Purpose
and Scope This interagency policy is
issued jointly by the federal banking agencies, including the Office
of the Comptroller of the Currency (OCC), the Federal Deposit Insurance
Corporation (FDIC), the Board of Governors of the Federal Reserve
System (Board), and the Office of Thrift Supervision (OTS) (the agencies)
to alert banking organizations, including their boards of directors
and senior management, of the safety-and-soundness implications of
and the legal impediments to a bank providing financial support to
investment funds
1 advised by the bank, its subsidiaries,
or affiliates. A banking organization’s investment advisory services
can pose material risks to the bank’s liquidity, earnings, capital,
and reputation, and can harm investors, if the associated risks are
not effectively controlled. The agencies have concluded that recent
market developments, including market volatility, the continued low-interest-rate
environment, and operational and corporate governance weaknesses,
warrant the issuance of this guidance.
Banks are under no statutory requirement to provide financial
support to the funds they advise; however, circumstances may motivate
banks to do so for reasons of reputation risk and liability mitigation.
This type of support by banking organizations to funds they advise
has included credit extensions, cash infusions, asset purchases, and
acquisition of fund shares. In very limited circumstances, certain
arrangements between banks and funds they advise have been expressly
determined to be legally permissible and safe and sound when properly
conducted and managed. However, the agencies are concerned about other
occasions when emergency liquidity needs may prompt banks to support
their advised funds in ways that raise prudential and legal concerns.
Federal laws and regulations place significant restrictions
on transactions between banks and their advised funds. In particular,
sections 23A and 23B of the Federal Reserve Act and the Board’s Regulation
W (12 CFR 223) place quantitative limits and collateral and market
terms requirements on many transactions between a bank and certain
of its advised funds. Additionally, the OCC’s fiduciary activities
regulation (12 CFR 9) may restrict transactions between a bank and
its advised funds.
2To avoid engaging in unsafe and unsound banking practices,
banks should adopt appropriate policies and procedures governing routine
or emergency transactions with bank-advised investment funds. Such
policies and procedures
should be designed to ensure that the bank
will
not (1) inappropriately place its resources and reputation
at risk for the benefit of the funds’ investors and creditors; (2)
violate the limits and requirements contained in sections 23A and
23B of the Federal Reserve Act and Regulation W, other applicable
legal requirements, or any special supervisory condition imposed by
the agencies; or (3) create an expectation that the bank will prop
up the advised fund. Further, the agencies expect banking organizations
to maintain appropriate controls over investment advisory activities
3 that include:
- Establishing alternative sources of emergency support
from the parent holding company, nonbank affiliates or external third
parties prior to seeking support from the bank.
- Instituting effective policies and procedures for
identifying potential circumstances triggering the need for financial
support and the process for obtaining such support . In the limited
instances that the bank provides financial support, the bank’s procedures
should include an oversight process that requires formal approval
from the bank’s board of directors, or an appropriate board designated
committee, independent of the investment advisory function. The bank’s
audit committee also should review the transaction to ensure that
appropriate policies and procedures were followed.
- Implementing an effective risk-management system
for controlling and monitoring risks posed to the bank by the organization’s
investment advisory activities. Risk controls should include establishing
appropriate risk limits, liquidity planning, performance measurement
systems, stress testing, compliance reviews, and management reporting
to mitigate the need for significant bank support.
- Implementing policies and procedures that ensure
that the bank is in compliance with existing disclosure and advertising
requirements to clearly differentiate the investments in advised funds
from obligations of the bank or insured deposits.
- Ensuring proper regulatory reporting of contingent
liabilities arising out of its investment advisory activities in the
banking organization’s published financial statements in accordance
with FAS 5, and fiduciary settlements, surcharges, and other losses
arising out of its investment advisory activities in accordance with
the instructions for completing call report Schedule RC-T—Fiduciary
and Related Services.
Notification Because of the potential risks posed by
the provision of financial support to advised funds, bank management
should notify and consult with its appropriate federal banking agency
prior to (or immediately after, in the event of an emergency) the
bank providing material financial support to its advised funds. The
appropriate federal banking agency will closely scrutinize the circumstances
surrounding the transaction and will address situations that raise
supervisory concerns.
Issued jointly be the
Board of Governors of the Federal Reserve System, the Office of the
Comptroller of the Currency, the Federal Deposit Insurance Corporation,
and the Office of Thrift Supervision Jan. 5, 2004 (SR-04-1).
