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Global Asset Management and Custody Banks document sample
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Regulator Open
Session - OCC
Joel Miller
Asset Management Group Leader
Office of the Comptroller of the Currency
April 29, 2009
1
Presentation Overview
OCC – Asset Management Supervision
Asset Management Risks
Focus on Market Disruption Issues
Managing Asset Management Risk
Asset Management Examination Focus
Conclusions
Appendix I: OCC Guidance
2
OCC - Asset Management
Supervision
3
OCC Asset Mgt. Supervision
OCC regulates 1600 national banks and 70
limited purpose trust companies
Range from large complex banks with global
operations to community banks
Approximately half of all national banks have
fiduciary, retail brokerage, investment banking
or advisory activities.
About 150 OCC examiners with AM expertise
perform on and off-site supervision.
4
OCC Asset Mgt. Supervision
Supervision by Risk
Objective: Assess a bank’s ability to identify,
measure and monitor risk
Risk Assessment System (RAS) – For nine risk
categories, determine:
Quantity of risk
Quality level of risk management
Direction
FFIEC: Uniform Ratings System (CAMELS)
FFIEC: Uniform Interagency Trust Ratings System
(UITRS) – OCC focus: Composite Rating
5
OCC Asset Mgt. Supervision
Integrated risk-based supervision
Large Banks: EIC/AM Team Leader
Mid-size Banks: EIC/Functional EIC-AM
Community Banks: Portfolio Manager/AM
Examiner
Supported by five AM Lead Experts and
Washington based AM Policy Group
6
Asset Management
Risks
7
Asset Management Risk Areas
Broad Risk Categories - Asset
Management Activities
Reputation
Strategic
Compliance
Transaction (Operational)
CAMELS: Management & Earnings
Market Disruption – Has highlighted these
risks, especially in certain products and
activities 8
Asset Management Risk Areas
Reputation and Litigation Risks
Market disruption resulted in a substantial
decline in the market value of fiduciary
assets across almost all asset classes.
Discretionary (managed) accounts and employee
benefit accounts (e.g., 401-k), pose the greatest
reputation and litigation risk to bank fiduciaries.
Clients reassessing which asset managers best
weathered the storm and moving assets
accordingly. Client retention a key focus.
9
Asset Management Risk Areas
Valuation of assets in illiquid markets
Accounting guidance (FAS 157) requires fair
value to represent current market conditions,
but not the price that would be received in a
forced or distressed sale.
Pricing services dropped coverage of illiquid
securities and bank asset managers and
custodians had to seek other pricing
sources.
10
Asset Management Earnings
Why Focus on AM Earnings?
Effects Earnings/CAMELS
Significant losses can erode Capital
Market disruption
Firmwide high risk initiatives may be driven by
earnings pressure
Effective risk management in AM needed to
avoid taking on excessive risk to compensate for
lost earnings
11
Asset Management Risk Areas
Market Sensitive Earnings Decline
Asset base and administrative fees contract as
market value of assets declines.
Performance fees decline as many alternative
investment strategies have turned negative.
Flight to quality – investor movement away from
higher profit margin business (equities) to lower
margin cash/cash equivalents (MMMFs) – reduces
management fees.
EB Defined Contribution Plans Fees effected by:
Reductions in employer match reductions
Reductions in employee contributions as a result of layoffs
or uncertainty 12
Asset Management Revenue
AM revenue of $6.36 billion in 4Q08
comprised 25% of national banks’ non-
interest income and 7% of operating
income.
National Bank AM revenue by Call Report
category:
Fiduciary Revenue $3.6 billion
Securities Brokerage Revenue $1.3 billion
Annuity Sales Revenue $95 million
Investment Banking, Advisory and Underwriting
Revenue $1.4 billion
13
Source: Call Report. Includes full-service national banks and limited-purpose national trust banks as of 12/31/08.
Fiduciary Income Linked to
Assets under Management
Positive correlation between Fiduciary income
and S&P 500.
Decline in equity markets = decrease in bank’s
AUM and income.
$9.50 1,600
$9.00
$8.50 1,400
$8.00
$7.50 1,200
$7.00
1,000
S & P 500
$ Billions
$6.50
$6.00
800
$5.50
$5.00 600
$4.50
$4.00 400
$3.50
$3.00 200
$2.50
$2.00 0
Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec-
02 03 03 03 03 04 04 04 04 05 05 05 05 06 06 06 06 07 07 07 07 08 08 08 08
Income $4.91 $5.25 $5.52 $5.63 $5.92 $6.19 $6.03 $5.87 $6.55 $6.43 $6.51 $6.63 $7.20 $6.78 $7.35 $6.84 $7.18 $7.50 $7.90 $7.40 $8.50 $8.50 $9.00 $8.20 $7.40
S&P 500 885 875 909 994 1,044 1,114 1,124 1,111 1,148 1,192 1,186 1,217 1,228 1,276 1,284 1,278 1,366 1,420 1,471 1,497 1,493 1,388 1,359 1,280 1,003
14
Source: Call Report. Includes all full-service commercial banks and limited-purpose national trust banks as of 12/31/08.
Total Fiduciary & Custody Assets
All Banks (2004 – 2008)
Growth in both fiduciary and custody assets leveled
off by mid-year 2008, then dropped significantly by
end of year.
Total Fiduciary Assets - All Banks Total Custody Assets - All Banks
$25.0 $22.6 $22.9 $70.0
$21.8
$20.0 $57.8 $57.1
$60.0
$20.0 $17.3 $18.3 $18.2 $50.4 $50.3
$16.1 $47.4
$15.5 $50.0 $42.3
Trillion
Trillion
$15.0 $40.0 $35.7 $36.5
$33.2
$10.0 $30.0
$20.0
$5.0
$10.0
$0.0 $0.0
Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08
Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.
15
Asset Management Risk Areas
AM products and services impacted by
ongoing Market Disruption
Hedge Funds
Securities Lending
Auction Rate Securities
Collective Investment Funds
Money Market Mutual Funds/STIFs
16
Asset Management Risk Areas
Hedge Fund Issues
Most strategies performing poorly in current market
Performance and client liquidity needs lead to increasing
redemption requests
Which leads to gates raised/fund lock-ups
Risks to bank fund managers.
Decline in earnings potential due to industry contraction
Litigation risk
Reputation risk
Banks are particularly vulnerable where they placed
discretionary client assets in hedge funds and funds-of-funds
that are now frozen or in liquidation.
Bank custodians also vulnerable as clients seek out deep
pockets to indemnify their hedge fund losses.
17
Asset Management Risk Areas
Madoff Fraud
Direct and Indirect Exposures
Investments by individuals, foundations,
endowments, and pension plans in Madoff “fund” –
bank may be acting in a fiduciary capacity
Indirect investments in fund-of-funds that invest a
percentage of their assets in a Madoff “fund”
Custodial relationships in which bank holds Madoff
“fund” assets
Lending exposure to clients who invested in Madoff
“fund.”
18
Asset Management Risk Areas
Securities Lending Issues
Once viewed as low risk by clients and banks
Decline in value of sec-lending pools (e.g. Lehman,
AIG assets) holding reinvested cash collateral:
Litigation and settlements
Restrictions imposed on customers’ ability to withdraw
assets
Many customers now unwilling to take on additional
risk and sec-lending opportunities dry up.
For some banks, contraction has substantial decreased
sec-lending business and earnings
Banks perceived to be stronger in sec-lending have
prospered in “flight to quality”.
19
Asset Management Risk Areas
Auction Rate Securities Issues
Regulatory actions - settlements with SEC, FINRA
and state regulators that include buy-back schedules
and CMPs.
Voluntary ARS buybacks undertaken to preempt
litigation.
Both voluntary and involuntary buy-backs can be
costly and saddle banks with illiquid securities with
corresponding impact on bank earnings, capital and
liquidity.
Capital support agreements extended to affiliated
funds holding these illiquid securities to buy time and
keep ARS off the bank’s books. 20
Asset Management Risk Areas
Collective Investment Fund Issues
Funds holding illiquid assets such as RE
facing flurry of redemption requests.
Industry seeks to avoid liquidating fund
assets at fire sale prices.
Expect issuance of new Labor Department
regulation, or Congressional action, that will
compel substantial new fee and conflict
disclosures for employee benefit assets.
21
Market Value of Collective Investment
& Common Trust Funds Decline
National banks continue to be major players in offering collective investment funds.
•66 NBs offer over 1,600 collective investment funds totaling $1.3 trillion.
$3.50
$3.00
$2.94
$3.00
$2.68
$2.51
$2.50
$2.29
$2.01 $2.02 $2.00
$2.00
$ trillion
$1.75 $1.74
$1.67
$1.51 National Banks
$1.50 $1.33 All Banks
$1.30
$1.00 $0.85 $0.90
$0.50
$0.00
2001 2002 2003 2004 2005 2006 2007 2008 22
Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.
Asset Management Risk Areas
MMMFs and Short Term CIF Issues
Sponsors provide support to stabilize NAVs
or unit values. (SIVs, Lehman…)
“Flight to safety” from Prime funds to
Treasury and Government funds.
Low rates – waived fees
Some funds closed or restricted
Government Support Programs
23
Pledge Requirements – Reg 9.10
Enhanced FDIC insurance reduces trust
pledge requirements:
Coverage to $250,000 for certain retirement
accounts
Coverage expanded for irrevocable trusts
Temporary coverage increase from $100K to $250K
(through 12/31/09) for other accounts
Temporary (through 12 /31/09) FDIC guarantee of
certain non-interest bearing accounts
FDIC insurance pass-through guidance applies to
individual accounts held in covered non-interest
bearing omnibus account.
24
Employee Benefits Deposit
Prohibition – Problem Banks
Banks that are no longer “well capitalized”
or “adequately capitalized” are prohibited
from accepting any employee benefit plan
deposits.
Federal Deposit Insurance Act as amended
in 2006 (12 USC 1821(a)(1)(D)(ii)) imposes
this prohibition.
EB depositors still receive pass through
coverage, but bank is in violation if it accepts
EB deposits, including additions to existing
accounts
25
Managing Asset
Management Risk
26
Managing AM Risk
Investment Management:
Adhere to prudent investment standards
Maintain effective and ongoing due diligence
over external investment managers
Maintain effective and ongoing due diligence
over complex and alternative investments
Properly conduct and document investment
reviews
27
Managing AM Risk
Effective valuation policies and
oversight - Valuation of assets in illiquid
markets
Market disruption has made it difficult to
value suddenly illiquid assets
Pricing services dropped coverage of
illiquid securities
Accounting guidance (FAS 157) requires
fair value on audited financial statements
Improper valuations have been a key
factor in disruption related litigation
28
Managing AM Risk
Operational Focus:
Potential increase in operating losses and
trade errors associated with market volatility
Potential stress on bank controls, operations,
and risk management resulting from expense
reduction
Impact of loss of key personnel resulting
from corporate-wide downsizing
Need for due diligence over sub-custodians
as highlighted by recent fraud disclosures 29
Asset Management
Examination Focus
30
Asset Management Risk Areas
GLBA/Regulation R
Effective date for most banks - 1/1/09. Must ensure
all securities activities conducted by a bank
department, including the Treasury desk, comply
with broker/dealer requirements.
Bankers need to look across all lines within the bank
(e.g., asset management, capital markets and
commercial) to ensure compliance with the new
regulatory requirements.
Failure to comply could result in securities law
violations and rescission of trades to the detriment of
the bank. 31
Recent OCC Issuances
Conflicts of Interest Associated with
Divestiture of Asset Mgt. Affiliates
OCC Bulletin 2008-5
Annual Reg 9 Reviews
OCC Bulletin 2008-10
Expectations
Automated vs. Manual Reviews
Unique Assets
32
AM Examination Observations
Investments
Effective annual reviews
Process/oversight
Documentation/Exceptions
Understanding, due diligence and oversight
of alternative investments (hedge funds)
Oversight of third party investment advisors
Proper authorization for use of affiliated
funds or brokers
Oversight of pricing for illiquid or thinly traded
assets 33
AM Examination Observations
Account Administration and Compliance
Inadequate Compliance/Risk Management
programs - testing
Accepting direction from authorized parties
EB administration/expertise
Adequate/current policies and procedures
Oversight of account overdrafts
34
AM Examination Observations
Operations/Internal Controls/Audit
Segregation of duties & dual control
Controls over system access
Corporate action processing automation
BSA audit scope/trust activities
Monitor 9.10 pledge requirements
35
Conclusions
36
Conclusions
Earnings Pressures/Effective Risk
Management
Investment Management
Due diligence/risks of complex investments
Back to Basics
Investment oversight
Account Administration
Operations
37
Appendix I:
OCC Guidance
38
OCC Asset Management
Handbooks & Guidance
Retirement Plan Services
Collective Investment Funds
Asset Management
Conflicts of Interest
Custody Services
Investment Management Services
Personal Fiduciary Services
Retail Nondeposit Investment Sales
Insurance Activities
A Guide to the National Banking System
http://www.occ.treas.gov/nb/nbguide.pdf
39
OCC Handbooks & Guidance
OCC 2008–10, Fiduciary Activities of National Banks: Annual
Reviews of Fiduciary Accounts Pursuant to 12 CFR 9.6(c)
OCC 2008-5, Conflicts of Interest: Risk Management Guidance –
Divestiture of Certain Asset Management Businesses
OCC 2007–42, Bank Securities Activities: SEC's and Federal
Reserve's Final Regulation R
OCC 2007-21, Supervision of National Trust Banks: Revised
Guidance: Capital and Liquidity
OCC 2007-7, Soft Dollar Guidance: Use of Commission Payments
by Fiduciaries
OCC 2007-6, Registered Transfer Agents: Transfer Agent
Registration, Annual Reporting, and Withdrawal from Registration
40
OCC Handbooks & Guidance
OCC 2006-24, Interagency Agreement on ERISA Referrals
OCC 2004-2, Banks/Thrifts Providing Financial Support to Funds
Advised by the Banking Organization or its Affiliates
41
QUESTIONS?
Contact:
Joel Miller, (202) 874-4493
Joel.Miller@occ.treas.gov
42
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