Shadow Banking (eBook)

Roy J. Girasa is a Professor of Law at the Lubin School of Business, Pace University, USA. He has authored over 100 journals articles and newspaper columns on the topics of financial law, securities law, and regulations. He is the author of the bestselling textbook Cyberlaw: National and International Perspectives (2001), and two previous Palgrave Macmillan books, Corporate Governance and Finance Law (2013) and Laws and Regulations in Global Financial Markets (2013). 

Dedication 5
Also by Roy Girasa 6
Preface 7
Contents 8
Acronyms and Abbreviations 9
List of Figures 13
List of Tables 14
List of Appendices 15
Introduction 16
Definitions of “Shadow Banking” 16
Division of Text 17
Notes 18
Chapter 1: Traditional Banking in the United States and Its Evolution as Bank Holding Companies 20
1.1 Traditional Banking 20
1.2 Role and Types of Transformation of the Financial System 22
1.2.1 Role 22
1.2.2 Transformations 22
1.3 Historical Development of the US Banking System 23
1.3.1 The Federal Reserve System 24
1.3.2 The Glass-Steagall Act of 1933 and Bank Separation 25
1.3.3 The Riegel-Neal Interstate and Branching Efficiency Act of 1994 26
1.3.4 Gramm-Leach-Bliley Act of 1999 27
1.4 Dodd-Frank Act Bank Requirements 28
1.4.1 The Volcker Rule 29
1.4.2 Additional Prohibitions: Credit Rating Agencies 30
IOSCO Principles 31
1.4.3 Dodd-Frank Act and CRAs 31
Transparency of Ratings Performance 33
Corporate Governance, Organization, and Management of Conflicts of Interest 34
1.4.4 Prohibition of Certain Mergers 34
1.5 Bank Holding Companies 36
1.5.1 Definition 36
1.5.2 Dodd-Frank Changes to the Bank Holding Act 37
1.5.3 FED’s Final Rule of Enhanced Prudential Standards for BHCs 37
1.5.4 Requirements for BHCs with Total Consolidated Assets of $10 Billion but Less Than $50 Billion 37
Management Oversight 39
Baseline, Adverse, and Severely Adverse Hypothetical Scenarios 40
1.5.5 Requirements for Publicly Traded BHCs with Total Consolidated Assets of $10 Billion and Less Than $50 Billion42 41
Risk-Management Framework 42
Corporate Governance Requirements 42
1.5.6 Enhanced Prudential Standards for BHCs with Total Consolidated Assets of $50 Billion or More 43
Risk Factors 43
Risk-Management and Risk Committee Requirements 43
Liquidity Risk-Management Requirements 44
Senior Management Responsibilities 45
Cash-Flow Projections 45
Liquidity Stress Testing Requirements 46
Liquidity Buffer Requirements 47
1.6 International Banking Requirements 47
1.6.1 Basel III Requirements and Implementation 47
Global Regulatory Framework for Banks and Banking Systems 48
Large Exposure to a Single Counterparty 51
1.6.2 Basel Committee Guidelines for Identifying and Dealing with Weak Banks 52
Notes 55
Appendix 1: Iosco Code of Conduct for Credit Rating Agencies 58
Appendix 2: Basel III Core Principles for Effective Banking Supervision 60
Supervisory Powers, Responsibilities and Functions 60
Prudential Regulations and Requirements 62
Chapter 2: Shadow Banking (Non-Bank Financial Intermediation) 66
2.1 Economic Mechanisms Motivating Shadow Banking 67
2.2 Systemic Risks of Shadow Banking 73
2.2.1 Recommendations to Lessen Systemic Risk 74
2.2.2 Backstops for Shadow Banking 80
2.3 International Regulation: IOSCO 82
2.3.1 Nature of Risk and Regulation 82
2.3.2 Macro-Level Indicators of Systemic Risk 83
2.3.3 Micro-Level Indicators of Systemic Risk 83
2.4 Conclusion 84
Notes 85
Appendix 1: IOSCO Principles of Securities Regulation52 90
Notes 94
Appendix 2: IOSCO Recommendations Concerning Risk Management53 94
Structure 94
Systems/Processes 95
Cooperation and Coordination 97
Culture and Resourcing 97
Chapter 3: Governance of Shadow (Non-Bank) Financial Institutions 99
3.1 The Dodd-Frank Act and Its Application 100
3.1.1 Title I. Financial Stability and Application to Shadow Banks (Non-Bank Financial Companies) 102
3.2 The Financial Stability Oversight Council 105
3.2.1 Voting by Council Members 105
3.2.2 Purposes and Duties of the Council 106
Purposes 106
Duties 107
3.2.3 Council Procedures Under Dodd-Frank Act 108
Council Committee Structure 108
3.3 Considerations for Making SIFI Determinations 110
3.3.1 US Companies 110
3.3.2 Foreign Non-Bank Companies 111
Anti-Evasion Provisions 111
“Financial Activities” Covered by the Act 112
3.3.3 Financial Data Collection 112
3.3.4 The Office of Financial Research 113
3.3.5 Application of Determination Standards 113
3.3.6 Threat to the Financial Stability of the USA 114
Exposure 114
Asset Liquidation 115
Critical Function or Service 115
Material Financial Distress 115
Nature, Scope, Size, Scale, Concentration, Interconnectedness, or Mix of Activities 116
3.3.7 Six-Category Analytic Framework 116
Interconnectedness 117
Substitutability 117
Size 118
Leverage 118
Liquidity Risk and Maturity Mismatch 119
Existing Regulatory Scrutiny 120
3.3.8 Council’s Three Stage Process to Determine SIFI Designation 120
Stage 1 121
Stage 2 122
Stage 3 123
3.3.9 Proposed Determination Procedures 124
3.3.10 Re-Evaluation and Rescission 126
3.3.11 Backup Examination of the Board of Governors 126
3.3.12 Additional Regulatory Oversight and Compliance 127
3.4 The GE Capital Corporation SIFI Designation 127
3.4.1 SIFI Determination 127
3.4.2 Application and Order of Enhanced Prudential Standards and Reporting Requirements 128
3.4.3 GECC’S Initial Response to SIFI Designation and Order 130
3.4.4 The GE Conundrum: Disgorge or Comply? 134
3.5 Financial Market Utilities as SIFIs 134
3.5.1 Standards for SIFI Designation 136
Notes 140
Chapter 4: Enhanced Prudential Standards 143
4.1 Statutory Requirements 143
4.1.1 Required Prudential Standards 144
Additional Standards 145
Contingent Capital 145
Resolution Plan 145
Credit Exposure Report 146
Deficiencies of Resolution Plan and Credit Exposure Report 147
Concentration Limits 147
Short-Term Debt Limits 147
Risk Committee 148
Leverage Limitation 148
Inclusion of Off-Balance-Sheet Activities in Computing Capital Requirements 148
Stress Tests 149
4.1.2 SIFIs in Default or in Danger of Default 150
FDIC Proposed Resolution Authority 151
4.2 Regulatory Prudential Requirements 153
4.2.1 Enhanced Prudential Requirements 154
4.2.2 Capital Planning 156
4.2.3 Resolution Plans 157
Financial Stability Board (FSB) 157
4.3 UNCITRAL and US Chapter 15 Bankruptcy Code 163
4.3.1 UNCITRAL Model Law 164
Purpose of the Model Law 164
4.3.2 Basic Principles of the Model Law 165
Access Principle 165
Recognition Principle 165
Relief Principle 166
Cooperation and Coordination Principle 166
Scope of Application 167
Public Policy Exception 167
Commencement and Recognition of Foreign Proceedings 167
Center of Main Interest (COMI) 168
Cooperation with Foreign Courts and Representatives 168
Relief upon Recognition 168
4.4 Final Rule for Global Systemically Important BHCs (G-SIB)69 169
• Complexity. Complexity is characterized under the Final Rule as a category of systemic importance. In the event of failure or distress, the more complex a banking organization is, the greater the expense and time necessary to resolve it. Costly re 172
OTC Derivatives Activity 173
Cross-Jurisdictional Activity 173
Use of Short-Term Wholesale Funding (Maturity of Less Than One Year) 173
4.4.1 Enhanced Prudential Standards for Foreign Banking Organizations (FBO) 175
4.4.2 FBO with $50 Billion or More of Total Consolidated Assets but Under $50 Billion of Combined US Assets 175
4.4.3 FBO with Total Consolidated Assets of $50 Billion or More and Combined US Assets of $50 Billion or More 176
4.5 Commentary on Director Independence 177
Notes 180
Chapter 5: Securitization and Repos 184
5.1 Securitization 184
5.1.1 The Subprime Mortgage Fiasco 186
5.1.2 Dodd-Frank Act and Securitization 187
Dodd-Frank Act Mortgage Requirements 188
Minimum Standards for Mortgages 189
Safe Harbor Provisions 190
High-Cost Mortgages 191
5.1.3 Asset-Backed Securities (ABS) 192
5.1.4 International Regulation 195
International Monetary Fund 195
European Union Regulation of Securitization 197
5.2 Repurchase Agreements (Repos) 198
5.2.1 Repos Defined 198
5.2.2 Types of Repos 198
Federal Reserve Board 200
5.2.3 Regulation of Repos 202
5.2.4 Arguments Against Repo Regulation 204
5.2.5 International Regulation 205
Financial Stability Board 205
EU European Market Infrastructure Regulation (EMIR) 207
E.U. Directive on Markets in Financial Instruments as Amended (MiFID II)47 208
Notes 209
Chapter 6: Hedge Funds and Mutual Funds as SIFIs 213
6.1 Hedge Funds 213
6.1.1 Nature and Structure of Hedge Funds 214
6.1.2 Legal Structures of Hedge Funds: USA 214
6.1.3 Non US Hedge Funds 215
6.1.4 Risk Management 215
6.1.5 Regulation of Hedge Funds 217
US Hedge Funds 217
SEC Enforcement 221
Non-Governmental Oversight 223
Non-US Hedge Funds 223
6.1.6 Hedge Funds as Shadow Banks 223
Opposition to Designation of Hedge Funds as Shadow Banks 224
6.2 International Regulation 225
6.2.1 European Union Regulation 225
6.2.2 IOSCO Principles on the Regulation of Hedge Funds 226
6.3 Mutual Funds 227
6.3.1 Types of Mutual Funds 229
6.3.2 Regulation of Mutual Funds 230
US Regulation 230
Mutual Funds’ Use of Derivatives 233
Money Market Final Rule 235
Regulatory Changes 236
6.3.3 Designation of Mutual Funds as SIFIs 237
Arguments for Inclusion of Mutual Funds as SIFIs 237
Arguments Against Designation of Mutual Funds as SIFIs 238
6.4 International Regulation 240
6.4.1 European Union’s Money Market Proposed Regulations 240
Types of MMFs 240
Proposal of New Type of MMF 241
Diversification and Assessment 241
Transparency 241
Liquidity Fees and Redemption Gates 241
6.4.2 IMF Report 241
Notes 242
Chapter 7: Insurance Companies as SIFIs: The MetLife Inc. Litigation 247
7.1 Insurance Companies 247
7.1.1 US Regulation of Insurance Companies 247
7.1.2 AIG Ripple Effect 248
7.1.3 Financial Stability Oversight Council (Council) 249
7.1.4 Federal Insurance Office 250
7.1.5 Preemption of State Laws 250
7.2 The Council’s Regulation of Insurance Companies as SIFIs 251
7.2.1 Council’s Final Determination Regarding American International Group Inc. (AIG) 252
7.2.2 Council’s Final Determination Regarding Prudential Financial Inc. (Prudential) 253
Dissenting Views 254
7.3 METLIFE Litigation 256
7.3.1 Background to the Determination 256
7.3.2 Regulatory Basis for the SIFI Determination 257
7.3.3 Application of Regulatory Factors to MetLife 257
7.3.4 Council’s Analysis of Potential Effects in the Event of Material Distress at MetLife 259
Transmission Channel 259
Exposure Transmission Channel 260
7.3.5 Asset Liquidation Transmission Channel 261
7.3.6 Critical Function or Service Transmission Channel 261
7.3.7 Existing Supervision, Regulation, and Resolvability 262
7.4 METLIFE’S Complaint Against the Council 262
7.4.1 Parties to the Litigation 264
7.4.2 Statement of Claims by MetLife 264
7.5 Commentary 269
7.5.1 Case Law Precedents 269
7.5.2 Opinions as to the Outcome of the MetLife Litigation 275
Insurance Industry Views 276
7.5.3 Insurance Companies as SIFIs Debate 280
Brookings Institution 282
7.5.4 Reinsurance as SIFIs 283
7.6 International Regulation 286
7.6.1 Financial Stability Board Recommendations 286
Globally Systemically Important Insurers (GSIIs) 286
7.6.2 European Union’s Views Concerning Insurance Companies as SIFIs 289
Notes 290
Chapter 8: International Institutions Affecting Shadow Banking 295
8.1 International Regimes 295
8.2 G20 295
8.2.1 G20 Seoul Summit 296
8.3 Financial Stability Board 297
8.3.1 Mission of the FSB 298
8.3.2 FSB and Shadow Banking 299
8.3.3 FSB Policy Toolkit for Economic Functions 301
8.3.4 FSB Methodologies for Identifying G-SIFIs 304
8.3.5 High-Level Framework for Identifying NBNI G-SIFIs 304
8.3.6 NBNI Financial Sector-Specific Methodologies 305
8.3.7 Finance Companies 305
8.3.8 Market Intermediaries (Securities Broker-Dealers) 308
8.3.9 Investment Funds 308
8.3.10 Asset Managers 312
Definition 312
Systemic Importance of Asset Managers 312
Materiality Thresholds for Asset Managers 313
8.3.11 FSB 2014 Report 314
8.3.12 Other NBNI Financial Entities 315
8.4 International Organization of Securities Commissions (IOSCO) 315
8.4.1 Possible Conflict of FSB and IOSCO Regarding Regulation of Asset Managers 317
8.5 European Union (EU) 318
8.5.1 Historical Evolution 318
8.5.2 EU Institutions 318
8.5.3 Shadow Banking 319
Transparency 320
Responsibility 320
Supervision 321
Crisis Prevention and Management 321
8.5.4 European Commission Green Paper 322
8.5.5 EU Commission Communication 324
8.6 China 327
8.7 Other National Entities 328
8.8 Conclusion 329
Notes 330
Index 333