New York Clearing House Association L.L.C.February 9, 2004 Securities and Exchange Commission
Re: Release No. 34-48690 (File No. S7-21-03) - Proposed Rule: Alternative Net Capital Requirements for Broker-Dealers
Ladies and Gentlemen: The member banks of the New York Clearing House Association L.L.C. ("The Clearing House")1 appreciate the opportunity to comment on the proposal (the "Proposal") by the Securities and Exchange Commission (the "Commission") to adopt alternative net capital requirements under the Securities Exchange Act of 1934 for broker-dealers that are part of consolidated supervised entities. The Proposal would establish a voluntary alternative method for computing net capital charges for certain broker-dealers that are part of so-called "consolidated supervised entities" ("CSEs"). To utilize the proposed alternative net capital computations ("ANCC"), a broker-dealer that is part of a holding company must have a group-wide internal risk management control system and must consent to group-wide Commission supervision. The Proposal also provides that such supervision would, in some cases, include examination of and reporting by, holding companies and subsidiaries of such holding companies that are not "primarily in the insured depository institutions business."2 Our comments focus on the potential impact of the Proposal on bank holding companies ("BHCs"), foreign banks subject to the International Banking Act of 1978 as to which the Board of Governors of the Federal Reserve (the "Federal Reserve") has made a determination that the foreign banks' home country regulator provides comprehensive consolidated supervision ("CCS") (such foreign banks, "FBOs" and, together with BHCs, "Supervised Banking Organizations") and subsidiaries of each. We fully agree with the Commission's basic concept that modified capital requirements based on the Basel Accord should be applied to institutions subject to consolidated supervision. As currently drafted, however, the supervisory regime contemplated by the Proposal would be untenable for Supervised Banking Organizations. Although it may not have been the Commission's intent in drafting the Proposal, as a practical matter, it would require Supervised Banking Organizations to accept a second, overlapping regulatory oversight regime (the Commission as well as bank regulatory authorities) in order to participate in the benefits of net capital reform. Non-bank organizations would not face such a dilemma. Unless the regulatory oversight issues we describe below are addressed, the Proposal could have the practical effect of making the benefits of net capital relief - which we think will be considerable - available on an unequal and inequitable basis. This would not be consistent with the fundamental policy objective adopted by Congress in the Gramm-Leach-Bliley Act of 1999 (the "GLB Act")3 of establishing a level playing field for bank and non-bank firms in the securities industry. This also would be inconsistent with the system of functional regulation established by the GLB Act whereby the Federal Reserve acts as the "umbrella supervisor" over Supervised Banking Organizations and their subsidiaries, and the Commission is the functional regulator of any broker-dealer and investment advisor subsidiaries of such Supervised Banking Organizations. Moreover, it could in practice limit the application of the Commission's proposed regime to at most a few firms. The Commission Should Recognize Supervised Banking Organizations and Their Subsidiaries as Entities that have a Principal Regulator Without Reference to being Primarily in the Insured Depository Institutions Business. The Commission has specifically requested comment on the proposed definition of the term, "entity that has a principal regulator," which includes the concept of being, "primarily in the insured depository institutions business." We believe that the Commission should include in the definition of "entity that has a principal regulator" Supervised Banking Organizations and their subsidiaries. In addition, we believe that the Commission should not incorporate any requirement that such Supervised Banking Organizations and their subsidiaries be "primarily in the insured depository institutions business." A. Supervised Banking Organizations and their subsidiaries are already subject to CCS and consolidated capital requirements. With respect to BHCs, the Federal Reserve maintains examiners on the premises of major BHCs on a full-time basis, supervising both bank and non-bank operations. The Federal Reserve conducts full-scope inspections of BHCs "through point in time or through a series of targeted or limited-scope reviews conducted on an ongoing or continuous basis for the largest and most complex banking organizations."4 As contemplated by the GLB Act, the Federal Reserve coordinates with other responsible bank, thrift and functional regulators to avoid duplication and minimize regulatory burden.5 In addition, the Bank Holding Company Supervision Manual provides that
With respect to foreign banks, in order to make a CCS determination, the Federal Reserve must determine that the foreign bank has a home country supervisor that receives sufficient information on the worldwide operations of the foreign bank (including its relationships with affiliates) to assess its overall financial condition and compliance with law and regulation. In making such determination, the Federal Reserve looks at, among other things, the extent to which the home country supervisor: (i) ensures that the bank has adequate procedures for controlling and monitoring its activities worldwide; (ii) obtains information on the bank's worldwide condition, including its subsidiaries, through regular reports of examination, audit reports or otherwise; (iii) obtains information on affiliate dealings; (iv) receives consolidated financial information; and (v) evaluates prudential standards, such as capital adequacy and risk asset exposure, on a worldwide basis.7 In short, Supervised Banking Organizations and their subsidiaries are already subject to significant regulatory supervision by the Federal Reserve in the case of BHCs, and, in the case of FBOs, a home country regulator. The addition of another level of supervision by the Commission is inconsistent with the statutory scheme Congress carefully adopted in the GLB Act and, as further discussed below, an unnecessary use of the Commission's resources. B. The term "primarily in the insured depository institutions business" is both unworkable and unnecessary and therefore should not be included in the ANCC rules with respect to Supervised Banking Organizations. The Clearing House believes that it is likely that many of the Supervised Banking Organizations that the Commission expected to include in the definition of "an entity that has a principal regulator" under proposed sections 240.15c3-1(c)(13)(ii)(A) and (C)8 would in fact be excluded from the definition given their mix of businesses and diversified sources of funding (i.e., few rely primarily on FDIC insured deposits in funding). Moreover, any formulation based on particular characteristics of an institution's business mix in our view would be unworkable given the varied business mixes of these large organizations. Most acutely, the standard as applied to FBOs is manifestly unworkable, as only a few FBOs are engaged at all in the insured depository institutions business in the U.S.9 Furthermore, the types of businesses in which Supervised Banking Organizations engage are likely to change over time. Therefore, even if a Supervised Banking Organization met the primarily in the insured depository institutions business test, or another test based on its business mix at the time of application, it may not so qualify at a later date as it business evolves. This would create unacceptable uncertainty in a rapidly developing financial services industry. Furthermore, the magnitude of an institution's insured depository business has nothing to do with whether the Supervised Banking Organization is sufficiently regulated on a consolidated basis already so that additional Commission regulation is unwarranted. Because Supervised Banking Organizations are subject to stringent CCS and capital requirements regardless of whether such entities are "primarily in the insured depository institutions business," the distinction for these purposes is unnecessary and would likely create an uneven playing field for broker-dealers that are held by Supervised Banking Organizations and those that are not so held. This is plainly contrary to the policy that Congress specifically enacted in the GLB Act to facilitate affiliation among banks, securities firms and insurance companies. If the Commission were to revise the Proposal to include in the definition of "entity that has a principal regulator" all Supervised Banking Organizations and their subsidiaries (each without the qualifier that the entity be primarily in insured depository institutions business), the Commission would have available to it substantial supervisory information without increasing the already significant regulatory burden on these institutions. The Commission Should Rely on the Existing Supervisory Scheme for Supervised Banking Organizations and Their Subsidiaries and Such Entities Should Not Be Subject to Examination by the Commission. The Clearing House believes that the Commission should in the first instance rely on the existing supervisory scheme for the purpose of determining eligibility for modified capital treatment where the broker-dealer is part of a CSE that is a Supervised Banking Organization. As described above, each is already subject to vigorous consolidated supervision. Furthermore, Supervised Banking Organizations are already subject to consolidated capital requirements consistent with the Basel Accord that are applicable to the consolidated entity. We are not suggesting that the Commission rely on other regulatory schemes merely because they theoretically include jurisdiction over a firm on a consolidated basis. Instead, we ask that the Commission rely only where there is in fact meaningful consolidated supervision, including consolidated capital requirements. Such supervision is provided by the Federal Reserve itself with respect to BHCs and by a home country supervisor with respect to FBOs that are Supervised Banking Organizations. The Proposal states that the Commission would not examine any holding company that is primarily in the insured depository institutions business. We understand this provision to mean that any Supervised Banking Organization that would not be considered "primarily in the insured depository institutions business" would be subject to examination by the Commission. Moreover, it could be read to mean that any nonbank subsidiary of a Supervised Banking Organization (regardless of whether the Supervised Banking Organization is primarily in the insured depository institutions business) would be subject to examination by the Commission. Such examination would be duplicative of the already thorough primary supervision and regulation of these entities and is therefore unnecessary. Moreover, reliance on the bank regulators will allow the Commission to target its examination resources most effectively and efficiently by focusing on entities not subject to CCS. The Commission Should Utilize Reports Provided by Supervised Banking Organizations to the Federal Reserve and Should Specifically Set Forth in Advance Any Additional Reports and Information it May Require from Supervised Banking Organizations. As to information on a consolidated entity that is a Supervised Banking Organization, we believe that the Commission should first utilize information that is already reported to the bank regulatory authorities. Moreover, any information sought in addition to the information already provided to the bank regulatory authorities should be specifically set out in advance by the Commission either by rule or order. As described in more detail below, The Clearing House believes that the Commission should obtain any confidential information that is already reported to the Federal Reserve from the Federal Reserve. Any public information and additional or different information required to be provided should be obtained from the banking organization's broker-dealer subsidiary both so that such information travels through a central point with a preexisting relationship with the Commission and so the confidential data submitted enjoys unquestionable confidential protection. A. The existing consolidated supervisor already collects voluminous information. The Federal Reserve requires various reports to be provided to it by Supervised Banking Organizations. In addition to the annual reports of these entities, the Federal Reserve requires reporting of selected financial information for individual U.S. nonbank subsidiaries of Supervised Banking Organizations10 as well as consolidated regulatory capital information from Supervised Banking Organizations.11 We recognize that the Commission may require more or different information than is provided to bank regulatory authorities, but, by accepting to the extent feasible the reports provided to the Federal Reserve, the relevant entities will avoid costly duplication and possible conflicts among regulatory regimes. B. The Commission should obtain from the Federal Reserve confidential information provided to the Federal Reserve by Supervised Banking Organizations. The Clearing House believes that the Commission should obtain from the Federal Reserve all confidential information provided to the Federal Reserve by Supervised Banking Organizations because this approach follows the approach for consolidated supervision incorporated after great deliberation in the GLB Act. 12 As described in more detail below, The Clearing House also believes that the Commission should obtain only from the Supervised Banking Organization's broker-dealer subsidiary any public information previously provided to the Federal Reserve. The Clearing House believes that the Commission should utilize a procedure similar to the procedure established under the GLB Act that the Federal Reserve must follow when it acts as the consolidated umbrella supervisor, with respect to obtaining information about functionally regulated subsidiaries of Supervised Banking Organizations. This procedure requires that, to the fullest extent possible, the Federal Reserve must accept reports that have been provided or required to have been provided to other Federal or state supervisors or to self regulatory organizations ("SROs"). If the Federal Reserve requires a report of a functionally regulated subsidiary of a kind that is not required by another Federal or state regulatory authority or an SRO, the Federal Reserve is required to first request that the appropriate regulatory authority or SRO obtain the report from the Supervised Banking Organization or subsidiary.13 C. The type of additional information required must be specified and to the extent possible, should be the same as already prepared for management. With respect to additional or different information the Commission may require from Supervised Banking Organizations, The Clearing House believes that it is essential to the successful implementation of the ANCC rules that the Commission identify to Supervised Banking Organization applicants in detail any additional reporting obligations required either by regulation or in the order granting an organization authority to use the ANCC. Specifically, we recommend that the Commission outline which reports ordinarily provided to the Federal Reserve the Commission will utilize and, to the extent the Commission requires additional or different information, specific details of any such information to be required. Moreover, to the extent possible, The Clearing House suggests that, in order not to materially increase the regulatory burden on these firms, such additional information should be of the type already generated for management. The Clearing House believes that with this certainty as to what information is required and the use of reports already prepared for management, the implementation of the ANCC rules is likely to be more successful and will not overly burden Supervised Banking Organizations seeking to utilize ANCC. D. Any public information reported to the Federal Reserve and any additional or different information required under the ANCC rules should be obtained from the broker-dealer subsidiary of the Supervised Banking Organization. With respect to any information to be obtained from a Supervised Banking Organization including public information provided to the Federal Reserve and any additional or different information required under the ANCC rules, The Clearing House believes that all such information should be requested from and provided by the broker-dealer subsidiary of such Supervised Banking Organization. Because the Commission already regulates the broker-dealer subsidiary, it would therefore likely have a contact system in place. In addition, personnel of the broker-dealer subsidiary have experience with providing information to the Commission and are in the best position to provide meaningful responses to Commission inquiries. Finally, an exemption exists from disclosure under the Freedom of Information Act ("FOIA") for matters that are "contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions."14 It is clear that materials provided by a Supervised Banking Organization's broker-dealer subsidiary to the Commission would be exempt from disclosure under this exemption because broker-dealers are financial institutions and the Commission is an agency responsible for the regulation or supervision of broker-dealers for purposes of this FOIA exemption.15 The Clearing House believes this is the best way to protect confidential and sensitive information required by the Commission.16 Although there is at least one court decision supporting the conclusion that an agency need not be directly responsible for regulating or supervising the entity to which the exempt information pertains,17 we believe that, if the Commission were to obtain the relevant confidential information from the Supervised Banking Organizations' broker-dealer, there is more certainty that these documents would not be subject to disclosure under FOIA.18 Until the Full Implementation of Basel II, the Commission Should Take a Flexible Approach with Respect to Capital Regimes. The Clearing House believes that eventually most BHCs, both at the bank and consolidated levels, will follow Basel II upon its full implementation. In the interim, we believe that it is essential for the Commission to take a flexible approach to avoid causing undue burden for regulated firms. That flexible approach should include allowing the capital regime at the broker-dealer and holding company level to be the same. Furthermore, this approach allows the Supervised Banking Organizations to avoid running multiple systems and incurring unnecessary costs while providing meaningful information regarding their consolidated capital calculations. Finally, to the extent that the Commission has concerns about any risk model or other procedure used by the Supervised Banking Organization in calculating its capital which it cannot resolve after discussion with the Supervised Banking Organization and its consolidated bank regulator, it should address the concern through imposing an additional capital charge. It should not seek to require a change in the model or procedure. The imposition of inconsistent requirements of this nature would be a particularly troublesome manifestation of the problem inherent in having multiple consolidated supervisors. * * * The Clearing House appreciates the opportunity to comment on the Proposal. If the Agencies would like additional information regarding these comments, please contact Norman R. Nelson General Counsel of The Clearing House, at (212) 612-9205. Very truly yours, ____________________________
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