Statement of
Martin J. Gruenberg, Chairman,
Federal Deposit Insurance Corporation
On
Oversight of Financial Stability and Data Security
Before the
Committee on Banking, Housing, and Urban Affairs,
U.S. Senate; 538 Dirksen
Senate Office Building
February 6, 2014
Chairman Johnson, Ranking Member Crapo and members of the Committee, thank you
for the opportunity to testify today on the Federal Deposit Insurance Corporation's
(FDIC) actions to implement the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act).
The FDIC has made significant progress in recent months in implementing the new
authorities granted by the Act.1 My testimony will address several topics. First, I will
discuss the recently adopted regulation implementing the Volcker Rule and the actions
we have taken on the risk retention and qualified mortgage rules. I will then provide an
update on our progress in implementing the authority provided to the FDIC to resolve
systemically important financial institutions and proposals to improve the quantity and
quality of capital. Finally, I will address data integrity issues for the banking industry.
The Volcker Rule
Section 619 of the Dodd-Frank Act, also known as “the Volcker Rule,” requires the
Securities and Exchange Commission (SEC), the Commodities Futures Trading
Commission (CFTC), and the federal banking agencies to adopt regulations to prohibit
banking entities from engaging in proprietary trading activities and to limit the ability of
banking entities to invest in, or have certain relationships with, hedge funds and private
equity funds. In general terms, proprietary trading occurs when an entity places its own
capital at risk to engage in the short-term buying and selling of securities primarily to
profit from short-term price movements, or enters into derivative products for similar
purposes.
On December 10, 2013, the FDIC, along with the Federal Reserve Board (FRB), the
Office of the Comptroller of the Currency (OCC), the SEC, and the CFTC, adopted a
final rule implementing Section 619. The Volcker Rule is designed to strengthen the
financial system and constrain the level of risk undertaken by firms that benefit, directly
or indirectly, from the federal safety net provided by federal deposit insurance or access
to the Federal Reserve’s discount window. The challenge to the agencies in
implementing the Volcker Rule was to prohibit the types of proprietary trading and
investment activity that Congress intended to limit, while allowing banking organizations
to provide legitimate intermediation in the capital markets.
Martin J. Gruenberg, Chairman,
Federal Deposit Insurance Corporation
On
Oversight of Financial Stability and Data Security
Before the
Committee on Banking, Housing, and Urban Affairs,
U.S. Senate; 538 Dirksen
Senate Office Building
February 6, 2014
Chairman Johnson, Ranking Member Crapo and members of the Committee, thank you
for the opportunity to testify today on the Federal Deposit Insurance Corporation's
(FDIC) actions to implement the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act).
The FDIC has made significant progress in recent months in implementing the new
authorities granted by the Act.1 My testimony will address several topics. First, I will
discuss the recently adopted regulation implementing the Volcker Rule and the actions
we have taken on the risk retention and qualified mortgage rules. I will then provide an
update on our progress in implementing the authority provided to the FDIC to resolve
systemically important financial institutions and proposals to improve the quantity and
quality of capital. Finally, I will address data integrity issues for the banking industry.
The Volcker Rule
Section 619 of the Dodd-Frank Act, also known as “the Volcker Rule,” requires the
Securities and Exchange Commission (SEC), the Commodities Futures Trading
Commission (CFTC), and the federal banking agencies to adopt regulations to prohibit
banking entities from engaging in proprietary trading activities and to limit the ability of
banking entities to invest in, or have certain relationships with, hedge funds and private
equity funds. In general terms, proprietary trading occurs when an entity places its own
capital at risk to engage in the short-term buying and selling of securities primarily to
profit from short-term price movements, or enters into derivative products for similar
purposes.
On December 10, 2013, the FDIC, along with the Federal Reserve Board (FRB), the
Office of the Comptroller of the Currency (OCC), the SEC, and the CFTC, adopted a
final rule implementing Section 619. The Volcker Rule is designed to strengthen the
financial system and constrain the level of risk undertaken by firms that benefit, directly
or indirectly, from the federal safety net provided by federal deposit insurance or access
to the Federal Reserve’s discount window. The challenge to the agencies in
implementing the Volcker Rule was to prohibit the types of proprietary trading and
investment activity that Congress intended to limit, while allowing banking organizations
to provide legitimate intermediation in the capital markets.
In finalizing this rule, the agencies carefully reviewed more than 18,000 comments and
made changes to the original proposal to address commenters’ concerns. The final rule
is intended to preserve legitimate market making and hedging activities while
maintaining market liquidity and vibrancy. The final rule also is designed to reduce
overall burden by focusing requirements on those institutions that are more likely to
engage in proprietary trading and covered fund activities.
The final rule is structured around the three main elements of Section 619: 1) the
proprietary trading prohibition, 2) the covered funds prohibition, and 3) the compliance
requirements.
Proprietary Trading Prohibition
In general, the final rule prohibits proprietary trading by banking entities. However,
consistent with Section 619, the final rule includes exemptions for underwriting, market
making, and risk-mitigating hedging, among other exemptions provided in the final rule.
The underwriting exemption requires that a banking entity act as an underwriter for a
distribution of securities and that the trading desk’s underwriting position be related to
that distribution. The underwriting position must be designed not to exceed the
reasonably expected near-term demands of customers.
The exemption for market making-related activities requires that a trading desk routinely
stand ready to purchase and sell one or more types of financial instruments. The trading
desk’s inventory of these instruments must be designed not to exceed the reasonably
expected near-term demands of customers. Under the final rule, determining customer
demand is based on such things as historical demand and consideration of current
market factors. A market-making desk may hedge the risks of its market-making activity
under this exemption, provided it is acting in accordance with certain risk management
procedures required under the final rule.
The requirements of the risk-mitigating hedging exemption are generally designed to
ensure that hedging activity is limited to risk-mitigating hedging in purpose and effect.
For instance, hedging activity must be designed to demonstrably reduce or significantly
mitigate specific, identifiable risks of individual or aggregated positions of the banking
entity. In addition, the banking entity must conduct an analysis (including a correlation
analysis) supporting its documented hedging strategy, and the effectiveness of hedges
must be monitored and, as necessary, recalibrated on an ongoing basis.
Under the final rule, a banking entity would be allowed to hedge individual exposures or
aggregate exposures—for example, a specific loan book. However, a banking entity
would not be allowed to engage in so-called “macro hedging.” The result is to allow
cost-effective, risk-reducing hedging while preventing banking entities from entering into
speculative transactions under the guise of hedging.
The final rule allows a bank to engage in proprietary trading in certain government
obligations and generally does not prohibit certain trading activities of foreign banking
entities, provided the trading decisions and principal risks of the foreign banking entity
made changes to the original proposal to address commenters’ concerns. The final rule
is intended to preserve legitimate market making and hedging activities while
maintaining market liquidity and vibrancy. The final rule also is designed to reduce
overall burden by focusing requirements on those institutions that are more likely to
engage in proprietary trading and covered fund activities.
The final rule is structured around the three main elements of Section 619: 1) the
proprietary trading prohibition, 2) the covered funds prohibition, and 3) the compliance
requirements.
Proprietary Trading Prohibition
In general, the final rule prohibits proprietary trading by banking entities. However,
consistent with Section 619, the final rule includes exemptions for underwriting, market
making, and risk-mitigating hedging, among other exemptions provided in the final rule.
The underwriting exemption requires that a banking entity act as an underwriter for a
distribution of securities and that the trading desk’s underwriting position be related to
that distribution. The underwriting position must be designed not to exceed the
reasonably expected near-term demands of customers.
The exemption for market making-related activities requires that a trading desk routinely
stand ready to purchase and sell one or more types of financial instruments. The trading
desk’s inventory of these instruments must be designed not to exceed the reasonably
expected near-term demands of customers. Under the final rule, determining customer
demand is based on such things as historical demand and consideration of current
market factors. A market-making desk may hedge the risks of its market-making activity
under this exemption, provided it is acting in accordance with certain risk management
procedures required under the final rule.
The requirements of the risk-mitigating hedging exemption are generally designed to
ensure that hedging activity is limited to risk-mitigating hedging in purpose and effect.
For instance, hedging activity must be designed to demonstrably reduce or significantly
mitigate specific, identifiable risks of individual or aggregated positions of the banking
entity. In addition, the banking entity must conduct an analysis (including a correlation
analysis) supporting its documented hedging strategy, and the effectiveness of hedges
must be monitored and, as necessary, recalibrated on an ongoing basis.
Under the final rule, a banking entity would be allowed to hedge individual exposures or
aggregate exposures—for example, a specific loan book. However, a banking entity
would not be allowed to engage in so-called “macro hedging.” The result is to allow
cost-effective, risk-reducing hedging while preventing banking entities from entering into
speculative transactions under the guise of hedging.
The final rule allows a bank to engage in proprietary trading in certain government
obligations and generally does not prohibit certain trading activities of foreign banking
entities, provided the trading decisions and principal risks of the foreign banking entity