On May 7, following a short open meeting, the Financial Stability Oversight Council (FSOC)—the body established by the Dodd-Frank Act to identify and respond to risks to the stability of the U.S. financial system—released its 2014 annual report. As with past reports, this report reviews market and regulatory developments, and identifies emerging risks to the financial system. Among several new risks identified by the FSOC are those related to the increase in the transfer of mortgage servicing rights (MSRs) from banks to nonbank servicers. The report asserts that many nonbank servicers “are not currently subject to prudential standards such as capital, liquidity, or risk management oversight,” and that where mortgage investors’ ability to collect on mortgages is dependent on a single mortgage servicing company, “failure could have significant negative consequences for market participants.” The FSOC recommends that, in addition to continuing to monitor risks associated with transfers to nonbanks, state regulators should work together and with the CFPB and the FHFA on prudential and corporate governance standards for nonbank servicers. The report elevates and reinforces recent regulatory scrutiny of MSRs and nonbank servicers. Earlier this year, the CFPB’s deputy director detailed the CFPB’s expectations with regard to the transfer of MSRs and compliance with the CFPB’s mortgage servicing rules, and New York financial services regulator Benjamin Lawsky expressed his view that nonbank mortgage services are insufficiently regulated and that state regulators need to intervene on the front end of MSR transactions to prevent undue harm to homeowners before it occurs.
On November 5, the Board finalized Reg. XX thereby implementing Section 622 of the Dodd-Frank. The final rule, which was proposed in May, prohibits a financial company from combining with another company if the resulting company’s liabilities exceed 10 percent of the aggregate consolidated liabilities of all financial companies. The final rule also adds an exemption to clarify that a financial company may continue to engage in securitization activities if it has reached the limit and establishes reporting requirements for financial companies that do not otherwise report consolidated information to the Board or other Federal banking agency. Financial companies subject to the limit include insured depository institutions, bank holding companies, savings and loan holding companies, foreign banking organizations, companies that control insured depository institutions, and nonbank financial companies designated by the Financial Stability Oversight Council for Board supervision. The final rule will be effective on January 1, 2015.
On August 16, the Federal Reserve Board issued a final rule establishing the process by which it will assess annual fees for its supervision and regulation of large financial companies. The Dodd-Frank Act directed the Board to collect assessment fees equal to the expenses it estimates are necessary or appropriate to supervise and regulate bank holding companies and savings and loan holding companies with $50 billion or more in total consolidated assets and nonbank financial companies designated by the Financial Stability Oversight Council. The final rule outlines how the Board will (i) determine which companies are assessed, (ii) estimate the total anticipated expenses, (iii) determine the assessment for each of the covered companies, and (iv) bill for and collect the assessment from the companies. For the 2012 assessment period, the first year for which assessment fees will be collected, the Board will notify each company of the amount of its assessment when the rule becomes effective in late October. Payments for the 2012 assessment period will be due no later than December 15, 2013. The Board estimates it will collect about $440 million for the 2012 assessment period. Beginning with the 2013 assessment period, the Federal Reserve will notify each company of the amount of its assessment fee no later than June 30 of the year following the assessment period. Payments will be due by September 15.
On August 1, the U.S. District Court for the District of Columbia dismissed in its entirety a lawsuit that challenged Titles I, II, and X of the Dodd-Frank Act as unconstitutional. The lawsuit was brought originally by three private parties and later joined by several state attorneys general. The court determined that that the plaintiffs lacked standing and had not demonstrated injury sufficient to permit a challenge of the law on any of their claims.
The private plaintiffs’ challenge to Title X, which created the CFPB, was based on “financial injuries directly caused by the unconstitutional formation and operation of the [CFPB,]” including substantial compliance costs, increased costs of doing business, and forced discontinuance of profitable and legitimate business practices in order to avoid risk of prosecution. The court concluded that such “self-inflicted” harm could not confer standing to challenge Title X. With respect to the private plaintiffs’ challenge to the Financial Stability Oversight Council (FSOC) created by Title I, the court concluded that while an unregulated party is not precluded from establishing standing to challenge the creation and operation of FSOC, standing is “substantially more difficult to establish” under such circumstances and the theories asserted by the plaintiffs were too remote to confer standing.
Both the private plaintiffs and the state attorneys general challenged Title II, claiming that the “orderly liquidation authority” (OLA) provisions violate the separation of powers, deny due process to creditors of a liquidated firm, and violate the requirement for uniformity in bankruptcy. The court again concluded that none of the plaintiffs established either present or future injury sufficient to confer standing to challenge the OLA.
According to media reports, an appeal of the ruling by at least one of the private plaintiffs is anticipated.
On April 25, the Financial Stability Oversight Council (FSOC) met in an open session to announce the release of its 2013 Annual Report to the Congress. The Annual Report outlines the FSOC’s views with regard to, among other things, (i) the need for housing finance reform to attract private capital to the housing finance system, (ii) increased awareness of operational risks, whether from cyberattack or acts of nature, and (iii) the importance of working with foreign counterparts to reform the governance and integrity of interest reference rates like LIBOR. FSOC Chairman and Treasury Secretary Lew also advised that the FSOC met in executive session to discuss its continuing analysis of non-bank financial companies and that he expects a vote on an initial set of systemically important designations of non-bank financial companies soon.
On April 15, the Federal Reserve Board proposed a rule that would establish an annual assessment for bank holding companies and savings and loan holding companies with $50 billion or more in total consolidated assets and for nonbanks designated by the Financial Stability Oversight Council. The Dodd-Frank Act directed the Board to establish such an assessment to cover expenses the Board estimates are necessary to carry out its supervision and regulation of those companies. This proposed rule outlines how the Board would (i) determine which companies are assessed, (ii) estimate the total anticipated expenses, (iii) determine the assessment for each of the covered companies, and (iv) bill for and collect the assessment from the companies. Beginning this year, the Board proposes to notify covered companies of the amount of their assessment no later than July 15 of the year following each assessment period (the calendar year). After an opportunity for appeal, assessed companies would be required to pay their assessments by September 30 of the year following the assessment period. For the 2012 assessment period, the Board estimates that the assessment basis would be approximately $440 million. Comments on the proposal are due by June 15, 2013.
On April 3, the Federal Reserve Board approved a final rule that establishes the requirements for determining when a company is “predominantly engaged in financial activities.” The requirements will be used by the Financial Stability Oversight Council when considering whether to designate a nonbank financial company as systemically important and subject to supervision by the Federal Reserve Board. Pursuant to the rule, a company is considered to be predominantly engaged in financial activities if 85 percent or more of the company’s consolidated revenues or assets are derived from or related to activities that are defined as financial in nature under the Bank Holding Company Act. In addition, the FSOC may issue recommendations for primary financial regulatory agencies to apply new or heightened standards to a financial activity or practice conducted by companies that are predominantly engaged in financial activities. The final rule largely mirrors the rule as proposed, but includes some changes. For example, final rule states that engaging in physically settled derivatives transactions generally will not be considered a financial activity. The final rule also defines the terms “significant nonbank financial company” and “significant bank holding company.” The rule will become effective on May 6, 2013.
On October 9, the OCC and the FDIC each finalized a rule to implement the company-run stress test requirements of the Dodd-Frank Act. The stress tests are exercises designed to gauge the losses that covered institutions might experience under hypothetical scenarios established by the regulators. The OCC and FDIC rules apply to covered institutions with average total consolidated assets greater than $10 billion. Covered institutions with assets over $50 billion are subject to the stress test requirements immediately. They will be required to submit results in January 2013 of stress tests based on data as of September 30, 2012 and scenarios that the FDIC and the OCC plan to publish next month. Implementation of the stress test requirements for institutions with assets of $10 billion to $50 billion will not begin until October 2013. Also on October 9, the Federal Reserve Board (FRB) finalized two stress test-related rules. The first rule establishes the stress test requirements for bank holding companies, state member banks, and savings and loan companies with more than $10 billion in total consolidated assets. As with the OCC and FDIC rules, the FRB rule delays implementation of stress test requirements for covered institutions with $50 billion or less in assets until the fall of 2013. Additionally, the results of that first test will not have to be publicly disclosed. The second FRB rule establishes the company-run stress test requirements for bank holding companies with $50 billion or more in total consolidated assets, and nonbank financial companies designated as systemically important by the Financial Stability Oversight Council. These institutions are required to conduct two internal stress tests each year, in addition to a stress test performed by the FRB. Like the OCC and the FDIC, the FRB expects to release its stress test scenarios in November.
On September 20, the Attorneys General (AGs) of Michigan, Oklahoma, and South Carolina joined an earlier-filed lawsuit in the U.S. District Court for the District of Columbia that challenges aspects of the Dodd-Frank Act, including the CFPB and its director. The AGs joined an amended complaint that seeks to challenge as unconstitutional the “formation and operation” of the CFPB, and that argues the President side-stepped constitutional checks and balances by refusing to submit his nominee for CFPB Director to the Senate. The AGs also charge that the “orderly liquidation authority” (OLA) for financial institutions provided to the Treasury Secretary by the Dodd-Frank Act violates the separation of powers doctrine, as well as the Fifth Amendment’s bar against the taking of property without due process. The AGs cite their state pension funds—each of which is invested in “a variety of institutions” subject to the OLA—as their basis for standing, claiming that the OLA exposes the states and their funds to “the risk that their credit holdings could be arbitrarily and discriminatorily extinguished.” Finally, the private plaintiffs that originally filed the suit also contest based on a separation of powers argument the “unconstitutional creation” of the Financial Stability Oversight Council.
This week, the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR) each published annual reports to Congress, as mandated by the Dodd-Frank Act. This is the first such report the OFR has prepared. The FSOC annual report surveys the macroeconomic environment within which the U.S. economy exists, identifies risks to U.S. financial stability, reports on implementation of the Dodd-Frank Act and activities of FSOC, and provides a series of recommendations for policymakers. The FSOC’s recommendations fall into four categories: (i) reforms to address structural vulnerabilities, (ii) heightened risk management and supervisory attention, (iii) housing finance reforms, and (iv) implementation and coordination of financial reform. Within the housing finance category, the FSOC notes recent efforts to encourage private capital to re-enter the market in the near term but stresses the continued need for long-term housing finance reform. This section also reviews federal efforts to alter mortgage servicing standards and recommends that federal agencies finalize comprehensive servicing standards. The OFR report summarizes the OFR’s efforts to (i) analyze threats to financial stability, (ii) conduct research on financial stability, (iii) address data gaps, and (iv) promote data standards. According to the report, over the next year, the OFR will focus on the migration of financial activities into the so-called shadow banking system, and will continue to build on research related to threats to financial stability, stress tests, and risk management.