Broker-Dealer and Bank Counterparties in the New Bank Regulatory Landscape

RMA and Debevoise and Plimpton recently presented its Fourth Annual Broker-Dealer Seminar. Panelists representing both banks and broker-dealers offered insights into the new bank regulatory landscape and touched upon capital and liquidity issues for banks and brokers in 2018, broker-dealer enforcement, and broker-dealer and investment advisor duties.  

Capital and Liquidity Issues for Banks and Brokers in 2018

On May 24, 2018, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act. The bill raises the asset thresholds that trigger application of enhanced prudential standards (EPS) (including single-counterparty credit limits) under section 165 of the Dodd-Frank Act for U.S. and foreign banks.

Banks with less than $100B in global assets are no longer subject to EPS. Effective after 18 months of the bill’s enactment, banks with global assets between $100B and $250B are no longer subject to EPS unless the FRB affirmatively acts to apply EPS to an institution or category of institutions. Banks with global assets greater than $250B and U.S. globally systemically important banks (GSIBs) have no change to the application of EPS.

The bill largely retains the status quo for GSIBs but provides specific supplementary leverage ratio relief to certain custody banks with respect to cash held at certain central banks and deposits linked to fiduciary, custodial, and safekeeping accounts.

With a record number of empty positions, the Federal Reserve is in the process of being reconstituted. The new candidates are pro industry, which is good news for big banks as these folks begin to implement the proposals outlined in this summary.

Basel III

Basel III was developed in response to the financial crisis of 2007–2009. The initial set of revisions focused on capital ratios, while the most recent reforms of 2017 focus on risk-weighted assets (RWAs). The 2017 reforms move towards a transparent approach and address key weaknesses the Basel Committee identified in the Basel II framework during the financial crisis.

A number of studies found wide variation in RWAs across banks that could be explained solely by differences in banks’ portfolios. This undermined comparability and confidence in capital ratios. The Basel Committee noted that banks had strong incentive to minimize risk weights when using internal model approaches to calculate capital requirements.

Single-Counterparty Credit Limits

The Federal Reserve Final Rule puts a hard cap limit on exposures. A bank’s credit exposure to unaffiliated counterparties is limited to 25% of the bank’s eligible capital base. Banks must aggregate credit exposures of any affiliates (counterparty also includes affiliates).  

Volcker Rule

On May 30, 2018, the Federal Reserve began the interagency rulemaking process by proposing revisions to the Volcker Rule implementing regulations and asking questions on potential additional changes. These revisions are an effort to simplify the rule and lessen the burden on affected banks. Key issues for trading firms include compliance regime, proprietary trading exemptions, and TOTUS.

Broker-Dealer Enforcement

The SEC enforcement focus is on Main Street and retail investors and ICO/cyber fraud, although there is an overall downward trend in enforcement activity. The SEC is experiencing a hiring freeze which is challenging resources and impacting its scope.

FINRA has seen restructuring and leadership changes, however its disciplinary action activity continues as usual. FINRA’s priorities center on more issue-focused sweeps and using exams to gain market insight. Predictions for future enforcement priorities include initial coin offerings and other cyber issues, sales of structured and complex products, anti-money laundering, and cybersecurity policies and procedures/data retention.  

Broker-Dealer and Investment Advisor Duties

In an effort to more clearly define the distinctions between broker-dealers and investment advisors, i.e., services offered, differing duties, and regulatory approach, the SEC issued a three-part proposal on May 9, 2018.

  • Regulation Best Interest: Broker-dealers making a recommendation to a retail customer must act in the “best interest” of the customer at the time the recommendation is made.
  • Investment Advisor Standard of Conduct: Details the federal fiduciary obligations of investment advisors.
  • Form CRS Relationship Summary: Requires broker-dealers and investment advisors to provide retail customers with a standardized relationship summary (Form CRS).

In light of this proposal, broker-dealers should assess whether their existing standardized disclosures are sufficient under the new standard. Additionally, broker-dealers should develop policies to affirmatively mitigate or eliminate material conflicts of interest arising from financial incentives associated with recommendations.


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