1

OCC Asset Management Initiatives

Joel Miller

Asset Management Group Leader

Office of the Comptroller of the Currency

April 9, 2008

2

OCC AM Initiatives Regulation R implementation Interagency Statement on Nondeposit

Investment Products Asset Divestiture issues Reg 9 Annual Reviews UITRS modifications Fee Transparency issues

3

Asset Management Issues in ‘08 Market Disruption - significant impact on

AM activities and valuations (in addition to capital markets and credit) Structured Investment Vehicles Money Market and Collective Fund “Breaking

the Buck” issues Monoline Insurance Companies – impact on

municipal securities

4

AM Initiatives Regulation R

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.

5

Regulation R – OCC Action

Reg R jointly issued by SEC and Fed September 2007.

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.

OCC will update policy guidance and examination procedures to reflect the changes. Training will be provided to OCC examiners.

6

Reg R – Banker Actions Review the final Fed/SEC rules to determine their likely

impact on your bank’s securities activities. Develop a strategic initiative to organize and conduct bank

securities activities in compliance with the new requirements.

Establish compliance systems to ensure conformance with those requirements and the recordkeeping rules.

Implement training for bank employees. Implement effective monitoring systems to ensure

compliance including an effective internal audit program. Note, the stakes are high…if not in compliance, bank

could be operating as an unregistered securities broker in violation of securities laws.

7

Interagency Statement on Retail Sales of Nondeposit Products

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 .

8

Interagency Statement Going forward . . .

Overlapping rules and regulations 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?

9

Interagency Statement What process does bank have to oversee B/D?

Who’s selling what to the bank’s customers? What is bank’s stake in these sales?

How effective is bank’s oversight of the B/D? What standards does bank rely upon?

How does bank document its oversight? Audit or Compliance reports? Vendor or bank

generated? What’s the scope?

10

Other OCC Initiatives Conflicts of Interest – Risk Management

Guidance - Divestiture of Certain Asset Management Businesses OCC Bulletin 2008-5 (March 6, 2008)

Sale of affiliated registered advisers and associated assets

Annual Reviews of Fiduciary Accounts Pursuant to 12 CFR 9.6(c) OCC Bulletin (March 2008)

Expectations Automated vs. Manual Reviews Unique Assets

11

Fiduciary Conflicts – Asset Management Divestitures 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

12

Fiduciary Conflicts – Asset Management Divestitures Financial incentives that could compromise a

bank’s fiduciary duty include: 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.

13

Fiduciary Conflicts – Asset Management Divestitures Risk Management Guidance

Pre-transaction Risk Controls: Independent legal opinion that focuses on

appropriateness of proposed transaction and effective implementation of any recommended actions

Focus on ERISA issues for ERISA accounts Affirmative consents where required by

applicable law, after timely and meaningful notice Independent fiduciary to vote proxies for

discretionary holdings of affected mutual fund shares.

14

Fiduciary Conflicts – Asset Management Divestitures Post-transaction risk controls:

Well documented, disciplined asset selection and monitoring process applied consistently across all advisers and funds used by fiduciary accounts.

Ongoing oversight function to ensure post-divestment investment decisions are not compromised by financial incentives.

Bottom line – act like a fiduciary!

15

Annual Reviews of Fiduciary Accounts 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: Effective annual investment review process Automated and manual review processes Unique and hard to value assets

16

Annual Reviews of Fiduciary Accounts Elements of an Effective Annual Investment

Review Process 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

17

Annual Reviews of Fiduciary Accounts Automated and Manual Investment Review

Process Manual Reviews - limitations

Can be time consuming, particularly if there are 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

18

Annual Reviews of Fiduciary Accounts Automated and Manual Investment Review Process

Automated Reviews - limitations 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

19

Annual Reviews of Fiduciary Accounts OCC Expectations

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.

20

UITRS Adopted interagency in 1998 OCC believes -

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

21

UITRS OCC will:

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

22

National Trust Banks NTB Capital & Liquidity Guidance (OCC

Bulletin 2007-21) 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.

23

Fee Transparency Issues DOL and SEC focused on enhancing fee

transparency Employee Benefit Plan litigation

Fund selection process Reasonable fees Transparency of fees and embedded costs

to plan sponsors and plan participants OCC Collective Investment Fund focus

24

Market Disruption Market Disruption has:

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 - 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

investment funds and other fiduciary accounts

25

SIVs – What are they? 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).

First introduced in 1988. As of August, 2007, 32 SIVs with assets totaling $400 Billion. SIV assets now below $300 Billion.

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.

26

Market Disruption Impact on SIVs

Liquidity tested last August when ABCP market froze. 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.

Investors were spooked by the market, and by a lack of transparency in SIVs. SIVs were tainted by perception of even small exposure to sub-prime mortgage.

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.

Rating agencies reassessed methodology and began downgrading SIVs.

27

Banking Companies Have Direct and Indirect SIV Exposure Direct Exposure:

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).

Indirect Exposure: BCs may manage Mutual Funds and other Asset Management

portfolios which have invested in SIVs. Credit Support Reputation Risk vs. purchasing assets

Reputation, liquidity, credit and compliance risks may increase due to these BC activities.

28

SIVs and Asset Management Most SIVs were initially highly rated instruments offering enhanced

yields that may have been permissible/prudent investments for: Money market mutual funds Short-term collective investment funds Enhanced cash funds Other pooled funds; securities lending cash collateral pools Other fiduciary accounts

Market disruption has led to increased focus on valuation of assets for which there is little or no current marketability.

AAA rated money market funds holding SIV ABCP in “enforcement” status risked downgrades.

As asset values declined, some money market funds and STIFs risked “breaking the buck”.

29

SIVs in Money Market Funds 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.

Bank of America (Columbia Funds) SEI Wachovia (Evergreen Funds) SunTrust US Bank (First American Funds) Morgan Stanley Legg Mason (Western Asset Mgt. Funds) Janus Toronto-Dominion Bank (TDAM Funds) Northern Trust

30

Asset Mgt. Supervisory Focus Exposure extends beyond Money Market Mutual Funds - valuation

issues critical to collective investment funds, and securities lending pools.

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.

31

Monoline Insurance Issues 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.

32

Monoline Insurance Issues 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.

33

QUESTIONS?

Reg R and other inter-agency initiatives

OCC issuances to address fiduciary risks

Market Disruption concerns

34

Appendix I: AM Industry Data

35

Growth in Fiduciary & Custody Assets All Banks (2003 – 2007)

Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.

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.

Growth in Fiduciary Assets All Banks

$14.55 $15.43 $15.54 $16.13$17.25

$18.26$19.95

$21.81 $22.60

$0.00

$5.00

$10.00

$15.00

$20.00

$25.00

Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07

trillio

n

Growth in Custody Assets All Banks

$35.91 $37.31$33.21 $35.72 $36.47

$42.32$47.42

$50.36

$57.76

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07

trilli

on

36

Banks Exercising Fiduciary Powers All Banks

December 31, 2007

Account Type Total Assets # of Accounts Average SizePersonal Trust & Agency $1.2 trillion 5% 755,000 $1,604,000Investment Management $1.6 trillion 7% 2,172,000 $727,000Retirement DB $6.9 trillion 31% 224,000 $30,780,000 DC $2.3 trillion 10% 763,000 $2,949,000 Other $2.5 trillion 11% 14,623,000 $172,000Corporate Trust $4.5 trillion 20% 510,000 $8,770,000Other $3.7 trillion 16% 461,000 $7,976,000

Total Fiduciary Assets $22.6 trillion 100% 19,509,000

Custody/Safekeeping $57.8 trillion 5,187,000 $11,136,000

Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.

37

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.

Source: Call Report RC-TS&P 500 data is the quarter-end 90-day moving average

Fiduciary Revenue (All Banks)

$2.0

$2.5

$3.0$3.5

$4.0

$4.5

$5.0$5.5

$6.0

$6.5

$7.0

$7.5$8.0

$8.5

$9.0

$ B

illions

0

200

400

600

800

1,000

1,200

1,400

1,600

S &

P 5

00

Income $4.91 $5.25 $5.52 $5.63 $5.92 $6.19 $6.03 $5.87 $6.55 $6.43 $6.51 $6.63 $7.20 $6.78 $7.35 $6.84 $7.18 $7.50 $7.90 $7.40 $8.50

S&P 500 885 875 909 994 1,044 1,114 1,124 1,111 1,148 1,192 1,186 1,217 1,228 1,276 1,284 1,278 1,366 1,420 1,471 1,497 1,493

Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07

38

Appendix II:OCC Guidance

39

OCC Asset ManagementHandbooks & Guidance

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

40

OCC Safety & SoundnessHandbooks & Guidance

OCC 2008-X, Fiduciary Activities of National Banks; Annual Reviews of Fiduciary Accounts Pursuant to 12 CFR 9.6(c)

OCC 2008-5, Conflicts of Interest; Risk Management Guidance – Divestiture of Certain Asset Management Businesses

OCC 2007-21, Supervision of National Trust Banks: Revised Guidance: Capital and Liquidity

OCC 2007-7, Soft Dollar Guidance: Use of Commission Payments by Fiduciaries

OCC 2007-6, Registered Transfer Agents: Transfer Agent Registration, Annual Reporting, and Withdrawal from Registration

OCC 2007-5, Bank Securities Activities: SEC's and Federal Reserve's Proposed Regulation R

OCC 2006-24, Interagency Agreement on ERISA Referrals

41

OCC Safety & SoundnessHandbooks & Guidance

OCC 2004-2, Banks/Thrifts Providing Financial Support to Funds Advised by the Banking Organization or its Affiliates

OCC 2002-39, Investment Portfolio Credit Risks: Safekeeping Arrangements

OCC 98-46, Uniform Interagency Trust Rating System

OCC 97-22, Fiduciary Activities of National Banks -- Q & As 12 CFR 9

OCC 96-25, Fiduciary Risk Management of Derivatives & Mortgage-backed Securities

OCC 95-52, Retail Sales of Non-deposit Investments -- Interagency Statement

OCC 94-13, Non-deposit Investment Sales Examination Procedures

42

OCC Safety & SoundnessHandbooks & Guidance

BC-277, Risk Management of Financial Derivatives

BC-275, Free Riding in Custody Accounts

BC-247, Application of Securities Laws to Common Trust Funds

BC-235, International Payment Systems Risk

BC-233, Acceptance Of Financial Benefits By Bank Trust Departments

BC-218, Sweep Fees

BC-196, Securities Lending FFIEC Statement

43

Contact information:

Email: joel.miller@occ.treas.govPhone: 202-874-4493Fax: 301-433-7903