OCC Asset Management Initiatives Joel Miller Asset Management

OCC Asset Management Initiatives Joel Miller Asset Management Group Leader Office of the Comptroller of the Currency April 9, 2008 1

OCC AM Initiatives o o o Regulation R implementation Interagency Statement on Nondeposit Investment Products Asset Divestiture issues Reg 9 Annual Reviews UITRS modifications Fee Transparency issues 2

Asset Management Issues in ‘ 08 o Market Disruption - significant impact on AM activities and valuations (in addition to capital markets and credit) n n n Structured Investment Vehicles Money Market and Collective Fund “Breaking the Buck” issues Monoline Insurance Companies – impact on municipal securities 3

AM Initiatives o Regulation R n n Jointly issued by SEC and Fed Banking agencies are finalizing a recordkeeping rule that will detail what records banks must retain to demonstrate compliance with GLBA and Reg R to qualify for exemptions from registration as a broker. Expect final rule to be issued by the Federal banking agencies in late Summer 2008. In 2009, OCC examiners will focus on bank compliance with the recordkeeping rule. 4

Regulation R – OCC Action o Reg R jointly issued by SEC and Fed September 2007. o Banking Agencies to adopt a recordkeeping rule that covers compliance with Title II of GLBA and Reg R – Expect final rule to be issued late summer 2008. o OCC will update policy guidance and examination procedures to reflect the changes. Training will be provided to OCC examiners. 5

Reg R – Banker Actions o Review the final Fed/SEC rules to determine their likely impact on your bank’s securities activities. o Develop a strategic initiative to organize and conduct bank securities activities in compliance with the new requirements. o Establish compliance systems to ensure conformance with those requirements and the recordkeeping rules. o Implement training for bank employees. o Implement effective monitoring systems to ensure compliance including an effective internal audit program. o Note, the stakes are high…if not in compliance, bank could be operating as an unregistered securities broker in 6 violation of securities laws.

Interagency Statement on Retail Sales of Nondeposit Products n n Adopted in 1994 – provides familiar NOT FDIC insured; NOT bank guaranteed; and MAY lose value disclosures. Bank regulators’ exam scope is limited by GLBA. Can only look through the bank into the broker/dealer; cannot examine B/D. However, bank customers are being sold investments in the lobby of a national bank. Interagency effort underway to consider what revisions, if any, should now be made to the Interagency Statement. 7

Interagency Statement o Going forward. . . n Overlapping rules and regulations o o n Interagency Statement Regulation R (Networking) and GLBA OCC Regulation 14 (Insurance Sales) NASD (FINRA) Rule 2350 How should these bank and broker/dealer requirements mesh? 8

Interagency Statement o What process does bank have to oversee B/D? n n o How effective is bank’s oversight of the B/D? n o Who’s selling what to the bank’s customers? What is bank’s stake in these sales? What standards does bank rely upon? How does bank document its oversight? n Audit or Compliance reports? Vendor or bank generated? What’s the scope? 9

Other OCC Initiatives o Conflicts of Interest – Risk Management Guidance - Divestiture of Certain Asset Management Businesses n OCC Bulletin 2008 -5 (March 6, 2008) o o Sale of affiliated registered advisers and associated assets Annual Reviews of Fiduciary Accounts Pursuant to 12 CFR 9. 6(c) n OCC Bulletin (March 2008) o o o Expectations Automated vs. Manual Reviews Unique Assets 10

Fiduciary Conflicts – Asset Management Divestitures o o o Reinforces existing OCC guidance that a conflict exists when a fiduciary receives an incentive to place or retain customer assets in a specific fund. Provides examples of incentives that could motivate a fiduciary to engage in a conflict Provides risk management guidance to assist fiduciaries in avoiding conflicts 11

Fiduciary Conflicts – Asset Management Divestitures o Financial incentives that could compromise a bank’s fiduciary duty include: n n Up-front payments and on-going financial incentives to maintain or increase AUM levels paid either at deal closing or over future periods. Noncompete clauses or penalties for declines in AUM levels. Purchaser payment of transaction costs -contingent on maintenance of specific AUM level. Revenue sharing arrangements paid by purchaser to induce seller to retain assets in a fund. 12

Fiduciary Conflicts – Asset Management Divestitures o Risk Management Guidance n Pre-transaction Risk Controls: o Independent legal opinion that focuses on appropriateness of proposed transaction and effective implementation of any recommended actions o Focus on ERISA issues for ERISA accounts o Affirmative consents where required by applicable law, after timely and meaningful notice o Independent fiduciary to vote proxies for discretionary holdings of affected mutual fund shares. 13

Fiduciary Conflicts – Asset Management Divestitures o Post-transaction risk controls: n n o Well documented, disciplined asset selection and monitoring process applied consistently across all advisers and funds used by fiduciary accounts. Ongoing oversight function to ensure postdivestment investment decisions are not compromised by financial incentives. Bottom line – act like a fiduciary! 14

Annual Reviews of Fiduciary Accounts o o OCC guidance clarifies regulatory requirement that banks annually review each asset of a fiduciary account, both individually and collectively, for which a bank has investment discretion Guidance focuses on: n n n Effective annual investment review process Automated and manual review processes Unique and hard to value assets 15

Annual Reviews of Fiduciary Accounts o Elements of an Effective Annual Investment Review Process n n n Ensure account investment objectives are current and that investments are consistent with those objectives Ensure investment review provides for an annual assessment of the portfolio in its entirety, particularly when there are unique assets in the account. Ensure that each asset is valued using an appropriate valuation process 16

Annual Reviews of Fiduciary Accounts o Automated and Manual Investment Review Process n Manual Reviews - limitations o o o Can be time consuming, particularly if there a large number of discretionary accounts with an array of unique assets Risk that reviews will become a rubber stamp or that they will not be completed on a timely basis Quality of reviews may vary depending upon the individual performing the review 17

Annual Reviews of Fiduciary Accounts o Automated and Manual Investment Review Process n Automated Reviews - limitations o o Wholly automated screening process may not provide independent perspective customarily provided by an effective committee review process Automated systems may not address whether an account's investment objectives have - or need to be - changed over time If account administrators are not included in the automated process, key information (account objectives, cash needs, grantor intent, and beneficiary requests) may not be considered Vendor systems may only identify exceptions limited to a number of pre-set parameters 18

Annual Reviews of Fiduciary Accounts o OCC Expectations n n n Timely and comprehensive annual investment reviews may be performed using either a manual, automated, or combination approach An effective program will be based upon policies and procedures that provide clear standards for the scope, documentation, and exception reporting and tracking Individual assets, as well as the account as a whole, must be reviewed. 19

UITRS o o Adopted interagency in 1998 OCC believes n o Disclosure of the five component ratings is not critical to effectively supervise a bank’s trust operations OCC’s supervision by risk approach means we identify significant risks and aggregate them in a composite rating, rather than focus on individual component ratings 20

UITRS o OCC will: n n Rely upon risk-based supervision Continue to rate each component, but examiner disclosure of each component rating is optional Disclose composite ratings Revise UITRS policy in the forthcoming Community Bank Supervision Handbook 21

National Trust Banks o NTB Capital & Liquidity Guidance (OCC Bulletin 2007 -21) n n n NTBs need a system to analyze and maintain adequate capital and liquidity. Capital and liquidity levels need to increase as size, complexity and risks of the NTB’s activities evolve. Capital and liquidity are not interchangeable. All banks, including NTBs, need contingent sources of liquidity. 22

Fee Transparency Issues o o o DOL and SEC focused on enhancing fee transparency Employee Benefit Plan litigation n Fund selection process n Reasonable fees n Transparency of fees and embedded costs to plan sponsors and plan participants OCC Collective Investment Fund focus 23

Market Disruption o Market Disruption has: n n n o Resulted in significant reductions in value and liquidity of certain asset classes – most notably ABCP and SIVs Resulted in ratings downgrades, and revised rating methodologies for certain asset classes Primarily affected assets with subprime exposure, or which lack transparency to assess actual subprime exposure Because most of these assets were both highly rated and highly liquid n n n You may have seen some of these assets on banks’ balance sheets Many were eligible investments for money market mutual funds Many would have been prudent investments for collective 24 investment funds and other fiduciary accounts

SIVs – What are they? o SIVs are limited-purpose investment companies that purchase higher yielding long term credit assets. They are funded via asset backed commercial paper and medium term notes as well as equity (capital notes). o First introduced in 1988. As of August, 2007, 32 SIVs with assets totaling $400 Billion. SIV assets now below $300 Billion. o SIVs are sponsored by banks such as Citi, HSBC, Societe Generale, as well as non-banks. The newer SIVs tend to have non-bank sponsors. 25

Market Disruption Impact on SIVs o Liquidity tested last August when ABCP market froze. o NAVs, which averaged 102% in June ’ 07, declined to 55% in December ‘ 07, signaling a decrease in the ability of capital note holders to cushion senior note holders from loss. o Investors were spooked by the market, and by a lack of transparency in SIVs were tainted by perception of even small exposure to sub-prime mortgage. o Inability to roll ABCP, and drop in prices at which assets could be liquidated, quickly tripped NAV triggers, forcing many SIVs into limited operating states or “enforcement” status. o Rating agencies reassessed methodology and began downgrading SIVs. 26

Banking Companies Have Direct and Indirect SIV Exposure o Direct Exposure: n n n o Indirect Exposure: n o Sponsors are supporting or consolidating their SIVs. Some BCs providing liquidity facilities to third party SIVs. Some BCs have purchased notes of third party SIVs for their own investment portfolio (minimal). BCs may manage Mutual Funds and other Asset Management portfolios which have invested in SIVs. o Credit Support o Reputation Risk vs. purchasing assets Reputation, liquidity, credit and compliance risks may increase due to these BC activities. 27

SIVs and Asset Management o Most SIVs were initially highly rated instruments offering enhanced yields that may have been permissible/prudent investments for: n n n Money market mutual funds Short-term collective investment funds Enhanced cash funds Other pooled funds; securities lending cash collateral pools Other fiduciary accounts o Market disruption has led to increased focus on valuation of assets for which there is little or no current marketability. o AAA rated money market funds holding SIV ABCP in “enforcement” status risked downgrades. o As asset values declined, some money market funds and STIFs risked “breaking the buck”. 28

SIVs in Money Market Funds o o Faced with valuation dilemmas, downgrades and/or “breaking the buck” MMMF and STIF sponsors considered supporting their funds. To date, there are published reports of ten fund sponsors which have entered into capital support agreements and/or purchased assets from their funds. o Bank of America (Columbia Funds) o SEI o Wachovia (Evergreen Funds) o Sun. Trust o US Bank (First American Funds) o Morgan Stanley o Legg Mason (Western Asset Mgt. Funds) o Janus o Toronto-Dominion Bank (TDAM Funds) o Northern Trust 29

Asset Mgt. Supervisory Focus o Exposure extends beyond Money Market Mutual Funds - valuation issues critical to collective investment funds, and securities lending pools. n n o 12 CFR 9. 18 sets forth CIF provisions addressing valuation. OCC policy guidance encourages CIFs to either segregate or purchase defaulted assets. Disparate treatment of STIFs vs. MMMFs that hold the same securities raises further questions. ERISA funds will be subject to even higher scrutiny. Fund support should come from the holding company, not the FDIC -insured bank. OCC Bulletin 2004 -2: Banks/Thrifts Providing Financial Support to Funds Advised by the Banking Organization or its Affiliates: Interagency Guidance. 30

Monoline Insurance Issues o o o Monoline insurers such as MBIA, AMBAC, and FGIC initially provided insurance to muni bonds. Enhanced the bond’s rating and lowered the cost of debt to the issuers. Monolines exposed to subprime through SIVs and CDOs when they expanded into insurance of asset backed and mortgaged backed securities. Losses on sub-prime led to downgrades and threatened downgrades of major monolines companies. 31

Monoline Insurance Issues o o o Many mutual funds, collective investment funds and fiduciary accounts contain municipal bonds for which the price or rating may be affected by the downgrade or default of their financial guarantor. Tax exempt MMMFs have moved away from instruments dependent upon monoline ratings - result has been significant drop in yields. Bank fiduciaries acting as investment advisors should focus on timely and fair valuation and be mindful of the potential impact of prospective monoline downgrades on the rating of portfolio holdings. 32

QUESTIONS? o Reg R and other interagency initiatives o OCC issuances to address fiduciary risks o Market Disruption concerns 33

Appendix I: AM Industry Data 34

Growth in Fiduciary & Custody Assets All Banks (2003 – 2007) The level of fiduciary assets in the commercial banking system has increased by $8 trillion or 55% from 12/03 to 12/07. The level of custody assets has increased by $22 trillion or 61% during the same time period. Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks. 35

Banks Exercising Fiduciary Powers All Banks December 31, 2007 36 Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.

Fiduciary Revenue (All Banks) o o Banks reported a combined $31. 3 billion in fiduciary revenue in 2007 compared to $28. 2 billion reported in 2006. Historically, there has been a strong correlation between the rise in the S&P 500 and an increase in fiduciary revenue. 37 Source: Call Report RC-T S&P 500 data is the quarter-end 90 -day moving average

Appendix II: OCC Guidance 38

OCC Asset Management Handbooks & Guidance q q q q q Retirement Plan Services (December 2007) Collective Investment Funds Asset Management Conflicts of Interest Custody Services Investment Management Services Personal Fiduciary Services Retail Nondeposit Investment Sales Insurance Activities 39

OCC Safety & Soundness Handbooks & Guidance o OCC 2008 -X, Fiduciary Activities of National Banks; Annual Reviews of Fiduciary Accounts Pursuant to 12 CFR 9. 6(c) o OCC 2008 -5, Conflicts of Interest; Risk Management Guidance – Divestiture of Certain Asset Management Businesses o OCC 2007 -21, Supervision of National Trust Banks: Revised Guidance: Capital and Liquidity o OCC 2007 -7, Soft Dollar Guidance: Use of Commission Payments by Fiduciaries o OCC 2007 -6, Registered Transfer Agents: Transfer Agent Registration, Annual Reporting, and Withdrawal from Registration o OCC 2007 -5, Bank Securities Activities: SEC's and Federal Reserve's Proposed Regulation R o OCC 2006 -24, Interagency Agreement on ERISA Referrals 40

OCC Safety & Soundness Handbooks & Guidance o OCC 2004 -2, Banks/Thrifts Providing Financial Support to Funds Advised by the Banking Organization or its Affiliates o OCC 2002 -39, Investment Portfolio Credit Risks: Safekeeping Arrangements o OCC 98 -46, Uniform Interagency Trust Rating System o OCC 97 -22, Fiduciary Activities of National Banks -- Q & As 12 CFR 9 o OCC 96 -25, Fiduciary Risk Management of Derivatives & Mortgagebacked Securities o OCC 95 -52, Retail Sales of Non-deposit Investments -- Interagency Statement o OCC 94 -13, Non-deposit Investment Sales Examination Procedures 41

OCC Safety & Soundness Handbooks & Guidance o BC-277, Risk Management of Financial Derivatives o BC-275, Free Riding in Custody Accounts o BC-247, Application of Securities Laws to Common Trust Funds o BC-235, International Payment Systems Risk o BC-233, Acceptance Of Financial Benefits By Bank Trust Departments o BC-218, Sweep Fees o BC-196, Securities Lending FFIEC Statement 42

Contact information: Email: joel. miller@occ. treas. gov Phone: 202 -874 -4493 Fax: 301 -433 -7903 43