-
The
whistleblower protection
provisions
of Sarbanes Oxley and other statutes
- Case
Studies
- Banks against the
amended Basel
ii Framework
Welcome
to the April 2010 edition of the International Association
of Risk and Compliance Professionals (IARCP) newsletter
E-book:
100 Job Descriptions in Risk and Compliance Management
Free
Download, no registration needed
Contents
1.
Risk
Professionals
2. Compliance
Professionals
3. Sarbanes
Oxley
Professionals
4. Basel
ii
Professionals
5. Solvency
ii
Professionals
6. Hedge
Funds
Professionals
7. Members of the Board
of Directors
A. Sarbanes Oxley News
Dear Members,
Today
we will try to understand better the
whistleblower protection provisions. Many members believe that
we have this protection only after the Sarbanes Oxley Act, but
this is not true.
The
Occupational Safety and
Health Act of 1970 created the Occupational Safety and Health
Administration - OSHA that investigates complaints and
enforces the whistleblower
provisions of Sarbanes-Oxley and 16 other
statutes protecting employees who report violations
of various securities laws; trucking, airline, nuclear power,
pipeline, environmental, rail, and workplace safety and health
regulations; and consumer product safety laws.
The Sarbanes Oxley Act's whistleblower
protection provision
The
Sarbanes Oxley Act's whistleblower protection provision
is encouraging employees of publicly traded companies to disclose
information that they reasonably believe indicates federal
securities violations or various forms of fraud, including fraud
against shareholders.
Employees of publicly traded companies
and contractors, subcontractors, and agencies of publicly traded
companies are protected.
A
complaint must be filed with the Department of Labor in writing
within 90 days of the time an employee
learns that he or she will be, or has been, subjected to
discrimination, harassment, or retaliation.
The
complaints should be be filed at:
U.S. Department of Labor
Office of the Assistant Secretary
Occupational Safety and
Health Administration - Room: S2315
200 Constitution Avenue
Washington, D.C. 20210
U.S. Department of Labor
Occupational Safety and Health Administration (OSHA)
The Occupational Safety and Health Act of 1970 created the
Occupational Safety and Health Administration to help employers
and employees reduce injuries, illnesses and deaths on the job in
America.
Since
then, workplace fatalities have been cut by more than 60 percent
and occupational injury and illness rates have declined 40
percent. At the same time, U.S. employment has more than doubled
and now includes over 115 million workers at 7.2 million
worksites.
Your Rights
as a Whistleblower
You may file a complaint with OSHA if your employer retaliates
against you by taking unfavorable personnel action because you
engaged in protected activity relating to workplace safety and
health, commercial motor carrier safety, pipeline safety, air
carrier safety, nuclear safety, the environment, asbestos in
schools, corporate fraud, SEC rules or regulations, railroad
carrier safety or security, or public transportation agency safety
or security.
Whistleblower Laws Enforced by OSHA
Each law requires that complaints be filed within a certain
number of days after the alleged retaliation.
You may file
complaints by telephone or in writing under the:
•
Occupational Safety and Health Act (30 days)
•
SurfaceTransportation Assistance Act (180 days)
• Asbestos
Hazard Emergency Response Act (90 days)
• International
Safe Container Act (60 days)
• Federal Rail Safety Act (180
days)
• NationalTransit Systems Security Act (180 days)
Under the following laws, complaints must be filed in writing:
• Clean Air Act (30 days)
• Comprehensive Environmental
Response, Compensation and Liability Act (30 days)
• Energy
Reorganization Act (180 days)
• FederalWater Pollution
Control Act (30 days)
• Pipeline Safety Improvement Act
(180 days)
• Safe DrinkingWater Act (30 days)
• Sarbanes-Oxley Act (90 days)
• SolidWaste Disposal Act (30 days)
• Toxic Substances
Control Act (30 days)
• Wendell H. Ford Aviation Investment
and Reform Act for the 21st Century (90 days)
Unfavorable Personnel Actions
Your employer may be found to have retaliated against you if
your protected activity was a contributing or motivating factor in
its decision to take unfavorable personnel action against you.
Such actions may include:
•
Firing or laying off
• Blacklisting
• Demoting
• Denying
overtime or promotion
• Disciplining
• Denying benefits
•
Failing to hire or rehire
• Intimidation
• Reassignment
affecting promotion prospects
• Reducing pay or hours
Filing a Complaint
If
you believe that your employer retaliated against you because you
exercised your legal rights as an employee, contact your local
OSHA office as soon as possible, because you must file your
complaint within the legal time limits.
OSHA conducts an
in-depth interview with each complainant to determine whether to
conduct an investigation. For more information, call your closest
OSHA Regional Office
• Boston (617) 565-9860
• NewYork
(212) 337-2378
• Philadelphia (215) 861-4900
• Atlanta (404)
562-2300
• Chicago (312) 353-2220
• Dallas (972) 850-4145
• Kansas City (816) 283-8745
• Denver (720) 264-6550
• San
Francisco (415) 625-2547
• Seattle (206) 553-5930
How OSHA Determines Whether
Retaliation Took Place
The investigation must reveal that:
• The employee engaged in protected activity;
• The employer knew about the protected activity;
• The
employer took an adverse action; and
• The protected activity
was the motivating factor (or under some laws, a contributing
factor) in the decision to take the adverse action against the
employee.
If the evidence
supports the employee’s allegation
and a settlement cannot be
reached, OSHA will issue
an order requiring the employer to
reinstate the
employee, pay back wages, restore benefits, and
other possible remedies to make the employee whole.
Whistleblower Protections When
Reporting Corporate Fraud
Employees who work for publicly traded companies or companies
required to file certain reports with the Securities and Exchange
Commission are protected from retaliation for reporting alleged
mail, wire, or bank fraud; violations of rules or regulations of
the SEC, or federal laws relating to fraud against shareholders.
Recent Case Study 1
US Labor Department orders
Tennessee Commerce Bank to reinstate whistleblower and pay more
than $1 million in back wages and other relief
Bank found in violation of whistleblower protection provisions
of Sarbanes-Oxley Act
NASHVILLE, Tenn. --
The U.S. Department of Labor's Occupational
Safety and Health Administration has ordered Tennessee Commerce
Bank in Nashville to reinstate a former corporate officer and pay
more than $1 million in back wages,
interest, attorney's fees, compensatory damages and other relief.
The
department found the bank had fired the
individual in violation of the whistleblower protection provisions
of the Sarbanes-Oxley Act of 2002.
"Sarbanes-Oxley provides protection to workers who report
alleged violations of mail, wire, bank or securities fraud;
violations of rules or regulations of the Securities and Exchange
Commission; or federal laws relating to fraud against
shareholders," said Assistant Secretary of Labor for OSHA Dr.
David Michaels.
"This
case clearly shows the department's commitment to ensuring that
individuals are provided the protections and relief afforded by
the law and sends a strong message that retaliatory actions will
not be tolerated."
A complaint filed with OSHA in April
2008 named Tennessee Commerce Bank and Tennessee Commerce Bancorp
Inc. as defendants.
The
complaint alleged that the employee was placed on administrative
leave in March 2008 and fired in May 2008 after raising concerns
about internal controls, employee accounts, insider trading and
other issues.
The
complainant first raised concerns to the bank's audit committee
and later to the Federal Deposit Insurance Corp. and the Tennessee
Department of Financial Institutions.
OSHA investigated the
complaint as part of its responsibilities
to enforce the whistleblower provisions of
Sarbanes-Oxley and 16 other statutes protecting employees
who report violations of various securities
laws; trucking, airline, nuclear power, pipeline, environmental,
rail, and workplace safety and health regulations; and consumer
product safety laws.
Fact
sheets and detailed information on employee whistleblower rights
are available online at
http://www.osha.gov/dep/oia/whistleblower/index.html
Either
party to the case may file objections and/or request a hearing
before the Labor Department's Office of Administrative Law Judges
within 30 days, but such an appeal does not stay the preliminary
reinstatement order.
Under the numerous whistleblower
provisions enacted by Congress, employers are prohibited from retaliating against employees
who raise various protected concerns or provide protected
information to the employer or to the government. Employees who
believe that they have been retaliated against for engaging in
protected conduct may file a complaint with the secretary of labor
for an investigation by OSHA's Whistleblower Protection Program.
Recent Case Study 2
US Department of Labor's OSHA orders
e-Smart Technologies Inc. to pay whistleblower back wages and
$600,000 in compensatory damages
Agency orders company to reinstate California worker
SAN FRANCISCO -- The U.S. Department of Labor's Occupational
Safety and Health Administration has ordered e-Smart Technologies
Inc. to pay back wages with interest
and approximately $600,000 in
compensatory damages to a California worker who was discharged
after raising concerns about misinformation contained in a draft
public filing.
OSHA
also ordered the company to reinstate
the whistleblower to his former position.
"It is vital that employees be able to raise fraud concerns to
their employers without fear of retaliation," said Assistant
Secretary of Labor for OSHA Dr. David Michaels.
"This
order reaffirms both the right of employees to raise concerns
regarding violations of Securities and Exchange Commission rules
and the Labor Department's commitment to protecting that right."
The action resulted from a whistleblower investigation
conducted by OSHA's regional office in San Francisco
under the whistleblower protection provisions
of the Sarbanes-Oxley Act of 2002.
The
investigation substantiated the employee's complaint that his job
duties were systematically removed and his paychecks were delayed
and ultimately stopped after he questioned the accuracy of several
statements made in the company's Securities and Exchange
Commission filings.
In addition to requiring e-Smart
Technologies to fairly compensate and rehire the whistleblower,
OSHA's order instructs the company to provide a neutral reference,
expunge his personnel file of any reference to his exercise of
rights under the Sarbanes-Oxley Act and post a notice to employees
outlining whistleblower protections.
E-Smart Technologies is a registered Nevada corporation with an
office in New York. The company or complainant may file objections
or request a hearing before the Labor Department's Office of
Administrative Law Judges within 30 days.
Recent Case Study 3
US Department of Labor secures back
wages for fired whistleblower in Corpus Christi, Texas
CORPUS CHRISTI, Texas — A former employee of Corpus
Christi-based Orion Drilling Co., fired after complaining to
management about being exposed to mold in the workplace,
has been paid $10,000 in back wages as a
result of a settlement secured by the U.S. Department of Labor.
The former employee, who served as a crew member on a drilling
rig, complained to management about being exposed to mold in the
crew members' living quarters.
After
being fired, the former employee filed a complaint with the
department's Occupational Safety and Health Administration (OSHA)
alleging a violation of the whistleblower provisions of the
Occupational Safety and Health (OSH) Act of 1970.
OSHA's
investigation found merit to the complaint.
After OSHA
informed the employer of its preliminary finding and referred the
case to the Labor Department's Office of the Solicitor for
enforcement, the employer elected to settle the case.
In
addition to paying the complainant the $10,000 in lost wages, the
settlement agreement requires the employer to post a notice in the
workplace informing employees of their rights under the OSH Act
and to purge all derogatory or negative statements from the fired
employee's personnel file.
"Employees should be free to exercise their rights under the law
without fear of retaliation by their employers," said Dean
McDaniel, OSHA's regional administrator in Dallas, Texas.
"This
settlement underscores the Labor Department's commitment to
vigorously take action to protect worker rights."
QUESTION
How can the Obama Administration and Congress restore
investor confidence?
ANSWER OF MICHAEL OXLEY TO FORTUNE (MARCH
2010)
We need to figure out
financial reform. In the wake of AIG and Lehman, it's very
difficult today to make the case that the market will take care of
itself and that we don't need a lot of transparency or even a
minimal regulatory structure.
(Congressmen Paul Sarbanes of
Maryland and Michael Oxley of Ohio crafted Sarbanes-Oxley, which
was enacted in 2002. Michael Oxley is now working at law firm
Baker Hostetler in D.C.)
B. Basel ii News
Today we will
study the comments from Goldman Sachs on 'Revisions
to the Basel II market risk framework' and
'Guidelines for computing capital for incremental
risk in the trading book'.
We will also see that several European banks have a
similar approach. Main target: The Basedl ii Market
Risk Amendment of 2009
Introduction
Accordint to the Bank of
International Settlements, since
the financial crisis began in mid-2007, an important
source of losses and of the build up of leverage
occurred in the trading book.
A main contributing factor was that
the current capital framework for market risk, based
on the 1996 Amendment to the Capital Accord to
incorporate market risks, does
not capture some key risks.
In response, the Basel Committee on
Banking Supervision (the Committee)
supplements the current value-at-risk based trading
book framework with an incremental risk capital
charge, which includes default risk as well as
migration risk, for unsecuritised credit products.
For securitised products, the
capital charges of the banking book will apply with a
limited exception for certain so-called correlation
trading activities, where banks may be allowed by
their supervisor to calculate a comprehensive risk
capital charge subject to strict qualitative minimum
requirements as well as stress
testing requirements.
These measures will
reduce the incentive for
regulatory arbitrage between the banking and trading
books.
An additional response to the
crisis is the introduction of a
stressed value-at-risk requirement.
Losses in most banks’ trading books
during the financial crisis have been significantly
higher than the minimum capital requirements under the
former Pillar 1 market risk rules.
The Committee therefore requires
banks to calculate a stressed
value-at-risk taking into account a one-year
observation period relating to significant losses,
which must be calculated in addition to the
value-at-risk based on the most recent one-year
observation period.
The additional stressed
value-at-risk requirement will also help reduce the
procyclicality of the minimum capital requirements for
market risk.
Goldman Sachs comments on
'Revisions to the Basel II market risk framework'
and 'Guidelines for computing capital for
incremental risk in the trading book'
“Revisions to the Basel II
market risk framework” (“MRF”) and “Guidelines for
computing capital for incremental risk in the trading
book” (“IRC Guidelines”)
13 March 2009
Basel Committee on Banking
Supervision
Bank for International Settlements
Centralbahnplatz 2 CH-4002 Basel Switzerland
Dear Committee Members
The Goldman Sachs
Group, Inc. (“Goldman Sachs”) is pleased to have the opportunity
to provide comments on these two consultative documents issued
in January 2009 by the Basel Committee on Banking Supervision
(“the Committee”).
In doing so, we would like to express
our appreciation of the efforts that have been made by the
Committee, and by the members of the International Organization
of Securities Commissions (“IOSCO”), to develop these proposals,
the importance of which has been heightened by the financial
crisis.
Goldman Sachs supports the central principle
underpinning the Basel 2 Framework: a risk sensitive capital
adequacy regime.
In particular we are fully supportive
of the Basel Committee’s stated goal of arriving at
“significantly more risk-sensitive capital requirements that are
conceptually sound”.
We believe the Basel Committee has
moved away from this underlying principle in these consultation
papers.
In particular we
are concerned that the new proposals will not address the
material tail risks which VaR is not designed to capture and
will stifle risk management development.
We recommend a principles-based
framework that will capture all material tail risks and promote
risk management practice and modelling.
We believe that
a principles-based framework would need to be bolstered at the
Supervisory level by a more rigorous assessment and enforcement
process that promotes consistency of coverage of the material
tail risks, but that allows firms to adapt the methodology as
appropriate for their portfolios.
We support a level
playing field but note that it has not been recognised
explicitly that some firms are already holding capital to cover
many of the risks identified by the Basel Committee.
It
is apparent from public disclosures, that different firms report
widely varying amounts of market risk-weighted assets relative
to reported VaR.
This leads us to the conclusion that
some firms have been holding capital to
cover various risks that are not captured by VaR models and that
others have not.
We believe the Committee should
acknowledge in its proposals and in the Quantitative Impact
Study that the starting point is different depending on the firm
and jurisdiction.
We are concerned therefore that a firm
such as Goldman Sachs, which has been holding capital for many
such risks based on methodologies agreed with supervisors, will
be required to discard these methodologies in favour of the
standard rules set out in these proposals.
We believe
that the proposals do not address the event risks and other
material risks associated with securitisation positions
appropriately.
We understand
that some firms’ models and add-ons did not capture the tail
risks observed during 2007/8, in particular where firms were
using public credit ratings to manage and measure risk and
capital.
The solution to this is not a backwards step
towards simplified approaches, but a more forward-looking Basel
2 framework which requires firms to hold capital for all
material risks.
We believe that material event risks
cannot be captured in VaR, but alternatively can be captured by
suitable risk-based methodologies (including add-ons), and that
the important aim is that there is sufficient capital to cover
these risks.
Under the
current proposals (i.e. limited to credit ratings for
securitisation positions), material risks will continue to be
omitted from capital.
We
set out the reasons for this below.
We refute the common presumption that
capital under the Trading Book Framework is necessarily lower
than under the Banking Book Framework. In certain cases Trading
Book positions can attract much higher capital charges and we
think this is not inappropriate. In particular, illiquid assets
in the Trading Book should attract more capital than the same
position booked in the banking book at historical cost.
We explain our thinking below.
The proposal to restrict netting to similar financial
instruments in the IRC framework will have a very material
impact on capital charges, and is incongruent with the AIRB
framework which requires firms to consider exposure on an
obligor basis.
We suggest that netting on an
intra-obligor basis should be permitted, and would be fully
reflective of the way positions are managed and hedged within
the Trading Book.
Proposals
relating to Securitisation Exposures
Tying to the Securitisation Framework
We
fundamentally disagree that banking book securitisation risk
weights should be used to calculate trading book specific risk
capital requirements for the following reasons:
-- Risk
weights are based on public credit ratings.
This is not
risk sensitive – there are other dominant factors that have
driven price changes, in particular the risk associated with the
correlation structure.
AAA-rated ABSs attracting 7%
risk weight are a good example of how, under this method,
capital would have been inappropriate and unresponsive to
changes in market value, particularly where firms are marking to
market.
The banking book securitisation framework
should apply only to held to maturity securitisation positions
recorded at historical cost because the probability of default
is the key driver of their value.
If trading book
securitisation positions are forced into a ratings based
framework, the resulting capital requirements will not capture
the price risks (or potential changes in value) that ratings are
not designed to capture.
-- Carving out securitisation
positions from a trading desk’s portfolio will lead to an
incoherent picture of the risk, affecting capital charges for
the portfolio in an unpredictable way and resulting in varying
and, in some cases, potentially lower capital charges than under
the current framework.
Risk sensitivity should be the
overriding principle of the Basel Committee’s proposals –
capital should be aligned to the material risks in the
portfolio.
Dealer exemption
We strongly advocate the re-insertion of paragraph 718 (xcv)
that contains the exemption language for firms whose positions
are part of market-making activity.
Without this
exemption language, firms with significant correlation trading
business, or who offer tranched portfolio protection to
financial institutions, will experience multiple fold increases
in capital requirements not commensurate with risk.
The
exemption was inserted into the Basel 2 Framework in recognition
of the fact that firms with correlation books have dynamically
hedged portfolios that are re-valued on a daily basis and are
subject to active risk management.
It is not
appropriate to regard such portfolios as directional portfolios
(e.g. long only strategies that suffered severe deterioration in
value during the recent financial events).
Rather they
are portfolios which manage “correlation risk”.
As such
it is correlation risk which needs to be appropriately captured
in the capital charge.
Such portfolios typically contain
bespoke tranche synthetic positions that are not rated by
external rating agencies.
As such, most positions are
likely to be treated as equity tranches and deducted from
capital under these proposals, even though there may be dynamic
hedges in place or the tranches may be unrated mezzanine
tranches.
Whilst we do not disagree that capital levels
should be increased for some firms’ portfolios with tranched
exposures, capital levels should not be set by the
securitisation framework which relies on public credit ratings
agencies that to date have not been rating synthetic tranches,
and anyway would only capture the default probability.
It
has become apparent that some firms that were net long
securitisation exposures and recorded significant mark to market
losses may have been relying on public credit ratings to
determine and manage the level of risk in the portfolio.
The proposals should not compound this error by requiring all
firms to use public credit ratings for capital requirements
purposes as set out in the Securitisation Framework.
Market making activity in credit markets will be severely
disrupted by the proposed rules.
We believe that the
Basel Committee should set a broader policy objective of
promoting active, liquid capital markets.
Following on
from this, the proposals should steer clear of setting capital
requirements that are poorly aligned with risk.
Otherwise there is a serious risk that capital markets will
suffer materially from a loss in liquidity and price
transparency, which will have knock on effects on underlying
debt liquidity and prices.
We fully support the arguments
in the ISDA/LIBA/IIF/IBFed industry response that describe in
more detail the correlation trading business and why this
exemption is fundamental to dealers.
Arbitrage
Furthermore, we believe that the securitisation exposure
proposals have the potential to result in a perverse outcome for
unhedged long securitisation positions in the trading book which
are marked to market.
The combination of existing
trading book specific and general market risk charges together
with recognition of any losses on a mark-to-market basis will
almost certainly result in a larger impact to capital than if
the positions were held in the banking book.
Applying
banking book charges will incentivise banks to hold in the
banking book positions that are in fact held with trading
intent.
Please see comments below with respect to
trading book versus banking book classification.
Backwards step
We would suggest a proper risk based measure that would take
into account more than just the capital charge derived from a
public credit rating.
Properties of such a measure
would allow for some diversification benefits, taking into
account long and short positions, both synthetic and physical.
We note that the UK FSA standard position risk
requirements for credit derivative positions are considerably
more risk sensitive than the Basel proposals.
Incremental
Risk Charge (IRC)
Reduced
scope
We are disappointed
that the scope of the IRC has been reduced to cover default and
migration risks for positions that have specific interest rate
risk and instead would advocate returning to the scope outlined
in July 2008 (i.e. all material price risks for all products
except non-default interest products, commodities and FX).
The reduced scope is not forward looking.
We suggest a
high level principle that firms must capture material price
risks and to cover all positions including securitisation
positions.
Non-VaR capital
add-ons
VaR does not capture
all risks.
Therefore the proposals should be
underpinned with the key principle that all material risks
should be captured in capital, through a combination of VaR and
separate risk-based add-ons. Separate event risk methodologies
remain part of the suite of risk management tools.
We
believe the Committee should not want to distort VaR by
requiring it to cover risks which it is not designed to do.
Banks using capital add-on methodologies must be able to
demonstrate that the capital is sufficient to capture all
material risks.
Following on from this, we are concerned
by the re-addition of the wording “capture event risk” in para
718(LXXXViii) and by the continued deletion of para 718
(LXXXiX).
Together, these amendments require firms to
capture event risk in VaR models.
We believe this may
not be possible in some cases and strongly advocate that the
Basel Committee should clarify that it is necessary to ensure
capital is sufficient to capture event risk, but this does not
necessarily mean it will be covered within firms’ VaR models.
Many event risks will be tail events not likely to be
captured in 1 year historical data periods or within the
confidence intervals measured by VaR models.
Concentrations and lack of liquidity can result in impacts to
capital from tail events that would be better captured by add-on
type capital charges designed to be calibrated to the potential
impact on the firm’s portfolio, and more in line with stress
testing techniques.
We believe this would address the
Committee’s concern with more clarity as well as, importantly,
would be likely to raise capital for the tail risks.
Therefore we would ask for 718 (LXXXiX) to be reinstated but
amend the words “internal capital assessment” to “additional
Pillar 1 capital charges” using a methodology to be agreed
between a firm and its regulator.
Soundness standard
Whilst we agree that the trading book should meet a safety
and soundness standard equivalent to that used for the banking
book, we believe that it is an absolutely fundamental
requirement the proposals explicitly recognise that trading book
positions should, in general, attract different capital
requirements compared to the same position held in the banking
book.
Setting the soundness standard to 99.9% 1 year is
not the same as setting the same absolute capital level for a
given position regardless of where it is booked.
Trading Book Behaviour
As a firm with predominantly trading activity, we are
acutely aware of the importance of strong risk management and
measurement.
In particular, we see mark to market as a
core discipline, not just, as is more commonly perceived, a
“valuation methodology”.
As such, trading book
positions are subject to active management on a daily basis with
daily valuations.
Traders and risk managers make
decisions based on this information.
Therefore we
believe there should be explicit recognition that capital
charges should be different for the same position if booked in
the trading book rather than the banking book.
Constant
level of risk assumption and Minimum liquidity horizon
The constant level of risk assumption is not adequate and cannot
apply to trading book positions.
We do not believe that
a requirement to rollover positions to a one year horizon is
appropriate for the trading book, since it does not reflect
actual trading and risk management practice, either in benign or
stressed environments.
It is clear that firms have been
reducing trading positions and have not been attempting to take
on new risk during the recent stressed period.
For
positions that are illiquid, concentrated and of low quality,
capital charges should be increased.
However we believe
it is wholly inappropriate and inconsistent with the evidence of
firms’ behaviour during the crisis, to presume that firms will
consciously increase trading risk in stressed environments.
Therefore we propose that capital should be set according
to the applicable liquidity horizon and to a soundness standard
of 99.9%.
In combination, prescribed minimum liquidity
horizons, and the incongruent rollover to a single, arbitrary
horizon, will, perversely, deemphasise the illiquid, low-rated
and concentrated positions the Committee is rightly most
concerned about in the capital calculation.
Netting restrictions
Basel has proposed that netting should only be allowed where
positions refer to the same financial instrument, i.e.
intra-obligor netting is no longer permitted.
This
requirement is burdensome and inconsistent with the AIRB
framework which requires firms to consider credit exposures at
the risk party level. Intra-obligor offsets should be permitted
but there should be an explicit requirement that material basis
risks should be adequately capitalised.
Trading book versus banking book
We strongly disagree with the suggestions to treat Trading
Book positions under the Banking Book framework.
On the
contrary, we would argue that the Banking Book treatment is
inferior given its limitation to credit risk, coupled with less
stringent requirements to risk manage on a frequent and dynamic
basis.
Positions accounted for using fair value that
would be treated under the banking book framework would not
require capital for material price risks.
In downturn
scenarios, where asset prices are depressed, banking book
capital requirements would be insufficient. Also under the
banking book approach, interest rate risk is addressed in the
Pillar 2 framework only and does not necessarily require further
capital.
The banking book framework should apply only
to held to maturity assets recorded at historical cost because
the probability of default is the key driver of the value of
such assets.
Therefore, we would suggest as an
alternative, that assets that are valued on a fair value basis,
but are booked in the banking book, should be subject to forward
looking capital charges that capture the material price risks,
and are not limited to credit risk charges.
Such a
regime should set capital requirements at a level higher than
positions held in the Trading Book because, importantly, such
positions carry all of the same price risks but have none of the
discipline required under a rigorous risk management process in
the Trading Book.
Factors that are used to arrive at
the fair value of an asset should also be used in assessing the
potential value deterioration for the purpose of determining a
risk-based capital requirement
This would be consistent
with Basel’s proposal to extend prudent valuation guidance to
all positions subject to fair value accounting (para 9 of the
MRF).
Therefore any asset marked at fair value should
be subject to capital charges that are aligned with the
underlying risk factors, regardless of whether the asset is
booked in the trading book or banking book.
Only assets
that are held at historical cost (less impairment), should be
eligible for banking book treatment i.e. treatment that only
capitalises against the default of the underlying name(s).
The above suggestion would need to be coupled with the
increased scope as set out above i.e. that all material price
risks for all trading book positions should be caught by the
Incremental Risk Charge.
For example, a less liquid
tranched credit position, whether booked in the trading book or
banking book, will attract a capital charge to cover default
risk, migration risk, interest rate risk and correlation risk.
This would clearly be a better outcome than booking
this in the banking book and attributing a 7% risk weight to the
position according to the default risk only.
Stressed VaR
Purpose lacks clarity
The goal of the stressed
VaR additional capital requirement is not clear.
We do
not believe the proposals clarify whether it is intended to
address procyclicality or deficiencies in a firm’s VaR model.
If the aim is to compensate for models which are not
sufficiently responsive to changes in market conditions, we
believe there are better ways to address that concern. For
example, the plus factors for backtesting breaches could be
increased.
There is evidence which would suggest that
firms with many backtesting breaches also suffered severe losses
in their trading books over the recent period.
Alternatively, as the Committee itself has recognised, some
firms have used weighting schemes for historical data to ensure
that VaR models are more responsive to changes in market
conditions.
Event risk
Importantly, the stressed VaR
measure does not capture any of the tail risks which have been
central to market losses during the crisis.
Tail events
need to be captured by an increased scope in the IRC guidelines
as set out above.
We believe the increased capital
levels resulting from the stressed VaR concept will provide a
false sense of security.
Although capital in the system
will increase for trading book positions, there is still clear
potential for some firms with less liquid and more risky (in
terms of tail risk) positions to continue to have insufficient
capital resources.
Risk
insensitivity
The Stressed
VaR concept will result in capital levels that are much less
responsive to changes in risk.
As such we believe the
proposal is counter effective and inconsistent with the core
Basel principle of a risk based capital framework.
It
is important that a risk based capital measure should capture
and react quickly to risks.
Without this, the proposals
do not incentivise good risk management practice.
Perverse incentives
The Stressed VaR proposal
incentivises a lower core VaR number and a simpler model.
Models that have a fast decay are more reactive and responsive
to a market stressed environment, and can lead to increased
capital requirements of 2-3 times compared to benign economic
environments.
A stressed VaR measure therefore has
level playing field issues in that firms with more reactive VaR
measures will be penalised more than firms with less reactive
VaR measures.
In closing, we wish to repeat our support
of the efforts of the Committee, and to express our desire to
assist the Committee in any way that would be helpful.
Yours sincerely
Robert Charnley
cc. Ms Norah Barger,
Deputy Director, Division of Banking Supervision & Regulation,
Federal Reserve System
Mr Thomas McGowan, Assistant Director,
Division of Trading & Markets, Securities & Exchange Commission
Mr Paul Sharma, Director of Wholesale and Prudential Policy,
Financial Services Authority
Basel ii in the USA - It will take
some time...
Case
Study
Goldman Sachs
FORM 10-K: ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009 The Goldman Sachs
Group, Inc.
Capital
Requirements
We are subject to regulatory capital requirements
administered by the U.S. federal banking agencies.
Our
bank depository institution subsidiaries, including GS Bank USA,
are subject to similar capital requirements.
Under the
Federal Reserve Board’s capital adequacy requirements and the
regulatory framework for prompt corrective action (PCA) that is
applicable to GS Bank USA, Goldman Sachs and its bank depository
institution subsidiaries must meet specific capital requirements
that involve quantitative measures of assets, liabilities and
certain off-balance-sheet items as calculated under regulatory
reporting practices.
Goldman Sachs and its bank
depository institution subsidiaries’ capital amounts, as well as
GS Bank USA’s PCA classification, are also subject to
qualitative judgments by the regulators about components, risk
weightings and other factors.
We report capital ratios computed in
accordance with the regulatory capital requirements currently
applicable to bank holding companies, which are based on the
Capital Accord of the Basel Committee on Banking Supervision
(Basel I). These ratios are used by the Federal Reserve Board
and other U.S. federal banking agencies in the supervisory
review process, including the assessment of the firm’s capital
adequacy.
Our Tier 1 capital
consists of common shareholders’ equity, qualifying preferred
stock and our junior subordinated debt issued to trusts, less
deductions for goodwill, disallowed intangible assets and other
items.
Our total capital consists of our Tier 1 capital
and our qualifying subordinated debt, less certain deductions.
Our total capital ratio is equal to total capital as a
percentage of Risk-Weighted Assets (RWAs), which are calculated
in accordance with the Federal Reserve Board’s risk-based
capital requirements, and our Tier 1 capital ratio is equal to
Tier 1 capital as a percentage of RWAs.
The calculation
of RWAs is based on the amount of the firm’s market risk and
credit risk.
Certain measures included in the calculation
of the firm’s RWAs for market risk are under review by the
Federal Reserve Board.
As
of December 2009, our total capital ratio was 18.2%, and our
Tier 1 capital ratio was 15.0%.
We are currently working
to implement the requirements set out in the Revised Framework
for the International Convergence of Capital Measurement and
Capital Standards issued by the Basel Committee on Banking
Supervision (Basel II) as applicable to us as a bank holding
company.
U.S. banking
regulators have incorporated the Basel II framework into the
existing risk-based capital requirements by requiring that
internationally active banking organizations, such as Group
Inc., transition to Basel II over several years.
During
a parallel period, we anticipate that Group Inc.’s capital
calculations computed under both the Basel I rules and the Basel
II rules will be reported to the Federal Reserve Board for
examination and compliance for at least four consecutive
quarterly periods.
Once the parallel period and
subsequent three-year transition period are successfully
completed, Group Inc. will utilize the Basel II framework as its
means of capital adequacy assessment, measurement and reporting
and will discontinue use of Basel I.
The Basel II
framework was implemented in several countries during the second
half of 2007 and in 2008, while others began implementation in
2009.
The Basel II rules
therefore already apply to certain of our operations in non-U.S.
jurisdictions.
The Federal
Reserve Board also has established minimum leverage ratio
requirements.
The Tier 1 leverage ratio is defined as
Tier 1 capital under Basel I divided by adjusted average total
assets (which includes adjustments for disallowed goodwill and
certain intangible assets).
The minimum Tier 1 leverage
ratio is 3% for bank holding companies that have received the
highest supervisory
rating under Federal Reserve Board
guidelines or that have implemented the Federal Reserve Board’s
risk-based capital measure for market risk. Other bank holding
companies must have a minimum Tier 1 leverage ratio of 4%.
Bank holding companies may be expected to maintain ratios well
above the minimum levels, depending upon their particular
condition, risk profile and growth plans.
As of
December 2009, our Tier 1 leverage ratio under Basel I was 7.6%.
European banks against the Basel ii Market
Risk Amendment
European Association of Public Banks
European Association of
Public Banks and Funding Agencies AISBL
Avenue de la Joyeuse
Entrée 1 – 5, B-1040 Brussels
The European Association of Public Banks (EAPB) represents
the interests of 32 public banks, funding agencies and
associations of public banks throughout Europe, which together
represent some 100 public financial institutions. The latter
have a combined balance sheet total of about EUR 3,500 billion
and represent about 190,000 employees, i.e. covering a European
market share of approximately 15%.
EAPB comments on the
Basel Committee’s consultation on “Guidelines for computing
capital for incremental risk in the trading book” and “Revisions
to the Basel II market risk framework”
Basel Committee
on Banking Supervision
Bank for International Settlements
CH-4002 Basel, Switzerland
The EAPB is grateful for the
opportunity to comment of the two consultation papers “Revisions
to the Basel II market risk framework” (CP 148) and “Guidelines
for computing capital for incremental risk in the trading book”
(CP 149).
We would like to provide our response in the
following.
Before we comment on the changes presented in
the two papers in detail, we would like to start with a few
basic comments.
General comments
Unintended side-effects
Against the background of the most recent financial market
turbulences, we can in principle understand the efforts made by
the regulatory authorities to increase capital requirements in
order to cover market risks and additional risks in the trading
book.
However, in the future, capital requirements
should also be in line with risks assumed by the banks.
From the point of view of the credit services sector,
comprehensive efforts are already being made in broad areas of
internal risk management to counteract the causes and effects of
the financial market crisis.
We are of the opinion that
a revision of a bank’s specific situation has clear advantages
over a global increase of own funds prescribed by regulators.
Furthermore, a synchronised balance between the models used
internally by banks in future and the regulatory requirements
("use test") should be ensured.
The (further)
development of models must not be restricted by rigid regulatory
requirements, particularly in the area of
measuring
incremental risks, for which no market standards currently
exist.
Banks prefer to
implement risk models, as these are more flexible and
appropriate for their individual risk profile and portfolio
configuration.
With inflexible regulatory model
requirements, which are primarily conservative in nature, the
advantages of an internal model will be lost.
The incentive of risk control on
the basis of a bank-specific model would therefore be
significantly reduced.
In this respect, we still have
doubts about whether it is possible to fulfil the use-test
requirements on the basis of the specifications in the third
consultation paper.
Assessments by the credit services
sector show that the proposed regulatory requirements for the
modelling of incremental risks and the introduction of the
stress VaR would result in a huge in-crease in capital charges
for the trading book, irrespective of the portfolio.
This multiplication of the capital charges would also lead to
secondary effects.
According to our assessment, the
capital-orientated incentive of transferring from market risk
standard procedures to model procedures will thus be negated by
the increasing capital charges for the latter method.
This will make internal further development and the regulatory
use of risk models unattractive.
This would also result
in an incentive to not include and manage risk positions in the
trading book but to allocate these to the banking book wherever
possible.
This is particularly evident in the example
of securitisation positions: Our understanding of Item 38 is
that the capital
charges for securitisations in the trading
book must effectively be determined on the basis of the banking
book regulations.
However, as such items are also to be
taken into account in the standard VaR general market risk (must
rule) and, if applicable, in the standard VaR specific risk (can
rule) and the stress VaR (must) for the capital requirements,
apparently desired arbitrage incentives arise which benefit the
banking book.
A lack of incentives for trading book
activities does not only have an effect on the bank itself.
In general, the development of these incentives could lead
to fewer market participants with the consequence that higher
margins could be imposed in less liquid markets, thus increasing
the costs for many financial service providers.
The
distortions in the market lead to arbitrage opportunities, which
could have a negative effect on market
prices.
Time schedule
We welcome the extension of the implementation deadline
compared to the second consultation paper. We would nevertheless
like to draw the attention of the Basel Committee to the
differences in terms of content and deadlines between the Basel
provisions on the one hand and the currently valid European and
national regulations for the management of incremental risks on
the other hand.
This uncertainty regarding how national
regulators will handle discrepancies must not result in any
disadvantages for the banks.
At the same time, the
extension of the implementation deadline should also be made use
of in order to complete the discussions still to be held without
excessive time pressure and with the appropriate care.
Hasty decisions must be avoided at all costs due to the
comprehensive internal model adjustments.
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