Change may be afoot at one of the nation’s most powerful, but sometimes opaque regulators. On Friday, Vice Chairman for Supervision of the Federal Reserve, Randal Quarles, laid out a suite of changes he intends to implement aimed at bringing more transparency to the regulatory regime.

In a speech announcing his proposed changes, Quarles acknowledged the difficult act of balancing responsible, robust supervision with fairness and efficiency, stating, “we have a public interest in a confidential, tailored, rapid-acting and closely informed system of bank supervision. And we have a public interest in all governmental processes being fair, predictable, efficient, and accountable. How do we square this circle?”

In Quarles’ estimation, this complex and consequential question has received too little attention for too long. SIFMA has long advocated exactly this point and based on the Vice Chairman’s speech, we are optimistic that his seemingly well-thought out views reflect growing recognition that the current balance is in fact, out of balance.

Broadly, the actions outlined address SIFMA’s long-standing advocacy points, particularly:

Expansion of CCAR Transparency including GMS Factor Shocks Development

• Expansion of the CCAR model and scenario transparency around the design process including how the GMS factor shocks are developed, and to give firms more time to respond to stress test results.
  • Increased transparency regarding the development of models and scenarios will allow firms to better align their internal stress testing with the Federal Reserve’s stress tests.
  • This is expected to occur in 2020.
• Implementation of some mechanism to smooth volatility in the CCAR results stemming from yearly changes to the Macro scenarios and GMS factor shocks
  • Some type of an averaging approach to CCAR results over time will tamp down much of the volatility in capital planning currently occurring in the industry. This will likely be studied of the coming year and proposed for comment in 2021
• More time to review the Federal Reserve’s stress test results will allow firms to draft better capital plans and tailor their capital plans around the complete set of regulatory capital requirements.
  • This is expected to occur in 2020.

Revision to the Large Institution Supervision Coordinating Committee (LISCC) portfolio- designation approach and increased transparency into LISCC-only requirements

• Consideration of the publication the LISCC procedural manual which describes the supervisory processes and approach to risk identification and assessment critical to determining a firms’ supervisory approach and assessment.
  • Firms will have a much clearer understanding of supervisory expectations preparing them for more effective supervisory engagement.
• The recent tailoring rule implemented clear and measurable guidance as to how firms are segmented into supervisory portfolios; however, that did not apply to the LISCC portfolio. Quarles committed that the Fed will develop a clear and transparent standard for identifying LISCC firms.
  • It will also provide clarity for all firms to evaluate the cost and impact of acquisition, growth or business strategy which could potentially push them into a more stringent category.
• Acknowledgement of the substantial de-risking of the four current large FBO members of the LISCC portfolio and that their risk profile was a fraction of the remaining members of the LISCC portfolio. It is highly likely the new LISCC portfolio designation formula will not capture these four FBOs.
  • There will be a measurable reduction in supervisory intensity and the application of certain requirement that apply only to the four FBO LISCC members.

Address the delineation and application of guidance versus rule

• Going forward the FRB will seek comment on material supervisory guidance and will subject existing material supervisory guidance to the Congressional Review Act.
  • The evaluation of existing guidance will allow firms the opportunity to address some of the disconnects between risk management and market practices and the supervisory view and to reduce the level of prescription. It will also help to identify where guidance exceeds the intention of the regulation.
• Adoption of a rule which will affirm that guidance is not binding, and noncompliance cannot be the basis of an enforcement action or importantly, an MRA (matter requiring attention) supervisory criticism. Moreover, the Fed will limit the use of MRAs to violations of law, regulation and material safety and soundness issues and reintroduce the use of “observation” type of issue classification to denote lesser safety and soundness concerns.
  • This is a very positive development particularly as the number of MRAs are a considerable driver of a firm’s supervisory rating.

Supervisory Process Efficiency Improvements

• Increase in the ability of firms to share Federal Reserve confidential supervisory information without the protracted request process currently in place.
  • It greatly improves and make more efficient the coordination between affiliates, law firms and consultants when dealing with enforcement actions or other issues which are based on supervisory concerns.

Evaluation of the newly implemented rating system. Quarles committed to create a more user friendly, comprehensive and searchable database of historical interpretations of applicable rules and regulations.

• The Fed will evaluate the success and effectiveness of the new rating system with attention on the interplay between the qualitative and quantitative aspects of the liquidity and capital components. Furthermore, they will also be evaluating the reasonableness of determining “Well Managed” status by the lowest rating component.

SIFMA appreciates the focus and attention on these issues and we look forward to working with the Federal Reserve to implement these important changes.

Joseph L. Seidel is SIFMA’s Chief Operating Officer; Coryann Steffanson is SIFMA Managing Director and Head of Prudential Capital and Liquidity Policy; and Carter McDowell is Managing Director, Associate General Counsel and Head of Prudential Policy. 

Joe, Carter and Cory also recorded a podcast further discussing the proposed changes and what they would mean for the capital markets, which can be found here.