed dramatic increase in capital requirements for
securitization as part of its fundamental review of the
trading book. With political paralysis persisting in
Washington for the foreseeable future, Fannie and
Freddie will continue to be hobbled colossuses striding
across the mortgage market.
Connecting the Columns, First Quarter 2016: Inaugural Issue l 7
This report is a summary of certain recent legislative and regulatory developments that may be of interest to clients of UBS AG and its affiliates or subsidiaries
(“UBS”). This report is intended for general information purposes only, is not a complete summary of the matters referred to, and does not represent investment,
legal, regulatory or tax advice. Recipients of this report are cautioned to seek appropriate professional advice regarding any of the matters discussed in this report
in light of the recipients’ own particular situation. UBS does not undertake to keep the recipients of this report advised of future developments or of changes in
any of the matters discussed in this report.
Issued in the U.S. by UBS Americas Inc.
©UBS 2016. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved. UBS Americas Inc. is a subsidiary of UBS
AG.
160121-4503