2012

A N N U A L 

REPORT

Financial Stability Oversight Council i i

Financial Stability Oversight Council

The Financial Stability Oversight Council (Council) was established by the DoddFrank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and is 

charged with three primary purposes:

1. To identify risks to the financial stability of the United States that could 

arise from the material financial distress or failure, or ongoing activities, 

of large, interconnected bank holding companies or nonbank financial 

companies, or that could arise outside the financial services marketplace.

2. To promote market discipline, by eliminating expectations on the part of 

shareholders, creditors, and counterparties of such companies that the 

U.S. government will shield them from losses in the event of failure.

3. To respond to emerging threats to the stability of the U.S. 

financial system.

Pursuant to the Dodd-Frank Act, the Council consists of 10 voting members 

and 5 nonvoting members and brings together the expertise of federal financial 

regulators, state regulators, and an insurance expert appointed by the President.

The voting members are:

•	 the Secretary of the Treasury, who serves as the Chairperson of 

the Council;

•	 the Chairman of the Board of Governors of the Federal Reserve System;

•	 the Comptroller of the Currency;

•	 the Director of the Bureau of Consumer Financial Protection;

•	 the Chairman of the Securities and Exchange Commission;

•	 the Chairperson of the Federal Deposit Insurance Corporation;

•	 the Chairperson of the Commodity Futures Trading Commission;

•	 the Director of the Federal Housing Finance Agency;

•	 the Chairman of the National Credit Union Administration; and

•	 an independent member with insurance expertise who is appointed by 

the President and confirmed by the Senate for a six-year term.

The nonvoting members, who serve in an advisory capacity, are:

•	 the Director of the Office of Financial Research;

•	 the Director of the Federal Insurance Office;

•	 a state insurance commissioner designated by the state insurance 

commissioners;

•	 a state banking supervisor designated by the state banking supervisors; and

•	 a state securities commissioner (or officer performing like functions) 

designated by the state securities commissioners.

The state insurance commissioner, state banking supervisor, and state securities 

commissioner serve two-year terms.
2012 FSOC // Annual Report ii

Statutory Requirements for the Annual Report

Section 112(a)(2)(N) of the Dodd-Frank Act requires that the Annual Report 

address the following:

i. the activities of the Council;

ii. significant financial market and regulatory developments, including 

insurance and accounting regulations and standards, along with an 

assessment of those developments on the stability of the financial system;

iii. potential emerging threats to the financial stability of the 

United States;

iv. all determinations made under Section 113 or Title VIII, and the 

basis for such determinations; 

v. all recommendations made under Section 119 and the result of such 

recommendations; and 

vi. recommendations—

I. to enhance the integrity, efficiency, competitiveness, and stability 

of United States financial markets;

II. to promote market discipline; and

III. to maintain investor confidence.

Approval of the Annual Report

This Annual Report was approved unanimously by the voting members of the 

Council on July 18, 2012. Except as otherwise indicated, data cited in this report 

is as of July 6, 2012.

Abbreviations for Federal Member Agencies of the Council

•	 Department of the Treasury (Treasury)

– Office of Financial Research (OFR)

– Federal Insurance Office (FIO)

•	 Board of Governors of the Federal Reserve System (Federal Reserve)

•	 Comptroller of the Currency (OCC)

•	 Bureau of Consumer Financial Protection (CFPB)

•	 Securities and Exchange Commission (SEC)

•	 Federal Deposit Insurance Corporation (FDIC)

•	 Commodity Futures Trading Commission (CFTC)

•	 Federal Housing Finance Agency (FHFA)

•	 National Credit Union Administration (NCUA)
Contents iii

1 Member Statement ...................................................... 1

2 Executive Summary ..................................................... 3

3 Annual Report Recommendations..............................11

3.1 Reforms to Address Structural Vulnerabilities ........................................11

3.2 Heightened Risk Management and Supervisory Attention .....................13

3.3 Housing Finance Reforms .....................................................................16

3.4 Progress on Implementation and Coordination of Financial Reform .......19

4 Macroeconomic Environment.................................... 23

4.1 U.S. Economic Activity..........................................................................23

4.2 Private Nonfinancial Balance Sheets and Credit Flows ............................27

4.3 Government Sectors ............................................................................33

4.4 External Environment............................................................................37

5 Financial Developments............................................. 45

5.1 Major Financial Markets....................................................................... 45

BOX A: Impacts of Downgrade of U.S. Treasury Securities .................................46

BOX B: Greek Sovereign Debt Restructuring ......................................................48

BOX C: Recent Fiscal and Banking Developments in Spain .................................50

5.2 Bank Holding Companies and Depository Institutions ........................... 64

5.3 Other Financial Institutions....................................................................73

BOX D: MF Global Bankruptcy ............................................................................78

BOX E: Current Status of Remaining Stabilization Facilities Inaugurated 

During the Crisis.....................................................................................84

5.4 Financial Market Infrastructure ............................................................ 86

BOX F: Algorithmic and High-Frequency Trading .................................................88

Contents
iv 2012 FSOC // Annual Report

6 Regulatory Developments; Council Activities ........... 97

6.1 Safety and Soundness..........................................................................97

6.2 Financial Infrastructure, Markets, and Oversight..................................106

6.3 Consumer and Investor Protection....................................................... 113

6.4 Council Activities ................................................................................ 118

7 Potential Emerging Threats ..................................... 123

7.1 Framework: Threats as a Combination of Shocks and Vulnerabilities ...123

7.2 Areas of Heightened Uncertainty.........................................................124

7.3 Robustness of Financial Institutions and Markets ...............................127

7.4 Continuing Vulnerabilities in the Financial System................................130

BOX G: Ongoing Vulnerabilities in the Tri-Party Repo Market............................. 133

BOX H: Money Market Fund Responses to Euro Area Uncertainty .................... 134

Appendix A ................................................................... 145

Glossary ........................................................................ 189

Abbreviations................................................................ 199

Notes on the Data ......................................................... 207

List of Charts ................................................................ 209

Endnotes ....................................................................... 215
Member Statement 1

In accordance with Section 112(b)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act, for the reasons outlined in the annual report, I believe that additional actions, as described below, 

should be taken to ensure that the Council, the Government, and the private sector are taking all 

reasonable steps to help ensure financial stability and to mitigate systemic risk that would negatively affect 

the economy: the issues and recommendations set forth in the Council’s annual report should be fully 

addressed; the Council should continue to build its systems and processes for monitoring and responding 

to emerging threats to the stability of the United States financial system, including those described in the 

Council’s annual report; the Council and its member agencies should continue to implement the laws they 

administer, including those established by, and as amended by, the Dodd-Frank Act through efficient and 

effective measures; and the Council and its member agencies should exercise their respective authorities 

for oversight of financial firms and markets so that the private sector employs sound financial risk 

management practices to mitigate potential risks to the financial stability of the United States. 

1 Member Statement

The Honorable John A. Boehner 

Speaker of the House 

United States House of Representatives

The Honorable Nancy Pelosi 

Democratic Leader 

United States House of Representatives

The Honorable Joseph R. Biden, Jr.

President of the Senate 

United States Senate

The Honorable Harry Reid 

Majority Leader 

United States Senate

The Honorable Mitch McConnell

Republican Leader 

United States Senate

Executive Summary 3

In the nearly five years since the initial strains of the subprime crisis emerged, 

the U.S. financial system has traveled from the brink of collapse in late 2008 

and early 2009 to a more resilient system with stronger capital, more liquidity, 

improved funding, and important progress on reform. Even with that progress, 

however, the Financial Stability Oversight Council (Council) believes that the 

financial system in the United States and globally still faces significant challenges. 

Investor confidence has not been restored to pre-crisis levels. The crisis in the 

euro area and general weakness in global economic growth present identifiable 

threats to financial stability. There is still work to be done to address structural 

vulnerabilities within the financial system itself. 

A key feature of the current environment is the stress in the euro area, which has 

disrupted sovereign debt markets and put considerable pressure on euro area 

banks. European leaders recognize the need to address near-term strains and 

are continuing to elaborate a path toward greater fiscal and financial union that 

would garner both political and market support. Because the combined economies 

of the euro area constitute the second largest economy in the world and are home 

to many of the world’s largest and most interconnected financial institutions, 

problems in Europe could have very real consequences for financial stability in the 

United States.

The potential threats from the crisis in Europe and continued economic weakness 

in the United States and globally underscore the need for regulators to continue 

strengthening the financial system and addressing structural vulnerabilities. Such 

reforms are essential to ensure that financial markets continue to serve the real 

economy even during periods of stress. Reducing amplification mechanisms and 

strengthening shock-absorbing capacity make the financial system more resilient, 

whether shocks originate from inside or outside the system. This increased 

resilience in turn can reduce, though not eliminate, the impact these shocks 

deliver to economic activity and employment. More broadly, a sound financial 

system is a necessary foundation for sustained growth.

Both our financial health and our reform efforts are inextricably linked to 

the rest of the world. The very complexity of the global financial system makes 

designing and implementing effective reforms an inherently challenging process 

that at times moves more slowly than would be the case if we acted alone. 

International coordination is necessary, however, as there are key areas where the 

effectiveness of the U.S. reforms will depend on a level playing field with strong 

and consistent regulatory regimes internationally.

Macroeconomic Environment

Three years after the end of the deepest and longest recession since the Great 

Depression, the U.S. economy is expanding at a moderate pace, but growth has 

not accelerated to the rate required to make rapid progress replacing lost jobs 

2 Executive Summary
4 2012 FSOC // Annual Report

and meeting the employment needs of a growing workforce. Consequently, while 

unemployment has trended down, it remains at unacceptably high levels. 

Investment spending in the first half of 2012 appears to be growing at a restrained 

pace, likely reflecting continued subdued confidence and elevated uncertainty. 

Corporate balance sheets are generally strong, and large businesses have access to 

ample financing in the capital markets. Smaller businesses, in contrast, continue to 

face a more challenging operating environment that has constrained their recovery.

Consumption continues to expand, but U.S. households still see only modest 

growth in income. Housing remains a drag on household balance sheets 

and weighs on broader economic activity, as housing wealth has declined by 

50 percent or $6.8 trillion from its peak in 2006:Q1 to 2012:Q1. Aggregate 

household debt is declining gradually, but remains well above historical levels 

as a percentage of GDP. Access to mortgage credit is still constrained for many 

households, limiting the extent to which they can benefit from low interest 

rates. Overall, the mortgage market remains dependent on the Federal Housing 

Administration and the government-sponsored enterprises (GSEs). Housing 

activity remains weak, but there are some positive signs emerging in recent data. 

Fiscal policy is no longer providing support to growth as it did in 2009-2010, and 

the federal deficit is declining as a share of GDP. In addition, states and localities 

are a drag on demand and employment as they struggle to repair their finances. 

However, the U.S. government has benefited from very low interest costs, a factor 

that will reverse over time as monetary policy normalizes.

In the long run, U.S. budgetary trends are unsustainable and must be addressed 

in a manner that is consistent with supporting the ongoing recovery. The aging of 

the population and the rising costs for health care will add to long-term deficits. 

States and localities remain challenged by unfunded pension obligations. 

Abroad, growth in Europe has slowed sharply as GDP has declined in a 

number of nations. Growth in most emerging market economies (EMEs) 

remains high relative to the industrialized world, but has been slower of late, 

with more variation in performance. EMEs, particularly China, have taken an 

increasingly important role in the global economy. However, dependence on 

export and investment-led growth leaves many of these economies exposed to 

weaker prospects in the developed world. Weak global growth limits the selfhealing capacity of financial institutions and can put stress on parts of the 

financial system. 

Financial Developments

Market volatility increased sharply in the summer and fall of 2011 around the 

U.S. debt ceiling debate, and intensified at the end of 2011 and in the spring 

and early summer of 2012 amid concern over Europe. The debt limit debate and 

questions about the political will to resolve U.S. fiscal challenges led Standard 

and Poor’s to downgrade the long-term sovereign credit rating of the United 

States from AAA to AA+ in August 2011. However, demand for U.S. sovereign 

debt remains strong. As sovereign bond yields in the euro area periphery 
Executive Summary 5

increased, sovereign yields in the United States, Japan, the United Kingdom 

and Germany declined further and are now at historically low levels. These 

low yields reflect both safe-haven inflows as well as expectations that global 

economic weakness may warrant prolonged monetary policy accommodation. 

Extraordinarily low interest rates provide essential support to growth and 

jobs, but this low-growth, low-rate environment represents a challenge for life 

insurers, pension funds, money market funds (MMFs), and some banks and 

credit unions, which invest the savings of many Americans.

Financial stress in Europe and consequent spillovers to the United States has 

been mitigated to some degree by the aggressive provision of liquidity within 

the euro area. In the initial stages of the crisis, the European Central Bank 

(ECB) purchased peripheral sovereign debt directly. U.S. dollar swap lines were 

extended and their fees reduced, and the ECB conducted two large longer-term 

refinancing operations and authorized further financing under the Emergency 

Liquidity Assistance process for banks in the hardest-hit countries. 

U.S. financial institutions have strengthened their balance sheets by augmenting 

their capital levels and by accumulating more liquid assets. They also have more 

stable funding profiles than in recent years, with greater use of deposits and less 

reliance on short-term wholesale funding. The number of bank failures has been 

decreasing since 2010, and the FDIC’s list of problem banks is shrinking.

Within the euro area, a number of banking systems remain under stress. 

Recently, the Spanish government announced plans to strengthen its bank 

recapitalization fund with EU support. In late June 2012, euro area heads of 

government proposed to allow the European Stability Mechanism (ESM) to 

recapitalize banks directly, rather than through national governments, and to 

establish a single European banking supervisor. At a subsequent meeting on July 

9, euro area finance ministers welcomed the European Commission’s intention 

to present proposals in early September for a single supervisory mechanism 

involving the ECB, with the European Council expected to consider these 

proposals by the end of 2012. 

Meanwhile, European financial institutions are reducing their share of lending 

activity—including sovereign debt purchases—in other euro area states. Crossborder financing of current account deficits by private sector financial institutions 

in core Europe has declined. Official sector funding, notably in the form of ECB 

loans to banks in peripheral Europe, is making up for this decline.

Periods of risk aversion in short-term funding markets, particularly in the fall of 

2011, have only reinforced the need to promptly address sources of vulnerability 

in these markets, such as weaknesses in the tri-party repo infrastructure and 

among money market funds. Over the past year, the U.S. tri-party repo market 

continued to shift away from non-traditional, riskier collateral towards Treasury 

and agency obligations. However, limited progress has been made in substantially 

reducing the reliance of this market on intraday credit or improving riskmanagement and collateral practices to avoid fire sales in the event of a large 

dealer default. Money market funds continue to maintain short weighted average 
6 2012 FSOC // Annual Report

maturities and have shifted their portfolio composition more toward government 

debt and repurchase agreements, although they retain some exposure to riskier 

assets. As highlighted last year, money market funds remain susceptible to 

destabilizing runs because the commitment to a stable net asset value, without 

the requisite buffers to absorb losses, gives investors, particularly institutional 

investors, an incentive to be the first movers in redeeming shares.

Meanwhile, advances in technology continue to transform the business of 

trading, providing financial markets with enhanced speed and efficiency while 

potentially enabling increased transparency. The market infrastructure has 

generally functioned well over the past year. Still, the trend towards high-speed 

algorithmic trading, and the resulting increases in market complexity, may create 

vulnerabilities like those witnessed in the “flash crash” of 2010.

Dodd-Frank Implementation and Activities of the Financial Stability Oversight Council

Over the past year, financial regulators have focused on strengthening the 

financial system against potential threats and eliminating incentives to take 

excessive risk. These efforts are most notable in steps to implement the DoddFrank Act. The financial reforms in the Dodd-Frank Act are designed to create a 

more resilient financial system that is better able to absorb a wide range of shocks, 

whether they originate within the financial system (as with the subprime crisis of 

2007), outside it (for instance in the event of an oil price shock), or a combination 

of the two (as is the case with the problems in the euro area). Regulators are 

making progress in implementing the Dodd-Frank Act in a consistent and 

coordinated manner. The reform effort has proceeded along four broad 

dimensions: strengthening the safety and soundness of core financial institutions; 

making financial markets more resilient and transparent; implementing new 

authorities to resolve large, complex financial institutions; and enhancing investor 

and consumer protections. 

As a result of this effort, federal banking regulators have imposed tougher 

standards on the largest, most complex financial institutions. The Federal 

Reserve has proposed enhanced prudential standards for large bank holding 

companies—standards that will also apply to nonbank financial companies 

designated by the Council for Federal Reserve supervision. Through the 

Comprehensive Capital Analysis and Review (CCAR) process, it evaluated bank 

holding companies’ capital planning processes to ensure that they would remain 

well capitalized in a stressed economic scenario. In addition, the Federal Reserve, 

FDIC, OCC, SEC, and CFTC proposed substantively identical proposals to 

implement the Volcker Rule, which prohibits banks from engaging in proprietary 

trading, and (subject to certain exemptions) from owning, sponsoring, or having 

certain relationships with, a hedge fund or private equity fund. In June 2012, 

federal banking regulators finalized changes to the market risk capital rule to 

better reflect the risks faced by an institution and to help ensure the adequacy 

of capital related to an institution’s trading positions. Concurrently, they invited 

comment on three joint proposed rules to implement Basel III and the DoddFrank Act that will increase the amount of high-quality capital banks are required 

to hold relative to their risk exposures. 
Executive Summary 7

Regulators led by the FDIC have also taken important steps to build a framework 

under the “orderly liquidation authority” (OLA) that could be used to resolve a 

large failing financial company in cases where normal bankruptcy would have 

serious adverse effects on financial stability in the United States. The purpose of 

OLA is to ensure that in the event of a big financial company’s failure the cost is 

borne by its shareholders and creditors and not the U.S. taxpayer. Establishing 

the framework under OLA and progressively working through the many practical 

issues required to implement this authority is essential to end the perception 

that some financial companies are “too big to fail” and to address other moral 

hazard problems. The Dodd-Frank Act also requires the largest bank holding 

companies to produce resolution plans or “living wills” to explain how they could 

be resolved in an orderly manner if they failed. In July 2012 the first such plans 

were submitted to the Federal Reserve and the FDIC.

A stable financial system also requires resilient and transparent markets. To this 

end, the CFTC and SEC have proposed and begun to finalize rules that will 

provide, for the first time, a comprehensive regulatory framework for the overthe-counter derivatives market. The CFTC and SEC have adopted final rules that 

provide precise definitions of the instruments and entities to be covered. The 

CFTC has adopted rules that increase market transparency for both the public 

and regulators; provide for centralized reporting of trades; require swap dealers 

to establish risk-management policies; and require swap dealers to interact fairly 

with customers in their sales practices. In addition, the CFTC has completed 

rules related to designated contract markets, which will be able to list and trade 

swaps, and position reporting rules for physical commodity swaps. Regulators 

are also working together to strengthen financial market utilities (FMUs)—the 

infrastructures that transfer, clear, and settle financial trades—to enhance their 

ability to withstand the failure of participating firms. To this end, the Federal 

Reserve and the SEC have proposed, and the CFTC has finalized, rules for FMUs, 

including rules establishing risk-management requirements for these entities. In 

addition, the Council has made its initial designations of systemically important 

FMUs. The Office of Financial Research (OFR) is making substantial progress to 

improve the quality and availability of financial market data.

Regulators continue to bring greater transparency to the financial markets. The 

SEC has implemented the Dodd-Frank Act’s requirement that advisers to most 

hedge funds and certain other private funds register with the SEC. As of March 

31, 2012, public reporting of the identities of these advisers is required, as well as 

information about the private funds’ size and key service providers. In addition, 

in October 2011 the SEC and CFTC adopted a joint rule that requires non-public 

reporting by certain advisers to hedge funds and other private funds to facilitate 

the assessment of systemic risk. This non-public reporting includes information 

about the operations and risk profiles of these private funds, which will enable 

regulators to review risk trends over time.

Regulators are working to strengthen protections for consumers and investors. 

Notably, the CFPB has adopted and proposed a variety of rules required 

under the Dodd-Frank Act, including the adoption of new rules to provide 

protections to consumers who make remittance transfers and the proposal of 
8 2012 FSOC // Annual Report

rules to consolidate mortgage loan disclosure forms to make loan information 

more useful to consumers and to reduce burdens on lenders. In addition, the 

CFPB launched its supervision program for very large depository institutions 

(in coordination with prudential regulators) and for certain nonbanks. It 

has established its consumer response function, and assumed rulemaking 

responsibility for federal consumer financial laws. 

Because financial markets are global, U.S. authorities are closely engaged 

in international regulatory negotiations as they continue to implement the 

Dodd-Frank Act. The effectiveness of reform at home could be undermined 

if risk is able to migrate to jurisdictions with weaker standards. Therefore, it is 

essential to have internationally consistent regulations on capital and liquidity, 

resolution regimes, derivatives markets and regulation of large, complex financial 

institutions, while acknowledging that individual countries may require different 

approaches based on structural differences in their financial systems. The task of 

achieving strong and consistent global standards is essential because the ultimate 

outcomes of U.S. and international reform efforts are intimately connected. 

While much progress has been made, U.S. regulators are operating with 

limited resources to implement reforms that apply to very complex markets and 

institutions and are essential for the national economic interest. Ultimately, for 

these reforms to be successful, regulators must have the necessary resources to 

undertake their policymaking, supervisory and enforcement responsibilities.

The Council—which brings together our many different regulatory agencies—

has convened 12 times since last year’s report to share information on key 

financial developments, coordinate on regulatory implementation, and monitor 

progress on recommendations from the first annual report. The Council finalized 

a rule outlining the process it will use for determining which nonbank financial 

companies will be supervised by the Federal Reserve and subject to enhanced 

prudential standards, including resolution planning requirements. As previously 

discussed, the Council has also designated an initial set of systemically important 

financial market utilities that will be subject to enhanced risk-management 

standards. It remains focused on both identifying near-term threats and 

addressing structural vulnerabilities in the financial system.

Potential Emerging Threats to U.S. Financial Stability

Threats to financial stability, like threats to national security, are always present, 

even if they are not always easy to discern in advance. The euro area poses an 

obvious risk to U.S. financial stability. To date, euro area authorities have been 

able to prevent a major dislocation by providing large quantities of liquidity to 

their banking systems, and by providing official sector funding on a case-bycase basis, conditional on fiscal and structural reforms, for nations that have 

lost market access. The nations under stress have taken painful steps to reduce 

structural fiscal deficits, and have undertaken some economic liberalization 

in an effort to boost growth and competitiveness. Euro area leaders have also 

taken actions towards recapitalizing troubled banks. However, the uncertainty 

surrounding euro area developments remains high. 
Executive Summary 9

Many argue that the euro area needs a more system-wide solution that deepens 

financial and fiscal integration and completes economic and monetary union. 

Such a solution might include a roadmap to strengthen the institutional 

foundations of the euro, with appropriate governance and incentives, as well as a 

credible crisis-fighting bridge to that future set of arrangements. 

Moreover, the challenges surrounding Greece have focused market attention 

on the sustainability of countries’ euro membership and the costs of a potential 

euro breakup. The establishment of the single currency was a remarkable step 

towards greater European unity, and dissolution of the euro would come at 

great cost. Specifically, market participants highlight credit risk, legal risk, and 

redenomination risk—the risk that obligations due in euros will be repaid in an 

alternative, less valuable, currency. 

The direct net exposures of large U.S. banks to the most stressed euro area 

sovereigns are very small relative to capital. However, a systemic crisis in Europe, 

in which contagion and spillover effects spread widely among euro area countries 

and markets, represents a significant risk for U.S. institutions. In addition, asset 

price declines due to shocks originating in the euro area would likely have an 

adverse impact on the balance sheets of U.S. institutions, as would a generalized 

deterioration in market sentiment due to increased European volatility.

While Europe is the principal financial stability risk facing the U.S. financial 

system today, it is not the only source of potential threat. The U.S. recovery has 

not yet transitioned from moderate to self-sustainable growth. The “fiscal cliff” 

around year end—including expiration of the tax cuts originally enacted in 

2001 and 2003, the expiration of payroll tax cuts and extended unemployment 

benefits, and the Budget Control Act-mandated sequester—represents a threat to 

the recovery and financial stability if not addressed. 

Structural and cyclical weaknesses persist in the housing sector, including the 

large number of households with low or negative equity in their homes. As a 

result, the housing market could face increased pressures should there be a 

slowdown in economic growth. Meanwhile, cybersecurity remains a constant area 

of concern and potential vulnerability.

Risks could also arise from uncertainty about the vigor of global growth outside 

Europe, including in the emerging markets. Authorities in China and a number 

of other EMEs face the challenge of supporting demand and employment at a 

time of weakness in the industrialized world while attempting to avoid fuelling 

domestic real estate bubbles. China’s substantial contribution to global growth 

and its purchases of advanced economy debt mean that a hard landing there 

would have important implications for the U.S. economy.

It is essential to enhance the resilience of the financial system against both the 

threats that we can identify today and ones we cannot. Vulnerabilities in the 

financial system can be grouped into three broad classes or types: inherent 

vulnerabilities (features of our financial system that will always make financial 

markets and institutions fragile), potential control weaknesses (failures in 
10 2012 FSOC // Annual Report

operations, risk management, and governance), and behavioral vulnerabilities 

(incentives to take too much risk). 

One area that merits ongoing scrutiny is the potential interaction between reliance 

on short-term wholesale funding (an inherent vulnerability) and incentives to 

“reach for yield” (a behavioral vulnerability) in a low interest rate environment, 

for instance, by taking on excessive duration or credit risk or by shortening the 

tenor of funding. Some nonbank financial companies already rely heavily on 

short-term market financing, which could represent a source of instability if 

borrowers were to have difficulty rolling over liabilities in a time of stress. For 

example, while short-term funding markets were not disrupted by the recent 

downgrades of internationally active financial institutions, these events are causing 

market participants to reevaluate both concentration and duration of exposures 

in these markets. While the use of short-term liabilities to fund long-term assets 

is central to financial intermediation, the risks associated with this practice must 

be carefully managed and subjected to appropriate oversight. Events over the 

past year have also highlighted the importance of potential control weaknesses 

particularly for concentrated exposures or complex trading strategies. 

While member agencies of the Council are engaged in implementing the DoddFrank Act, much of the Council’s attention has also been on vulnerabilities 

that require additional focus beyond Dodd-Frank rulemaking. As emphasized 

in last year’s report, the instability of short-term wholesale funding markets is 

exacerbated by ongoing structural vulnerabilities in the tri-party repo market and 

in the money market fund industry. These vulnerabilities cannot be adequately 

addressed only at the firm level and must be tackled at the system level. 

Consistent with the recommendation of the Council last year, the Federal 

Reserve has now taken a more direct supervisory approach to pursuing the 

necessary changes to the tri-party repo market. Similarly, the SEC continues to 

work through policy options for much needed reform of money market funds. 

Section 3 of this report sets out the Council’s 2012 recommendations in these and 

other areas.

The Council remains vigilant against potential shocks and vulnerabilities in 

financial markets. Regulators cannot eliminate risk nor provide guarantees that 

in the event of a major disruption in the euro area or elsewhere, there would 

be no impact on U.S. financial stability. However, thanks in part to progress on 

financial reform, the U.S. financial system is stronger and better able to absorb 

shocks than was the case even a year ago. Moreover, the member agencies of the 

Council have important tools to combat contagion and mitigate its effects on our 

national economy, and will not hesitate to use these tools should the national 

interest require them.
Annual Report Recommendations 11

The Dodd-Frank Act requires the Council to make annual recommendations 

to: (1) enhance the integrity, efficiency, competitiveness, and stability of U.S. 

financial markets; (2) promote market discipline; and (3) maintain investor 

confidence. In this section, we discuss the ongoing work of the Council, its 

members, and the private sector to address these important mandates and lay out 

concrete recommendations. 

3.1 Reforms to Address Structural Vulnerabilities

Reforming Structural Vulnerabilities in Wholesale Short-Term Funding Markets

Stable wholesale short-term funding markets are a critical component of a wellfunctioning financial system, but if they suffer disruptions, these markets can 

rapidly spread shocks across financial institutions. The Council continues to be 

particularly focused on structural vulnerabilities in money market funds (MMFs) 

and the tri-party repo market, as follows.

Money Market Funds

The Council continues to support the implementation of structural reforms 

to mitigate the run risk in MMFs. Specifically, these reforms are intended to 

address the structural features of MMFs that caused a run on prime MMFs and 

the freezing of the short-term credit markets after the Reserve Primary Fund was 

unable to maintain a stable net asset value (NAV) in September 2008. In 2010, 

the SEC adopted MMF reforms designed to make MMF portfolios more resilient 

by improving credit quality standards, reducing maturities, and—for the first 

time—instituting liquidity requirements. The 2010 reforms appear to be working 

as designed and meeting the intended goals. However, the SEC’s 2010 reforms 

did not address—and were not intended to address—two core characteristics of 

MMFs that continue to contribute to their susceptibility to destabilizing runs. 

First, MMFs have no mechanism to absorb a sudden loss in the value of a portfolio 

security, without threatening the stable $1.00 NAV. Second, there continues to be 

a “first mover advantage” in MMFs, which can lead investors to redeem at the first 

indication of any perceived threat to the value or liquidity of the MMF. 

SEC Chairman Schapiro recommended two alternative reforms to address these 

remaining structural fragilities. They are (1) a mandatory floating NAV; and/

or (2) a capital buffer to absorb losses, possibly combined with a redemption 

restriction to reduce the incentive to exit the fund. The Council supports this 

effort and recommends that the SEC publish structural reform options for public 

comment and ultimately adopt reforms that address MMFs’ susceptibility to runs. 

In addition, the OCC issued a proposed rulemaking in April 2012 that would 

partially align the requirements for short-term bank common and collective 

investment funds (STIFs) with the SEC’s revisions to Rule 2a-7 under the 

Investment Company Act. In an effort to impose comparable standards on 

3 Annual Report Recommendations
12 2012 FSOC // Annual Report

comparable financial activities, the Council further recommends that, where 

applicable, its members align regulation of cash management vehicles similar 

to MMFs within their regulatory jurisdiction to limit the susceptibility of these 

vehicles to run risk.

Tri-Party Repo Market

The elimination of most intraday credit exposure and the reform of collateral 

practices in the tri-party repo market continues to be an area of intense focus for 

the Council. The Tri‐Party Repo Infrastructure Reform Task Force was formed 

in September 2009 in response to the financial crisis. Before being disbanded in 

February 2012, the Task Force accomplished a number of changes in process and 

practice that laid a foundation for future risk reduction, including: (1) moving 

the daily unwind of some repos from 8:30 a.m. to 3:30 p.m., which shortens the 

period of credit exposure; (2) introducing automated collateral substitution; and 

(3) introducing three-way trade confirmation functionality. While important, 

these changes do not meaningfully reduce reliance on intraday credit from the 

clearing banks. 

The industry has indicated that elimination of intraday credit associated with 

tri-party settlement will be a multi-year effort. The Council views this proposed 

timeline as unacceptable to achieve timely substantive reductions in risk. The 

Council recommends that the industry implement near-term steps to reduce 

intraday credit usage within the next 6 to 12 months and an iterative strategy over 

six-month increments to continue both to reduce intraday credit substantially 

and to implement improvements in risk-management practices across all market 

participants. In addition, the Council recommends that regulators and industry 

participants work together to define standards for collateral management in 

tri-party repo markets, particularly for lenders, such as MMFs, that have legal or 

operational restrictions on the instruments that they can hold.

Customer Protection Standards and Segregation of Customer Assets 

Financial intermediaries hold customer assets for a variety of purposes, such as 

maintaining cash balances prior to investment and as margin. Intermediaries 

are able to increase efficiencies and lower costs for their customers by investing, 

and earning a return on, these customer assets. However, appropriate limits 

on the ways in which intermediaries can use these assets, including customer 

segregation rules, are a necessary part of strong customer protection standards 

that contribute to market integrity and confidence. Customer protection 

standards also help ensure the prompt return of assets to customers in the event 

of a financial intermediary’s insolvency. Recent developments highlight the 

importance of such standards, including protection standards for trading in 

foreign markets, that are well-understood by market participants and enforced 

by regulators.

The CFTC and SEC recently took a number of actions to maintain strong 

standards for customer protection. Specifically, in December 2011, the CFTC 

amended its rules to add additional safeguards to the processes whereby 

customer funds may be invested by derivatives clearing organizations and futures 

commission merchants. In addition, in February 2012, the CFTC adopted new 
Annual Report Recommendations 13

standards to protect the collateral posted by customers clearing swaps through 

futures commission merchants on derivatives clearing organizations. Further, the 

SEC recently reopened the comment period on a 2007 proposal to amend certain 

customer protection rules.

The Council recommends that regulators continue to take steps to enforce 

existing customer protection standards and to enhance such standards going 

forward, particularly in light of the reforms to the swaps market introduced by 

the Dodd-Frank Act. The Council further recommends that regulators consider 

strengthening regulations governing the holding and protection of customer 

funds deposited for trading on foreign futures markets. 

Clearinghouse Risk Management

The Dodd-Frank Act mandates central clearing of standardized swaps to mitigate 

the counterparty risk inherent in bilateral, over-the-counter (OTC) transactions. 

Although central clearing decreases counterparty risk, it also increases the 

concentration and operational risks presented by a clearinghouse standing 

between the two sides of numerous transactions. 

The Dodd-Frank Act provides various tools that can be used to address this 

increased concentration risk. For example, the Council is authorized to designate 

financial market utilities as systemically important, which subjects such utilities 

to heightened risk-management standards. As discussed in more detail in Section 

6, the Council recently designated a number of financial market utilities. The 

CFTC and SEC also took actions to further strengthen clearinghouse riskmanagement standards. For example, in November 2011, the CFTC adopted 

new risk-management standards for derivatives clearing organizations and 

the SEC continues to work to finalize rules on risk-management standards for 

clearing agencies. 

The Council recommends that regulators continue to seek ways to strengthen the 

risk-management standards for clearinghouses and to work together to monitor 

clearinghouse practices across their respective jurisdictions to determine industry 

best practices that could be followed more broadly.

3.2 Heightened Risk Management and Supervisory Attention 

Robust Capital and Liquidity Planning 

Capital and liquidity buffers form the most fundamental protection for the 

broader financial system and the economy against unexpected risks or failures 

of risk management at financial institutions. Consistent with the Council’s 

2011 report, considerable progress has been made over the past 12 months on 

robust capital and liquidity planning at U.S. financial institutions. In addition 

to carrying out the 2012 Comprehensive Capital Analysis and Review (CCAR) 

exercise, the Federal Reserve proposed enhanced prudential standards, including 

capital and liquidity planning requirements, for the largest bank holding 

companies and for nonbank financial companies designated by the Council. 

Jointly with the FDIC and OCC, the Federal Reserve released supervisory 

guidance on stress testing for all banking organizations with total consolidated 
14 2012 FSOC // Annual Report

assets over $10 billion in May 2012. In June 2012, the Federal Reserve, FDIC, and 

OCC invited public comment on three proposed rules that would implement 

in the United States the Basel III and other regulatory capital reforms and 

the changes required by the Dodd-Frank Act. Concurrently, the agencies also 

approved a final rule to implement changes to the market risk capital rule. 

The Council recommends continued interagency coordination on regulation to 

help ensure enhanced capital planning and robust capital buffers for financial 

institutions. The Council also recommends continued research and development 

of stress-test methodologies to reflect evolution of the financial markets. 

On liquidity planning, supervisors and private sector risk managers should 

closely monitor the risks inherent in short-term funding of longer-term assets. 

Although this practice is an essential function of the financial system, institutions 

should refrain from over-reliance on wholesale short-term funding where it could 

create additional vulnerabilities in extreme but plausible stress scenarios. In 

2010, the federal banking agencies, state bank regulators, and the NCUA issued 

a policy statement on funding and liquidity risk management that addressed the 

importance of cash flow projections, diversified funding sources, stress testing, 

a cushion of liquid assets, and a formal, well-developed contingency funding 

plan as primary tools for measuring and managing liquidity risk. In late 2011, 

the Federal Reserve proposed a rule to require enhanced risk management of 

funding and liquidity risk by U.S. bank holding companies with total consolidated 

assets of $50 billion or more. In addition, the Basel III liquidity framework 

augments these expectations and proposes thresholds for short-term and longerterm funding resilience. The Council recommends that financial institutions take 

particular care to construct their funding models to be resilient to disruptions in 

wholesale short-term funding markets. 

Effective Resolution Plans

Effective resolution plans for the largest financial institutions are important 

supervisory tools to address the operational and legal complexity of these 

firms on an ongoing basis, as well as to implement the new orderly liquidation 

authority. Last fall, the Federal Reserve Board and the FDIC approved a final rule 

that requires bank holding companies with total consolidated assets of $50 billion 

or more and nonbank financial companies designated by the Council to develop, 

maintain, and periodically submit resolution plans, also known as “living wills.” 

The FDIC also issued another rule requiring FDIC-insured depository institutions 

with assets of $50 billion or more to file resolution plans. Taken together, these 

resolution plan requirements will improve efficiencies, risk management, and 

contingency planning. The Council recommends that firms use these plans 

to reduce organizational complexity to facilitate orderly resolution under the 

bankruptcy code. 

Bolster Resilience to Interest Rate Shifts 

While the ongoing environment of low interest rates supports the economic 

recovery, it can also pose particular challenges for financial institutions 

by compressing net interest margins and inducing losses on products with 

guaranteed returns, leading such institutions to pursue riskier investment 
Annual Report Recommendations 15

strategies in an effort to “reach for yield.” Often, such strategies only show their 

negative consequences when a shift occurs in interest rates or credit conditions. 

Banking regulators and the NCUA, working with the Federal Financial 

Institutions Examination Council (FFIEC), released an advisory on Interest 

Rate Risk Management in January 2010 and provided additional clarification 

on this advisory through the issuance of an FAQ in January 2012. This guidance 

recommends stress testing for: (1) instantaneous and significant changes in the 

level of interest rates; (2) substantial changes in rates over time; (3) changes in 

the relationships among key market rates; and (4) changes in the slope and the 

shape of the yield curve. The NCUA also issued a final rule in January 2012 aimed 

at mitigating interest rate risk in credit unions.

The Council recommends that regulatory agencies and private sector risk 

managers continue their scrutiny of how potential changes in interest rates could 

adversely affect the risk profiles of financial firms and recommends using extreme 

but plausible interest rate scenarios in stress testing. 

Maintain Discipline in Complex Trading Strategies, Underwriting, and New 

Financial Products

Events in the past year, including the publicly announced trading loss at 

JPMorgan Chase, demonstrate the importance of robust risk management 

when addressing complex trading strategies, illiquid positions, or concentrated 

exposures to areas of heightened risk. Such risk-management practices include: 

strong and clear lines of authority, reporting, and oversight; rigorous and 

ongoing validation of models used to design, execute, and control trading 

strategies; a formal process for changes to approved models; appropriate risk 

limits and metrics; and strong capital buffers. The Council recommends that 

financial institutions’ senior management establish, and directors approve, 

strong risk-management and reporting structures to help ensure that risks are 

assessed independently and at appropriately senior levels. The Council further 

recommends that institutions establish clear accountability for failures of 

risk management. 

While these examples highlight the importance of risk management in 

trading strategies, similar dynamics operate in maintaining disciplined credit 

underwriting standards and in vetting emerging financial products. In its 2011 

Report, the Council noted the importance of maintaining discipline in credit 

underwriting standards and responding appropriately when there are signs 

that loan terms may allow borrowers to take on excessive risk. The 2011 Report 

also highlighted leveraged lending as an area for continued monitoring. While 

there was a pull-back in leveraged lending during the crisis, volumes have since 

increased while underwriting practices have deteriorated. In response to these 

trends, the federal banking agencies in March 2012 issued for comment revised 

and strengthened supervisory guidance to govern leveraged transactions financed 

by banks. The Council recommends that oversight of all of these activities 

continue to form an ongoing focus of supervisors’ efforts and the Council’s 

monitoring of the financial system. 
16 2012 FSOC // Annual Report

High-Speed Trading 

High-speed trading activities, combined with automated mechanisms for the 

generation, transmission, and matching of orders, represent technological 

developments that require particular attention. Speed and automation confer 

important advantages to financial markets. However, potential operational, credit, 

transmission, and other risks require careful monitoring. This is particularly 

true for markets that have limited experience with high-speed and algorithmic 

trading or where regulatory circuit breakers are not in place. In its 2011 Annual 

Report, the Council stressed the importance of keeping pace with competitive 

and technological developments in financial markets. The SEC and CFTC have 

taken a number of steps to address potential risks, such as facilitating improved 

audit trails for surveillance use by regulatory authorities, and requiring risk 

controls that pause or halt trading in securities and futures markets, including a 

new “limit up-limit down” for equity securities (described further in Section 6). 

For example, in July 2012, the SEC adopted a rule requiring the self-regulatory 

organizations (SROs) to develop a plan to create a consolidated audit trail that 

would provide for a centralized order tracking system—capturing customer 

and order event information for orders in exchange-listed equities and equity 

options, across all markets, from the time of order inception, through routing, 

cancellation, modification, or execution. This single tracking system would 

enable regulators to monitor trading that is widely dispersed across a variety of 

market centers. The Council supports these efforts by the two Commissions. More 

generally, the Council recognizes that acceleration in the speed and automation 

of trade execution requires a parallel acceleration in trading risk management 

and controls. The Council recommends that the CFTC and SEC consider error 

control and risk-management standards for exchanges, clearing firms, and other 

market participants that are relevant for a high-speed trading environment. 

The Council also recommends that the CFTC and SEC continue to track 

developments in current and evolving market structure and analyze the need for 

policy responses when appropriate.

Issues Related to Cybersecurity

The quickly evolving cyber threat environment requires strengthening the 

ongoing collaboration and coordination among financial regulators and private 

entities in the financial sector. The Council recommends continued engagement 

by financial regulators with both public and private sector organizations to 

identify and respond to emerging cyber threats against the financial system. 

The development of mechanisms for sharing information related to cyber 

threats and vulnerabilities should continue to be explored. Regulators should 

continue to take steps to help ensure that information security standards for 

financial institutions are appropriate to the current threat environment, and that 

examinations assess institutions’ performance against those standards. 

3.3 Housing Finance Reforms

Reforms to the Housing Finance System

The U.S. housing finance system has required extraordinary federal government 

support over the past several years. Since September 2008, Freddie Mac and 

Fannie Mae (the government-sponsored enterprises, or GSEs) have been in 
Annual Report Recommendations 17

conservatorship under FHFA. Even today, nearly four years later, approximately 

90 percent of newly issued mortgages carry some form of government support, 

and the market continues to lack sufficient private capital to back residential 

mortgage credit risk.

During the past year, certain member agencies of the Council worked on 

a framework for housing reform that facilitates increased private sector 

involvement, while protecting consumers from abuses and reducing taxpayer 

exposures. In early 2012, FHFA released a Strategic Plan for the GSEs to develop 

approaches to mortgage finance infrastructure that could support any potential 

path towards broader housing reform going forward. The Strategic Plan is 

designed to reduce the GSEs’ risk profile and to increase incentives for the private 

sector to absorb mortgage credit risk through improved pricing and enhanced 

risk sharing. At the same time, it preserves a role for the GSEs in mitigating credit 

losses from the legacy book and providing foreclosure alternatives to borrowers. 

In addition, the CFPB is working toward implementing important Dodd-Frank 

Act rules to help ensure that lenders make a reasonable determination, based 

on verified information, that a consumer has the ability to repay a loan. Such 

provisions can help protect consumers from many of the abuses that led up to the 

crisis and can improve transparency and confidence in the mortgage markets. 

Member agencies of the Council are also working to promote more efficient 

markets for residential mortgage-backed securities (RMBS). In particular, the 

SEC continues to consider appropriate disclosure rules for RMBS, forming part 

of its Regulation AB, which will provide private market participants with more 

transparent information about the assets underlying RMBS. Enhanced clarity 

and guidelines for asset-backed securities, including securitization of residential 

mortgages, is also the goal of work by five Council member agencies, along with 

the U.S. Department of Housing and Urban Development (HUD), on the DoddFrank Act’s risk retention rule.

All of these efforts are important near-term steps to encourage private capital 

to take on additional mortgage credit risk. Nonetheless, additional certainty is 

necessary about the future of housing finance infrastructure and related policy 

issues to further promote the return of private capital. In particular, there do 

not yet exist broadly agreed-upon standards to characterize the quality and 

consistency of mortgage underwriting. Such standards are necessary to support 

the valuation and liquidity of mortgage-backed instruments. There continue to 

be non-uniform foreclosure practices across different states. And there remains 

uncertainty about the legal liability of a mortgage securitizer should a loan fail 

to conform to representations and warranties that were made about specific 

loan characteristics. 

Treasury and HUD, in their joint white paper on longer-term housing 

finance reform released in February 2011, put forth a range of options for the 

government’s role in a privatized system of housing finance. Treasury continues to 

evaluate these options and continues to pursue working with Congress on these 

issues to support a safer and more robust long-term housing finance system.
18 2012 FSOC // Annual Report

The Council recommends continued work to develop a long-term housing 

finance reform framework that supports the central role of private capital and 

the emphasis on consumer and investor protections in any future housing finance 

system. It is critical for the Council members, HUD, and Congress to continue 

their work to develop standards and best practices. In addressing these issues, 

Council members should be mindful of the important role of housing in the 

economy, the nascent recovery, and household finances and act to balance these 

concerns. As the Council members, HUD, and Congress continue their work to 

establish a new and lasting system for housing finance, it is critical to address the 

weaknesses that became evident in the recent housing crisis.

Mortgage Servicing Standards and Servicer Compensation Reform

The Council continues to focus on the need for national mortgage servicing 

standards and servicer compensation reform to strengthen confidence in the 

mortgage market. The lack of clear servicing standards in the period leading up 

to the housing crisis led to problems in assisting borrowers to avoid foreclosure, 

inappropriate servicing practices, and additional losses for investors. 

In early 2011, the federal prudential banking regulators, along with HUD, FHFA, 

and Treasury, formed an interagency working group to address the need for 

fair, clear, and uniform national servicing standards. This followed an earlier 

review by the Federal Reserve, OCC, and FDIC of major servicers that resulted 

in supervisory consent orders that are now being implemented by the largest 

mortgage servicers. Also in April 2011, FHFA announced the Servicing Alignment 

Initiative for Fannie Mae and Freddie Mac, which produced a consistent set of 

protocols for servicing mortgages from the onset of delinquency. In February 

2012, the federal government (led by the Department of Justice, together with 

Treasury and HUD) and 49 states reached a $25 billion settlement with the 

nation’s five largest mortgage servicers to address mortgage loan servicing and 

foreclosure abuses. The CFPB joined the interagency working group in July 2011, 

and in April 2012 provided a public outline of its plans for mortgage servicing 

regulations, with formal rules expected to be proposed for comment this summer. 

In addition, in September 2011, the Joint Mortgage Servicing Compensation 

Initiative, launched by FHFA, released a discussion document seeking comments 

on two alternative servicing compensation structures for servicing single-family 

mortgages. The current structure of mortgage servicing compensation could 

have contributed to an underinvestment in servicing capacity and greater 

concentration in the mortgage servicing industry. One proposal would establish a 

reserve account within the current compensation structure that could be used to 

increase servicing capacity in times of stress. The other proposal would create a 

new fee-for-service compensation structure to better align incentives and reduce 

the capital intensity of mortgage servicing assets. 

Mortgage servicing standards can contribute to long-term servicing improvements 

for all borrowers and other participants in the mortgage market. The Council 

recommends that the FHFA, HUD, CFPB, and the other agencies, as necessary, 

develop comprehensive mortgage servicing standards that require consistent 

and transparent processes for consumers and promote efficient alternatives to 
Annual Report Recommendations 19

foreclosure where appropriate. In addition, the Council recommends continued 

efforts to implement compensation structures that align the incentives of 

mortgage servicing with those of borrowers and other participants in the 

mortgage market. 

3.4 Progress on Implementation and Coordination of Financial Reform 

The Dodd-Frank Act

In the two years since the Dodd-Frank Act became law, members of the Council 

and their agencies have proposed and finalized a substantial number of rules 

implementing provisions of the Act, and they continue to work on additional rules 

in a coordinated manner. The reforms in the Dodd-Frank Act strengthen the 

resilience of the financial system and provide a clear agenda for the regulatory 

community to address vulnerabilities exposed in the recent crisis. As described 

in Section 6, the Dodd-Frank Act establishes new protections for financial 

consumers and investors. It improves financial markets through designation of 

and enhanced risk-management standards for systemically important financial 

market utilities. It provides for private fund adviser registration and reporting 

and imposes constraints on risk as well as transparency requirements for 

derivatives markets. In conjunction with international agreements on consistent 

global prudential standards, the Dodd-Frank Act will require financial firms to 

operate with larger capital and liquidity buffers and better risk controls, and it 

requires firms to submit resolution plans to the FDIC, Federal Reserve, and the 

Council. Finally, the Dodd-Frank Act provides important new authority to resolve 

a large, complex financial institution in an orderly manner. 

Finalizing the rulemakings under the Dodd-Frank Act and implementing the 

required changes effectively will require close coordination among the regulatory 

community and open dialogue with the public and industry. To meet the 

challenges of designing and enforcing these new rules, the resources dedicated 

to financial oversight must increase. Regulatory agencies must have sufficient 

resources to attract and retain talented individuals, acquire needed data, develop 

the requisite analytic capabilities, and invest in systems to monitor market activity 

and enforce the new rules. The Council recommends complete and expeditious 

implementation of the Dodd-Frank Act, along with the provision of the resources 

needed to accomplish this essential task. 

International Coordination

In its 2011 Annual Report, the Council stressed the importance of international 

financial regulatory coordination. Financial markets are global in scope, while 

regulation proceeds at the national level. To promote a level global playing field 

and to diminish the risk of having capital flow to the jurisdiction with the least 

restrictive regulatory regime, it is essential to have internationally strong and 

consistent regulations that form a coherent and effective whole, while allowing an 

appropriate degree of autonomy for individual countries to accommodate their 

own particular needs. It is particularly important for international regulators to 

consistently apply strong, well-calibrated standards for the critical areas of capital, 

liquidity, derivatives, central clearing, and failure resolution.
20 2012 FSOC // Annual Report

Considerable progress has been made over the past year on coordinating 

regulatory principles internationally. National regulators continue to implement 

the Basel III standards; and in June 2012, the Federal Reserve, OCC, and FDIC 

jointly issued the finalized market risk capital rules, as well as three notices of 

proposed rulemaking (NPR), that would replace the agencies’ current capital 

requirements with requirements consistent with aspects of Basel II, Basel 2.5 

and Basel III. The translation of these international agreements to domestic 

regulation is a key step in the regulatory reform efforts and is critical for 

enhancing the resiliency of regulated financial institutions and the financial 

system more generally. 

Furthermore, the Basel Committee established the assessment methodology and 

a capital surcharge framework for globally systemically important banks (G-SIBs) 

in November 2011 to enhance their loss absorbency capacity and reduce the 

probability of their failure. This methodology comprises five broad categories 

of size, interconnectedness, lack of readily available substitutes for the services 

provided, global (cross-jurisdictional) activity, and complexity. In the same 

month, the Financial Stability Board (FSB) issued the Key Attributes of Effective 

Resolution Regimes for Financial Institutions, which was endorsed by the G-20 

leaders and is intended to provide international standards for national recovery 

and resolution planning regimes. Specifically, it addresses the “too-big-to-fail” 

problem by making it possible to resolve any financial institution in an orderly 

manner without exposing the taxpayer to the risk of loss. 

In addition, the final version of the Principles for Financial Market 

Infrastructures (PFMI), issued by the Committee on Payment and Settlement 

Systems (CPSS) and the International Organization of Securities Commissions 

(IOSCO), was published in April 2012. The PFMI covers payments systems, 

central counterparties, securities settlement systems, and other financial 

utilities, and provides an updated set of international standards on issues such 

as governance, risk management, financial resources, liquidity, and operational 

robustness. These principles are especially important as the international 

community moves to implement the G-20 commitment to central clearing and 

reporting of OTC derivatives. In insurance, the International Association of 

Insurance Supervisors updated the Insurance Core Principles in October of 

last year. These principles provide a global framework for the supervision and 

regulation of the insurance sector.

The Council recommends continued international coordination of Basel III 

implementation, with an aim towards consistent and rigorous definitions of 

capital and risk weights across countries. The Council also recommends the 

continued development of international standards and national implementation 

for margin, central clearing, and reporting of OTC derivatives; and that 

supervision and regulation of financial market utilities (FMUs) embody the 

principles articulated in the PFMI. In addition, the Council recommends 

continued efforts to develop strong and internationally consistent procedures 

for the supervision and regulation of global systemically important financial 

institutions, including appropriate capital and liquidity requirements and 

internationally accepted resolution regimes for such institutions. The Council 
Annual Report Recommendations 21

strongly encourages international implementation and enhanced international 

coordination among home and host jurisdictions regarding recovery and 

resolution planning. 

Data Resources and Analytics

The Council recommends that improvement in data standards should be a 

high priority for financial firms as part of their risk-management process and 

for the regulatory community—not just in the United States but globally. The 

development of the Legal Entity Identifier is a valuable first step, one that will 

help to identify precisely the parties to particular financial transactions. It 

will also enable a more accurate and consistent understanding of legal entity 

hierarchies, which is essential for effective counterparty risk management. The 

Council recommends that the Office of Financial Research (OFR) continue to 

work with the member agencies to promote and establish, where necessary, data 

standards for identification of legal entities, financial products, and transactions, 

and to improve the access to and aggregation of data by the regulators. Finally, 

the Council recommends that cross-border exchange of supervisory data among 

supervisors and regulators continue to be facilitated in a manner that safeguards 

the confidentiality and privilege of such information, in order to help provide 

comprehensive oversight of financial institutions with a global reach and improve 

coordination on financial stability.

Macroeconomic Environment 23

4.1 U.S. Economic Activity

The economic recovery that began in the second 

half of 2009 continued in 2011 and early 2012. 

Nonetheless, the pace of activity and employment 

growth remained quite modest compared with previous 

economic expansions, as a number of factors have 

continued to weigh on growth in spending and 

production. These factors include a depressed housing 

market, the spillover effects of the fiscal and financial 

difficulties in Europe, continued fiscal retrenchment 

of state and local governments within the United 

States, uncertainty about the federal budget and 

related policies, and less credit availability for many 

households and small businesses compared to precrisis norms. 

4 Macroeconomic Environment

Chart 4.1.1 Change in Real Gross Domestic Product

4.1.1 Real Gross Domestic Product

Economic growth continued at a modest to 

moderate pace in 2011 and early 2012. Real 

GDP increased less than 1 percent at an annual 

rate in the first half of 2011, as economic 

activity was held down by temporary factors, 

particularly supply chain disruptions stemming 

from a major earthquake and tsunami in Japan 

and the damping effect of a sharp run-up in 

energy and commodity prices on consumer 

spending (Chart 4.1.1). Growth picked up in 

the second half of the year to an annual rate 

of nearly 2.5 percent, as the effects of these 

temporary factors waned. Real GDP expanded 

at an annual rate of 1.9 percent in the first 

quarter of 2012, and available indicators suggest 

a continued moderate pace of growth in the 

second quarter. Among the factors that are 

hampering growth are a depressed housing 

market, the spillover effects of the fiscal and 

financial difficulties in Europe, continued fiscal 

retrenchment of state and local governments 

within the United States, uncertainty about 

U.S. federal budget and policy, and credit 

availability that is significantly tighter relative 

to pre-crisis norms for many households and 

small businesses. 
24 2012 FSOC / / Annual Report

Consumption and Residential Investment

Real personal consumption expenditures (PCE) 

increased 1.6 percent in 2011 (Q4/Q4) and 2.5 

percent (annualized rate) in the first quarter 

of this year (Chart 4.1.2). Real disposable 

income rose more modestly, held down by the 

weak labor market. The weak pace of income 

growth over 2011 and early 2012, combined 

with increases in consumer outlays, brought the 

personal saving rate down from 5.2 percent in 

late 2010 to 3.7 percent in the first quarter of 

2012 (Chart 4.1.3).

In addition to the weak gains in income, a 

number of other factors also restrained the pace 

of improvement in consumer expenditures. 

Household wealth (relative to income) remains 

well below the elevated levels that prevailed 

in the mid-2000s, when it was supported by 

house prices and household equity holdings. 

Similarly, underwriting standards remain tight 

for many potential borrowers—particularly 

for mortgage credit, which continues to weigh 

down housing demand and refinancing activity 

despite historically low interest rates. In part, 

these factors have been reflected in readings on 

consumer sentiment, which remain low relative 

to levels before the financial crisis, despite 

having retraced much of the decline that 

occurred in the summer of 2011 as difficulties 

in Europe flared and the debate over the U.S. 

debt ceiling became heated. 

The housing market remains strained. In 2011, 

both new and existing home sales remained 

near the low levels that have prevailed, on 

average, since 2008. Residential construction 

activity and housing starts remained tepid, 

especially for single-family homes, given weak 

demand, the abundant stock of vacant homes, 

and low housing prices (Chart 4.1.4). However, 

recent indicators have been somewhat more 

encouraging. Home prices have begun to 

stabilize, with some measures showing an uptick 

in early 2012. In addition, multifamily housing 

starts have been trending upward since early 

2010, albeit from low levels.

Chart 4.1.2 Change in Real Personal Consumption Expenditures

Chart 4.1.3 Personal Saving Rate

Chart 4.1.4 Private Housing Starts
Macroeconomic Environment 25

Business Fixed Investment

Real business fixed investment (BFI) posted 

a solid increase in 2011, rising 8.1 percent on 

a Q4/Q4 basis. However, growth has been 

slower so far in 2012, and BFI as a share of GDP 

remains considerably below its pre-recession 

level. Much of the deceleration in BFI this year 

has been in expenditures on equipment and 

software (E&S), which rose at an annual rate of 

just 3.5 percent in the first quarter after rising 

9.6 percent (Q4/Q4) in 2011; this step-down 

in E&S investment may be related in part to 

renewed concerns among businesses about 

the global economic and financial situation. 

Meanwhile, investment in nonresidential 

structures has increased somewhat, on net, 

in recent quarters after a period of very steep 

declines, but conditions in the sector remain 

difficult: vacancy rates for commercial space are 

still high, prices of existing structures are low, 

and financing conditions for builders are still 

tight despite some signs of recent easing.

Government Purchases

Real government expenditures at the federal, 

state, and local level continue to contract. Real 

state and local government purchases fell by 

2.5 percent on a Q4/Q4 basis in 2011 due to 

ongoing budgetary pressures, continuing the 

pattern seen since the onset of the recession 

and financial crisis. Real federal government 

purchases fell throughout 2011 and early 2012 

following the withdrawal of the fiscal stimulus 

provided during the crisis and large declines 

in federal defense spending in 2011:Q4 and 

2012:Q1.

Imports and Exports

Real exports of goods and services rose 4.7 

percent over 2011, boosted by continued growth 

in overall foreign economic activity. The 

increase in export demand was concentrated 

in the emerging market economies (EMEs), 

while exports to the euro area declined toward 

the end of the year. As U.S. economic activity 

grew modestly in 2011, real imports of goods 

and services rose by 3.6 percent. Altogether, the 

contribution of net exports to growth in real 
26 2012 FSOC / / Annual Report

GDP was essentially zero last year and in the 

first quarter of this year.

4.1.2 The Labor Market

The labor market strengthened over the course 

of 2011 and the first several months of 2012. 

Nonetheless, the improvement in employment 

and other labor market indicators since the end 

of the recession has been modest, and the labor 

market has a considerable distance to go before 

returning to the conditions that prevailed prior 

to the recession and financial crisis.

Nonfarm payroll employment increased at an 

average monthly rate of 153,000 jobs in 2011 

(Chart 4.1.5). The private sector added an 

average of 175,000 jobs monthly last year, while 

government payrolls dropped at an average 

rate of 22,000 per month (mostly at state and 

local governments). During the first half of 

2012, private payrolls advanced about 159,000 

per month, just below the average pace in 2011, 

and the pace of job loss at governments has 

moderated somewhat. Overall through June 

2012, the level of payroll employment remains 

about five million below its peak in January 2008.

The unemployment rate has declined 

significantly, from its peak of 10 percent in 

October 2009 to 8.2 percent in June 2012, 

although it remains far above levels that 

prevailed prior to the recession (Chart 4.1.6). 

Some of this decline in the unemployment 

rate is attributable to reduced labor force 

participation (Chart 4.1.7). While part of the 

reduction in participation reflects demographic 

shifts associated with an aging baby boomer 

population, the weak economy has played an 

important role by discouraging many workers 

from continuing to search for positions. In 

addition, long-duration joblessness continues to 

account for an especially large share of the total. 

In June 2012, 5.2 million persons among those 

counted as unemployed—about 42 percent of 

the total—had been out of work for more than 

six months (Chart 4.1.8). The number of workers 

employed part-time for economic reasons has 

fallen somewhat over the past year, though it 

remains high by historical norms. 

Chart 4.1.5 Net Change in Payroll Employment

Chart 4.1.6 Civilian Unemployment Rate

Chart 4.1.7 Labor Force Participation Rate
Macroeconomic Environment 27

4.2 Private Nonfinancial Balance Sheets 

and Credit Flows 

4.2.1 Nonfinancial Corporate Sector

The ratio of debt to net worth in the nonfinancial 

corporate sector, which had spiked during the 

downturn, continued to decline in 2011. Credit 

flows to this sector have remained relatively strong, 

with robust bond issuance and an increased pace of 

lending from bank and nonbank companies. Credit 

quality indicators remain solid, with low delinquency 

and default rates. 

Nonfinancial corporate balance sheets 

deteriorated significantly during the recession, 

with measures of balance sheet leverage reaching 

historical highs. Corporate balance sheets 

improved markedly in 2010 and a bit more in 

2011. The ratio of debt to net worth in this sector 

is now in line with its average level over the past 

20 years (Chart 4.2.1). Profits at nonfinancial 

corporations increased sharply in 2010 and 

remained high in 2011, driving equity market 

values for nonfinancial corporations back to 

near pre-crisis levels and allowing nonfinancial 

corporations to boost capital through 

retained earnings. In particular, nonfinancial 

corporations have accumulated a substantial 

buffer stock of liquid assets (Chart 4.2.2).

This improvement in corporate profits 

and credit quality supported high levels of 

borrowing by nonfinancial corporate firms. 

In bond markets, which comprise the largest 

source of credit to the corporate sector, gross 

issuance by investment grade nonfinancial firms 

has been very strong (Chart 4.2.3), although 

issuing firms appear to have mainly used these 

bonds to refinance existing debt. Issuance of 

high-yield bonds dropped in the second half 

of 2011, but the pace of issuance through May 

2012 remained above the 2001-2012 average 

annual pace. Corporate bond spreads widened 

during fall of 2011 as investors became more 

cautious in the wake of the U.S. debt ceiling 

talks in August 2011 and developments 

in European markets (Chart 4.2.4). As of 

July 6, 2012 corporate spreads still remained 

elevated relative to early 2011. The amount of 

Chart 4.1.8 Long-Term Unemployment*

Chart 4.2.1 Nonfinancial Corporate Credit Market Debt to 

Net Worth

Chart 4.2.2 Financial Ratios for Nonfinancial Corporations
28 2012 FSOC / / Annual Report

commercial paper issued by businesses edged 

up only slightly over the past year despite 

relatively stable cost of issuance.

The net amount of loans to the nonfinancial 

corporate sector, which includes loans from 

bank and nonbank sources, rose at an annual 

rate of $132 billion in 2011, with the same 

pace of growth continuing in the first quarter 

of 2012. Bank lending to commercial and 

industrial (C&I) borrowers continued to rise 

between June 2011 and April 2012, reaching 

$1.4 trillion. While the bulk of this increase has 

been organic, charter conversions by thrifts 

boosted C&I loans in the banking sector by 

about $16 billion over this period. Over the 

same period, respondents to the Senior Loan 

Officer Opinion Survey (SLOOS) generally 

continued to report less stringent underwriting 

standards and lower spreads on C&I loans to 

large and medium-sized firms (Chart 4.2.5). 

Available indicators of credit quality remain 

solid: the default rate on nonfinancial 

corporate bonds is at a low level by historical 

standards (Chart 4.2.6); C&I loan delinquency 

rates continued to decline through the first 

quarter of 2012 (Chart 4.2.7); and expected 

year-ahead default rates for nonfinancial 

firms as measured by Moody’s KMV model 

remain steady. 

4.2.2 Commercial Real Estate Sector

Financing conditions in the commercial real estate 

sector remain strained following a long period of 

banks reporting tighter underwriting standards 

and subdued commercial mortgage-backed security 

(CMBS) issuance.

In contrast to the relatively sanguine credit 

conditions for corporate borrowers, financial 

conditions in the commercial real estate 

(CRE) sector remain strained amid weak 

underlying economic fundamentals and tight 

underwriting standards by banks. Prices for 

some segments of commercial properties 

have remained at low levels, and vacancy and 

delinquency rates continue to be elevated. 

After a sustained period of tightening, recent 

Chart 4.2.3 Bond Issuance by Nonfinancial Firms

Chart 4.2.4 Corporate Bond Spreads

Chart 4.2.5 Bank Business Lending Standards and Demand
Macroeconomic Environment 29

SLOOS data show that lenders have generally 

refrained from further tightening standards 

on CRE loans. At the same time, moderate 

fractions of respondents indicated stronger 

demand for CRE loans in recent quarters. 

Consistent with these results, the decline 

in CRE loans on banks’ balance sheets has 

slowed over the past year. Nonetheless, credit 

conditions for CRE remain tight by historical 

standards. In particular, respondents to a 

special question in the July 2011 SLOOS 

reported that CRE standards were at or near 

their strictest levels since 2005, and the survey 

results have shown little change in standards, 

on net, since July 2011. 

After relatively strong post-crisis issuance of 

CMBS in the first half of 2011, the amount of 

new CMBS issuance has been more subdued 

recently, and issuance in early 2012 was slightly 

below the pace set in the first half of 2011 

(Chart 4.2.8). CMBS delinquency rates and 

spreads remained high as borrowers struggled 

to refinance much of the approximately $33 

billion in maturing five-year loans that were 

originated at the peak of CRE prices in 2007. 

4.2.3 Noncorporate Business Sector

Small business lending remains subdued, in part 

because of the ongoing low real estate prices that 

have reduced the value of potential collateral for 

small business loans. There are some signs, however, 

that credit conditions for small business are 

gradually improving.

Net worth in the noncorporate sector, which 

is composed primarily of small businesses, fell 

sharply during the downturn but turned up in 

2010 and grew a bit more in 2011. Real estate 

comprises a large share of the assets held by the 

noncorporate sector (Chart 4.2.9), so changes 

in real estate values tend to have a very large 

impact on small business balance sheets. The 

value of real estate assets fell 12 percent in the 

noncorporate sector from 2007 to 2009, leading 

to a significant increase in the ratio of debt to 

net worth (Chart 4.2.10). This ratio recovered 

some in 2010 and 2011, as net worth improved 

Chart 4.2.6 Nonfinancial Corporate Bond Default Rate

Chart 4.2.7 Noncurrent Commercial & Industrial (C&I) Loans

Chart 4.2.8 CMBS New Issuance
30 2012 FSOC / / Annual Report

and debt contracted slightly, but it remains well 

above pre-recession levels.

Small businesses generally have access to a 

narrower range of financing options than 

corporations and thus depend more on bank 

loans, frequently secured by real estate. Since 

the beginning of the financial crisis, lower 

real estate collateral values and strains in 

the banking sector have constrained credit 

availability for many small businesses. However, 

there are signs that credit conditions for 

small businesses are gradually improving. 

Net borrowing by nonfinancial noncorporate 

businesses turned positive in the second half 

of 2011, after declining substantially during 

the crisis (Chart 4.2.11). Furthermore, after a 

sustained period of tightening of standards and 

terms on loans to small businesses, respondents 

to the SLOOS noted some easing on loan 

standards and spreads in recent quarters (Chart 

4.2.12). In addition, since the beginning of 

2012, the fraction of banks reporting stronger 

demand for C&I loans from small businesses 

has edged up. While the stock of small loans to 

businesses on bank balance sheets at the end 

of last year was more than 15 percent below its 

peak before the crisis, these loans ticked up in 

the fourth quarter of 2011, registering their first 

increase since 2008, and continued to increase 

in the first quarter of 2012. 

Business lending by credit unions, which 

predominantly lend to small businesses, 

increased by 6 percent in 2011 to reach nearly 

$16.5 billion. Similar improvements in credit 

conditions are evident in the small business 

surveys conducted by the National Federation 

of Independent Business. The fraction of firms 

reporting that credit had become more difficult 

to obtain declined through the first quarter of 

2012 (Chart 4.2.13). 

Notwithstanding these improvements, the 

fraction of firms reporting difficulty obtaining 

credit remains elevated relative to the pre-crisis 

period. Owners of new businesses, who might 

have tapped into the equity in their homes 

or used their homes as collateral for small 

Chart 4.2.9 Noncorporate Assets

Chart 4.2.10 Noncorporate Credit Market Debt to Net Worth

Chart 4.2.11 Net Borrowing by Nonfinancial Noncorporate 

Businesses
Macroeconomic Environment 31

business loans, have found conditions especially 

challenging in recent years. In addition, 

business receivables at finance companies, an 

important source of small business financing, 

continued to decline through February 2012 

and were down nearly 30 percent from their 

peak in July 2008. 

4.2.4 Household Sector

Household net worth improved slightly, on net, from 

the end of 2010 to the first quarter of 2012. The 

fraction of household income needed to cover debt 

service payments decreased further, though mortgagerelated debt remains high relative to home values. 

Consumer credit has grown steadily, mostly owing to 

an expansion in non-revolving credit, including a 

significant increase in the amount of student loans to 

finance higher education. 

Aggregate household net worth rose almost 

$1 trillion in 2011 to $60.0 trillion (nominal) 

in 2011:Q4, then jumped an additional $2.8 

trillion in 2012:Q1. This large increase in 

household net worth in the first quarter 

primarily reflected gains on corporate equity 

(directly and indirectly held), although gains on 

real estate assets and net saving also contributed 

to this increase in net worth (Chart 4.2.14). 

As discussed earlier, home prices continued to 

decline in 2011 but appear to have stabilized, 

and some measures of home prices have shown 

upticks recently. Owners’ equity in housing has 

remained near a record low of approximately 

40 percent since mid-2008 through March 

2012, roughly 20 percentage points lower than 

its average over 1990 to 2005 (Chart 4.2.15). 

All told, the ratio of household net worth to 

disposable personal income is now around 

its post-WWII average level, although it is far 

below the level reached in 2007. However, not 

all households have experienced a significant 

improvement in their balance sheet positions. 

For example, lower-income households with 

smaller exposures to the stock market have not 

benefitted much from the recovery in equity 

prices over the past several years. 

Household debt outstanding, about threequarters of which is accounted for by home 

Chart 4.2.12 Bank Business Lending Standards and Demand

Chart 4.2.13 Small Businesses’ Difficulty Obtaining Credit

Chart 4.2.14 Household and Nonprofit Balance Sheets
32 2012 FSOC / / Annual Report

Chart 4.2.17 Household Financial Obligations Ratio

mortgages, declined further in 2011. This 

decline represented, to some degree, efforts 

by households to pay down their existing 

debt, as well as a low volume of new mortgage 

originations. It also reflects the effects of 

foreclosures and “short sales,” which have, 

in the aggregate, reduced mortgage debt on 

household balance sheets. Moreover, access 

to residential mortgages remains constrained 

by tight underwriting standards, discussed 

further in Section 5.1.4. Deleveraging by 

households, along with low interest rates, 

various government tax and transfer programs, 

and rising employment and income, have 

helped households manage their monthly 

debt burdens. The household debt service 

ratio—the fraction of disposable income 

needed to cover household debt payments—

continued to fall last year (Chart 4.2.16). The 

financial obligations ratio, which measures a 

household’s burden from a broader measure 

of commitments, including rent payments and 

homeowners’ insurance, also moved down last 

year for homeowners (Chart 4.2.17). 

As of the first quarter of 2012, non-mortgage 

consumer credit outstanding increased nearly 

5 percent from a year earlier to $2.5 trillion. 

Most of this increase in consumer borrowing 

is in non-revolving credit (Chart 4.2.18), which 

accounts for nearly two-thirds of total consumer 

credit as of the first quarter in 2012. Among 

non-revolving credit, student and auto loans 

have been the fastest-growing categories, with 

new student loans primarily originated by the 

federal government. 

Growth in revolving credit, on the other hand, 

has continued to be weak, even contracting 

recently after posting gains in the fourth 

quarter of 2011. The reduction in revolving 

credit is in part driven by the fact that all but 

“super prime” borrowers continue to face 

tight underwriting standards for credit cards 

as lenders pursue higher-quality borrowers. 

While the credit card limits for super prime 

borrowers with credit scores greater than 750 

have been increasing since 2011, limits for 

“prime” borrowers with credit scores between 

Chart 4.2.15 Share of Owners’ Equity in Household Real Estate

Chart 4.2.16 Household Debt Service Ratio
Macroeconomic Environment 33

650 and 749 picked up only slightly. In contrast, 

credit card limits for “subprime” borrowers 

with credit scores less than 650 continued 

to edge down until the end of 2011 (Chart 

4.2.19). Data on credit card solicitations show 

a similar preference by banks toward higher 

quality borrowers.

Delinquency rates for consumer credit remain 

low. Student loan delinquencies and defaults 

are above pre-crisis level, but are below the 

peaks seen during the recession. Relatively low 

delinquency rates for revolving credit and auto 

loans likely reflect, in part, the composition 

shift toward higher-quality borrowers. In 

particular, the increases in delinquency rates 

on credit card and auto loans during the 

crisis were largely driven by a sharp rise in the 

delinquency rate of subprime borrowers, which 

remains significantly above historical levels 

(Chart 4.2.20). In contrast, the delinquency 

rates on credit card and auto loans to super 

prime and prime consumers were more stable 

through the crisis and are currently at their 

historical averages.

At the same time, demand for credit by most 

consumers continues to be modest relative to 

the pre-crisis period as households continue 

to recalibrate their balance sheets in the wake 

of large wealth losses during the crisis, tepid 

gains in labor markets, moderate economic 

growth, and economic uncertainties. Only a 

small fraction of respondents to the SLOOS, 

on net, report stronger demand for credit 

by consumers. Looking across the credit 

spectrum, credit applications increased 

slightly over the past year but, through the first 

quarter of 2012, remained largely subdued 

relative to the pre-crisis period (Chart 4.2.21). 

4.3 Government Sectors 

Government finances in the United States 

deteriorated sharply during the recession, as 

public sector borrowing largely replaced private 

borrowing in credit markets (Chart 4.3.1). So far, 

global financial markets have been able to absorb 

the substantial increase in U.S. federal debt, but 

Chart 4.2.18 Nonmortgage Consumer Credit Flows

Chart 4.2.19 Average Amount of Revolving Credit Available

Chart 4.2.20 Credit Card Delinquency Rates by Credit Score
34 2012 FSOC / / Annual Report

Chart 4.3.2 Federal Unified Budget Surplus

concerns about the prospects for meaningful deficit 

reduction in coming years persist.

4.3.1 Federal Government

The deficit in the federal unified budget 

widened significantly during the recession 

and gradually narrowed thereafter. The 

Congressional Budget Office (CBO) projects 

the deficit in the current fiscal year to be 7.6 

percent of nominal GDP—1.1 percentage points 

lower than in 2011 but substantially above the 

average value of 1.3 percent of GDP for precrisis fiscal years 2000 to 2007 (Chart 4.3.2). 

This appreciable increase in the deficit mostly 

reflects the usual cyclical response of revenues 

and spending to a weak economy, as well as the 

fiscal actions taken to ease the effects of the 

recession and aid the recovery.

The outlook for the budget over the medium 

term is subject to considerable uncertainty 

with respect to both the performance of the 

economy and the policy path that will be 

followed. The CBO presents two scenarios 

based on different assumptions about 

expenditure and tax configurations. In the 

CBO baseline projection for the period 

through 2022, which assumes that current laws 

generally remain unchanged, the deficit shrinks 

appreciably over the next couple of years and 

remains small thereafter. However, in the CBO 

“Alternative Fiscal Scenario,” which is arguably 

more plausible because it generally maintains 

the tax and spending policies that have recently 

been in effect, the deficit narrows much less 

in the near term and turns back up after 2018, 

mainly because of the budgetary pressures 

stemming from the aging of the population and 

rapidly rising costs for health care. Consistent 

with this projection for the deficit, federal debt 

held by the public is expected to rise from 68 

percent of GDP at the end of fiscal year 2011 to 

93 percent of GDP in 2022 (Chart 4.3.3).

Concerns about the budget outlook weighed 

on the rating agencies’ assessments of U.S. 

sovereign debt. In August 2011, Standard and 

Poor’s downgraded the long-term sovereign 

credit rating of the United States, citing that 

Chart 4.2.21 Applications for Credit

Chart 4.3.1 Net Debt Outstanding as a Percent of GDP
Macroeconomic Environment 35

the effectiveness, stability, and predictability 

of American policymaking and political 

institutions had weakened at a time of fiscal 

and economic challenges. (See Box A: Impacts 

of Downgrade of U.S. Treasury Securities.)

Moody’s and Fitch have U.S. sovereign debt 

on negative outlook. These rating actions do 

not appear to have affected the demand for 

Treasury securities, as market participants 

continue to purchase U.S. debt for its relative 

safety and liquidity. Bid-to-cover ratios at 

Treasury security auctions remain at the top 

end of historical ranges, and indicators of 

foreign participation have remained on trend 

with recent years. 

Despite the sizable increase in public debt 

outstanding, net interest costs amounted to 

only about 1.5 percent of GDP in recent years, 

consistent with trends of the past decade but 

lower than average values during the 1990s 

of about 3 percent of GDP (Chart 4.3.4). This 

decline reflects the fact the interest rates 

have fallen to historically low levels even as 

debt outstanding has increased. The average 

maturity of public debt outstanding has 

risen sharply since late 2008 and is above its 

30-year average. 

4.3.2 State and Local Governments

State and local budgets were strained during 

the recession, and municipalities continue 

to struggle to repair their fiscal positions. 

From the middle of 2008 to April 2012, these 

governments cut roughly 650,000 jobs (more 

than 3 percent of their workforces) and 

trimmed other operating expenditures to satisfy 

balanced budget requirements. They have also 

reduced capital expenditures, which, in real 

terms, have fallen to their lowest levels since the 

late 1990s. In part because of the weakness in 

capital spending, state and local borrowing has 

decelerated noticeably since the onset of the 

recession, and posted a small decline in 2011 

and in the first quarter of 2012 (Chart 4.3.5).

State and local government tax revenues, in 

aggregate, began to register mild growth in 

2010 after declining in the aftermath of the 

Chart 4.3.3 Federal Debt Held by the Public

Chart 4.3.4 Interest Outlays and Average Maturity of U.S. 

Public Debt

Chart 4.3.5 Change in State and Local Government Debt
36 2012 FSOC / / Annual Report

Chart 4.3.7 Change in Local Tax Revenue

Chart 4.3.8 Municipal Bond Issuance by Type

financial crisis (Chart 4.3.6). Much of the 

improvement has been at the state level, where 

personal income tax receipts in particular 

have picked up as the economic recovery has 

proceeded. In contrast, tax collections at 

the local level have exhibited essentially no 

growth over the past two years, mainly because 

property tax collections, which account for 

roughly three-fourths of local tax revenues, 

have been depressed by the downturn in home 

prices and a reluctance to raise tax rates at a 

time when real incomes of constituents are 

under pressure (Chart 4.3.7).

Overall, the resources available to state and 

local governments to finance their spending 

remain tight. The sector’s tax revenues are 

only slightly higher than they were in 2008. 

The federal stimulus grants provided under 

the American Recovery and Reinvestment Act 

of 2009 have largely wound down, and other 

initiatives (e.g., the Build America Bonds 

program) have expired. Many states have cut 

back on assistance to their localities in order to 

shore up their own budgets. Finally, balances 

in reserve funds, which provide an important 

safety valve in times of budgetary stress, have 

been depleted in many cases.

As a result of these budgetary issues, net credit 

flows to state and local governments have been 

mixed over the past year. While the amount 

of revenue bonds issued continues to exceed 

the amount of general obligation bonds, the 

share of general obligation bonds among the 

total issuance increased substantially in 2012 

(Chart 4.3.8). Net issuance of municipal bonds 

has been slow as of late, in part reflecting the 

weakness in infrastructure investment and 

ratings downgrades by Moody’s over the past 

12 months, which have substantially outpaced 

upgrades. At the same time, the cost of 

municipal bonds—as measured by the yield 

ratio to similar maturity Treasury securities—

has risen, with investors demanding higher 

returns from issuers facing fiscal challenges 

(Chart 4.3.9). The issuance of Variable Rate 

Demand Obligations (VRDOs), an important 

source of funding for municipalities, has 

Chart 4.3.6 Change in State Tax Revenue
Macroeconomic Environment 37

also been declining since the financial crisis 

(Chart 4.3.10). A primary reason is the gradual 

retraction of European banks from providing 

liquidity to this market. 

Budget trajectories will remain challenged 

in coming years, as many state and local 

governments will need to increase their 

contributions to their employee pension funds, 

both to rebuild assets after experiencing 

significant financial losses and to address 

chronic underfunding during the past 

decade. In addition, many governments are 

not setting aside money to fund their ongoing 

obligations to provide health care to their 

retired employees. Unfunded liabilities remain 

substantial. Estimates of aggregate unfunded 

pension liabilities span a wide range, in part 

because of differences in how liabilities are 

valued, but may be in the range of $2 trillion 

to $3 trillion. (For an additional discussion 

of accounting issues related to state and local 

pension funds, see Section 5.3.5.) Estimates 

for the cost of providing retiree health benefits 

are subject to even greater uncertainty, in part 

because of the difficulty of projecting health 

care costs decades into the future, but one 

estimate put the states’ collective unfunded 

liability as of 2010 at over $625 billion.

4.4 External Environment

Outside of the United States, both realized and 

prospective growth rates have been mixed over the past 

year. The primary financial stability focus has been on 

the developments in Europe. Despite ongoing efforts 

by European authorities to contain the crisis, debt 

sustainability concerns, fiscal consolidation efforts, 

bank deleveraging, and funding market stresses on 

banks and sovereigns continue to weigh on European 

growth prospects. Outside of the euro area, foreign 

growth picked up in 2012:Q1, with lower growth 

in the euro area and China partly offset by more 

positive developments in other regions. The tone of the 

incoming data in 2012:Q2 is decidedly weaker. 

4.4.1 Advanced Foreign Economies

In the aggregate, the advanced economies 

maintained positive growth through 2011 and 

Chart 4.3.9 Municipal Tax-Exempt Bond Yield Ratios

Chart 4.3.10 ARS and VRDO Funding of Long-Term Muni Bonds
38 2012 FSOC / / Annual Report

Chart 4.4.3 Euro Area GDP Growth

early 2012 (Chart 4.4.1). The growth rates 

across advanced economies reflect a mix of 

more positive outcomes in the United States 

and Japan, among others, and the challenges 

within European countries in managing fiscal 

problems, bank funding stress and deleveraging, 

and structural change (Chart 4.4.2). 

Euro Area Economic Conditions and 

Policy Initiatives

Over the last 12 months, the euro area 

sovereign debt crisis intensified as concerns 

about the sustainability of public finances and 

the robustness of banks in some countries 

soared. Some European financial institutions 

faced reduced access to funds, reflecting in 

part their large exposures to stressed sovereigns 

as well as their reliance on wholesale funding 

markets, including short-term dollar funding 

provided by money market funds. European 

leaders recognize the need to deepen their 

economic and monetary union, as exemplified 

by the new fiscal compact treaty signed by most 

European Union (EU) members in March 

2012 and by the proposal to establish a single 

European banking supervisor put forth in June 

2012. Work continues on elaborating a systemwide solution capable of commanding both 

political and market support.

The euro area economies experienced a 

widespread slowing of economic activity due 

to the intensification of the crisis, the effects 

of banking problems and the related bank 

deleveraging on lending to the real economy, 

and the impact of fiscal consolidation efforts. 

Despite various measures implemented by the 

European authorities to combat the crisis, 

discussed below, the euro area GDP contracted 

by 1.2 percent (annual rate) in the fourth 

quarter of 2011, and the GDP growth rate 

for the first quarter of 2012 was near zero. 

Similarly, labor market conditions deteriorated 

further, as the unemployment rate reached 

11.1 percent in May 2012, the highest level 

since 1995. 

Growth prospects in the euro area differ across 

countries (Chart 4.4.3). Germany, France, and 

Chart 4.4.1 Real GDP Growth

Chart 4.4.2 Developed Market Economies GDP Growth
Macroeconomic Environment 39

Ireland continue to grow, although at a more 

subdued pace, while Italy, Spain, Portugal, 

and Greece are projected to contract, with 

unemployment rates rising substantially. 

Vulnerable European countries continue to 

face important challenges as they strive to 

improve fiscal positions, strengthen vulnerable 

banks, and carry out structural reforms to 

improve their long-term growth outlook, even 

as short-term growth is weak or negative. The 

stresses in the sovereign debt markets of euro 

area countries are discussed in greater detail 

in Section 5.1.

European authorities responded to these 

developments with a number of policy 

measures. In response to Greece’s plunging 

output and challenges meeting fiscal targets, 

EU and IMF officials, the Greek government, 

and private creditors finalized an enhanced 

rescue package in February 2012. This package 

included a more ambitious private-sector debt 

exchange involving a significant principal 

write-down, together with additional official 

financing through early 2016. (See Box B: 

Greek Sovereign Debt Restructuring.)

Additionally, European authorities took actions 

to improve the fiscal governance in the region 

and to enhance their ability to provide financial 

support to euro area countries under stress. 

EU members, excluding the United Kingdom 

and the Czech Republic, signed a new fiscal 

compact treaty designed to strengthen fiscal 

rules, enhance surveillance, and improve 

enforcement. This treaty, if ratified, would 

require countries to legislate national fiscal 

rules and should generally limit structural 

fiscal deficits to 0.5 percent of GDP. Authorities 

moved up the introduction of the European 

Stability Mechanism (ESM), a permanent €500 

billion lending facility, to July 2012—about 

a year earlier than originally planned. In 

addition, they agreed to increase the combined 

lending capacity of their rescue facilities from 

€500 billion to €700 billion, of which €500 

billion remains uncommitted. Moreover, 

European authorities augmented the scope and 

flexibility of the existing facilities, empowering 
40 2012 FSOC / / Annual Report

Chart 4.4.4 ECB Liquidity Providing Operations them to purchase sovereign debt in primary and 

secondary markets and offer debt guarantees.

European policymakers also took steps to 

strengthen the capital positions of euro area 

financial institutions. In October of 2011, the 

European Banking Authority (EBA) announced 

that large banks would be required to build 

up “exceptional and temporary” capital 

buffers to meet a core tier one capital ratio 

of 9 percent and cover the cost of marking to 

market their sovereign debt exposures by the 

end of June 2012. According to a December 

2011 EBA report, 62 banks intended to create 

capital buffers equivalent to €98 billion, 

about 25 percent larger than required. (This 

does not include the Greek banks and three 

other institutions that would be recapitalized 

separately by national authorities.) More 

recently, in June 2012, Spain requested EU 

assistance to recapitalize its banking sector. 

(See Box C: Recent Fiscal and Banking 

Developments in Spain.) Finally, in an effort to 

address the link between banks and sovereigns, 

euro area leaders agreed in late June 2012 to 

establish a single supervisory mechanism for 

banks in the euro area and to grant the ESM 

the possibility of recapitalizing banks directly.

Meanwhile, the European Central Bank (ECB) 

adopted various policy measures to support 

liquidity conditions in financial markets. First, 

in August 2011, the ECB resumed purchases 

of euro area marketable debt, including the 

debt of Italy and Spain, in order to improve 

the functioning of sovereign debt markets 

and facilitate the transmission of monetary 

policy in the region. Then, in December 2011, 

the ECB eased rules on collateral for ECB 

refinancing operations and scheduled two 

longer-term refinancing operations (LTROs) 

to improve banks’ funding conditions. With 

the LTROs, the value of outstanding ECB 

liquidity providing operations has increased to 

over €1.25 trillion (Chart 4.4.4). Moreover, in 

November 2011, the Bank of Canada, the Bank 

of England, the Bank of Japan, the ECB, the 

Federal Reserve, and the Swiss National Bank 

engaged in coordinated actions to enhance 
Macroeconomic Environment 41

their capacity to provide liquidity support 

to the global financial system. In particular, 

the reduced fees applied to draws on dollar 

liquidity swap lines provided by the Federal 

Reserve, as well as the extended expiration of 

these facilities, were intended to ease strains 

in financial markets and thereby mitigate the 

effects of such strains on the supply of credit to 

households and businesses.

These measures contributed to improvements 

in euro area financial conditions during 

the first few months of this year, with dollar 

funding pressures substantially diminished. 

The net result was a considerable narrowing of 

euro-dollar foreign exchange (FX) swap basis 

spreads, reflecting reduced short-term dollar 

funding pressure for euro area institutions 

(Chart 4.4.5). Recent utilization of the dollar 

liquidity swap lines peaked at over $100 billion 

in February 2012, with the outstanding amount 

for the Federal Reserve’s dollar liquidity swap 

lines at $28 billion as of July 4 (Chart 4.4.6). 

Growth and financial stability conditions in 

the euro area remain under pressure. Market 

participants are attentive to the limited capacity 

of the euro area financial backstop in the 

context of its multiple possible uses. Although 

the Greek debt restructuring and subsequent 

triggering of credit default swap (CDS) 

contracts, discussed further in Box B: Greek 

Sovereign Debt Restructuring, passed without 

broad market disruption, much uncertainty 

remains in the region. Uncertainty about fiscal 

consolidation and structural reform highlight 

the challenges of adjustment within a monetary 

union. Meanwhile, concerns about other 

European peripherals (including Portugal, 

Ireland, Italy, and Spain), especially around 

fiscal sustainability, health of their banking 

sectors, and general competitiveness of their 

economies, continue to weigh on real growth 

and financial activity in these countries.

4.4.2 Emerging Market Economies

In the second half of last year, economic growth 

in many EMEs slowed slightly, as earlier policy 

tightening, a weakening of external demand 

Chart 4.4.5 Euro-Dollar Implied FX Swap Basis

Chart 4.4.6 Total Swap Line Amount Outstanding
42 2012 FSOC / / Annual Report

Chart 4.4.8 Net International Financial Flows to EMEs

owing to the fiscal crisis in Europe, and supply 

chain disruptions stemming from floods in 

Thailand weighed on growth (Chart 4.4.7). 

At the beginning of this year, growth in EMEs 

rebounded, reflecting a restoration of the 

normal supply chain and some improvement in 

demand from advanced economies. However, 

the indicators for the second quarter of 2012 

suggest significantly weaker activity in EMEs.

On balance, EMEs have received substantial 

volumes of net inflows of capital since late 2009, 

which also contributed to currency appreciation 

pressures. These inflows decelerated in the 

second half of last year, reflecting both a 

general flight to safety and concerns about 

growth spillovers from the deteriorating 

situation in Europe (Chart 4.4.8). Declining 

commodity prices are also a concern for 

some emerging economies, particularly in 

Latin America. Overall, while growth across 

major EMEs, including Brazil, Mexico, India, 

Russia, and China, stayed firmly in positive 

territory, these global headwinds weighed on 

local prospects.

Chinese growth prospects remain relatively 

solid by international standards. Year-overyear growth slowed in 2012:Q1 to just above 8 

percent, reflecting weaker investment spending, 

with macro-prudential restrictions weighing 

on the property sector, and slower export 

growth, especially to Europe. A possible hard 

landing of the Chinese economy is a risk that 

could spill over to other EMEs and the global 

economy, which has created some anxiety in 

financial markets. There are growing concerns 

that weaker external demand in the advanced 

economies, combined with a deceleration in 

domestic investment, could lead to a more 

prolonged economic slowdown in China than 

was previously expected. Another source of 

concern is the movement of savings into lesswell-regulated nonbank financing channels 

in an effort to obtain higher yields. Finally, 

additional risks could emerge from stresses in 

the banking sector, stemming from the massive 

increase in credit to the domestic economy 

(“social financing” in the official Chinese 

Chart 4.4.7 Emerging Market Economies GDP Growth
Macroeconomic Environment 43

terminology), deployed as part of China’s policy 

response to the global financial crisis in 2008-

2009 (Chart 4.4.9). To contain a potential 

run-up in inflation, property prices, and debt 

levels resulting from this credit expansion, 

Chinese authorities began taking a tighter 

monetary stance in late 2010, with some success. 

But with the latest data pointing to weakerthan-expected economic activity in China in 

the first five months of 2012, authorities began 

implementing a number of fiscal and monetary 

measures to support growth. 

Chart 4.4.9 Change in Total Chinese Social Financing

Financial Developments 45

Chart 5.1.1 Federal Debt Outstanding Held by Public

U.S. Sovereign Debt

The total amount of outstanding U.S. sovereign 

debt has risen to $11.0 trillion as of May 31, 

2012 (Chart 5.1.1). Despite this increase in 

supply, the U.S. sovereign yield curve flattened 

considerably since mid-2011, with a decline 

in longer-term yields driving this change 

(Chart 5.1.2). The historically low levels of 

longer-term yields are a reflection of both 

flight to quality and continued monetary policy 

accommodation associated with the weak 

pace of economic growth and the elevated 

unemployment rate. 

Foreign holdings of U.S. debt remain 

substantial, with over $2.2 trillion of U.S. 

Treasury securities held by China and Japan 

and almost $3 trillion across other foreign 

holders in April 2012 compared to about $2 

trillion and $2.4 trillion, respectively, in April 

2011 (Chart 5.1.3). Nearly three-quarters of 

these holdings are by foreign official entities.

5 Financial Developments

5.1 Major Financial Markets

5.1.1 Sovereign Debt Markets

Developments in sovereign debt markets during the 

last year were heavily influenced by the escalation 

of uncertainty in euro area sovereign and banking 

sectors and by continued concerns about the domestic 

and global growth outlook. While sovereign debt 

from the euro area periphery remains stressed, yields 

for sovereign debt from the United States, the United 

Kingdom, Germany, Switzerland, and Japan are 

at record or near-record lows, reflecting flight to 

quality and continued expectations of accommodative 

monetary policy.

Chart 5.1.2 Yield Curve

Chart 5.1.3 Foreign Holders of U.S. Federal Debt
46 2012 FSOC / / Annual Report

In addition to the U.S. sovereign rating, several other 

entities were downgraded shortly after August 5. These 

included clearinghouses, highly rated insurers, and various 

government related entities and their debt. 

There was little market reaction to a move by the Chicago 

Mercantile Exchange (CME) to increase haircuts on U.S. 

Treasury securities just before the downgrade, and most 

clearinghouses did not adjust their haircuts on Treasury 

securities even after the downgrade. 

BOX A: IMPACTS OF DOWNGRADE OF U.S. TREASURY SECURITIES 

On August 5, 2011, Standard & Poor’s (S&P) lowered their 

long-term sovereign credit rating on the United States of 

America to AA+ from AAA and reaffirmed their short-term 

rating of A-1+. S&P stated that the downgrade reflected 

their opinion that the Budget Control Act, which was 

signed into law on August 2, fell short of what would be 

“necessary to stabilize the government’s medium-term 

debt dynamics.” They further stated that, “More broadly, 

the downgrade reflects our view that the effectiveness, 

stability and predictability of American policymaking and 

political institutions had weakened at a time of ongoing 

fiscal and economic challenges.”

Before the downgrade, there was significant market 

focus on the debt ceiling debate in Congress. As the 

deadline approached, there were dislocations in the front 

end of the Treasury yield curve, and some T-Bill yields 

rose dramatically then normalized after the debt limit 

was raised.

Because of widespread speculation in the market that 

S&P would take action, and the relatively minor scale 

of the downgrade, Treasury market participants were 

prepared, and there were no reports of forced selling. 

Also, many institutions’ portfolio restrictions specifically 

carved out “obligations of the U.S. government” rather 

than specifying a level or degree of credit rating. 

Treasury yields fell immediately following the downgrade, 

while major stock indices declined, indicating that 

investors were less concerned with the inherent 

riskiness of Treasury securities than with the potential 

consequences of fiscal retrenchment for the near-term 

macroeconomic recovery. Specifically, on Monday August 

8 (the business day immediately following the downgrade), 

the 10-year Treasury yield closed down 24 basis points. 

The cumulative yield changes through August 11 for the 

two-year, five-year, and ten-year yields were -10 basis 

points, -23 basis points, and -22 basis points, respectively 

(Chart A.1). Risky securities lost value following news of 

the downgrade, with the S&P 500 index registering a 6.8 

percent decline and the Nikkei index falling by 2.2 percent 

by close of trading August 8 (Chart A.2). 

Chart A.1 S&P Downgrade of U.S. Debt: Flight to Quality

Chart A.2 S&P Downgrade of U.S. Debt: Effect on Equities
Financial Developments 47

Chart 5.1.4 Euro Area 10-Year Yield Spreads to German Debt European Sovereign Debt

Over the last 12 months, the European 

fiscal crisis intensified as concerns about the 

sustainability of public finances in peripheral 

European countries escalated and banks 

struggled to obtain financing. (See Section 4.4.) 

In July 2011, euro area authorities proposed a 

voluntary debt exchange on Greek sovereign 

bonds. This, along with weakening growth 

prospects and fiscal slippage, led to a surge in 

Greek government bond yields (Chart 5.1.4). 

As discussed in Section 4.4, European 

authorities responded to these developments 

with a number of policy measures. The private 

sector exchange of Greek sovereign debt, which 

was largely concluded in March of this year, 

involved a significant principal write-down 

and additional official disbursements of aid 

financing through early 2016. The insertion 

and triggering of collective action clauses for 

the purpose of the debt exchange caused credit 

default swaps (CDS) contracts written on Greek 

sovereign debt to be triggered, which occurred 

without any significant market disruptions. 

The participation rate in this exchange was 

over 95 percent. (See Box B: Greek Sovereign 

Debt Restructuring.)

More recently, market pressure on Spain 

intensified. On May 11, the Spanish government 

announced a series of measures to address 

vulnerabilities in the Spanish banking sector, 

including enhanced provisioning requirements 

on real estate related loans, clear separation of 

problem real estate assets into independently 

managed asset management vehicles, and plans 

to have independent external auditors evaluate 

the quality of bank assets. This was followed 

two weeks later by an unexpectedly large 

capital support request from Bankia, Spain’s 

fourth largest bank, and on June 9 by Spain’s 

announcement of its intent to request European 

support for bank recapitalization (for which 

European authorities agreed to provide up to 

€100 billion). (See Box C: Recent Fiscal and 

Banking Developments in Spain.)
48 2012 FSOC / / Annual Report

protection sellers subsequently paid out only an estimated 

$2.5 billion to protection buyers, reflecting the relatively 

small net exposure to outstanding CDS contracts. 

Chart B.2 Greece: Debt Exchange

As with all International Monetary Fund (IMF) programs, 

sustainable debt dynamics were a pre-condition for 

European Union (EU) and IMF lenders to disburse funds 

under a second official sector aid program. Greece’s debt 

restructuring helped to achieve this, putting Greece’s 

high public debt burden (165 percent of GDP in 2011) on 

a path toward 120 percent by 2020. Although the debt 

exchange substantially reduced Greece’s outstanding 

debt to private sector creditors, Greece’s overall debt 

burden is expected to remain quite heavy, reflecting 

continued borrowing from official sector creditors to 

finance the debt exchange, bank recapitalization costs 

related to losses resulting from the debt exchange and 

deteriorating asset quality, and continued deficit financing. 

As a result, public sector creditors are projected to 

hold nearly three-quarters of Greek sovereign debt by 

end of 2012. The new Greek bonds trade at distressed 

levels; yields hovering near 20 percent reflect Greece’s 

heavy indebtedness and the high degree of uncertainty 

about the outlook for implementation of Greece’s reform 

program. On June 17, parties supporting the EU/IMF aid 

program won enough seats in the Greek Parliament to 

form a governing majority, easing fears about a near-term 

exit from the euro and confirming Greece’s commitment 

to reform. 

BOX B: GREEK SOVEREIGN DEBT RESTRUCTURING 

In March and April 2012, Greece restructured 

approximately €199 billion in government and governmentguaranteed debt through a discounted exchange of 

instruments. Due to the use of collective action procedures, 

the restructuring was subsequently deemed a credit event 

by the International Swaps and Derivatives Association 

(ISDA), triggering payouts on Greek credit default swaps 

(CDS). In the aftermath of the Greek restructuring event, the 

CDS market largely functioned as intended. Despite early 

attempts to achieve a purely voluntary restructuring that 

would have circumvented a CDS trigger, low preliminary 

participation rates indicated a need to trigger collective 

action clauses to force higher participation, which in turn 

triggered CDS payouts (Chart B.1). 

Chart B.1 Greece: Average Bond Price and CDS

The exchange reduced Greece’s debt held by the private 

sector by €106 billion, equivalent to 53.5 percent of the 

tendered debt. Creditors participating in the exchange 

received a combination of new Greek government bonds 

(31.5 percent for a total of €63 billion) and short-term 

European Financial Stability Facility (EFSF) notes (15 

percent for a total of €30 billion) (Chart B.2). Participating 

creditors also received detachable GDP warrants, which 

pay up to 1 percent of the outstanding bonds’ face 

amount in years when real GDP growth and nominal 

GDP exceed specified targets. Taking into consideration 

the lower coupons and extended maturities of the new 

bonds, the exchange entailed net present value losses for 

participating creditors estimated at 75-80 percent. CDS 
Financial Developments 49

The strains in the peripheral euro area 

sovereign debt and bank funding markets 

also caused additional pressure in some core 

countries, such as France. In August 2011, the 

central banks of the euro system recommenced 

purchasing euro area sovereign bonds, 

including Spanish and Italian bonds, in the 

context of the Securities Markets Programme 

(SMP), to address the severe tensions in some 

market segments that had been hampering 

monetary policy transmission. This activity 

occurred in the context of intensified 

strains in peripheral sovereign debt markets, 

widening credit spreads and bid-ask spreads, 

particularly for Spanish and Italian sovereign 

debt, and sharply higher liquidity risk premia. 

As funding markets tightened further, euro 

area governments announced plans for 

enhanced fiscal and structural reforms, while 

central banks announced the extension and 

repricing of U.S. dollar swap lines, and the 

European Central Bank (ECB) implemented 

two unprecedented three-year longer-term 

refinancing operations (LTROs), as discussed 

in Section 4.4. 

These various measures helped stabilize 

markets in late 2011 and early 2012, as new 

governments were elected in Spain and Italy. 

However, general uncertainty over conditions 

in the euro area has increased once again over 

the past few months, as the sustainability of the 

strategies currently being undertaken in the 

hardest hit countries is called into question. 

Sovereign debt and bank credit spreads 

increased for Spain and Italy, after having 

narrowed over the first quarter of 2012. Credit 

spreads remain elevated in many sovereign 

debt and bank funding markets—notably 

for bank maturities beyond the ECB LTRO 

period of three years—and market functioning 

remains irregular with marked recent pressure 

on spreads in Italy and Spain. The primary 

buyers of Italian and Spanish sovereign debt in 

recent months have been their own domestic 

banks, which in turn rely on ECB financing and 

support. Private foreign investors, such as prime 

money market funds (see Section 5.3), have 

continued to reduce participation in euro area 
50 2012 FSOC / / Annual Report

BOX C: RECENT FISCAL AND BANKING DEVELOPMENTS IN SPAIN 

Spain announced on June 9 that it intends to request 

European Union (EU) assistance to recapitalize its 

troubled banking sector. Euro area finance ministers 

indicated they would support the request for up to €100 

billion (10 percent of GDP), which is expected to cover 

estimated stress-case capital needs plus an additional 

safety margin. On June 21, independent consultants 

engaged by the Spanish government estimated the 

recapitalization needs of Spanish banks at up to €62 

billion under an adverse macroeconomic scenario. The 

formal request is expected to follow this estimate, which is 

within the range of most private estimates of capital needs 

(€50 billion to €100 billion). Although the announcement 

stipulates that no additional explicit conditionality will be 

imposed with regards to fiscal policy, Spain must meet 

existing fiscal and structural reform commitments, which 

were previously agreed with the EU. 

On June 29, euro area heads of government agreed 

to use euro area funds to support Spanish banks. The 

region’s finance ministers subsequently announced that 

the agreement would be signed on July 20 and an initial 

tranche of €30 billion would be disbursed by the end 

of July. The funds will be channeled through the EFSF 

to the Spanish government, and then transferred to 

the European Stability Mechanism (ESM) once it is fully 

operational. Direct ESM funding to Spanish banks will 

become available only after the establishment of a single 

supervisory mechanism for euro area banks. It was 

further agreed that aid for the Spanish banking sector 

would not be subject to the preferred creditor status 

embedded in the ESM treaty.

Separately, Moody’s, S&P, and Fitch downgraded the 

Spanish sovereign by several notches into the BBB 

range within the last two months, largely reflecting 

concerns about the Spanish banking sector and fiscal 

performance. The sovereign downgrades were followed 

by downgrades of the banks themselves. Notably, the 

International Monetary Fund (IMF) concluded from 

its stress tests that Spain’s largest banks appear 

sufficiently capitalized to withstand a significantly weaker 

macroeconomic environment, given their substantial 

earnings generation from international operations.

Concern about Spanish fiscal performance has persisted, 

fueling doubts about the prudence of adhering to strict 

budget targets amid deepening recession. As a result, 

euro area finance ministers agreed on July 9 to ease 

Spain’s deficit objectives, raising the 2012 target by one 

percentage point to 6.3 percent of GDP and giving the 

government an additional year—to 2014—to lower the 

deficit below 3 percent of GDP. The agreement will be 

made official at the next Eurogroup meeting on July 20. 

The relaxation of fiscal targets follows two revisions to the 

2011 fiscal deficit. On May 20, the Spanish government 

revised its 2011 budget deficit upward to 8.9 percent 

of GDP from a previous 8.5 percent estimate, a major 

deviation from the 6 percent target. Both the overrun and 

the latest revision were driven by the deficits of regional 

governments, exposing the difficulty of reining in these 

regional deficits. Market reaction to developments in 

Spain subsequent to the assistance request was generally 

negative, with yields on 10-year Spanish sovereign debt 

exceeding 7 percent, a euro era high.
Financial Developments 51

sovereign and bank funding markets. European 

pension funds and insurance companies also 

have reduced exposures to the periphery, 

including to Spanish and Italian sovereign debt.

Other Sovereign Debt

The decline in yields across a range of 

developed countries’ sovereign bonds has 

been further reinforced by strong investor 

interest in high credit quality assets and more 

accommodative monetary policies. Through 

early July 2012, 10-year nominal U.S. Treasury 

yields had declined more than 150 basis points 

since July 2011, in part reflecting both the 

lower expected path of short-term interest 

rates and a fall in the term premium. The 

pattern of decline in yields has been similar 

for German, Swiss, and U.K. sovereign debt. In 

Japan, 10-year sovereign debt yields, which were 

already close to 115 basis points, declined more 

modestly to just below 85 basis points over the 

same period (Chart 5.1.5). 

Emerging European market spreads to 

Treasury yields as measured by the Emerging 

Markets Bond Index Plus (EMBI+), have 

widened over 100 basis points over the past 

year through early July—largely in line with 

U.S. BBB corporate credit spreads—reflecting 

global growth concerns and the pull-back in 

risk appetite, as well as specific developments 

in certain countries. The spreads on bonds 

for other emerging markets also fluctuated in 

response to stresses and policies in external 

markets (Chart 5.1.6). Some differences 

across emerging market economies are 

likely associated with country risk and 

growth prospects, as well as their policies for 

managing capital inflows and outflows. 

5.1.2 Other Asset Markets

Asset markets outside of sovereign debt have also been 

heavily influenced by developments in the euro area 

and the growth outlook, with the notable exception of 

agricultural land and some commodities. Corporate 

debt spreads widened over the past 12 months, with 

spreads for financial firms increasing more than for 

nonfinancial firms. The dollar appreciated against 

the euro, reflecting continued concerns with euro area 

peripheral sovereign debt.

Chart 5.1.5 10-Year Sovereign Debt Yields

Chart 5.1.6 Emerging Market Bond Spreads
52 2012 FSOC / / Annual Report

Chart 5.1.8 Global Equities

Equities

U.S. equity markets outperformed other major 

equities markets from mid-year 2011 through 

early July 2012 after a period of considerable 

volatility (Chart 5.1.7). Equity markets in 

advanced and emerging economies fell sharply 

in the third quarter of 2011 as numerous 

concerns—including the unfolding European 

crisis, the sustainability of U.S. fiscal policy, 

and a slowdown in global growth—weighed 

on sentiment (Charts 5.1.8). By early October 

2011, the S&P 500 was around 17 percent below 

its level at the end of June 2011. The Euro 

Stoxx index declined around 27 percent over 

the same period, reflecting outsized declines 

in peripheral equity markets. As concerns 

subsequently eased during the first quarter of 

2012, buoyed in part by global central bank 

actions and ongoing signs of economic recovery 

in the United States, U.S. equity markets 

reported strong gains. However, much of these 

recent gains in the United States have reversed 

following weaker than expected data on the 

U.S. recovery, weak global economic data and 

renewed concerns about the European crisis. As 

of July 6, 2012, the S&P 500 was nearly 4 percent 

lower than at the end of the first quarter of 

2012, and European stocks fell almost 10 

percent over the same period.

Corporate Bonds

Corporate bond spreads to sovereign 

equivalents in the United States and Europe 

have generally widened since mid-2011, 

although this development has been less 

pronounced in the United States. A particular 

feature has been the large divergence between 

spreads on debt issued by financial firms 

versus nonfinancial firms, as investors focus 

on risks associated with the financial sector 

(Chart 5.1.9). A similar pattern can be found in 

the relative increase in CDS spreads of financial 

firms over nonfinancial firms. Issuance of 

covered bonds has outpaced unsecured debt 

issuance in a number of European banking 

systems, reflecting increased concerns about the 

creditworthiness of these institutions. Overall, 

U.S. dollar corporate bond issuance has 

rebounded strongly in 2012, particularly among 

nonfinancial issuers. 

Chart 5.1.7 Price Changes in Selected Equities Indices

Chart 5.1.9 U.S. Corporate Bond Spreads—Investment Grade
Financial Developments 53

Foreign Exchange 

Over the past 12 months, foreign exchange 

markets were strongly influenced by euro 

area developments and monetary policy 

expectations. The euro broadly declined over 

the second half of 2011 and first half of 2012, 

with downside pressure against the major 

currencies particularly evident late in 2011 

and 2012:Q2. In dollar-euro markets, bid-ask 

spreads widened slightly and options markets 

placed above average value on protection from 

further euro depreciation. Within Europe, 

the sharp depreciation against the safe haven 

of the Swiss franc prompted a strong market 

intervention by the Swiss National Bank in 

August and early September 2011, culminating 

with the establishment of a floor for the eurofranc exchange rate. Downside pressure on 

the euro against major currencies abated 

somewhat in early 2012, particularly against 

the yen. The Bank of Japan had intervened 

in foreign exchange markets in late October 

through early November 2011, selling yen and 

buying dollars, and also engaged in further 

monetary easing through the end of April 2012. 

The improvement in risk tone over that period 

was also associated with a partial rebound in 

many emerging market currencies, after they 

had depreciated sharply in the second half 

of 2011 as reflected in the other important 

trading partners (OITP) and broad dollar 

indices (Chart 5.1.10). More recently many 

emerging market currencies fell against the 

dollar, prompting intervention by some of these 

countries to support their currencies.

Overall, between July 2011 and July 2012, the 

U.S. dollar appreciated by nearly 15 percent 

against the euro, was broadly unchanged 

against the yen, and appreciated against most 

emerging markets currencies. Options markets 

are again placing a relatively high value on 

protection against euro depreciation, as 

measured by the price differential between outof-the-money puts and calls.

Commodities

Commodity prices have displayed elevated 

volatility for the past several years, driven by 

Chart 5.1.10 U.S. Dollar Exchange Rates
54 2012 FSOC / / Annual Report

market-specific fundamental factors as well 

as broader global growth concerns and risk 

sentiment. Oil prices were near their three-year 

highs early in 2012, with continued geopolitical 

uncertainty in the Middle East raising concerns 

over global supply and limited spare capacity. 

More recently, however, prices moderated 

slightly. In the United States, nominal gasoline 

prices were also near historic highs early in 

2012 but have likewise moderated. Natural 

gas prices almost halved over the past year 

on expectations of increased supply arising 

from hydraulic fracturing technology (Chart 

5.1.11), though prices increased again through 

July 6, albeit from quite a low base, as result of 

announced cutbacks in drilling and some signs 

of accelerated coal-to-gas switching activity. 

Industrial metal prices have also declined 

since June 2011, with the majority of the fall 

occurring in the third quarter of 2011, when 

global growth fears were most pronounced. This 

period was also associated with marked strength 

in gold prices. Commodity markets continued 

to function well with only limited impact from 

the bankruptcy of MF Global*, despite its role 

as a futures clearing merchant in these markets. 

(See Box D: MF Global Bankruptcy.)

Agricultural Land

Agricultural land values are estimated to have 

increased further through mid-2011, driven 

by increasing crop yields, rising commodity 

prices, favorable crop export conditions, and 

low interest rates (Chart 5.1.12). Adjusting for 

commodity prices and improvements in crop 

yields, agricultural land values have retreated 

somewhat from the record highs reached in 2005 

and 2006. Price-to-rent ratios for agricultural 

land are at multi-decade highs for a number of 

Corn Belt and Plains states but have moderated 

from peaks for the United States as a whole.

Currently, aggregate incomes in the U.S. 

farm sector are performing well, forecasts 

for production and demand are positive, and 

debt levels in general do not appear to have 

Chart 5.1.11 Commodities

Chart 5.1.12 Farm Land Prices and Value of Crop Yield

Chart 5.1.13 Agricultural Real Estate Debt Outstanding

* Chairman Gensler did not participate in the preparation 

or review of the portions of this report specifically regarding 

MF Global.
Financial Developments 55

been rising sharply. Adjusting for inflation, 

current agricultural real estate debt levels 

remain significantly below the levels of the 

late 1970s (Chart 5.1.13). The Farm Credit 

System and community banks that specialize in 

agriculture lending have the bulk of exposures 

to agricultural land. Delinquency rates on real 

estate farm loans at commercial banks declined 

in recent quarters to about 3 percent at the end 

of 2011, slightly above the historical average of 

about 2.6 percent over the past 20 years.

5.1.3 Wholesale Funding Markets 

Use of short-term wholesale funding has dropped 

significantly, with declines in outstanding volumes of 

both repurchase agreements and corporate paper. This 

development is likely to enhance stability of funding 

for financial institutions, as these entities shift to 

more stable funding sources such as retail deposits. 

However, this shift is partially due to market reaction 

to uncertainty and flight to safety, and it could be 

retraced as these uncertainties abate.

Short-Term Wholesale Funding Markets Overview

Short-term wholesale funding markets, 

which include large time and checking 

deposits, repurchase agreements (repos), 

and commercial paper, provide financial 

intermediaries with funds that supplement 

retail deposits to support their activities (Chart 

5.1.14). Sources of lending in the wholesale 

short-term funding markets are largely 

wholesale cash pools, including cash on the 

balance sheets of nonfinancial companies, 

reinvestments of cash collateral from securities 

lending, cash held by long-term mutual funds, 

and money market funds. These sources of 

funds have grown markedly as a percentage of 

GDP over the past two decades, although this 

percentage has been declining through the first 

quarter of 2012 (Chart 5.1.15). Nonfinancial 

corporate cash, in particular, has been growing 

at an accelerating rate, a pattern that continued 

through early 2012.

Measures of reliance on short-term wholesale 

funding of domestic banking firms continue 

to decline and remain well below their peaks 

in 2008 (Chart 5.1.16). Slow growth in loans 

Chart 5.1.14 Large Bank Holding Company Liability Structure

Chart 5.1.15 Wholesale Cash Investors

Chart 5.1.16 Retail Deposits vs. Short-Term Wholesale Funding
56 2012 FSOC / / Annual Report

relative to large deposit inflows, which have 

been bolstered by the FDIC’s temporary 

unlimited insurance coverage for noninterest-bearing transaction deposits, also 

supported this decline. 

Recent LIBOR Investigations 

Recent investigations into possible manipulation 

of the London Interbank Offered Rate (LIBOR) 

underscore the importance of effective control 

processes to help ensure the integrity of funding 

markets. LIBOR rates serve as reference rates 

for most interest rate derivatives and variable 

rate loans. However, LIBOR rates are not 

transaction rates. Rather, the LIBOR rate for a 

given currency and tenor is calculated based on 

the rates submitted by a panel of member banks 

each morning to the British Bankers’ Association 

(BBA). The accuracy of LIBOR as a measure of 

interest rates in the London interbank market 

depends crucially on the accuracy of banks’ 

responses to the BBA survey. 

While media reports of anomalies in the 

LIBOR rates have surfaced as far back as 

2007, concerns with the integrity of the 

LIBOR process escalated in late June 2012. 

Specifically, on June 27, in an internationally 

coordinated enforcement effort, the CFTC, U.S. 

Department of Justice (DOJ) and the United 

Kingdom Financial Services Authority (FSA) 

each announced actions finding that Barclays 

had provided false information to the BBA 

surveys and attempted to manipulate LIBOR 

and another benchmark, the Euro Interbank 

Offered Rate (Euribor), on numerous occasions 

and sometimes on a daily basis over a four-year 

period, commencing as early as 2005. In 

addition, certain Barclays euro swaps traders, 

led at the time by a senior trader, coordinated 

with and aided and abetted traders at other 

banks in attempts to manipulate Euribor. 

Among other things, Barclays improperly made 

submissions both to benefit its derivatives 

trading positions and to protect against 

negative perceptions of the bank’s health. 

Barclays entered into settlement agreements 

with the CFTC, DOJ and FSA. The CFTC 
Financial Developments 57

imposed a $200 million penalty and issued 

an Order requiring Barclays to implement 

measures to help ensure that its submissions 

are transaction focused, based upon a rigorous 

and honest assessment of information and 

not influenced by conflicts of interest. Among 

other undertakings in the CFTC Order, in 

making submissions, Barclays transactions will 

be given the greatest weight subject to certain 

specified adjustments and considerations. In 

addition, Barclays was ordered to implement 

firewalls to prevent improper communications 

and submissions. As part of a non-prosecution 

agreement, the DOJ ordered Barclays to pay 

a $160 million penalty. In its action, the FSA 

imposed a penalty of £59.5 million.

Repo Markets

The overall repo market is composed of both 

bilateral transactions negotiated between 

two market participants and tri-party repo 

transactions in which the exchange of cash and 

collateral is administered by a clearing bank. 

The size of the overall repo market is difficult 

to measure, due to issues related to netting and 

accounting conventions. Additionally, existing 

data do not provide adequate visibility into 

the composition of repo activity. Chart 5.1.17

displays two measures of the size of the repo 

market: tri-party repos and primary dealer 

repos, which include both tri-party and bilateral 

repos. According to both measures, the overall 

volume of repo activity remains substantially 

below that seen in the run-up to the crisis. In 

particular, tri-party repo activity peaked in 2008 

at $2.7 trillion and fell below $1.8 trillion in the 

years since the end of the recession, well below 

pre-crisis levels. 

As the volume of tri-party activity has declined, 

so has the level of traditional and nontraditional collateral in tri-party since July 

2008. Traditional collateral consists of Treasury 

securities, agency mortgage-backed securities 

(MBS), agency debentures, and agency 

collateralized mortgage obligations (CMOs). 

Non-traditional collateral includes corporate 

bonds, equities, private label CMOs, assetbacked securities (ABS), commercial paper 

Chart 5.1.17 Estimated Value of the Repo Market
58 2012 FSOC / / Annual Report

(CP), other money market instruments, whole 

loans, and municipal bonds. Non-traditional 

collateral accounts for only 16 percent of triparty collateral as of May 2012 (Chart 5.1.18), 

down from 21 percent of the total in May 2011 

and 25 percent in July 2008. Among traditional 

collateral in the tri-party repo market, the 

share of Treasury securities has increased at 

the expense of agency paper, consistent with 

relative shifts in supply and flight-to-quality 

in recent years. Most types of non-traditional 

collateral have fallen significantly, with private 

CMOs declining the most.

There are considerable concerns about 

structural weaknesses in the tri-party repo 

market. (See Box G: Ongoing Vulnerabilities in 

the Tri-Party Repo Market.)

Commercial Paper and Asset-Backed 

Commercial Paper 

CP outstanding peaked at $2.2 trillion in July 

2007 and stood at $1.0 trillion at May-end 2012 

(Chart 5.1.19). As of May 2012, asset-backed 

commercial paper (ABCP) accounts for 32 

percent of the market, financial commercial 

paper accounts for 48 percent, and nonfinancial 

corporate commercial paper accounts for 

20 percent. Financial CP and certificates of 

deposit (CDs) outstanding are around 40 to 

50 percent below their pre-crisis peaks and, 

in recent months, financial commercial paper 

outstanding has continued to decline, largely 

due to reduced demand from investors for 

foreign bank commercial paper.

ABCP was only about 6 percent of the total 

commercial paper market in 1990, but it 

accounted for about 60 percent of the total 

market in mid-2007, or approximately $1.2 

trillion. The market has shrunk steadily and, 

as of the beginning of July 2012, it is currently 

at about $311 billion outstanding, with foreign 

bank sponsored conduits comprising the 

majority of the market. The Moody’s downgrade 

of 15 large U.S. and European banks in June 

2012, discussed in Section 5.2, also resulted 

in the downgrade of 18 ABCP conduits that 

rely on these banks for liquidity support. The 

Chart 5.1.18 Tri-Party Repo Collateral Distribution

Chart 5.1.19 Commercial Paper Outstanding
Financial Developments 59

affected conduits have a combined value of 

almost $70 billion. These downgrades elicited a 

noticeable market response, with an increase in 

the cost of funding these conduits.

Securities Lending

Securities lending is a transaction involving 

the temporary transfer of a security by one 

party (the lender) to another (the borrower), 

in exchange for collateral in the form of either 

cash or non-cash instruments. Institutions 

may want to borrow securities to facilitate 

short selling, for derivative hedges, or to 

avoid failing on a delivery. The main lenders 

of securities are institutional investors, such 

as pension plans, investment funds, and 

insurance companies. The main borrowers are 

hedge funds, broker-dealers, asset managers, 

derivatives traders, and market makers. Most 

domestic securities lending is done against cash 

collateral. Typically, the lender of a security 

pays an interest rate to the borrower for the 

cash collateral. Lenders, in turn, seek to earn 

an additional return by investing this cash in a 

variety of instruments. 

The global value of securities lending 

transactions remained fairly flat through June 

2012 at an average value below $2 trillion 

(Chart 5.1.20). The total market value of 

securities on loan in the United States was 

about $820 billion at the end of the second 

quarter of 2012. About 50 percent of the total 

U.S. market is represented by U.S. government 

securities, about 40 percent by equities, and the 

rest by fixed income securities. Reinvestment 

of cash collateral from securities lending 

declined in volume over the past year from $775 

billion in 2011:Q1 to $670 billion in 2012:Q1. In 

addition, the weighted average maturity of such 

cash reinvestment declined markedly in late 

2011, likely in response to concerns associated 

with the euro area debt situation (Chart 5.1.21).

5.1.4 Housing Markets

The housing market remains stressed. However, 

national home prices show signs of stabilizing after 

a long-term decline, and some measures of house 

prices have shown upticks recently. Housing markets 

Chart 5.1.20 Value of Securities on Loan

Chart 5.1.21 Securities Lending Cash Reinvestment
60 2012 FSOC / / Annual Report

continue to be weighed down by elevated inventories of 

foreclosed homes, homes in the foreclosure process, and 

homes in danger of foreclosure, although the latter 

has been decreasing over the past year. In addition, 

the inventory of existing homes for sale has continued 

to decline and now stands at levels comparable to 

2004. Despite the overall improvement in economic 

and financial market conditions and historically low 

interest rates, access to residential mortgages remains 

constrained. The public sector continues to offer 

solutions aimed at stabilizing the housing markets by 

providing refinancing and modification options to 

prevent additional foreclosures. 

Housing Market Overview 

Housing activity remains at a historically 

low level. Home prices continued to decline 

through late 2011, though early 2012 showed 

signs of stabilization, including a rise in some 

housing price indices (Chart 5.1.22). National 

house prices are still as much as 30 percent 

below their peak in 2006. Going into the second 

quarter of 2012, nearly 13 million homeowners 

had mortgage balances exceeding the values 

of their homes, a condition known as “negative 

equity” (Chart 5.1.23). Although housing starts 

and existing home sales remain significantly 

below pre-crisis highs, they have risen by more 

than 30 percent from their respective 2009 and 

2010 lows through April 2012. The inventory 

of existing homes for sale has declined 

significantly over the last two years and is 

currently comparable to levels last seen in 2004. 

Indicators of credit quality in the residential 

mortgage sector continue to reflect the 

challenges confronting homeowners and 

lenders. The fraction of mortgages that 

are delinquent more than 90 days but not 

yet in foreclosure is sometimes referred 

to as the “shadow inventory” of homes in 

danger of foreclosure. This measure has 

declined from a high of 5 percent to around 

3 percent; however, it remains at elevated 

levels. Moreover, there has been little change 

in the fraction of mortgages that are in 

foreclosure, which remains around 4.4 percent 

(Chart 5.1.24). The inventory of mortgages 

Chart 5.1.23 Mortgages with Negative Equity

Chart 5.1.22 National Repeat Sales Home Price Indices

Chart 5.1.24 Mortgage Delinquency and Foreclosure
Financial Developments 61

that are in some stage of the foreclosure 

process remains high (Chart 5.1.25).

Mortgage Credit Flows

Mortgage credit flows remain quite constrained. 

High unemployment and heightened 

uncertainty contributed to weak provision of 

housing credit, but tighter credit standards 

have also been a major factor. In particular, 

the credit quality of new originations—both 

purchases and refinances—is far higher than 

prior to the crisis (Chart 5.1.26). According 

to the Senior Loan Officer Opinion Survey 

(SLOOS) data, the persistent net tightening 

in mortgage credit standards from 2007 

through 2009 has only recently begun to 

ease, and only for prime residential loans. 

When asked to indicate their willingness to 

originate government-sponsored enterprise 

(GSE) eligible mortgages relative to 2006 for 

borrowers across a range of creditworthiness, 

banks were less likely to lend to all credit 

categories except those with pristine credit. 

While higher credit scores and larger down 

payments tended to increase banks’ willingness 

to lend, many banks were unwilling to provide 

mortgage credit even when the loans were 

within GSE requirements. Higher “put-back 

risk” (the risk that the mortgage originator may 

have to repurchase the loan if it violates the 

GSE’s requirements) and borrower costs, along 

with difficulty in obtaining mortgage insurance, 

were cited as important factors contributing to 

banks’ reluctance to originate such loans. The 

events of the last several years also exposed 

severe deficiencies in the nation’s housing 

finance infrastructure. In areas ranging 

from the securitization process to servicing 

of delinquent mortgages to the foreclosure 

process, a system that was designed for a rising 

market was shown to function poorly in a 

declining price environment. This increased 

the level of uncertainty among market 

participants, contributing to constrained 

credit availability.

Measures to Strengthen the Housing Market

To strengthen the housing market, the 

government developed a number of programs 

Chart 5.1.26 Median Credit Score at Mortgage Origination

Chart 5.1.25 Foreclosure Pipeline
62 2012 FSOC / / Annual Report

aimed at providing relief to struggling 

homeowners, including Making Home 

Affordable (MHA), the Home Affordable 

Refinance Program (HARP) and the Hardest 

Hit Fund. MHA, which was announced in 2009, 

was enhanced in January 2012, with expanded 

eligibility to reach a broader pool of distressed 

borrowers. As of April 2012, MHA has granted 

over 1.1 million homeowner assistance 

actions, mostly through the Home Affordable 

Modification Program (HAMP), which 

provides first lien permanent modifications. 

Additional MHA programs include a secondlien modification program, an unemployment 

forbearance program, and a short-sale or 

deed-in-lieu-of-foreclosure program. The 

end-date of MHA, based on the January 2012 

enhancements, is December 31, 2013.

In April of 2009, the Home Affordable 

Refinance Program (HARP) was established 

to help homeowners refinance their GSEguaranteed mortgages if they had a loan-tovalue ratio (LTV) higher than 80 percent. As 

of March 2012, 1.2 million loans had been 

refinanced out of an estimated 3 to 4 million 

HARP-eligible homeowners. In October of 

2011, the FHFA announced modifications to 

HARP in an effort to increase efficiency and 

expand the eligible universe of borrowers who 

can benefit from refinancing. The revisions 

extended the expiration until December 2013, 

removed the 125 percent LTV cap in order to 

accommodate more borrowers with negative 

equity, and provided additional representation 

and warranty relief for same-servicer refinances. 

These changes seem to have led to increased 

HARP refinancing in early 2012 (Chart 5.1.27). 

In 2010, the Hardest Hit Fund was announced, 

which provides $7.6 billion to Housing Finance 

Authorities in the 18 states most affected by 

price declines and unemployment as well as 

in the District of Columbia. These funds have 

been used to develop a range of programs 

tailored to their local housing markets, 

including mortgage payment assistance 

for unemployed borrowers, reinstatement 

Chart 5.1.27 HARP Refinancings
Financial Developments 63

programs, principal reduction, and transition 

assistance for borrowers.

In addition to these programs, the government 

agencies have made substantial efforts to 

address loan servicing and foreclosure abuses. 

In early 2012, 49 states and the federal 

government announced a $25 billion settlement 

with the five largest loan servicers. Under the 

terms of the settlement agreement, servicers 

are required to pay $5 billion to be allocated to 

states, borrowers, and the FHFA. In addition, 

servicers are also required to dedicate $20 

billion toward various forms of financial 

relief to borrowers, including reduction of 

principal balances on loans with negative 

equity and assistance in refinancing. These 

actions complement consent orders and other 

actions already being taken by the OCC, the 

FDIC, the Federal Reserve, and the FHFA to 

address and correct deficiencies in mortgage 

foreclosure processing.

Government-Sponsored Housing Enterprises 

Government support to Fannie Mae and 

Freddie Mac has helped keep mortgage credit 

markets functioning, as private securitization 

largely remains absent. At the end of 2011, GSE 

mortgage credit flow accounted for 71 percent 

of total mortgage origination (Chart 5.1.28), 

considerably higher than pre-crisis levels, with 

most of the remaining originations coming 

from the Federal Housing Administration 

(FHA) and Department of Veterans Affairs 

(VA). Residential mortgage-backed securities 

(RMBS) continue to be issued solely by housingrelated GSEs and Ginnie Mae (GNMA), with 

negligible issuance of securities by non-agency 

entities (Chart 5.1.29). 

The financial position of the GSEs has 

improved recently. In 2012:Q1, Fannie Mae 

earned $2.7 billion income, and it did not 

request additional capital support from the 

government. In contrast, Freddie Mac reported 

a net income gain of $577 million for the same 

quarter and is seeking an additional $19 million 

in capital from the Treasury (Chart 5.1.30). 

Although the loss rate from single-family 

Chart 5.1.29 Issuance of RMBS

Chart 5.1.28 Mortgage Originations

Chart 5.1.30 GSE Net Income and Losses
64 2012 FSOC / / Annual Report

loans has been declining, this activity is still 

the main driver of losses at the GSEs. As of 

March 31, 2012, Fannie Mae and Freddie Mac 

reported single-family mortgage delinquency 

rates of 3.7 percent and 3.5 percent respectively, 

representing the lowest delinquency rates 

since 2009.

5.2 Bank Holding Companies and 

Depository Institutions

5.2.1 Bank Holding Companies

Bank holding companies (BHCs) continue to 

enhance their overall strength with improved capital 

and liquidity positions. Both the quality and 

amount of capital at BHCs continue to improve due 

to positive operating results, capital raising, and 

regulatory changes. Most of the largest BHCs have 

resumed capital distributions after undergoing stress 

testing and capital planning under the enhanced 

supervision of the Federal Reserve. However, 

revenues at the largest BHCs remain challenged by 

general market uncertainty, slowing global growth, 

and the low interest rate environment; credit default 

swap (CDS) spreads remain elevated, and increases 

in pretax income continue to be driven largely by 

non-recurring items.

A majority of commercial banks are owned 

by BHCs, which include the bank and any 

nonbank subsidiaries such as broker-dealers, 

investment companies, or insurance companies. 

As of year-end 2011, there were 4,743 top tier 

BHCs in the United States (excluding Puerto 

Rico), with aggregate assets of about $17.4 

trillion. Aggregate pretax income in 2011 

totaled $148 billion, an increase of 26 percent 

from 2010 (Chart 5.2.1).

Capital and Liquidity

In aggregate, capital ratios for BHCs improved 

from 2010:Q4 to 2012:Q1, with the tier one 

common capital ratio under current riskbased capital rules (“Basel I”) increasing 1.4 

percentage points to 11.1 percent as of 2012:Q1. 

Increases in retained earnings, primarily 

from positive operating results, contributed 

1.1 percentage points to this increase, while 

Chart 5.2.1 Aggregate BHC Pre-Tax Income
Financial Developments 65

additional capital raising contributed 0.4 

percentage points (Chart 5.2.2). 

For the 19 largest U.S. BHCs, capital ratios 

continue to improve from post-crisis levels, 

with the aggregate tier one common capital 

ratio under Basel I improving 1.5 percentage 

points from 2010:Q4 to 2012:Q1 to 10.9 

percent (Chart 5.2.3). These 19 BHCs also 

underwent additional stress testing as part 

of the Comprehensive Capital Analysis and 

Review 2012 (CCAR 2012). Similar to the 2011 

exercise, CCAR 2012 was a forward-looking 

cross-sectional analysis designed to examine the 

capital planning processes at these firms. A key 

part of the Federal Reserve’s examination was 

a supervisory assessment of capital adequacy 

under a hypothetical stress scenario. This stress 

scenario was intended to help ensure a rigorous 

assessment of the BHCs’ capital plans and was 

significantly more severe than prior stress tests. 

For example, one of the macroeconomic factors 

used in the stress scenario is the unemployment 

rate, which peaks at just over 13 percent for 

CCAR 2012—considerably higher than the 

comparable stress scenarios in both the 2009 

Supervisory Capital Assessment Program (SCAP) 

and the prior year’s CCAR exercise (Chart 5.2.4). 

In the hypothetical stress scenario, the Federal 

Reserve projected that the 19 BHCs would 

have a total of $438 billion in tier one common 

capital, implying an aggregate tier one common 

ratio under Basel I of 6.3 percent at the end of 

the nine-quarter projection period—well above 

the 5 percent target established in the Capital 

Plans Rule issued by the Federal Reserve in 

November 2011. The pro forma capital level 

under the stress scenario actually exceeded 

the BHCs’ aggregate tier one common ratio 

at the start of the 2009 SCAP, reflecting the 

more than $300 billion increase in tier one 

common equity at these BHCs since early 2009 

(Chart 5.2.5). However, 4 of the 19 BHCs had 

one or more projected regulatory capital ratios 

fall below regulatory minimum levels at some 

point over the stress scenario horizon.

Chart 5.2.3 Change in Tier 1 Common Ratios for 19 Largest BHCs

Chart 5.2.2 Change in Tier 1 Common Ratios for Aggregate 

U.S. BHCs

Chart 5.2.4 U.S. Unemployment Rate: Actual vs. Stress Scenarios
66 2012 FSOC / / Annual Report

Along with higher capital levels, balance sheets 

at the largest BHCs continue to be more robust, 

as assets became more liquid and liabilities 

more stable following the financial crisis. 

In particular, the fraction of assets on BHC 

balance sheets consisting of highly liquid assets 

is more than two standard deviations above its 

average from 1995 to the end of 2011 (Chart 

5.2.6). Less reliance on short-term wholesale 

funding (Chart 5.2.7), combined with an 

increase in core deposits, offers a more stable 

and resilient funding base. 

Since some of this rebalancing away from 

short-term funding across all banks is a result of 

flight to quality by wholesale funding suppliers 

and since some of the increase in core deposits 

may be associated with the expanded FDIC 

guarantee that is scheduled to expire at the 

end of 2012, the longer-run persistence of these 

balance sheet improvements is unresolved. 

Moreover, some banks have large amounts of 

wholesale funding that are not necessarily fully 

covered by liquidity buffers. 

For U.S. BHCs with assets less than $50 billion, 

the tier one common ratio under Basel I 

improved by approximately 1.6 percentage 

points to 12.6 percent over the 2010:Q4 to 

2012:Q1 period, primarily due to capital raising 

(1.4 percentage points) and positive operating 

results contributing to retained earnings 

(1 percentage point) (Chart 5.2.8). These 

increases were somewhat mitigated by the 

increase in risk-weighted assets that reduced the 

tier one common capital ratio under Basel I by 

0.7 percentage point.

Many BHCs continue to engage in moderate 

share repurchases and dividend payouts in spite 

of continued economic uncertainty, forthcoming 

higher regulatory capital requirements, and 

enhanced regulatory scrutiny. Although many 

of the 19 largest BHCs that participated in the 

CCAR resumed distributions of capital in the 

form of dividends and share repurchases in 

2011, U.S. BHCs saw only a slight increase in 

dividends and a net issuance of common equity 

in aggregate (Chart 5.2.9).

Chart 5.2.7 Short-Term Wholesale Funding at Largest BHCs

Chart 5.2.6 Consolidated Liquidity Ratio* for Top 50 BHCs

Chart 5.2.5 Initial and Stressed Tier 1 Common Capital Ratios
Financial Developments 67

As noted in the Council’s 2011 Annual Report, 

the Basel Committee on Banking Supervision 

(BCBS) agreed in December 2010 to a further 

revised set of capital and liquidity standards 

collectively referred to as Basel III. In June 

2012, the Federal Reserve, FDIC, and OCC 

invited public comment on three proposed 

rules that would revise and replace the agencies’ 

current capital rules. These proposals would 

implement, in the United States, the Basel 

III regulatory capital reforms from the BCBS 

and the changes required by the Dodd-Frank 

Act. Among other minimum standards, the 

proposals would establish a tier one common 

equity requirement equal to 4.5 percent of 

risk-weighted assets. It would also establish a 

capital conservation buffer above the minimum 

risk-based capital requirements, which must 

be maintained to avoid restrictions on capital 

distributions and certain discretionary bonus 

payments. As proposed, and consistent with 

Basel III, banking organizations generally 

would begin implementing the proposed capital 

reforms on January 1, 2013, and would be fully 

subject to the new standards by January 1, 2019. 

Concurrently, the agencies also approved a 

final rule to implement changes to the market 

risk capital rule, including those made by the 

BCBS in 2005 and 2010, to better capture 

positions for which the market risk capital rule 

is appropriate. The final rule will be effective 

on January 1, 2013. 

In November 2011, the BCBS released its 

framework and assessment methodology to 

identify globally systemically important banks 

(G-SIBs) that are subject to an additional 

common equity tier one capital buffer ranging 

from 1.0 to 3.5 percent of risk-weighted assets. 

Eight U.S. BHCs were designated as G-SIB and 

would be subject to the higher capital standards 

beginning in 2016, with full implementation 

by 2019. As with Basel III standards, the G-SIB 

framework would be incorporated by member 

jurisdictions into their local capital rules.

Performance

Despite strengthened balance sheets and 

liquidity, BHC market indicators have been 

Chart 5.2.9 BHC Dividends and Repurchases

Chart 5.2.8 Change in Tier 1 Common Ratios for BHCs < $50B
68 2012 FSOC / / Annual Report

weighed down by concerns around potential 

contagion from Europe, among other 

vulnerabilities, discussed further in Section 7. 

Within the subset of 69 BHCs with assets greater 

than $10 billion, aggregate pretax income 

increased by 20 percent in 2011 to $138 billion, 

but return on assets still remains lower than the 

levels that prevailed in the 10 years before the 

crisis (Chart 5.2.10). Trading revenue in 2011 

was negatively affected by sharply lower client 

activity and volumes amid fears of European 

contagion and concerns of slowing global 

economic growth. Earnings were also adversely 

affected by the interest rate environment 

characterized by both low short-term rates and 

low term premiums. Furthermore, approximately 

40 percent of this pretax income for 2011 was 

due to two non-recurring accounting items: (1) 

increased releases of reserves against losses on 

loans and leases due to improved credit quality; 

and (2) so-called “debt valuation adjustments” 

(DVAs), whereby decreases in the mark-to-market 

value of a BHC’s liabilities is booked as a profit. 

It is unclear to what degree these non-recurring 

items will contribute to the profitability of U.S. 

BHCs going forward, as the pace of reserve 

releases continues to decline, and potentially 

tightening credit spreads would result in 

reversals of these mark-to-market DVA gains. 

On June 21, 2012, Moody’s announced the 

results of its review of the credit ratings of 

large international banks with global capital 

markets operations. Fifteen global banks were 

downgraded, with 10 of these banks incurring a 

two-notch downgrade to their long-term ratings; 

Credit Suisse was downgraded three notches. 

(In addition, two dealer banks, Nomura and 

Macquarie, had been downgraded in March.) 

These downgrades reflected a re-assessment by 

Moody’s of heightened uncertainties associated 

with capital market operations. However, 

Moody’s continues to rate more highly those 

banks seen to have superior risk-management 

capabilities, more conservative funding profiles, 

and/or lower reliance on capital markets 

activities. These ratings actions were generally 

in line with market expectations and with prior 

guidance provided by Moody’s in February. 

Chart 5.2.10 Return on Average Assets
Financial Developments 69

Market Indicators

Following the heightened level of duress in 

capital markets during the second half of 

2011, market indicators for BHCs reflected an 

improved investor sentiment and greater risk 

appetite in early 2012. These improvements 

later receded during the second quarter of 

2012. The market capitalization weighted priceto-book ratio of the six largest BHCs improved 

in 2012, but market valuations remained at a 

more than 25 percent discount to book value 

in July 2012, which is below both the pre-crisis 

level and the average level over the past 12 years 

(Chart 5.2.11). In late 2011, an equally weighted 

average of CDS spreads for the six largest 

BHCs reached levels last seen during the crisis. 

Spreads remain elevated relative to early 2011 

levels (Chart 5.2.12).

5.2.2 Insured Depository Institutions 

Performance within the commercial banking 

industry continues to rebound, coinciding with the 

general improvement in credit quality within the 

economy. Despite the rate of bank failures declining, 

the commercial banking sector has become more 

concentrated, as larger banks have seen higher levels 

of profitability and rebounded faster post-crisis.

Insured Commercial Banks and Savings 

Institutions

The banking industry is composed of more 

than 7,300 commercial banks and savings 

institutions. Of these, approximately 6,600 

institutions have assets under $1 billion, 88 

institutions have assets between $10 billion and 

$100 billion, and 19 institutions have assets over 

$100 billion. Failures, mergers, and a decline in 

chartering activity have contributed to further 

consolidation over the past several years. 

Failures of insured depository institutions 

continue to decline from crisis levels, as 92 

institutions representing $35 billion in assets 

failed in 2011 (Chart 5.2.13). An additional 

31 insured institutions have failed thus far in 

2012 (through July 6) representing $7.6 billion 

in assets. As of March 31, 2012, some 772 

institutions, accounting for 10.6 percent of all 

institutions, were on the FDIC’s problem bank 

Chart 5.2.11 Price-to-Book Ratio of 6 Large Complex BHCs

Chart 5.2.12 CDS Spreads of 6 Large Complex BHCs

Chart 5.2.13 FDIC-Insured Failed Institutions
70 2012 FSOC / / Annual Report

list, with financial, operational, or managerial 

weaknesses that threatened their continued 

financial viability. 

Pretax net income for U.S. commercial banks 

and savings institutions totaled $169.3 billion 

in 2011, representing a significant increase 

over 2010 and a continuation of the rebound 

following the crisis. A rebound in credit quality 

with the associated reduction of loan loss 

provisions and other expenses continues to 

drive the improvements in pretax net income 

since 2009 (Chart 5.2.14). Although the largest 

institutions and community banks benefited 

from reductions in loan loss provisions, 

community banks have experienced a smaller 

increase in net revenue than large banks. In 

addition, community banks continue to deal 

with credit problems associated with relatively 

outsized concentrations in the commercial 

real estate sector, which remains depressed 

(Chart 5.2.15).

Credit Unions

The number of credit unions declined to 

7,094 institutions by year-end 2011, down 

from 7,339 at year-end 2010. This 3 percent 

decline in the number of credit unions is in 

line with recent trends. As in other parts of 

the banking system, assets in the credit union 

system have become more concentrated, with 

the top 100 credit unions increasing their 

share of total credit union assets to 39 percent 

(Chart 5.2.16). Corporate credit unions—

which provide critical services to the broader 

credit union system—are consolidating and 

deleveraging as they refocus their business 

models on providing operational support to 

consumer credit unions, raising capital, and 

adjusting to the new regulatory environment. 

As of year-end 2011, there are 24 corporate 

credit unions with $34 billion in assets—a 

decline from 27 corporate credit unions with 

$96 billion in assets in 2007.

The credit union system experienced an 

improved return on assets (ROA) in 2011 of 67 

basis points, an increase from 50 basis points 

in 2010. Improved credit conditions were the 

Chart 5.2.14 Commercial Bank and Thrift Pre-Tax Income

Chart 5.2.16 Concentration of Credit Union Assets

Chart 5.2.15 Commercial Property Price Indices
Financial Developments 71

primary driver behind the provision for loan 

losses declining from 0.8 percent of assets in 

2010 to 0.5 percent of assets in 2011 (Chart 

5.2.17). Aggregate net income increased to $6.3 

billion, a 39 percent improvement from 2010. 

Overall loan levels within the credit union system 

rebounded by 1.2 percent to $571 billion after 

experiencing a decline of 1.4 percent in 2010. In 

2011 loan growth was driven by increases in real 

estate, credit cards, and auto loans. 

Profitability continues to vary based on the size 

of the institution, with smaller credit unions 

historically lagging behind larger credit unions. 

The industry still faces some uncertainty over 

future losses associated with failed corporate 

credit unions; with future resolution costs 

projected to total between $2.7 billion and $6.0 

billion over the coming years, these assessments 

are not likely to curtail industry growth and 

profitability. Larger concerns for the industry 

are challenges related to the low interest 

rate environment and managing through a 

transition into a higher rate environment. As 

Chart 5.2.18 shows, fixed-rate real estate as a 

share of loans and long-term assets as a share of 

assets have risen over the past several years. 

5.2.3 U.S. Branches and Agencies of 

Foreign Banks

U.S. branches and agencies of foreign banks support 

lending activity in the United States, but also tend 

to rely on a funding mix that is less stable than that 

of most U.S. commercial banks. These branches and 

agencies are sensitive to the funding and liquidity 

needs of their parent organizations and depend on 

access to uninsured deposits that pose a heightened 

flight risk. Stresses on parent banks and constrained 

access to short-term dollar funding impinged on 

branch lending and investment in the United States 

over the past year, especially by the European branches 

and agencies. 

In addition to the U.S. BHCs, foreign bank 

families have a large presence within the United 

States. Together, the U.S. branches and agencies 

of foreign banks account for close to $2 trillion 

of banking assets, over 15 percent of total U.S. 

Chart 5.2.17 Federally Insured Credit Union Income

Chart 5.2.18 Credit Union Fixed Rate Real Estate and 

Long-Term Assets
72 2012 FSOC / / Annual Report

banking assets. These entities represent an 

important source of credit for U.S. borrowers.

There are different business models in the 

operations of branches in the United States, 

with a mix of targeted investment and asset 

strategies and a range of different funding 

approaches. On average, branches and 

agencies generally dedicate about 30 percent 

of their balance sheets to loans, but can differ 

substantially in the composition of their lending 

across commercial and industrial (C&I) activity 

versus other U.S. domestic customers. Direct 

C&I loans outstanding by these banks, which 

represents a major source of financing for U.S. 

businesses and investment projects, has been 

as high as $365 billion, but more recently has 

fallen closer to $260 billion, out of total loans 

of over $500 billion (Chart 5.2.19). Other 

securities held as assets have risen sharply 

from about $300 billion pre-crisis to closer to 

$1 trillion by 2012:Q1. Some of these branches 

and agencies also send dollar flows to their 

parent organizations and related affiliates, 

as indicated by the levels of Net Due from 

Related Depository Institutions in the balance 

sheet decompositions in Chart 5.2.19. These 

flows support dollar lending and investment 

activities in the United States and elsewhere. 

European parent banks in particular have 

actively used their branches to source dollar 

funding. Outstanding positions vis-à-vis parent 

banks currently are a smaller percentage of 

branch and agency assets than at any point in 

recent history.

The liability side of balance sheets of the U.S. 

branches and agencies of foreign banks also has 

bearing on financial stability (Chart 5.2.20). 

Most of these U.S. branches are not allowed to 

offer deposits insured by FDIC and thus lack 

access to the stable source of funds represented 

by households’ checking, savings, and other 

transaction accounts. Instead, money market 

funds and other noninsured deposits provide 

the majority of funding for these institutions. 

When such funds and depositors withdraw 

from particular banks, which occurred in the 

summer of 2011 when European banks were 

Chart 5.2.19 U.S. Branches and Agencies of Foreign 

Banks: Assets

Chart 5.2.20 U.S. Branches and Agencies of Foreign 

Banks: Liabilities
Financial Developments 73

viewed as particularly risky, it can destabilize 

the balance sheets of those banks, leading to 

deleveraging or potential reversals of support 

to the parent organization. (See Box H: 

Money Market Fund Responses to Euro Area 

Uncertainty.) Such dynamics are masked, to 

some extent, in the aggregate statistics, as 

these deposits may be reoriented to other U.S. 

branches and agencies. However, the recent 

increases in Net Due to Related Depository 

Institutions shows a greater degree of support 

from foreign parent banks than previously 

had been the case, as investments are made 

to maintain the presence of these banks in 

U.S. asset classes and reduce contractions of 

lending activity and asset sell-offs that could 

otherwise occur. 

5.3 Other Financial Institutions

5.3.1 Insurance

Despite a substantial net decline in income in 2011, 

capital levels within the insurance industry improved. 

The life insurance industry continues to play a 

significant role in long-term funding of assets through 

the investment of premium income. The low interest 

rate environment has proved challenging for life life 

insurers to generate sufficient investment returns to 

meet high guaranteed benefits promised in prior years. 

Property and casualty insurers faced historically 

higher catastrophe losses that impeded performance 

in 2011. 

For life insurance companies, which sell 

retirement products such as traditional life 

insurance contracts and annuities, book capital 

grew modestly, despite net income declining 

by over 50 percent or $13.6 billion in 2011 

compared to 2010 (Chart 5.3.1). The spread 

between the yield that life insurers earn on their 

investments and a measure of the interest rate 

necessary to maintain policyholder reserves, 

also known as the required interest rate, has 

narrowed since 2007 (Chart 5.3.2). If this spread 

had stayed at 2007 levels, net income would have 

been $13.0 billion higher during the period 

from 2008 through 2011—$1.2 billion higher in 

2011 alone. 

Chart 5.3.1 Life and Other Insurance: Capital and Income

Chart 5.3.2 Life Insurers: Impact of Low Rate Environment
74 2012 FSOC / / Annual Report

The low interest rate environment poses a 

significant challenge for life insurers with 

sizable blocks of liabilities incorporating 

embedded interest rate guarantees, such as 

annuities or universal life insurance policies. 

The industry has reduced its minimum 

guarantees over time, but products sold when 

interest rates were higher represent a continued 

drag on profits. The share of life and annuity 

product account values subject to a minimum 

guaranteed rate of return of 5 percent or 

higher fell from 20 percent to 10 percent 

over the 2006-2010 period, but more than 40 

percent of account values were still subject to 

a minimum guaranteed rate of return of 3.5 

percent or higher in 2010. Life insurers have 

exited selected markets due to the inability 

to meet the minimum guaranteed returns 

associated with the underlying products in this 

low rate environment. Of note, life insurers 

have increased their use of non-traditional 

investments, such as hedge funds and private 

equity, perhaps as a response to the low interest 

rates that currently prevail.

The role of the life insurance industry in 

funding new commercial mortgages has 

increased since the collapse of conduit activity 

in 2008. Life insurers funded roughly 25 

percent of new commercial mortgages in 2011, 

compared to 10 percent in 2007 (Chart 5.3.3). 

Although the industry is playing a larger role 

in financing new loans, commercial mortgages 

as a share of total life insurance assets have 

decreased modestly from 2007 to 2011 to less 

than 1 percent of assets. 

Property and casualty insurers, who sell 

insurance on homes, cars, and businesses, 

are less affected by the low interest rate 

environment because they underwrite shorter 

duration liabilities without embedded interest 

rate guarantees. However, property and casualty 

insurers were pressured by large catastrophe 

losses in 2011. Insured catastrophe losses were 

$33.6 billion in 2011, 135 percent higher than 

in 2010 and exceeded only by the extraordinary 

losses associated with Hurricane Katrina in 

2005. Property and casualty assets fell slightly 

Chart 5.3.3 Commercial Mortgage Origination by Lender Type
Financial Developments 75

during 2011, although book capital levels were 

largely unchanged despite a 46 percent decline 

in net income from 2010 to 2011 (Chart 5.3.4). 

5.3.2 Money Market Funds

Total money market fund (MMF) assets declined 

over calendar year 2011, reflecting low yields and 

concerns over European exposures. Low rates also 

reduced revenue flows to fund managers. Substantial 

redemptions from MMFs in the summer of 2011 in 

response to heightened financial market uncertainty 

associated with euro area stresses and federal budget 

negotiations in the United States illustrates the 

extent to which MMFs are still subject to pro-cyclical 

redemption pressures.

Total U.S. MMF assets declined from $2.80 

trillion at year-end 2010 to $2.56 trillion as of 

May 2012. Prime MMF assets declined from 

$1.62 trillion to $1.42 trillion, while government 

and Treasury MMF assets increased from $855 

billion to $872 billion during this period. 

Tax-exempt funds also declined from $330 

billion to $272 billion (Chart 5.3.5). During 

July and August of 2011, there was significant 

redemption activity due to the European debt 

crisis and the political uncertainty in the United 

States leading up to the debt limit extension 

in early August 2011. Between the end of May 

and the end of August 2011, prime MMF assets 

fell by more than $160 billion (9.8 percent) 

(Chart 5.3.6), with some funds diminished by 

as much as 50 percent over this period. Prime 

fund bank holdings in France continued to 

decline through the end of 2011. (See Box H: 

Money Market Fund Responses to Euro Area 

Uncertainty.) Since that period, prime MMFs 

have bolstered their liquidity levels to better 

handle redemptions, with daily liquidity levels 

ranging from 26 percent to over 30 percent and 

weekly liquidity levels holding at over 40 percent 

in late 2011 and early 2012 (Chart 5.3.7). MMFs 

also reduced maturities since the summer of 

2011, with the weighted average life for prime 

MMFs falling to around 70 days (Chart 5.3.8). 

Chart 5.3.4 Property and Casualty Insurance: Capital and Income

Chart 5.3.5 Money Market Mutual Fund Assets by Fund Type

Chart 5.3.6 Institutional vs. Retail Money Market Fund Assets
76 2012 FSOC / / Annual Report

The low interest rate environment also affected 

revenues of MMF managers. Total expense 

ratios for MMFs have fallen from 49 basis points 

to 25 basis points for retail MMFs and from 26 

basis points to 18 basis points for institutional 

MMFs from 2009 to 2011. This significant drop, 

particularly among retail MMFs, is primarily 

due to fee waivers by MMF sponsors to preserve 

a positive net yield for MMF investors. As 

the extended low interest rate environment 

continues to put pressure on MMF yields, some 

MMFs have shown a willingness to take on 

additional portfolio risk (Chart 5.3.9), which 

increases MMF gross yields and offsets the 

pressure to provide fee waivers. Thus, while 

on average MMFs have shown a decreased risk 

appetite in 2012, some funds have sought to 

increase their risk profile.

5.3.3 Broker-dealers

The broker-dealer (BD) industry contracted 

significantly while reducing leverage. Concentration 

in the industry increased.

As of year-end 2011, there were 4,679 domesticand foreign-owned BDs operating in the United 

States. Coinciding with a sharp decline in 

leverage within the industry, assets held within 

the U.S. BD industry fell sharply to $4.8 trillion 

at 2012:Q1—a decline of 25 percent since 2007 

(Chart 5.3.10).

The U.S. BD sector is relatively concentrated; at 

year-end 2011, 60 percent of industry assets were 

held by the top 10 BDs, the largest of which 

are affiliated with foreign banks and domestic 

BHCs. By contrast, the top 10 independent BDs 

represented only 6 percent of industry assets. In 

late 2011, the third largest independent BD, MF 

Global, filed for bankruptcy. (See Box D: MF 

Global Bankruptcy.) 

Aggregate pretax income declined by 59 

percent in 2011 to $14 billion, as trading 

revenues declined sharply (Chart 5.3.11).

Chart 5.3.7 Prime Funds Liquidity

Chart 5.3.8 MMF WAL*

Chart 5.3.9 Gross Yield of 5 Outlier MMF Families
Financial Developments 77

5.3.4 Specialty Lenders

Specialty lenders continue to play a critical role in 

providing credit to those markets not served by the 

traditional banking industry and providing necessary 

funding in certain segments of the mortgage markets. 

The specialty lending sector is composed of 

a wide range of entities, ranging from real 

estate investment trusts (REITs) who invest 

a majority of their capital in mortgage and 

mortgage-related holdings, to captive finance 

arms of major manufacturers who facilitate 

the financing of the parent firm’s products. 

As of April 2012, specialty lenders owned 

approximately $654 billion of consumer loans, 

$330 billion of real estate loans, and $434 

billion of business loans. Aside from consumer 

credit revolving loans and retail business loans 

(Charts 5.3.12 and 5.3.13), specialty lenders 

experienced a slight decline in loan balances 

across a wide variety of loan categories, which 

was consistent with overall trends in the 

traditional banking industry. 

As the GSEs have reduced their investment 

portfolios, REITs have been a rapidly 

growing source of investment capital for 

agency mortgage-backed securities (MBS). 

As of 2012:Q1, REITs held $299.4 billion of 

agency MBS, a 109 percent increase from 

2010 and roughly five times pre-crisis levels 

(Chart 5.3.14).

5.3.5 Investment Funds

Across the various types of investment companies, 

fund flows seem to reflect a general shift towards 

deleveraging and risk reduction by households 

and corporations within the uncertain financial 

environment. Performance in this low interest rate 

environment tended to be lackluster. 

Mutual Funds

Mutual fund flows from year-end 2010 to 

2012:Q1 reflect growing investor preference for 

capital preservation, income generation, and 

lower volatility. Mutual funds had an estimated 

$202 billion net inflow for the period, largely 

attributable to taxable bond funds, which 

received a net $217 billion (Chart 5.3.15). Of 

Chart 5.3.10 Aggregate Broker-Dealer Assets and Leverage

Chart 5.3.11 Broker-Dealer Revenues

Chart 5.3.12 Consumer Loans Outstanding
78 2012 FSOC / / Annual Report

BOX D: MF GLOBAL BANKRUPTCY

MF Global Holdings Ltd. (MFG) and MF Global Finance 

USA Inc. filed on a consolidated basis for relief under 

Chapter 11 bankruptcy protection on October 31, 2011. 

Of particular interest in the United States was the jointly 

registered broker-dealer (BD) and futures commission 

merchant (FCM), operating as MF Global Inc., which 

entered liquidation proceedings under the Securities 

Investor Protection Act (SIPA). 

The jointly registered BD-FCM was a clearing member 

at several domestic central counterparty (CCP) 

clearinghouses, including the Chicago Mercantile 

Exchange (CME), the Options Clearing Corporation, and 

National Securities Clearing Corporation (NSCC). The BD 

was also a primary dealer in government securities with 

the Federal Reserve Bank of New York. The BD-FCM 

conducted business for its own account, as well as for 

customers. 

A series of events led to the bankruptcy of MFG. 

Between March 2010 and March 2011, MFG entered 

into repurchase agreement transactions collateralized to 

maturity with European sovereign debt securities. During 

2011, the company continued its almost uninterrupted 

series of quarterly operating losses (9 of 11 quarters 

through September 2011) that resulted partly from 

declining interest income earned from investing customer 

funds. On October 24, Moody’s downgraded MF Global 

Holdings Inc., citing exposure to European sovereign debt, 

high leverage, and its likely inability to achieve financial 

targets. The following day, MFG announced a $192 

million quarterly loss. MF Global Holdings Inc.’s debt was 

subsequently downgraded to junk. Industry observers 

believe that the ratings downgrade also precipitated the 

lowering of the collateral advance rate on the term to 

maturity repurchase agreements, prompting a margin call. 

The earnings report and credit-rating downgrade also 

impacted MFG’s liquidity, as certain counterparties and 

clearing organizations assessed their credit exposure to 

MFG and imposed increased collateral requirements. 

On the day of the bankruptcy, the company did not 

default to the CME, the Options Clearing Corporation, 

or NSCC. However, later on the same day, the company 

reported a shortfall in customer-segregated assets.

The full extent of the shortfall in commodities customer 

funds will not be known until the Trustee managing MFG’s 

liquidation completes its efforts to recover assets and 

finalizes the customer claims process. The Trustee has 

distributed approximately $3.9 billion to date to customers 

who were trading primarily on U.S. futures markets. This 

represents approximately 72 percent of such customers’ 

account balances. The Trustee also received the approval 

of the Bankruptcy Court on April 26, 2012, to distribute 

up to an additional $685 million, including $600 million 

to customers with claims for accounts trading on U.S. 

contract markets.

The Trustee, however, has stated that there is an 

approximate $1.6 billion gap between the value of the 

Trustee’s estimate of potentially allowable commodities 

claims and the assets that are currently under the 

Trustee’s control. A significant component of the gap in 

customer funds is attributable to approximately $700 

million of customer assets that were deposited with 

MF Global UK Limited, an MFG affiliate in the United 

Kingdom, for trading on non-U.S. markets. The Trustee 

is disputing the treatment of these funds under English 

law with the Joint Special Administrators of MF Global 

UK Limited, and the likelihood of such assets being 

repatriated is uncertain at this time and is expected to be 

subject to future litigation or further United Kingdom court 

action. In addition, multiple federal agencies are reviewing 

the circumstances surrounding the transfers of monies 

out of customer-segregated bank accounts (particularly 

certain transfers that occurred during the week prior to 

the bankruptcy filing).

An SIPC-led liquidation was initiated on October 31. The 

firm had 200 to 300 securities accounts totaling less 

than $500 million in assets and over 38,000 commodity 

customer accounts totaling over $7 billion. The SIPA 

Trustee managing the liquidation is responsible for returning 

customers’ property as quickly as possible, including 

both securities and commodities customers. As stated 

previously, approximately 72 percent of U.S. segregated 
Financial Developments 79

customer property has been distributed to commodities 

customers trading on U.S. designated futures markets as 

of April 25 on a pro rata basis. As a result of a distribution 

of funds recently approved by the bankruptcy court, that 

number should increase to over 80 percent. 

The missing customer money highlights the issue of 

customer protection for commodities accounts. FCM 

accounts at custodians that contain customer property 

are under the control of the account holder, the FCM. 

FCMs routinely keep substantial amounts of their own 

capital in their customer accounts in order to protect 

against any possibility of a shortfall in customer accounts 

that may result from daily market moves, margin 

requirements, and other activity. Accordingly, it is critical 

for custodians to monitor the transfer of any money out of 

segregated accounts. 

The CFTC has taken steps to enhance customer 

protection. In December 2011, the CFTC amended its 

regulations governing derivatives clearing organizations 

(DCOs) and FCM investment of customer funds. Among 

other things, the CFTC eliminated from the list of 

permitted investments BD-FCM in-house transactions that 

are the economic equivalent of repurchase agreements, 

repurchase agreements with affiliates, corporate notes 

and bonds that are not federally guaranteed, and foreign 

sovereign debt instruments. The amended regulations 

also imposed asset-based concentration limits and repo 

counterparty concentration limits, in addition to mandating 

stricter issuer-based concentration limits than had been 

applied previously. 

The CFTC has also issued a new rule for customer 

segregation of cleared swaps, called legal segregation 

with operational commingling (LSOC). Under this model, 

each FCM will provide the DCO with position and 

collateral valuation information at the customer account 

level. The DCO can hold customer collateral provided by 

FCMs in the same commingled manner as it holds margin 

assets for exchange traded products. In a situation of 

“double default,” where the default of an FCM customer 

causes the FCM to default to the DCO, the DCO would 

be able to then identify and access the collateral of the 

defaulting customers of the FCM but not the collateral of 

the non-defaulting customers, as is permitted today with 

exchange-traded futures. 
80 2012 FSOC / / Annual Report

note, the strong asset growth rates in highyield funds (17 percent growth rate, relative to 

2011 year-end net assets) and emerging market 

bonds (55 percent growth rate) over this period 

may reflect investor preference for yield among 

lower volatility fixed income products (Chart 

5.3.16). In contrast, U.S. equity funds had 

net outflows of $86 billion, with net monthly 

outflows since May 2011. 

Pension Funds

As of the fourth quarter 2011, the combined 

assets under management of private and public 

pensions were over $15.3 trillion (Chart 5.3.17). 

Both public and private defined benefit plans 

remain significantly underfunded relative 

to the present value of their liabilities due to 

inadequate past contributions, low interest 

rates, and losses incurred in 2007 and 2008. 

As of year-end 2011, public defined benefit 

plans were only 76 percent funded, while 

private defined benefit plans were 79 percent 

funded (Chart 5.3.18). Some private pension 

funds have received contributions to make up 

shortfalls or have been able to adjust their plans 

to reduce future outlays. 

A number of state and local pension funds 

continue to grapple with structural shortfalls 

between their assets and liabilities. While 

these pension funds face pressure to reduce 

their expected return assumptions, many 

are reluctant to change assumptions in a 

meaningful way, reducing expected returns 

by only 25 to 50 basis points over the past 

three years. Currently the median assumed 

expected return across public plans is 8 

percent, while private sector estimates of 

returns are closer to 6 percent. 

Over the past three years, many states and 

localities have increased efforts to address 

long-term pension funding issues by curtailing 

benefits and increasing employee contributions, 

among other measures. Analyst views on the 

impact of these changes on pension funding 

profiles differ, with some viewing them as 

positive for long-term plan sustainability, while 

Chart 5.3.13 Business Loans Outstanding

Chart 5.3.14 Real Estate Investment Trust (REIT) Assets

Chart 5.3.15 Mutual Fund Flows by Asset Class (2011 to 2012 Q1)
Financial Developments 81

others regard them as insufficient to address 

medium-term funding needs. To reduce fiscal 

pressures, state and local pension funds may 

seek to further curtail benefits for current 

and future retirees or seek increased financial 

support from their respective sponsors. If 

successful, these developments could lead to 

lower expected payouts for employees, reduced 

services, higher taxes, or some combination of 

all three. However, public pension benefits are 

often legally guaranteed, and amending them 

remains challenging.

Private Equity Funds

U.S. private equity assets under management 

increased to $1.7 trillion in 2011 (Chart 5.3.19). 

The growth in assets continued to be supported 

by allocations from institutional investors such 

as pension funds, which comprise 43 percent of 

U.S. private equity capital. Although leveraged 

buyouts and venture capital account for over 

half of private equity assets under management, 

advisers continue to diversify their investment 

strategies into areas such as real estate, natural 

resources, distressed assets, and emerging 

market opportunities (Chart 5.3.20). 

The high volume of fund-raising and robust 

deal activity that signified pre-crisis private 

equity activity created the conditions that 

currently prevail, with advisers now focused 

on exiting existing investments and deploying 

committed capital. Given the constrained initial 

public offering (IPO) environment and tepid 

mergers and acquisitions activity amid ongoing 

economic uncertainty, private equity firms are 

focused on realizing returns on historically 

high levels of existing portfolio investments. 

They are also seeking investment opportunities 

for over $500 billion in undeployed capital 

commitments stemming from record 

levels of fund-raising from 2005 to 2007. 

(See Chart 5.3.19.)

Hedge Funds 

Institutional investors continue to be interested 

in hedge funds as an asset class in part because 

of the perception that the correlations between 

hedge funds and broad asset classes are low. 

Chart 5.3.16 Mutual Fund Taxable Bond Flows (2011 to 2012 Q1)

Chart 5.3.17 Retirement Funds by Type

Chart 5.3.18 Public and Private Pension Funding Level
82 2012 FSOC / / Annual Report

At year-end 2011, assets managed by hedge 

funds were approximately $2.13 trillion, which 

represents a 3.5 percent increase from year 

2010. This growth in assets under management 

primarily reflected inflows, rather than fund 

performance in 2011 (Chart 5.3.21). In fact, 

hedge funds had lackluster performance across 

the major strategies for the calendar year 

(Chart 5.3.22). Similar to other investment 

options, hedge fund performance has 

rebounded slightly in early 2012. 

Following the crisis, institutional investor 

preferences for larger, more established funds 

with longer track records led to a greater 

concentration of industry assets at larger 

firms. This trend continued through 2011 and 

into 2012 as larger funds benefitted from the 

perception of increased stability.

Exchange Traded Funds 

Exchange traded funds (ETFs) remain a 

popular means of achieving exposure to various 

market indices, as evidenced by their continued 

growth in terms of product launches and asset 

growth (Chart 5.3.23). In 2011, the number of 

U.S.-listed ETFs grew by 28 percent to 1,353 

products, and ETF assets grew by 6 percent to 

$1.06 trillion. Compared to 2010, net inflows 

in 2011 remained flat at $121 billion with 

higher concentrations of funds moving into 

ETFs with taxable bond, U.S. stock, and sectorspecific strategies. 

The U.S. ETF market remains populated 

predominately by passively managed 

products that track widely followed indexes 

in equity, fixed income, and commodity 

markets. Recently, alternative index strategies 

have emerged as ETF providers adapt to 

an increasingly saturated market. These 

“fundamental indexing” products rebalance 

their holdings according to proprietary 

methodologies that seek to extract value that is 

either not captured, or is obscured by, existing 

index construction. For example, among equitybased ETFs, such products may focus on lower 

volatility, lower beta to the broader market, 

higher earnings quality, higher dividend yield, 

Chart 5.3.19 U.S. Private Equity AUM

Chart 5.3.20 U.S. Private Equity AUM by Strategy

Chart 5.3.21 Change in Hedge Fund AUM
Financial Developments 83

and so forth. On a related note, fixed income is 

widely viewed by industry observers as a likely 

avenue of growth for passively managed funds. 

In addition to the growth of fundamental 

indexing, actively managed ETFs are cited 

by some as a potential new avenue for the 

ETF industry to grow. ETFs are required to 

disclose their holdings daily, while traditional 

mutual funds generally disclose their holdings 

quarterly. The requirement for daily disclosure 

is a matter of concern to some active managers, 

who fear the exposure of their strategies in 

the ETF structure may adversely affect the 

values of their funds. However, 2012 has seen 

notable launches of and filings for new actively 

managed ETFs, particularly for fixed income 

products, indicating that active management 

may indeed overcome the disclosure issue. 

Despite the continued robust growth of the 

global ETF market, market participants remain 

attentive to some potential risks pertaining to 

ETFs, which may not yet be fully understood. In 

particular, some market participants continue 

to highlight the synthetic ETF structure as a 

potential transmission mechanism for risks 

between the United States and European 

financial systems. A synthetic ETF generates 

the return of an index through a total return 

swap with a bank, whereas a “physical” ETF 

holds the actual index constituents. Synthetic 

ETFs are common in Europe but not in the 

United States. Synthetic ETFs may manage 

to track indexes with lower trading costs and 

lower tracking error—particularly for less 

liquid markets—compared to an ETF. However, 

despite their potential advantages, some market 

participants continue to voice concerns over the 

potential for this structure to amplify financial 

market stresses in the event that a bank 

engaging in swaps with a synthetic ETF sponsor 

should be unable to meet its obligation. In 

addition, the emergence of new types of ETFs 

and similar products, such as leveraged and 

inverse-leveraged ETFs, actively managed ETFs, 

and ETFs based on very particularized asset 

classes, is a growing trend in the market and a 

focus of regulators.

Chart 5.3.22 Hedge Fund Performance by Strategy

Chart 5.3.23 Growth in ETF Assets and Number of Funds
84 2012 FSOC / / Annual Report

provided unlimited deposit and share insurance coverage 

for non-interest-bearing transaction accounts beginning 

December 31, 2010, is scheduled to expire December 31, 

2012. As of March 31, 2012, $1.3 trillion in non-interestbearing accounts at over 7,000 institutions exceeded the 

basic coverage limit of $250,000 per account but was fully 

insured by temporary coverage. Under the TLGP, the FDIC 

guaranteed newly issued senior unsecured debt of insured 

depository institutions, their holding companies, and certain 

affiliates. No new debt can be guaranteed under the TLGP, 

but approximately $109 billion in guaranteed debt remained 

outstanding as of May 31, 2012. 

Term Asset-Backed Securities Loan Facility

The Term Asset-Backed Securities Loan Facility (TALF), 

which the Federal Reserve and Treasury began operating 

in 2009, was created to help market participants meet 

the credit needs of households and small businesses by 

supporting the issuance of asset-backed securities (ABS) 

collateralized by certain consumer and business loans. 

Under the TALF, the Federal Reserve provided eligible 

borrowers with three-year and five-year non-recourse loans, 

collateralized by ABS.

In total, $71 billion in loans were provided under the TALF, 

but many were repaid early. The outstanding amount of 

TALF loans fell from $24.7 billion at the start of 2011 to 

$5.3 billion as of June 20, 2012. As of the end of March 

2012, all collateral pledged against outstanding TALF loans 

maintained their AAA ratings, and all loans were performing 

as scheduled. Treasury committed to provide the Federal 

Reserve up to $20 billion under TARP in credit protection for 

the TALF. This amount was later reduced to $4.3 billion in 

July 2010 and subsequently reduced to $1.4 billion in June 

2012. Treasury expects to incur no losses on this balance.

Maiden Lane LLC 

Outside of and prior to TARP, the Federal Reserve Board 

authorized the Federal Reserve Bank of New York (FRBNY) 

to form Maiden Lane LLC (ML LLC) to facilitate the merger 

of Bear Stearns with JPMorgan Chase (JPM). The Federal 

Reserve Board authorized FRBNY to extend credit to 

ML LLC, which it did through a $28.8 billion senior loan, 

During the crisis, various federal agencies set up facilities 

to help stabilize the financial system when private market 

functioning was severely disrupted. While several of these 

facilities still hold net balances, most have been wound 

down in a manner that protects the U.S. taxpayer.

Troubled Asset Relief Program Bank Support Programs

Key parts of the federal government’s response to the 

financial crisis were carried out by Treasury under the 

Troubled Asset Relief Program (TARP). Among several 

TARP programs targeting the banking system, the largest 

was the Capital Purchase Program (CPP), under which 

Treasury invested approximately $205 billion in over 700 

banking organizations. The CPP is now closed. As of June 

29, 2012, repayments—along with interest, dividends, 

and other income—exceeded the original disbursement. 

Treasury estimates that the total gain to taxpayers from the 

$245 billion disbursed under all bank support programs 

under TARP will ultimately exceed $20 billion (Chart E.1).

Temporary Liquidity Guarantee Program

The federal government’s response to the financial crisis 

also included the FDIC’s Temporary Liquidity Guarantee 

Program (TLGP). The Transaction Account Guarantee 

(TAG) portion of the TLGP guaranteed deposits in 

non-interest-bearing transaction accounts at insured 

depository institutions. The TAG expired on December 

31, 2010. Section 343 of the Dodd-Frank Act, which 

BOX E: CURRENT STATUS OF REMAINING STABILIZATION FACILITIES 

INAUGURATED DURING THE CRISIS

Chart E.1 TARP Bank Support Program Status
Financial Developments 85

market by purchasing mortgage-backed securities (MBS) 

issued by Fannie Mae and Freddie Mac. In 2008 and 

2009, Treasury purchased MBS on the secondary market 

at a cost of $225 billion and completed the liquidation of 

these holdings in March 2012. The proceeds of sales, 

in addition to principal and interest received, were $250 

billion, exceeding the program’s cost by approximately 

$25 billion.

Auto Industry

Treasury created the Automotive Industry Financing 

Program (AIFP) in December 2008 to prevent a 

significant disruption of the U.S. automotive industry 

because of the risks such a disruption could pose to 

financial stability and the U.S. economy. Under the AIFP, 

Treasury invested approximately $80 billion in General 

Motors (GM), Chrysler, and their respective financing 

arms. As of 2012:Q1, GM and Chrysler, after substantial 

reorganizations, reported nine and five consecutive 

profitable quarters, respectively.

Treasury has made substantial progress toward exiting 

its investments in automotive companies and continues 

to monitor the performance of these firms and evaluate 

options to exit its investments. As of June 30, 2012, 

Treasury’s investment in GM stood at $23.39 billion and 

in Ally Financial at $13.75 billion. Treasury has fully exited 

its investment in Chrysler and Chrysler Financial, which 

resulted in a $1.3 billion loss unlikely to be fully recovered. 

to partially fund the purchase of certain assets and 

associated hedges from Bear Stearns. As of June 14, 

2012, ML LLC fully repaid the loan (including interest) made 

by FRBNY.

Assistance to American International Group 

The Federal Reserve Board and the Treasury provided 

a coordinated response to alleviate capital and liquidity 

pressures on American International Group (AIG). At its 

peak, the amount committed to support AIG through 

FRBNY and Treasury was approximately $180 billion. 

FRBNY support included a secured revolving credit facility 

to AIG, as well as the formation and extension of credit to 

Maiden Lane II LLC (ML II) and Maiden Lane III LLC (ML III). 

To date, all of FRBNY’s loans to AIG and to MLII and ML III 

have been repaid with interest. 

As of June 29, 2012, only Treasury’s TARP investment 

in AIG remained outstanding. The $30.44 billion unpaid 

balance is less than the $34 billion market value of the 

AIG common stock that Treasury holds. This stake and 

FRBNY’s residual interest in assets held by ML II and ML 

III holdings related to FRBNY’s investments in AIG are 

likely to produce an additional profit for the U.S. public 

(Chart E.2).

Mortgage-Backed Security Purchase Program

Using its authorities under the Housing and Economic 

Recovery Act of 2008, Treasury supported the housing 

Chart E.2 AIG Investments Committed and Returned
86 2012 FSOC / / Annual Report

5.4 Financial Market Infrastructure

5.4.1 Electronic Trading of Exchange-Traded 

Instruments

Technology has dramatically changed the market 

for exchange-traded instruments, with the growth 

in computerized trading algorithms resulting in 

smaller trade sizes, higher volumes, and potentially 

more complex trading strategies. At the same time, 

a proliferation of trading venues outside traditional 

exchanges has resulted in increased fragmentation of 

equities markets and could have broader implications 

for the financial system. 

Advances in computing and communication 

technology, along with regulatory changes, have 

transformed electronic trading. High-speed 

computerized trading has been a hallmark of 

modern equities, futures, and foreign exchange 

markets and has spread in recent years to 

markets for derivatives and fixed income 

instruments. Computerized trading is used to 

facilitate a wide array of activities, including 

automated order routing and so-called highfrequency trading. (See Box F: Algorithmic and 

High-Frequency Trading.) A vast expansion of 

market data supports these activities. 

Along with decimalization of U.S. equity and 

equity options markets, electronic trading has 

resulted in smaller tick sizes and decreasing 

trade sizes. In particular, a common use of 

computerized trading algorithms is to split 

trades into multiple smaller transactions. As 

seen in Chart 5.4.1, average size per trade 

in U.S. equities markets declined 81 percent 

since 1997, while volumes increased more than 

500 percent through May 2012. This practice 

of trade splitting has become increasingly 

evident over the past 15 years. Its likely 

purpose is to minimize the price impact of 

trading, but decreased trade sizes may also be 

a component of more complex computerized 

trading strategies.

More generally, liquidity has been fragmented 

among various equity trading modalities, 

including exchanges, alternative trading 

systems, broker-dealer internalizers, and 

Chart 5.4.1 Average Trade Size—U.S. Equities
Financial Developments 87

so-called “dark pools.” The latter are trading 

systems that are not openly available to the 

public in which buyers and sellers submit orders 

anonymously, with neither order size nor price 

revealed publicly until the trade has been 

completed. In May 2012, almost a third of all 

trading in the equities market occurred outside 

exchanges in such dark pools and brokerdealer internalizers, where customer orders 

are matched against each other or against 

proprietary orders of the internalizing brokerdealer (Chart 5.4.2).

More recently, equities exchanges have been 

competing for market share in an environment 

of narrowing spreads, lower commissions, 

greater competition, and declining share 

volumes. Specifically, average daily volume of 

U.S. shares trading has declined 20 percent 

since a peak of 9.82 billion shares in 2009 to 

7.83 billion at the end of 2011 (Chart 5.4.3). 

Also noteworthy is the growth of trading in 

the Asia Pacific region. From 2000 through 

2009, Asia’s share of global trading more than 

doubled (Chart 5.4.4). This growth in Asian 

trading is a by-product of the rapid economic 

growth in this region, with a concomitant 

growth in demand for financial services.

5.4.2 Wholesale Payments and Settlements

Activity within the wholesale payments utilities has 

rebounded as both volumes and values continue 

to increase since the crisis. Robustness for the 

largest of these utilities, the Fedwire® Funds 

Service, has improved, with earlier settlement times 

and reduced operational risk. In addition, new 

and more demanding international standards 

have been released for large value payments and 

settlement utilities, as well as for other financial 

market infrastructures. 

The major wholesale payments utilities 

supporting U.S. financial markets are the 

Fedwire Funds Service, a real-time gross 

settlement system operated by the Federal 

Reserve Banks, and the Clearing House 

Interbank Payments System (CHIPS), a 

continuous net settlement system operated 

by The Clearing House Payments Company 

Chart 5.4.2 Average Daily Volume Shares by Venue

Chart 5.4.3 U.S. Equities Share Volume

Chart 5.4.4 Regional Market Share of Trades
88 2012 FSOC / / Annual Report

BOX F: ALGORITHMIC AND HIGH-FREQUENCY TRADING

Advancements in technology have had a profound effect 

on trading, as activity has become faster, more complex, 

and highly automated. Although computer-based 

algorithms have been utilized in U.S. equities markets for 

quite a while, the expansion into other markets and the 

proliferation of high-speed algorithmic trading—along with 

the current fragmented market structure—could lead to 

unintended errors cascading through the financial system. 

Regulators and market participants must help ensure that 

adequate controls and risk-management practices are in 

place to mitigate these risks. 

High-speed algorithmic trading utilizes computer 

algorithms to determine the timing, price, and quantity 

of trades. High-frequency trading (HFT) is one particular 

type of algorithmic trading. While there is no standard, 

commonly accepted definition of HFT in the industry, HFT 

typically refers to the use of computerized trading to move 

in and out of positions rapidly, generally ending the day 

flat with little or no exposure to the market on an overnight 

basis. In contrast, other styles of algorithmic trading allow 

positions to be held over longer time horizons. HFT is 

widely used in U.S. equities, global futures, and global 

foreign exchange, accounting for nearly 56 percent, 52 

percent, and 35 percent of total trading, respectively, in 

2011 (Chart F.1).

Algorithms have long been used in U.S. equities markets, 

notably to route orders to the trading venue with the best 

execution price in compliance with the SEC’s Regulation 

National Market System (NMS). Over the past decade, 

algorithms have been adapted for trading in other 

asset classes. A notable class of computerized trading 

algorithms is so-called “black box” strategies, which are 

fully automated and preprogrammed, and which generally 

have trades initiated directly by the algorithm itself. Black 

box trading algorithms are capable of reacting to market 

data, transmitting thousands of order messages per 

second directly to electronic trading venues, cancelling 

and replacing orders based on changing market 

conditions, and capturing price discrepancies with little or 

no human intervention. 

Given the speed with which these transactions are 

executed, errors can propagate rapidly through systems 

and across markets. Such errors could include unintended 

accumulation of large positions, out-of-control algorithms, 

and erroneous “fat finger” trades. As a result, prudent 

and timely risk management is of paramount importance 

in these markets. Appropriate pre- and post-trade risk 

controls are desirable at all levels of the trade life cycle, 

from trade submission to trade matching, clearing, and 

settlement. Therefore, trading firms, exchanges, brokerdealers (BDs), future commission merchants (FCM), foreign 

exchange prime brokers (FXPB), service providers, and 

clearing organizations each have an important role to 

play in preventing, detecting, and responding to potential 

computer-generated trading errors.

The desire for faster execution has prompted changes 

within the marketplace to minimize latency. Latency is a 

measurement of the time it takes to send an order to a 

trading venue and for a trading venue to acknowledge 

the order. Participants seek to minimize latency in 

order to increase the chances of getting prompt 

order execution at the best price. Factors affecting 

latency include geographical distance and response 

time from the exchange’s matching engine and the 

speed at which market data and other signals from the 

marketplace are processed.

Chart F.1 HFT % Use in Various Asset Classes
Financial Developments 89

Reducing latency is particularly important for highfrequency traders because the passage of time, even for 

an instant, exposes them to market risk. Price makers 

are exposed to the risk that their orders could remain 

in the order book after the market has moved in the 

opposite direction of their trading strategy and before their 

cancellations are processed. Price takers are exposed 

to the risk that a resting order they want to capture could 

be cancelled prior to execution or could be captured by 

another, faster trader.

In response to demand for faster execution, some trading 

venues allow “direct access” (sometimes referred to 

as “sponsored access”), through which certain trading 

firms access the exchange’s matching engine directly, 

bypassing the systems of their sponsoring BD, FCM, or 

FXPB. It is important that sponsoring entities offering 

direct access have proper controls in place for monitoring 

their clients’ activity across the relevant platforms. Another 

way trading firms can reduce latency is to place (colocate) their servers as near as possible to the trading 

venue’s matching engine(s). An important policy issue 

is the extent to which trading firms have equal access 

to co-location or direct access services. BDs, FCMs, 

and FXPBs are financially responsible for the trades 

of all their customers, including those that engage in 

algorithmic trading. To help ensure prudent customer risk 

management in the equity market, the SEC implemented 

Rule 15c3-5 in July 2011, which (among other things) 

requires BDs to maintain a system of controls and 

supervisory procedures reasonably designed to limit 

the financial exposures arising from customers that 

access the markets directly. In addition, the SEC recently 

approved two proposals by the SRO and FINRA. The 

first proposal would update, on a pilot basis, the existing 

single-stock circuit breaker mechanism with an additional 

“limit-up” and “limit-down” mechanism that effectively 

prohibits trades from being immediately executed at 

prices outside of prescribed rolling bands. The second 

proposal would update, also on a pilot basis, the existing 

market-wide circuit breakers that, when triggered, halt 

trading in all exchange-listed securities throughout 

the U.S. markets. The proposed changes lower the 

percentage-decline threshold for triggering a market-wide 

trading halt and shorten the amount of time that trading 

is halted. Among other things, these mechanisms would 

help mitigate the impact of any algorithmic orders that 

could otherwise rapidly drive the price of a stock up or 

down. In the futures market, the CFTC has adopted rules 

to bolster risk management at the exchange, clearing firm 

and other levels. In the foreign exchange market, prime 

brokers are increasingly making use of post-trade services 

designed to help prime brokers manage client risk on a 

real-time, intraday basis across multiple trading venues.
90 2012 FSOC / / Annual Report

LLC. The Fedwire Securities Service 

provides securities issuance, settlement, 

and transfer services for the U.S. Treasury, 

U.S. government agencies and governmentsponsored enterprises, and certain 

international organizations.

There was a sharp decline in 2009 in annual 

payment clearing volume and value for the 

Fedwire Funds Service, CHIPS, and the 

Fedwire Securities Service from pre-crisis peaks 

(Charts 5.4.5 and 5.4.6). From 2009 through 

2011, volume and values continued to modestly 

decline for the Fedwire Securities Service and 

showed a moderate rebound for Fedwire Funds 

Service and CHIPS.

Two noteworthy developments in U.S. large 

value payment systems are the reduced use 

of daylight overdrafts (Chart 5.4.7) and the 

earlier submission of payments (Chart 5.4.8). 

Before 2008, only 20 percent of Fedwire Funds 

Service payments (by value) were settled by 

1:00 p.m. (Eastern), and only 50 percent were 

settled by 4:00 p.m. (Eastern). As of May 2012, 

some 20 percent of Fedwire Funds Service 

value settled by 10:00 a.m., and 50 percent 

settled before 2:00 p.m. (Eastern). Both of 

these developments appear to be driven largely 

by the increase in the quantity of reserves on 

bank balance sheets (Chart 5.4.9). From an 

operational risk perspective, earlier payment 

submission decreases the potential magnitude 

of liquidity dislocations and risk in the financial 

industry should an operational disruption 

occur near the close of the Fedwire day at 6:30 

p.m. (Eastern). An open question is whether 

payments will revert back to late-in-the-day 

settlements if and when reserve balances revert 

to the pre-crisis norm. 

A final noteworthy development in wholesale 

payments and settlements is the release by 

the Committee on Payment and Settlement 

Systems (CPSS) and the Technical Committee 

of the International Organization of Securities 

Commissions (IOSCO) of a new package of 

standards called Principles for Financial Market 

Infrastructures, subject to adoption by regulators 

Chart 5.4.5 Annual Payment Clearing Volumes

Chart 5.4.6 Annual Payment Clearing Values

Chart 5.4.7 Fedwire Funds Daylight Overdrafts
Financial Developments 91

in individual jurisdictions. The principles 

are intended to apply to all systemically 

important payment systems, central securities 

depositories, securities settlement systems, 

central counterparties, and trade repositories 

(collectively “financial market infrastructures”). 

These principles contain new and more 

demanding international requirements that are 

designed to help ensure that the infrastructure 

supporting global financial markets is more 

robust and thus well placed to withstand 

financial shocks. The CPSS and IOSCO 

members (including the Federal Reserve, the 

CFTC, and the SEC) will strive to implement the 

new standards by the end of 2012. 

5.4.3 Derivatives Infrastructure

Global use of over-the-counter (OTC) derivatives 

expanded in 2011. Increasingly, these derivatives are 

centrally cleared, and data on these derivatives trades 

are reported to trade repositories, developments which 

enhance robustness of these markets.

Global Derivatives Volumes

As measured by notional value, the global OTC 

market has grown considerably faster than the 

exchange-traded derivatives markets (Chart 

5.4.10). Comparing the second half of 2011 

to the second half of 2010, the OTC market 

grew at an 8 percent pace, reflecting continued 

strong demand by end users for customized 

risk-management products. In contrast, the 

exchange-traded markets declined by 17 

percent over this period. Notional volumes 

for both exchange-traded and OTC interest 

rate products declined sharply in the second 

half of 2011, with notional amounts for OTC 

interest rate swaps dropping from $553 trillion 

(U.S. dollars) to $504 trillion from 2011:H1 

to 2011:H2, and exchange-traded numbers in 

the same period declining from $76 trillion to 

$53 trillion (Chart 5.4.11). It is likely that these 

declines were due to less need for interest-rate 

hedging in an environment of low interest rates 

and diminished credit growth. 

As measured by number of contracts, over 

two-thirds of exchange traded derivatives 

were traded outside the United States in 

Chart 5.4.8 Deciles of Fedwire Value Time Distribution

Chart 5.4.9 Reserve Balances

Chart 5.4.10 Global OTC and Exchange-Traded Derivatives 

Growth
92 2012 FSOC / / Annual Report

2011 (Chart 5.4.12). The share of derivatives 

volume traded on non-U.S. exchanges has been 

increasing over the past several years.

Central Clearing of Derivatives

A major trend in OTC markets over the past 

few years is the increasing numbers of OTC 

derivatives cleared by central counterparty 

(CCP) clearinghouses. CCP provide credit risk 

mitigation for market participants by acting as 

buyer to every seller and seller to every buyer. 

Prior to 2009, there had been central clearing 

of OTC derivatives, including clearing of 

interest rate swaps (IRS) by LCH.Clearnet’s 

SwapClear and clearing of various energy 

derivatives by the ClearPort system operated 

by the New York Mercantile Exchange (now 

part of Chicago Mercantile Exchange, or CME) 

and by IntercontinentalExchange’s (ICE) 

ICE Clear Europe. In 2009, ICE Clear Credit 

(formerly known as ICE Trust) and ICE Clear 

Europe, as well as CME, began clearing credit 

default swaps (CDS). Since the 2009 G-20 

commitment, which calls for central clearing 

of all standardized OTC derivative contracts 

by the end of 2012, clearing activity has grown 

dramatically in all such asset classes. Subsequent 

legislation in the United States (the DoddFrank Act) and regulation in the European 

Union (the European Market Infrastructure 

Regulation) are consistent with the spirit of the 

G-20 commitment.

A good deal of progress has been made 

toward central clearing of standardized OTC 

derivatives contracts, although there is still 

progress to be made. LCH.Clearnet’s SwapClear 

reports that the outstanding notional value of 

cleared IRS has grown from about $70 trillion 

in 2007 to almost $300 trillion going into 

June 2012 (Chart 5.4.13). The number of new 

IRS contracts cleared per month (“monthly 

registration” in Chart 5.4.13) has risen from 

a bit over 20,000 in 2007 to nearly 150,000. 

SwapClear now estimates that 52 percent of new 

IRS trades are presented to it for clearing. As of 

June 29, 2012, 40 percent of the notional value 

of IRS cleared by SwapClear is denominated 

Chart 5.4.11 Global Exchange-Traded Derivatives

Chart 5.4.13 SwapClear Volume

Chart 5.4.12 Exchange-Traded Derivatives Globalization
Financial Developments 93

in euros, with 36 percent denominated in U.S. 

dollars (Chart 5.4.14). 

CDS markets also show a substantial increase 

in centrally cleared contracts. According to the 

International Swaps and Derivatives Association 

(ISDA), centrally cleared CDS contracts 

represented 10.6 percent of the notional 

amounts outstanding as of December 2011. The 

two major CCPs for CDS both show significant 

growth in clearing: ICE Clear Credit’s open 

interest has grown from de minimis amounts 

three years ago to $905 billion notional as of 

June 15, 2012, comprising $470 billion in index 

products, $390 billion in corporate singlename contracts, and $45 billion in sovereign 

single names. ICE Clear Europe reports similar 

growth (Charts 5.4.15 and 5.4.16). 

CCPs have added numerous new products to 

clearing. For example, the various clearing 

entities associated with the ICE added over 125 

new OTC derivatives to their lists of products 

accepted for clearing, including energy swaps, 

emission swaps, and additional index, singlename and sovereign CDS over the past few 

months. Eurex Clearing has announced its 

intention to begin clearing OTC IRS in the 

second half of 2012. In mid-March 2012, 

LCH.Clearnet’s ForexClear began clearing 

OTC foreign exchange (FX) non-deliverable 

forwards (NDFs). CME Group is also now 

clearing OTC FX, and NDFs. ICE announced 

their plans to begin NDF clearing as well. 

Finally, the Options Clearing Corporation is 

developing a Standard & Poor’s (S&P) 500 OTC 

option for clearing. 

One of the expected benefits of centralized 

clearing of OTC derivatives is the possibility 

of netting offsetting contracts that accumulate 

through repeated trading. LCH.Clearnet’s 

SwapClear reports a reduction of about 25 

percent of the notional value presented to it 

for clearing through netting, tearing up of 

offsetting contracts, and other processes to 

eliminate redundant contracts. ICE Clear 

Credit reports a much larger netting efficiency. 

They achieved a reduction of about 90 percent 

Chart 5.4.14 Outstanding SwapClear Volumes

Chart 5.4.15 ICE Clear Credit

Chart 5.4.16 ICE Clear Europe
94 2012 FSOC / / Annual Report

of the notional value of the original CDS trades 

presented for clearing through netting, tearups, and other compression processes. 

Trade Repositories

A relatively new feature in the market 

infrastructure for swaps is the development of 

trade repositories (TRs). Under Title VII of 

the Dodd-Frank Act, the details of all swaps 

(and security-based swaps) will have to be 

reported to a TR (or to the CFTC or SEC, as 

appropriate, if no TR is available). The major 

global swaps market participants are working to 

establish a trade repository for each asset class 

and have voluntarily provided information to 

the repositories on their ongoing and, in some 

instances, legacy trades. TRs are operational 

in the United States, United Kingdom, and/

or Luxembourg for interest rate swaps, credit 

default swaps, equities swaps, commodities 

swaps, and FX swaps. Additional TRs are 

expected to be operational by year-end 2012. 

TRs data can be used to measure the size and 

composition of different swaps markets. For 

example, according to TriOptima, a TR that 

served the interest rate derivatives market 

through mid-2012 (before being replaced 

by a unit of Depository Trust and Clearing 

Corporation), some $495.9 trillion (notional) 

interest rate derivatives contracts have been 

reported to the TR by the so-called G-14 

dealers, of which a bit over one-half are cleared 

by a CCP (Chart 5.4.17). The vast majority 

of these centrally cleared swaps are dealerto-dealer contracts. In addition, another 17 

percent reported as non-centrally cleared 

dealer-to-dealer contracts were among the 

G-14 major swaps dealers. Similarly, the Trade 

Information Warehouse, a TR for CDS, reports 

that $25.0 trillion (notional) CDS contracts 

were reported to the TR, of which $15.7 trillion 

(approximately 63 percent) are dealer-todealer (Chart 5.4.18). This preponderance of 

dealer-to-dealer swaps, especially those among 

the largest dealers, appears to be an ongoing 

feature of these markets. Industry contacts 

Chart 5.4.17 Interest Rate Derivatives

Chart 5.4.18 CDS and Other Credit Derivatives
Financial Developments 95

report that these interdealer trades are mostly 

for the purpose of hedging the risks associated 

with market-making activities. It is of interest 

that, in aggregate, dealer positions as seller 

of CDS protection ($20.343 trillion notional) 

approximately equal dealer positions as buyer of 

such protection ($20.341 trillion notional). In 

other words, the dealer community in aggregate 

has approximately a flat CDS book without a 

pronounced directional tilt.

Regulatory Developments; Council Activities 97

Over the last year, Dodd-Frank Act implementation included introducing 

stronger supervision, risk management, stress testing, and disclosure standards; 

establishing resolution plans and an orderly liquidation regime for financial 

companies; regulating the derivatives markets to reduce risk and increase 

transparency; reforming the securitization markets; enhancing standards and 

disclosure requirements for hedge fund advisers; and implementing measures to 

enhance consumer and investor protection.

In addition, the Council has continued to make progress in fulfilling its mandate. 

It has issued a final rule and guidance relating to the designation of nonbank 

financial companies for Federal Reserve supervision and enhanced prudential 

standards, and has finalized the designation of an initial set of eight systemically 

important financial market utilities that will be subject to enhanced riskmanagement standards. The Council also continued to monitor potential risks 

to U.S. financial stability; fulfilled explicit statutory requirements, including 

the completion of three reports; and served as a forum for discussion and 

coordination among the member agencies implementing the Dodd-Frank Act.

The following is a discussion of the significant implementation progress the 

Council and its member agencies have achieved since the Council’s previous 

annual report.

6.1 Safety and Soundness

6.1.1 Enhanced Prudential Standards and Dodd-Frank Act Stress Tests

Sections 165 and 166 of the Dodd-Frank Act require the Federal Reserve to establish 

enhanced prudential standards and early remediation requirements for certain large 

bank holding companies (BHCs) and for nonbank financial companies designated 

for Federal Reserve supervision. In December 2011, the Federal Reserve issued, 

for public comment, a proposal to implement the enhanced prudential standards 

and early remediation requirements. The Dodd-Frank Act requires the enhanced 

standards established by the Federal Reserve for covered companies under Section 

165 to (1) be more stringent than those standards applicable to other BHCs and 

nonbank financial companies that do not present similar risks to U.S. financial 

stability and (2) increase in stringency based on the systemic footprint and risk 

characteristics of individual covered companies. 

The Federal Reserve’s proposal includes risk-based capital, leverage, liquidity, singlecounterparty credit exposure limits, supervisory and company-run stress testing, 

risk management and a risk committee, and early remediation requirements. 

The proposal would generally apply to all U.S. BHCs with consolidated assets of 

$50 billion or more and any nonbank financial company that is designated by the 

Council for supervision by the Federal Reserve. The requirements to establish a 

risk committee of the board of directors and to conduct a company-run stress test 

6 Regulatory Developments; Council Activities
98 2012 FSOC // Annual Report

would also apply to BHCs with total consolidated assets of $10 billion or more. With 

the exception of the requirements related to company-run stress tests, savings and 

loan holding companies (SLHCs) that are not designated by the Council would not 

be subject to the requirements under this proposal. The Federal Reserve’s proposal 

addresses the following:

Risk-based capital and leverage requirements. These rules would be 

implemented in two phases. In the first phase, the institutions would be subject 

to the Federal Reserve’s capital plan rule, which was published in December 2011. 

That rule requires covered companies to develop annual capital plans, conduct 

stress tests, and maintain adequate capital, including a tier one common riskbased capital ratio greater than 5 percent, under both expected and stressed 

conditions. In the second phase, the Federal Reserve would issue a proposal 

to implement a risk-based capital surcharge based on the framework and 

methodology developed by the Basel Committee on Banking Supervision (BCBS). 

Liquidity requirements. These measures would also be implemented in multiple 

phases. First, covered companies would be subject to qualitative liquidity 

risk-management standards generally based on the interagency liquidity riskmanagement guidance issued in March 2010. These standards would require 

covered companies to conduct internal liquidity stress tests and set internal 

quantitative limits to manage liquidity risk. In the second phase, the Federal 

Reserve would issue one or more proposals to implement quantitative liquidity 

requirements based on the Basel III liquidity requirements. 

Stress tests. Stress tests of the covered companies would be conducted annually 

by the Federal Reserve using three economic and financial market scenarios. A 

summary of the results, including company-specific information, would be made 

public. In addition, the proposal would require covered companies to conduct 

one or more company-run stress tests each year and to make a summary of their 

results public.

Single-counterparty credit limits. These requirements would limit credit 

exposure of a covered financial company to a single counterparty as a percentage 

of the firm’s regulatory capital. Credit exposure between the largest financial 

companies would be subject to a tighter limit.

Risk management requirements. The proposal would require covered 

companies to establish a stand-alone risk committee of the board of directors, 

and appoint a chief risk officer to oversee enterprise-wide risk management. 

BHCs with $10 billion or more in consolidated assets would also be required to 

establish an independent risk committee of the board.

Early remediation requirements. These measures would be put in place for all 

firms subject to the proposal so that financial weaknesses are addressed at an early 

stage. The Federal Reserve has proposed a number of triggers for remediation—

such as capital levels, stress test results, and risk-management weaknesses—in 

some cases calibrated to be forward-looking. Required actions would vary based 
Regulatory Developments; Council Activities 99

on the severity of the situation but could include restrictions on growth, capital 

distributions, and executive compensation, as well as capital raising or asset sales.

The Federal Reserve consulted with members of the Council in developing this 

proposal. The comment period for the proposal closed on April 30, 2012.

In addition to the stress-testing requirements to be conducted by the Federal 

Reserve, Section 165(i)(2) of the Dodd-Frank Act also requires certain financial 

institutions to conduct stress tests based on regulations issued by that institution’s 

primary federal regulator. In January 2012, the OCC, Federal Reserve, and FDIC 

issued proposed rules to implement these stress test requirements for institutions 

where they are the primary federal regulator. The comment period on these rules 

closed in April 2012. The Federal Reserve, OCC, and FDIC are coordinating their 

respective rulemakings to implement these provisions.

6.1.2 Transfer of Office of Thrift Supervision Functions

Title III of the Dodd-Frank Act transferred various powers and functions of 

the former Office of Thrift Supervision (OTS) to the OCC, FDIC, and Federal 

Reserve. This transfer of functions occurred on July 21, 2011, with the Federal 

Reserve assuming responsibilities for SLHCs, the OCC assuming responsibilities 

for federal savings associations, and the FDIC for state savings associations. The 

OCC, FDIC, and Federal Reserve coordinated their efforts to help ensure a smooth 

transfer of these functions and affected OTS employees. To clarify which agency 

will be enforcing the OTS rules, the Dodd-Frank Act required the OCC, FDIC, 

and Federal Reserve to publish a notice in the Federal Register identifying those 

regulations of the OTS that the agencies will enforce. The FDIC and OCC issued 

a joint notice on July 6, 2011, and the Federal Reserve issued its notice on July 21, 

2011. The OCC has taken a number of additional actions to incorporate applicable 

OTS regulations in the OCC’s chapter of the Code of Federal Regulations and 

to integrate OTS and OCC regulations and supervisory guidance. The Federal 

Reserve has similarly taken several steps to establish regulations and supervisory 

guidance for SLHCs. On July 21, 2011, the Federal Reserve issued supervisory 

guidance discussing the Federal Reserve’s transitional supervisory approach for 

SLHCs. The Federal Reserve also published an interim rule to incorporate SLHCs 

into the Federal Reserve’s chapter of the Code of Federal Regulations and notices 

outlining the regulatory reporting requirements for SLHCs.

As of December 31, 2011, there were 417 top tier SLHCs with estimated 

total consolidated assets of approximately $3 trillion. These SLHCs include 

approximately 48 companies engaged primarily in nonbanking activities, such 

as insurance underwriting (approximately 27 SLHCs), commercial activities 

(approximately 11 SLHCs), and securities brokerage (10 SLHCs). 

The 25 largest SLHCs accounted for more than $2.6 trillion of total consolidated 

assets. Of the SLHCs engaged primarily in depository activities, only five 

institutions were in the top 25, yet approximately 88 percent of the total SLHCs 

were engaged primarily in depository activities. The depository firms, however, held 

only 13 percent or $388 billion of the total SLHC consolidated assets.
100 2012 FSOC // Annual Report

6.1.3 Capital Standards, Comprehensive Capital Analysis and Review, and 

Supervisory Guidance Regarding Stress-Testing Practices 

In June 2012, the federal banking agencies invited comment on three joint 

proposed rules that would revise and replace the agencies’ current capital 

rules. The proposals would implement, in the United States, certain aspects 

of Basel II and 2.5, the Basel III capital reforms, and the Dodd-Frank Act, and 

would address shortcomings in regulatory capital requirements that became 

apparent during the recent financial crisis. The first Basel III notice of proposed 

rulemaking (NPR) would apply to all insured banks and savings associations, 

top-tier BHCs domiciled in the United States with more than $500 million in 

assets, and SLHCs that are domiciled in the United States. Provisions of this NPR 

that would apply to these banking organizations include implementation of a new 

common equity tier one minimum capital requirement, a higher minimum tier 

one capital requirement, and, for banking organizations subject to the advanced 

approaches capital rules, a supplementary leverage ratio that incorporates a 

broader set of exposures. Additionally, consistent with Basel III, the agencies 

propose to apply limits on a banking organization’s capital distributions and 

certain discretionary bonus payments if the banking organization does not hold a 

specified “buffer” of common equity tier one capital in addition to the minimum 

risk-based capital requirements. This NPR also would revise the agencies’ 

prompt corrective action framework by incorporating the new regulatory capital 

minimums and introducing common equity tier one capital as a new regulatory 

capital component. Prompt corrective action is an enforcement framework that 

constrains the activities of an insured depository institution based on its level of 

regulatory capital.

In the second capital NPR, also known as the “standardized approach,” the 

agencies propose to revise and harmonize rules for calculating risk-weighted 

assets to enhance risk sensitivity and address weaknesses identified over recent 

years, including by incorporating aspects of the Basel II standardized framework, 

and alternatives to credit ratings, consistent with Section 939A of the DoddFrank Act. The revisions include methods for determining risk-weighted assets 

for residential mortgages, securitization exposures, and counterparty credit risk. 

The NPR also would introduce disclosure requirements that would apply to U.S. 

banking organizations with $50 billion or more in total assets. This NPR would 

apply to the same set of institutions as the first NPR.

The third Basel III NPR would revise the advanced approaches risk-based capital 

rules consistent with Basel III and other changes to the BCBS’s capital standards. 

The agencies also propose revising the advanced approaches risk-based capital 

rules to be consistent with Section 939A and Section 171 of the Dodd-Frank Act. 

Additionally, in this NPR, the OCC and FDIC propose that the market risk capital 

rules apply to federal and state savings associations, and the Federal Reserve 

proposes that the advanced approaches and market risk capital rules apply to 

top-tier SLHCs domiciled in the United States if stated thresholds for trading 

activity are met. Generally, the advanced approaches rules would apply to such 

institutions with $250 billion or more in consolidated assets or $10 billion or more 
Regulatory Developments; Council Activities 101

in foreign exposure, and the market risk capital rule would apply to SLHCs with 

significant trading activity.

In March 2012, the Federal Reserve disclosed summary results of the 2012 

Comprehensive Capital Analysis and Review (CCAR). The CCAR is an exercise 

to evaluate the capital planning processes and capital adequacy of the largest 

BHCs. This exercise includes both company-run and supervisory stress tests to 

evaluate whether firms would have sufficient capital in times of severe economic 

and financial stress to continue to lend to households and businesses. The Federal 

Reserve estimated revenue and losses under the stress scenario based on detailed 

data provided by the firms and verified by supervisors. (See Section 5.2 for a more 

detailed discussion of the CCAR.)

As a part of the CCAR, the Federal Reserve evaluates institutions’ capital plans 

across a range of criteria, including a stress test that examines whether a firm 

could make all the capital distributions included in its plan, such as dividends 

and stock repurchases, while still maintaining capital above the Federal Reserve’s 

standards in a hypothetical supervisory stress scenario. Other considerations for 

capital distributions include an evaluation of the firms’ capital planning processes 

and plans to meet the new Basel III requirements that are scheduled to be phased 

in beginning 2013, assuming the final adoption of the Basel III NPR.

Under the Federal Reserve’s proposed stress-testing rules (noted in Section 

6.1.1), the results of the company-run stress test would be incorporated into the 

analysis supporting a company’s capital plan submission. The supervisory stress 

test would be conducted by the Federal Reserve during the annual capital plan 

review process and would be used as a tool to help the Federal Reserve assess the 

adequacy of the company’s capital plan. 

In April 2012, the Federal Reserve announced the formation of the Model 

Validation Council (MVC). The MVC will provide the Federal Reserve with 

expert and independent advice on its process to rigorously assess the models 

used in stress tests of banking institutions. The MVC is intended to improve the 

quality of the Federal Reserve’s model assessment program and to strengthen the 

confidence in the integrity and independence of the program.

In May 2012, the Federal Reserve, OCC, and FDIC issued final supervisory 

guidance regarding stress-testing practices at banking organizations with 

total consolidated assets of more than $10 billion. The guidance highlights 

the importance of stress testing at banking organizations as an ongoing 

risk-management practice that supports a banking organization’s forwardlooking assessment of its risks and better equips it to address a range of 

adverse outcomes. While the guidance does not implement the stress-testing 

requirements of the Dodd-Frank Act for certain large BHCs and nonbank 

financial companies designated for supervision by the Federal Reserve (see 

Section 6.1.1), the guidance is intended to provide entities subject to the 

Dodd-Frank Act or other stress-testing requirements with principles to follow 
102 2012 FSOC // Annual Report

when conducting stress tests in accordance with the Dodd-Frank Act or other 

statutory or regulatory requirements.

6.1.4 Volcker Rule

Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule, 

generally prohibits banking entities from engaging in proprietary trading and 

from investing in or sponsoring hedge funds and private equity funds, subject to 

certain exceptions.

Section 619 requires implementation in several stages. First, the Council was 

required to conduct a study and make recommendations on implementing 

the Volcker Rule. The Council study, which was issued on January 18, 2011, 

recommended principles for implementing the Volcker Rule and suggested a 

comprehensive framework for identifying activities prohibited by the rule, including 

an internal compliance regime, quantitative analysis, reporting, and supervisory 

review. Second, the Federal Reserve was required to publish a rule to implement 

the conformance period during which banking entities, and nonbank financial 

companies supervised by the Federal Reserve, must bring their activities and 

investments into compliance with Section 619 of the Dodd-Frank Act. The Federal 

Reserve published a final conformance rule on February 14, 2011. 

By statute, following completion of the Council’s study, authority to adopt 

implementing regulations is divided among the Federal Reserve, FDIC, OCC, SEC, 

and CFTC. The statute requires the rulemaking agencies to consult and coordinate 

with each other, as appropriate, for the purposes of assuring, to the extent 

possible, that their rules are comparable and provide for consistent application and 

implementation. The Chairperson of the Council is responsible for coordination 

of the regulations. On October 11 and 12, 2011, four of the rulemaking agencies 

invited the public to comment on proposed rules implementing the Volcker Rule’s 

prohibitions and requirements. The CFTC requested comment on a substantively 

identical proposal on January 11, 2012. The agencies received over 18,000 

comments from the public on the proposal and are working to finalize their rules. 

Pending issuance of final rules, the Federal Reserve issued a statement of policy on 

April 19, 2012, clarifying that entities subject to the Volcker Rule have the full twoyear conformance period provided by statute, which would be until July 21, 2014, 

to conform their activities and investments to the requirements of the Volcker Rule 

and the final implementing rules. By statute, that deadline may be extended by 

the Federal Reserve. The Federal Reserve’s statement of policy noted that banking 

entities should engage in good-faith planning efforts to enable them to comply 

with the Volcker Rule and final implementing rules by no later than the end of 

the statutory conformance period. The rulemaking agencies also announced that 

they plan to administer their oversight of banking entities under their respective 

jurisdictions in accordance with the Federal Reserve’s conformance rule and 

statement of policy.
Regulatory Developments; Council Activities 103

6.1.5 Resolution Plans and Orderly Liquidation Authority

Resolution Plans

Section 165(d) of the Dodd-Frank Act requires nonbank financial companies 

designated by the Council for supervision by the Federal Reserve and BHCs with 

total consolidated assets of $50 billion or more (“covered companies”) to prepare 

and submit to the Federal Reserve, the FDIC, and the Council plans—sometimes 

referred to as “living wills”—for their rapid and orderly resolution under the U.S. 

Bankruptcy Code. The Federal Reserve and the FDIC must review each plan and 

may jointly determine that a resolution plan is not credible or would not facilitate 

an orderly resolution of the company under the U.S. Bankruptcy Code. Failure 

to resubmit a credible plan within the timeframe set by the Federal Reserve and 

FDIC may result in the agencies jointly imposing more stringent capital, leverage, 

or liquidity requirements, or restrictions on the growth, activities, or operations 

of the company, or any subsidiary thereof, until the company resubmits a 

plan that remedies the deficiencies. If the company has failed to resubmit 

an acceptable plan within two years after the imposition of more stringent 

requirements or restrictions, the Federal Reserve and FDIC, in consultation with 

the Council, may jointly require divestiture of certain assets or operations to 

facilitate an orderly resolution under the U.S. Bankruptcy Code in the event of 

the company’s failure.

In November 2011, the FDIC and the Federal Reserve published a joint final rule 

that implements the resolution plan requirement. In accordance with the joint 

final rule, covered companies with $250 billion or more in total nonbank assets 

(or, in the case of a foreign-based covered company, $250 billion or more in total 

U.S. nonbank assets) were required to submit their resolution plans to the Federal 

Reserve and the FDIC by July 1, 2012. Covered companies with at least $100 

billion (but less than $250 billion) in total nonbank assets (or at least $100 billion 

but less than $250 billion in total U.S. nonbank assets, for a foreign-based covered 

company) must submit their initial plans by July 1, 2013. Covered companies with 

less than $100 billion in total nonbank assets must submit their initial plans by 

December 31, 2013. 

As a complement to this rulemaking, the FDIC issued a final rule requiring any 

FDIC-insured depository institution with assets of $50 billion or more to develop, 

maintain, and periodically submit plans outlining how the FDIC would resolve it 

through the FDIC’s resolution powers under the Federal Deposit Insurance Act. 

These two rulemakings are designed to work in tandem by covering the full range 

of business lines, legal entities, and capital structure combinations within a large 

financial firm. Their overarching objective is to promote stability, but they should 

also improve contingency planning and risk management at a covered institution 

and improve the outcomes for an institution’s constituencies and stakeholders if 

the institution fails. Importantly, as covered companies prepare and submit their 

living wills and those plans are reviewed, the process is expected to result in an 

ongoing dialogue between the supervisors and the firms that allows for continual 

improvements as the plans develop.
104 2012 FSOC // Annual Report

Orderly Liquidation Authority

Title II of the Dodd-Frank Act establishes a new framework—the orderly 

liquidation authority (OLA)—to address the potential failure of a BHC or other 

financial company when the failure of the financial company1 and its resolution 

under the bankruptcy code or otherwise applicable federal or state law would 

have serious adverse effects on financial stability in the United States. Under 

OLA, the FDIC would act as receiver of the financial company, and would resolve 

the company subject to OLA.2

In July 2011, the FDIC board approved a final rule implementing its Title II 

authority. The rulemaking, among other things, clarified the claims process and 

priorities for unsecured creditors as well as the treatment of secured creditors in 

a Title II resolution. In March 2012, the FDIC published a proposed rule setting 

forth the conditions and requirements that would govern the FDIC’s exercise 

of its authority under the OLA to enforce certain contracts of subsidiaries or 

affiliates of a financial company notwithstanding contract clauses that purport 

to terminate, accelerate, or provide for other remedies based on the insolvency, 

financial condition, or receivership of the financial company. The comment 

period on the proposed rule closed on May 29, 2012. It is anticipated that a final 

rule will be issued in the near future. 

Under Title II, the FDIC has the authority to borrow funds from the Treasury and 

to incur other obligations in connection with the orderly liquidation of a financial 

company, subject to a maximum obligation limitation (MOL). In June 2012, 

the FDIC and Treasury published, after notice and comment, a joint final rule 

governing the calculation of the MOL. Also, in April 2012, the FDIC adopted, 

after notice and comment, a final rule that sets forth the conditions under 

which a mutual insurance holding company would be treated as an insurance 

company for purposes of Title II. The FDIC also intends to propose additional 

rules to implement the OLA, including (1) rules governing the minimum right of 

recovery and (2) joint rules with the SEC, after consultation with the Securities 

Investor Protection Corporation, governing the orderly resolution of certain 

broker-dealers (BD).

Furthermore, Section 210 of the Dodd-Frank Act requires the FDIC “to 

coordinate, to the maximum extent possible” with appropriate foreign regulatory 

authorities in the event of a resolution of a covered company with cross-border 

operations. The FDIC has been working diligently on both multilateral and 

bilateral bases with foreign counterparts in supervision and resolution to 

address these crucial cross-border issues. Although U.S. firms have operations 

in many countries, those operations tend to be concentrated in a relatively small 

number of key jurisdictions, particularly, the UK. The FDIC and UK authorities 

have made substantial progress in identifying and overcoming impediments 

to resolution. To facilitate bilateral discussions and cooperation, the FDIC is 

negotiating memoranda of understanding with certain foreign counterparts 

that will provide a formal basis for information sharing and cooperation relating 

to resolution planning and implementation under the legal framework of the 

Dodd-Frank Act.
Regulatory Developments; Council Activities 105

6.1.6 Removal of References to Credit Ratings

Section 939 of the Dodd-Frank Act removes references to credit ratings in certain 

statutes, while Section 939A requires each federal agency to review its regulations 

that require the use of an assessment of creditworthiness of a security or money 

market instrument and any references to or requirements in such regulations 

regarding credit ratings. Each agency must modify its regulations as identified by 

the review to remove references to or requirements of reliance on credit ratings 

and to substitute appropriate standards of creditworthiness. 

As required by Section 939A, after enactment of the Dodd-Frank Act, federal 

agencies reported to Congress on the review of their regulations that use credit 

ratings and a description of any of the regulations. Numerous federal agencies 

have proposed or finalized rules that would modify their regulations to comply 

with the Section 939A requirements. For example, the federal banking regulators, 

in June 2012, finalized revisions to the market risk capital rules that implement 

alternatives to credit ratings for debt and securitization positions. Concurrently, 

the federal regulators invited public comment on three proposed rules to revise 

and replace the agencies’ current capital rules, including implementing the 

changes required by Section 939A. The SEC adopted rule amendments removing 

credit ratings as conditions for companies seeking to use short-form registration 

when registering non-convertible securities for public sale and proposed several 

other rules that would remove credit rating agency references from many of its 

investment company rules and its rules applicable to BD financial responsibility, 

distributions of securities, and confirmations of transactions; the FDIC issued 

a final rule removing credit ratings from the calculation of deposit insurance 

risk-based assessments for large insured depository institutions; and the OCC 

issued a final rule to remove references to credit ratings in the OCC’s rules for 

investments in securities, securities offerings and foreign bank capital equivalency 

deposit regulations. In December 2011, the FDIC proposed revisions to part 362 

of the FDIC’s regulations that would prohibit an insured savings association from 

acquiring and retaining any corporate debt security unless it determines, prior to 

acquiring such security and periodically thereafter, that the issuer has adequate 

capacity to meet all financial commitments under the security for the projected 

life of the investment. The FDIC’s December 2011 NPR is consistent with the 

OCC’s final rule noted above regarding permissible investments. 

6.1.7 Insurance

Section 111 of the Dodd-Frank Act, which established the Council, also 

provides that one of the ten voting members, in addition to the nine named 

heads of federal agencies, shall be “an independent member appointed by the 

President, by and with the advice and consent of the Senate, having insurance 

expertise.” On September 28, 2011, the President’s appointee, referred to as the 

“independent member,” was sworn in and seated as a member of the Council for a 

six-year term. Since that time, the independent member has established an office 

and has actively engaged in the work of the Council and its committees with the 

assistance of a staff of two employees with insurance expertise. The independent 

member has also actively consulted with state insurance regulators and Federal 

Reserve System staff responsible for the development and implementation of the 

supervisory framework for insurance companies. 
106 2012 FSOC // Annual Report

The Federal Insurance Office (FIO) within the Treasury was established by the 

Dodd-Frank Act with the authority, among others, to monitor all aspects of the 

insurance industry, including identifying issues or gaps in the regulation of 

insurers that could contribute to a systemic crisis in the insurance industry or the 

U.S. financial system. FIO is authorized to coordinate federal efforts and develop 

federal policy on prudential aspects of international insurance matters, including 

representing the United States, as appropriate, in the International Association 

of Insurance Supervisors (IAIS). In exercising its authorities, FIO consults with 

federal agencies, insurance regulators, and interested parties.

This past year, FIO joined the IAIS and its executive and other committees, all 

of which also include U.S. state insurance regulators as members. Through the 

IAIS, insurance regulators, supported by the National Association of Insurance 

Commissioners (NAIC), and FIO work with the insurance supervisors of other 

countries on international regulatory initiatives such as a common framework 

for regulating internationally active insurance groups. Through the IAIS, FIO 

and U.S. state insurance regulators are also working collaboratively with other 

insurance supervisors to develop a sound approach to the identification and 

oversight of global systemically important insurers.

In addition to its existing responsibility for supervision of a BHC that is a 

major life insurance company, on July 21, 2011, the Federal Reserve assumed 

responsibility for over 25 SLHCs that engage in significant volumes of life, 

property and casualty, or title insurance underwriting. The unique aspects of 

the insurance industry are addressed in various regulations that have been 

published for the BHC and SLHC populations. The Federal Reserve developed 

and implemented a specialized supervisory approach and customized supervisory 

guidance that reflects the risks and characteristics of the industry. This approach 

includes communication and coordination with state insurance regulators.

Insurance regulators, through the NAIC, continue work on updating the 

Insurance Financial Solvency Framework. Two of the more important initiatives 

relate to the continued work of the Solvency Modernization Initiative, which led 

to the adoption of the Own Risk and Solvency Assessment (ORSA) Guidance 

Manual in March 2012 and the revised Credit for Reinsurance Model Law in late 

2011. Later this year, state regulators are expected to finalize the ORSA Model 

Law to establish the ORSA filing requirement and the Valuation Manual, which 

will allow states to consider adoption of the Standard Valuation Law to implement 

principles-based reserving.

6.2 Financial Infrastructure, Markets, and Oversight

6.2.1 Over-the-Counter Derivatives Reform

Title VII of the Dodd-Frank Act establishes a comprehensive regulatory 

framework for the over-the-counter (OTC) derivatives marketplace. The 

regulatory structure for derivatives set forth in the Dodd-Frank Act is intended 

to promote, among other things, exchange trading and centralized clearing of 

swaps and security-based swaps, as well as greater transparency in the derivatives 

markets and enhanced monitoring of the entities that use these markets.
Regulatory Developments; Council Activities 107

The CFTC and SEC have proposed and begun to finalize numerous rules 

pursuant to the public notice and comment process and have engaged in 

extensive public outreach and interagency coordination, including public 

roundtables with agency staff, market participants, and other concerned members 

of the public; meetings involving staff from multiple regulators, both domestic 

and international; and agency staff meetings with members of the public. 

The SEC and CFTC have jointly adopted rules further defining the terms “swap,” 

“security-based swap,” “security-based swap agreement,” and have also adopted 

final joint rules defining the terms “swap dealer,” “security-based swap dealer,” 

“major swap participant,” and “major security-based swap participant.”

In addition, the CFTC and the federal banking agencies issued proposed 

rules on capital and margin requirements for entities within their respective 

jurisdictions (for the CFTC, certain swap dealers and major swap participants; 

for the federal banking agencies, certain securities-based swap dealers and major 

swap participants as well). The proposed rules would impose initial margin and 

variation margin requirements for uncleared swaps held by entities under each 

agency’s jurisdiction. With respect to capital requirements, the federal banking 

agencies’ existing regulatory capital rules take into account and address the 

unique risks arising from derivatives transactions and would apply to transactions 

in swaps and security-based swaps. The CFTC has proposed capital requirements 

for entities under its jurisdiction.

The CFTC has adopted several final rules, including reporting requirements 

to swap data repositories for swap dealers, major swap participants, and swap 

counterparties; rules that establish the process by which the CFTC will review 

swaps to determine whether the swaps are required to be cleared; and business 

conduct standards and other regulatory requirements for swap dealers and major 

swap participants.

The SEC has proposed rules to implement corresponding requirements for 

security-based swaps, and has adopted final rules that establish the process by 

which the SEC will review security-based swaps to determine whether the securitybased swaps are required to be cleared. 

The SEC and the CFTC are considering the structural and systems changes 

market participants will have to make to satisfy the new derivatives regulatory 

framework. The agencies are also considering a phased-in approach to 

implementing the new rules. In June 2012, the SEC issued a policy statement 

describing the order in which it expects the rules regulating the security-based 

swap market to take effect. This ordering is intended to give security-based swap 

market participants adequate, but not excessive, time to come into compliance 

with the new rules applicable to them.

On an international level, U.S. regulators are working as part of a group 

composed of representatives of the BCBS, the Committee on the Global 

Financial System, the Committee on Payment and Settlement Systems, and the 

International Organization of Securities Commissions to develop international 
108 2012 FSOC // Annual Report

standards for margin on non-centrally cleared derivatives. This group took an 

important first step when it issued a consultative report in July 2012.

6.2.2 Private Fund Adviser Registration and Oversight

Title IV of the Dodd-Frank Act closes a regulatory gap by making numerous 

changes to the registration, reporting, and recordkeeping requirements of the 

Investment Advisers Act of 1940 (Advisers Act). These provisions are designed to 

provide the SEC with oversight authority over previously unregistered investment 

advisers to certain types of private funds, including hedge funds and private 

equity funds, and the authority to require recordkeeping and reporting by 

advisers to venture capital funds.

Sections 404 and 406 of the Dodd-Frank Act authorize the SEC to collect data 

from investment advisers about their private funds to enable the Council to 

assess systemic risk and require a joint rulemaking of the SEC and CFTC for 

investment advisers that are registered with both the SEC and CFTC. The 

agencies implemented this provision in October 2011 by adopting a rule that 

requires certain advisers to hedge funds, private equity funds, and liquidity 

funds to report non-public data regarding their operations and the risk profiles 

of the private funds they manage. Under the rule, SEC-registered investment 

advisers with at least $150 million in private fund assets under management 

must periodically file a new reporting form (Form PF). Private fund advisers that 

are also registered with the CFTC as commodity pool operators or commodity 

trading advisers may satisfy systemic risk reporting requirements of the CFTC 

by filing Form PF with the SEC. The first filings of Form PF, covering private 

fund advisers with $5 billion or more in private fund assets, are due in July 2012 

for liquidity fund advisers and in August 2012 for hedge fund advisers. Smaller 

liquidity fund and hedge fund advisers, as well as private equity fund advisers, will 

be required to begin filing Form PF for the period ending December 31, 2012.

In addition, in June 2011, the SEC adopted a rule that requires advisers to certain 

types of private funds, including hedge funds and private equity funds, to register 

with the SEC. To enhance the SEC’s ability to oversee these advisers and enable 

the public to better assess the activities of private funds, the SEC requires private 

fund advisers to provide basic public information on Form ADV about the funds 

they manage, including information about the amount of assets held by the 

fund and identification of fund service providers (e.g., auditors, prime brokers, 

custodians, administrators, and marketers). In addition, the SEC requires all 

advisers to provide further information on Form ADV about an adviser’s clients, 

employees, and advisory activities. Investment advisers that had previously 

relied on the Investment Advisers Act exemption for private advisers, which was 

eliminated by the Dodd-Frank Act, were required to register with the SEC by 

March 2012. Registered investment advisers are required to adopt and implement 

policies and procedures to prevent violation of the Advisers Act and SEC rules.

6.2.3 Office of Financial Research

The purposes of the Office of Financial Research (OFR) are to support the 

Council in fulfilling the Council’s purposes and duties and to support the 

Council’s member agencies. The OFR serves as a data and research resource for 
Regulatory Developments; Council Activities 109

the Council and its member agencies, and it is working with those agencies to 

mitigate reporting burdens and increase market transparency. In this context, 

the OFR serves as a shared resource for Council members and their agencies 

and staffs. 

The OFR provides data and analysis to support that work, either as a participant 

in Council activities or in response to requests from Council members or their 

agencies or staffs. The OFR will have the capacity to provide in-depth, longterm research, as well as rapid analyses of significant financial events to inform 

the Council’s policy discussions. The OFR also has a responsibility to evaluate 

and report on stress tests and other stability-related assessments of financial 

entities overseen by member agencies, provide advice to member agencies on the 

impact of their policies as they relate to financial stability, investigate disruptions 

and failures in the financial markets, and provide its analysis to the Council, 

Congress, and the public. 

The OFR is working with Council member agencies to support an international 

initiative to establish a unique, global standard for identifying parties to 

financial transactions. This Legal Entity Identifier (LEI) will allow for a better 

understanding by both regulators and market participants of true exposures 

and counterparty risks across the system. In July, the OFR publishes its first 

annual report to Congress on its research and data-related work to assess risks to 

financial stability.

The Dodd-Frank Act provides that the OFR would be headed by a Director 

appointed by the President and confirmed by the U.S. Senate. In December 2011, 

President Obama nominated Richard B. Berner to serve as the first Director of 

the OFR. That nomination is pending before the Senate.

6.2.4 Market Structure

Over the past several years, the SEC has been considering a range of issues 

relating to developments in equity market structure. As a part of this process, the 

SEC issued a concept release in January 2010 to seek public comment on a wide 

range of market structure issues, including high-frequency trading, order routing, 

market data linkages, and undisplayed, or “dark,” liquidity. The SEC continues 

to consider the issues raised in the 2010 concept release and whether additional 

regulatory actions are needed in this area.

Recently, the SEC has taken specific actions to address market structure issues. 

For example, in July 2012, the SEC adopted a rule that would require SROs to 

develop a plan to create a consolidated audit trail. Such a consolidated audit 

trail would improve the timeliness and breadth of the information available 

to regulators for surveillance, investigations, and analysis of equity market 

activity. In June 2012, the SEC approved two proposals submitted by the national 

securities exchanges and FINRA that are designed to address extraordinary 

volatility in individual securities in the broader U.S. stock market. One initiative 

establishes a “limit-up” and “limit-down” mechanism that prevents trades in 

individual exchange-listed stocks from occurring outside of a specified price 

band. The second initiative updates existing market-wide circuit breakers that, 
110 2012 FSOC // Annual Report

when triggered, halt trading in all exchange-listed securities throughout the U.S. 

markets. The changes lower the percentage-decline threshold for triggering a 

market-wide trading halt and shorten the amount of time that trading is halted. 

The exchanges and FINRA will implement these changes by February 4, 2013; 

the SEC approved both proposals for a one-year pilot period, during which the 

exchanges, FINRA, and the SEC will assess their operation and consider whether 

any modifications are appropriate. 

Further, in July 2011, the SEC adopted a new large-trader reporting rule that is 

designed to provide the SEC with a valuable source of useful data to support its 

investigative and enforcement activities, to facilitate the SEC’s ability to assess 

the impact of large-trader activity on the securities markets, to reconstruct 

trading activity following periods of unusual market volatility, and to analyze 

significant market events for regulatory purposes. Additionally, in June 2011, the 

SEC adopted Rule 15c3-5, which, among other things, requires BDs to maintain 

a system of controls and supervisory procedures reasonably designed to limit 

the financial exposures arising from customers that access the markets directly 

through the BD. 

Recent CFTC actions have addressed risk controls by requiring futures 

exchanges to establish risk controls that prevent and reduce the potential for 

price distortions and market disruptions, including pauses or halts on trading 

when necessary. The CFTC has also required clearing member firms to conduct 

automated, pre-trade screening of orders and required futures exchanges to 

have automated, pre-trade systems that facilitate firms’ management of financial 

risk. The CFTC also adopted measures that require swap dealers and major swap 

participants to implement policies and procedures for testing and supervising 

trading programs and requires “straight-through processing” by futures 

commission merchants, swap dealers, and major swap participants of trades 

submitted for clearing. Each of these measures responds to the increased speed 

and automation of CFTC-regulated financial markets by requiring a parallel 

increase in the speed and automation of pre-trade risk controls, post-trade 

processing, and other steps designed to reduce risk and increase trade certainty. 

6.2.5 Financial Market Utilities 

Financial market utilities (FMUs) manage or operate multilateral systems for the 

purpose of transferring, clearing, or settling financial transactions. 

Title VIII of the Dodd-Frank Act establishes a new supervisory framework for 

systemically important FMUs. It authorizes the Council to designate an FMU as 

systemically important if the failure of or a disruption to the functioning of the 

FMU could create or increase the risk of significant liquidity or credit problems 

spreading among financial institutions or markets and thereby threaten the 

stability of the U.S. financial system. The Council proposed the designation of a 

set of FMUs as systemically important at its May 22, 2012, meeting. As discussed 

further in Section 6.4.1, the Council designated eight FMUs as systemically 

important at its July 18, 2012, meeting.
Regulatory Developments; Council Activities 111

The Federal Reserve, CFTC, and SEC, in consultation with each other and 

with the Council, have published proposed rules regarding risk-management 

standards for designated FMUs subject to their respective supervisory authority. 

The CFTC published its final rule with respect to all FMUs that are derivatives 

clearing organizations in November 2011. The Federal Reserve’s, CFTC’s, and 

SEC’s final rules on risk management standards that will apply to designated 

FMUs are expected in 2012.

6.2.6 Securitization

Risk Retention

Section 941 of the Dodd-Frank Act added a new Section 15G to the Securities 

Exchange Act of 1934, requiring a securitizer to retain at least 5 percent of the 

credit risk for loans or other assets that a securitizer, through the issuance of an 

asset-backed security (ABS), transfers, sells, or conveys to a third party. On April 

29, 2011, the OCC, Federal Reserve, FDIC, SEC, FHFA, and the Department of 

Housing and Urban Development (HUD) jointly published proposed rules to 

implement this risk-retention requirement. The rulewriting agencies are carefully 

assessing the provisions of the proposed rule in light of the public comments 

received and are working to develop a final rule. The Chairperson of the Council 

is coordinating the rulemaking.

As required by Section 15G, the proposed rules would, in general, require 

securitizers of ABS to retain at least 5 percent of the credit risk of the assets 

underlying the securitization. The credit risk retained generally could not 

be directly or indirectly transferred or hedged. The proposed rule includes a 

menu of risk-retention options designed to meet the statutory risk-retention 

requirement in a way that takes into account the wide variety of established 

securitization structures and market practices. Section 15G specifically provides 

that a securitizer is not required to retain the 5 percent credit risk if all of the 

loans that collateralize the ABS are qualified residential mortgages (QRMs), as 

defined by the rulewriting agencies. The definition of a QRM in the proposed 

rule takes into account underwriting standards and loan features that historically 

indicate a lower risk of default, as required by the statute. These include loan 

documentation and verification of the borrower’s ability to repay the loan, the 

loan-to-value ratio of the loan, and the debt-to-income ratio of the borrower. In 

addition, if certain other loan underwriting standards are met, the proposed rule 

would exempt ABS collateralized exclusively by commercial loans, commercial 

mortgages, or automobile loans from the 5 percent risk-retention requirement. 

In crafting the proposed rule, the agencies sought to ensure that the amount 

of credit risk retained is meaningful, while reducing the potential for the 

proposed rules to negatively affect the availability and cost of credit to consumers 

and businesses.

SEC Rules Related to ABS 

Other provisions of the Dodd-Frank Act require SEC rulemaking for ABS. 

Pursuant to Section 943 of the Dodd-Frank Act, the SEC adopted final rules 

in January 2011 that require securitizers to disclose, in tabular form, fulfilled 

and unfulfilled repurchase requests made in connection with outstanding 
112 2012 FSOC // Annual Report

ABS. Repurchases often result from a loan that does not comply with the 

representations and warranties made in an underlying transaction pooling 

agreement. The rules also require that nationally recognized statistical rating 

organizations include information regarding the representations, warranties, and 

enforcement mechanism available to investors in an ABS offering in any report 

accompanying a credit rating issued in connection with such offering. Pursuant 

to Section 945, the SEC also adopted final rules in January 2011 requiring an 

issuer of ABS registered under the Securities Act of 1933 to perform a review of 

the assets underlying the ABS and to disclose information about the nature of 

the review. Under the rules, the issuer must also disclose information about (1) 

how the loans in the pool differ from the loan underwriting criteria disclosed in 

the prospectus, (2) loans that did not meet the disclosed underwriting criteria 

but were included in the pool, and (3) the entity that made the determination 

that loans be included in the pool even though they did not meet the disclosed 

underwriting standards.

Section 942(b) of the Dodd-Frank Act requires the SEC to adopt regulations to 

require issuers of ABS, at a minimum, to disclose asset-level or loan-level data 

regarding the assets backing the ABS, if such data are necessary for investors 

independently to perform due diligence. In April 2010, the SEC had proposed 

significant revisions to rules regarding the offering process, disclosure, and 

reporting for asset-backed securities, including revisions to Regulation AB. 

As part of its April 2010 proposal, to augment existing pool-level disclosure 

requirements, the SEC had proposed to require that standardized asset-level 

data points regarding each asset in the underlying pool be provided at the 

time of securitization and on an ongoing basis. In July 2011, the SEC issued a 

release requesting additional comment on whether the April 2010 proposals 

appropriately implement Section 942(b) of the Dodd-Frank Act.

In September 2011, the SEC proposed rules under Section 621 of the Dodd-Frank 

Act that would prohibit securitization participants of an ABS for a designated 

time period from engaging in certain transactions that would involve or result in 

a material conflict of interest.

6.2.7 Audit Standards

In the last year, the Public Company Accounting Oversight Board (PCAOB) 

has engaged in several projects related to auditing and professional practice 

standards. The PCAOB proposed a new auditing standard, Related Parties, and 

amendments to existing standards regarding significant unusual transactions, 

intended to enhance audit procedures in areas that have, at times, been used 

to engage in fraudulent financial reporting; proposed a new standard and 

amendments intended to enhance the relevance and quality of the communications 

between an auditor and a company’s audit committee; proposed auditing and 

attestation standards that would apply to the audits of SEC-registered BDs and to 

the supplemental information accompanying audited financial statements; and 

proposed amendments to improve the transparency of public company audits 

by requiring the disclosure of the audit engagement partner’s name in the audit 

report and the disclosure of other independent public accounting firms and other 

persons that took part in the audit.
Regulatory Developments; Council Activities 113

In addition, on June 21, 2011, the PCAOB issued a concept release seeking public 

comment on the potential direction of a standard-setting project on the content 

and form of auditors’ reports on financial statements.

Finally, on August 16, 2011, the PCAOB issued a concept release seeking public 

comment on ways that auditor independence, objectivity, and professional 

skepticism can be enhanced, including through mandatory rotation of audit firms. 

Mandatory audit firm rotation would limit the number of consecutive years for 

which a registered public accounting firm could serve as the auditor of a public 

company. The PCAOB received over 600 public comments on its release and is 

continuing to evaluate these ideas.

6.2.8 Accounting

The Financial Accounting Standards Board (FASB) and International Accounting 

Standards Board (IASB) are continuing their work to finalize converged 

standards in several major areas, including revenue recognition, lease accounting, 

financial instruments, and insurance contracts. In their revenue-recognition 

project, the FASB and IASB are working to clarify and align the principles for 

recognizing revenue. The FASB and IASB are considering comments from 

constituents on their joint 2011 proposal, and a final joint standard on revenue 

recognition is expected by early 2013. In their lease-accounting project, the FASB 

and IASB are working to provide greater transparency to lease arrangements by 

requiring balance sheet recognition of the rights and obligations associated with 

leases. The FASB and IASB are considering comments on their 2010 proposal, 

and a new joint proposal for public comment is expected in the second half of 

2012. In the area of financial instruments, the FASB and IASB are seeking to 

more closely align key aspects of their classification and measurement models and 

to develop a new approach to impairment for financial instruments. The FASB 

and IASB are expected to release a new proposal on impairment for financial 

instruments in the second half of 2012. For insurance contracts, the IASB 

currently does not have a comprehensive insurance model in IFRS. The FASB is 

evaluating this issue, including joint discussions with the IASB regarding whether 

to propose changes to the existing U.S. insurance accounting model to provide 

users of financial statements with more useful information. Further documents or 

proposals from FASB and IASB are expected in the second half of 2012.

6.3 Consumer and Investor Protection

6.3.1 Consumer Protection

On January 4, 2012, President Obama appointed former Ohio Attorney General 

Richard Cordray as the Director of the CFPB. The CFPB is an independent 

bureau within the Federal Reserve System. It has rulemaking authority under 

specifically listed statutes, as well as specified supervisory and enforcement 

authority for very large depository institutions and non-depository (nonbank) 

entities and other duties relating to consumer financial products and services. 

The CFPB is the primary federal regulator exclusively focused on, and 

accountable to Congress and the public for, consumer financial protection. The 

CFPB has launched its supervision program for very large depository institutions 

(in coordination with prudential regulators) and for nonbanks; established its 
114 2012 FSOC // Annual Report

consumer response function; assumed rulemaking responsibility for federal 

consumer financial laws transferred to the CFPB on July 21, 2011; and issued a 

variety of rules and reports required under the Dodd-Frank Act. In addition, the 

CFPB continues to work to ensure that consumers have the information they need 

to understand the costs and risks of consumer financial products and services, so 

they can compare products and choose the ones that are best for them. Moreover, 

the CFPB is taking steps to clarify and streamline regulations and guidance 

to reduce unnecessary burdens on providers of consumer financial products 

and services.

One of the CFPB’s first rulemaking initiatives is consolidation of mortgage loan 

disclosure forms under the Truth in Lending Act (TILA) and the Real Estate 

Settlement Procedures Act (RESPA) to make the information more useful to 

consumers and to reduce burdens on lenders. The Dodd-Frank Act consolidates 

rulemaking authority for the two statutes in the CFPB. The CFPB proposed 

regulations and model disclosures in July 2012. As part of its “Know Before 

You Owe” initiative, the CFPB has been testing prototype disclosure forms that 

contain information required to be disclosed to consumers who apply for a loan 

to purchase a house or refinance an existing mortgage loan.

In addition, the CFPB has been testing a prototype for a monthly mortgage 

statement designed to make it easier for borrowers to understand costs and 

fees associated with mortgage loans. The Dodd-Frank Act amends the TILA 

and requires creditors, assignees, or servicers to send the borrower a periodic 

statement for each billing cycle; the statement must include information about 

the mortgage’s principal loan amount, current interest rate, date on which the 

interest rate may next reset, and a description of any late payment fees, among 

other items. The CFPB plans, in the summer of 2012, to propose a rule, including 

a proposed form, to implement this requirement and several other servicingrelated requirements under the Dodd-Frank Act.

The Dodd-Frank Act also amends the Electronic Fund Transfer Act to provide 

protections to consumers who transfer funds to recipients located in another 

country (remittance transfers), and the CFPB adopted a rule implementing 

these consumer protections. In general, the rule requires remittance transfer 

providers to disclose to a consumer the exchange rate, fees, and amount to be 

received by the recipient when the consumer sends a remittance transfer. The 

CFPB also requested public comment on whether the rule should include a safe 

harbor to exempt community banks, credit unions, and other companies that 

process less than a certain number of remittance transfers per year from the 

new requirements. The final rule, with any adjustments, will go into effect on 

February 7, 2013.

The CFPB has supervision authority over certain nonbank entities, including 

mortgage companies, private education lenders, payday lenders, and “larger 

participants” of a market for other consumer financial products or services. On 

February 17, 2012, the CFPB published its initial proposed rule to define larger 

participants in the consumer reporting and debt collection markets. The CFPB 

indicated that it will issue additional rules to define criteria for larger participants 
Regulatory Developments; Council Activities 115

in other consumer financial markets, selecting the appropriate criteria and 

thresholds for each of those markets.

The Federal Reserve, FDIC, OCC, and NCUA have worked closely with the CFPB 

to help ensure a smooth transition of the CFPB’s examination and rulemaking 

authorities. These activities have included the transfer of certain staff to the CFPB 

and the development of information and examination coordination memoranda 

of understanding. For its part, the CFPB consults actively with the Federal 

Reserve, FDIC, OCC, and NCUA in the rulemaking process to help promote 

regulatory effectiveness and to meet the goals and requirements of the DoddFrank Act regarding consultation.

6.3.2 Mortgage Transactions and Housing

Title XIV of the Dodd-Frank Act, the “Mortgage Reform and Anti-Predatory 

Lending Act,” contains several measures designed to protect consumers in 

mortgage transactions. Many of these measures were enacted as amendments 

to the TILA and the RESPA. Prior to July 21, 2011, the Federal Reserve was 

responsible for regulations implementing the TILA requirements and HUD was 

responsible for RESPA, but those rulemaking authorities transferred to the CFPB 

on that date. In addition to the CFPB’s efforts to develop improved mortgage 

servicing disclosure standards (see previous text), the prudential regulators are 

working to develop regulations under safety and soundness authority that address 

the servicing of performing and nonperforming mortgage loans, which would 

supplement the CFPB’s TILA and RESPA rulemaking. Certain additional rules 

concerning appraisals must be promulgated on an interagency basis. The CFPB 

expects to issue proposals to implement a number of Title XIV requirements in 

the summer of 2012 and to finalize several rules by January 2013, including the 

rules described in the following text.

Under new standards regarding residential mortgages, a lender is required to 

make a reasonable, good faith determination of an applicant’s ability to repay 

before issuing a closed-end mortgage loan. In general, the “ability to repay” 

standard can be met if the loan is a “qualified mortgage,” as defined under the 

Dodd-Frank Act and by regulation. A lender receives certain protections from 

liability if a loan is a “qualified mortgage.” The CFPB is responsible for finalizing 

a proposed rule that was issued by the Federal Reserve in May 2011. The DoddFrank Act also requires escrow accounts to be established for certain mortgage 

loans and mandates certain new disclosures regarding escrow accounts. The 

Federal Reserve issued a proposed rule to implement these requirements in 

March 2011, and the CFPB is responsible for finalizing that rule. In addition, 

the Dodd-Frank Act expands the range of mortgage loans that are subject to the 

Home Ownership and Equity Protection Act and imposes new requirements on 

high-cost mortgages. These include mandatory counseling and other protections. 

For mortgage servicers, there will be requirements concerning provision of 

monthly statements, disclosures for hybrid adjustable rate mortgages, force-placed 

insurance, prompt crediting of payments, pay-off amounts, and error resolution. 

There also will be new requirements concerning compensation and qualification 

of mortgage loan originators, such as brokers and loan officers, and, for certain 

purposes, the companies that hire them. The Dodd-Frank Act also amends the 
116 2012 FSOC // Annual Report

Equal Credit Opportunity Act to require mortgage lenders to provide certain 

disclosures and copies of appraisal documents to consumers.

Subtitle F of Title XIV of the Dodd-Frank Act relates to appraisal reform, and 

certain additional rules concerning appraisals must be promulgated on an 

interagency basis. For higher-risk mortgages, the Dodd-Frank Act generally 

requires written appraisals based on a physical inspection of the property and, in 

some cases, second appraisals. The FDIC, Federal Reserve, OCC, NCUA, FHFA, 

and CFPB have authority under the Dodd-Frank Act to issue joint regulations 

and guidance on appraiser independence and are required to issue regulations 

on the appraisal requirements for higher-risk mortgages, appraisal management 

companies, and automated valuation models.

6.3.3 Investor Protection

The Dodd-Frank Act includes various provisions to strengthen investor 

protection. These provisions include regulation of the over-the-counter 

derivatives markets and governance and compensation reform. Under Section 

926 of the Dodd-Frank Act, the SEC is required to adopt rules that disqualify 

securities offerings involving certain felons and other “bad actors” from relying 

on the safe harbor from Securities Act registration provided by Rule 506 of 

Regulation D. The SEC proposed rules to implement the requirements of 

this provision in May 2011. In addition, the SEC adopted rule amendments in 

December 2011 implementing Section 413(a) of the Dodd-Frank Act, which 

requires the value of an individual’s primary residence to be excluded when 

determining if that individual’s net worth exceeds the $1 million threshold 

required for “accredited investor” status.

The investing public should benefit from increased oversight of investment 

advisers. Approximately 2,500 investment advisers with assets under management 

between $25 million and $100 million are transitioning from oversight by the SEC 

to oversight by state securities regulators. This transition, mandated by Section 

410 of the Dodd-Frank Act and implemented by June 2011 rulemakings by the 

SEC, is expected to result in more frequent examinations of the approximately 

17,000 smaller, local advisers, while also allowing the SEC to focus its resources on 

the approximately 10,000 larger, national advisers.

The securities laws also were modified in a number of ways to facilitate SEC 

enforcement actions. These changes include enhancing the application of 

antifraud provisions and providing authority to bring actions against aiders 

and abettors. For example, the Dodd-Frank Act established a whistleblower 

program that requires the SEC to pay an award to eligible whistleblowers that 

voluntarily provide the SEC with original information about a violation of the 

federal securities laws that leads to the successful enforcement of certain judicial 

or administrative actions. In May 2011, the SEC adopted rules to implement this 

provision. Since the rules went into effect in August 2011, the SEC has received 

hundreds of tips through the program, and the quality of the information 

received has, in many instances, been particularly helpful to the SEC’s 

investigative staff.
Regulatory Developments; Council Activities 117

6.3.4 Governance and Compensation

To facilitate prudent risk management at financial institutions and to align 

the interests of executives and other employees with the long-term health of 

their organizations, Section 956 of the Dodd-Frank Act requires the Federal 

Reserve, FDIC, FHFA, NCUA, OCC, and SEC to jointly prescribe rules or 

guidelines that require certain covered financial institutions to disclose to their 

appropriate federal regulator the structure of the incentive-based compensation 

arrangements offered by such covered financial institution sufficient to determine 

whether the compensation structure (1) provides an executive officer, employee, 

director, or principal shareholder of the covered financial institution with 

excessive compensation, fees, or benefits; or (2) could lead to material financial 

loss to the covered financial institution. Further, Section 956 requires the 

appropriate federal regulators jointly to prescribe regulations or guidelines that 

prohibit any types of incentive-based payment arrangement, or any feature of 

such arrangement, that the regulators determine encourages inappropriate risks 

by providing an executive officer, employee, director, or principal shareholder of 

the covered financial institution with excessive compensation, fees, or benefits, or 

that could lead to material financial loss to the covered firm. The proposed rule 

would impose additional requirements on the payment of incentive compensation 

to executive officers of certain larger covered financial institutions.

In April 2011, the agencies published a three-part proposed rule for public 

comment. First, a financial institution with $1 billion or more in total 

consolidated assets (a covered financial institution) would be required to 

file an annual report with its appropriate federal regulator describing the 

structure of the firm’s incentive-based compensation arrangements. Second, the 

proposed rule would prohibit a covered financial institution from establishing 

or maintaining an incentive-based compensation arrangement that could lead 

to material financial loss or that encourages inappropriate risks by providing 

certain “covered persons” (which include all executives, employees, directors, and 

principal shareholders) with excessive compensation. Finally, the proposed rule 

would require each covered financial institution to adopt specific policies and 

procedures approved by its board to help ensure and monitor compliance with 

the rule.

Section 952 of the Dodd-Frank Act requires the SEC to, by rule, direct the 

national securities exchanges and national securities associations to prohibit 

the listing of any equity security of an issuer that does not comply with new 

compensation committee and compensation adviser requirements. In June 

2012, the SEC adopted rules to implement Section 952 that require, among 

other things, that the exchanges establish listing standards that require each 

member of a listed issuer’s compensation committee to be a member of the 

board of directors and to be “independent.” The SEC also is required by 

the Dodd-Frank Act to adopt several additional rules related to corporate 

governance and executive compensation, including rules mandating new 

listing standards relating to specified “clawback” policies, and new disclosure 

requirements about executive compensation and company performance, 

executive to median employee pay ratios, and employee and director hedging. 

These provisions of the Dodd-Frank Act do not contain rulemaking deadlines, 
118 2012 FSOC // Annual Report

but SEC staff is working to develop recommendations for the SEC concerning 

the implementation of these provisions.

6.4 Council Activities

6.4.1 Determination of Nonbank Financial Companies to Be Supervised by the 

Federal Reserve and Designation of Financial Market Utilities

Nonbank Financial Companies

One of the Council’s statutory purposes is to identify risks to financial stability 

that could arise from the material financial distress or failure, or ongoing 

activities, of nonbank financial companies. Under Section 113 of the Dodd-Frank 

Act, the Council is authorized to determine that a nonbank financial company’s 

material financial distress—or the nature, scope, size, scale, concentration, 

interconnectedness, or mix of its activities—could pose a threat to U.S. financial 

stability. Such companies will be subject to consolidated supervision by the 

Federal Reserve and enhanced prudential standards.

The Dodd-Frank Act provides a list of 10 considerations the Council must 

use in making determinations under Section 113. In fall 2010, the Council 

began a rulemaking process to further clarify these statutorily mandated 

considerations. The Council issued an advance notice of proposed rulemaking 

(ANPR) in October 2010 and an NPR in January 2011. The Council received 

significant input from market participants, nonprofits, academics, and members 

of the public about the need to develop an analytic framework for making 

determinations that would provide a consistent approach and incorporate both 

quantitative and qualitative judgments. In response to comments the Council 

received on the NPR, the Council sought public comment on a second NPR 

and proposed interpretive guidance in October 2011 to provide (1) additional 

details regarding the framework that the Council intends to use to assess whether 

the material financial distress or failure, or ongoing activities, of a nonbank 

financial company could pose a threat to U.S. financial stability; and (2) further 

opportunity for public comment on the Council’s proposed approach to the 

determination process. In April 2012, the Council adopted a final rule and 

interpretive guidance.

The Council’s interpretive guidance includes an analytic framework that 

organizes the 10 statutory considerations into six broad categories that reflect 

a company’s role in the financial system and its potential to experience 

material financial distress. In addition, the interpretive guidance describes the 

three-stage process that the Council intends to use in evaluating companies 

in non-emergency situations, defines key terms related to the Council’s 

determination authority, and sets forth uniform quantitative thresholds 

that the Council intends to use to identify companies for further evaluation. 

While the Council’s assessments of companies will be based on a fact-specific 

evaluation of the statutory considerations, the rule and interpretive guidance 

describe the characteristics of companies the Council likely will evaluate for 

potential determination and the factors the Council intends to use when 

analyzing companies.
Regulatory Developments; Council Activities 119

In non-emergency situations, before a Council vote on any proposed 

determination, the company under consideration will have an opportunity to 

submit written materials to the Council regarding the proposed determination. 

Council members will vote on a proposed determination only after they have 

reviewed that information, and the proposed determination will proceed only 

if approved by two-thirds of the Council, including the affirmative vote of the 

Chairperson. Upon a proposed determination, a company may request a hearing, 

and the determination will be finalized only after a subsequent two-thirds vote 

of the Council, including the affirmative vote of the Chairperson. Any final 

determination will be subject to judicial review, and the Council must submit 

a report to Congress on, among other things, all determinations made under 

Section 113 of the Dodd-Frank Act and the basis for such determinations.

As of the date of this report, the Council has not made any determinations under 

Section 113 of the Dodd-Frank Act.

Financial Market Utilities

The Dodd-Frank Act authorizes the Council to designate an FMU as “systemically 

important” if the Council determines that the failure of or a disruption to the 

functioning of the FMU could create or increase the risk of significant liquidity 

or credit problems spreading among financial institutions or markets and thereby 

threaten the stability of the U.S. financial system.

Designated FMUs will become subject to the heightened prudential and 

supervisory provisions of Title VIII, which promote robust risk management and 

safety and soundness, including conducting their operations in compliance with 

applicable risk-management standards; providing advance notice and review of 

changes to their rules, procedures, and operations that could materially affect 

the nature or level of their risks; and being subject to relevant examination 

and enforcement provisions. Title VIII also requires the supervisory agencies 

to consult with each other when they are prescribing their respective riskmanagement standards, jointly develop risk-management supervisory programs, 

and consult and coordinate in planning and conducting examinations. To further 

strengthen settlement processes, the Federal Reserve Board may authorize a 

Federal Reserve Bank to provide accounts and settlement services to designated 

FMUs. Additionally, under unusual or exigent circumstances, designated FMUs 

could potentially gain access to the Federal Reserve’s discount window.

Following the publication of its final rule outlining the criteria, processes, and 

procedures for the designation of FMUs on July 27, 2011, the Council proposed 

the designation of an initial set of FMUs on May 22, 2012. At its July 18, 2012, 

meeting, the Council voted unanimously to designate eight FMUs as systemically 

important under Title VIII of the Dodd-Frank Act. 

The FMUs that the Council designated perform a variety of functions in the 

market, including the clearance and settlement of cash, securities, and derivatives 

transactions; many of them are central counterparties and are responsible for 

clearing a large majority of trades in their respective markets. The Council 

believes that the completion of the FMU designations process for this initial set 
120 2012 FSOC // Annual Report

of FMUs is a major milestone in the implementation of the Dodd-Frank Act and 

that the designation of these entities will instill confidence in their respective 

markets. The basis for the Council’s designation determination for each of these 

systemically important FMUs is described in Appendix A. 

6.4.2 Risk Monitoring

One of the Council’s central purposes is the ongoing identification of risks to U.S. 

financial stability. To help identify risks, promote market discipline, and respond 

to emerging threats, the Council facilitates information sharing, coordination, 

and communication among member agencies, among other things.

In the past year, the Council examined significant market developments and 

structural issues within the financial system, including topics discussed elsewhere 

in this report. The Council will continue to monitor potential threats to financial 

stability, whether from external shocks or structural weaknesses.

To facilitate this risk monitoring process, the Council established the Systemic 

Risk Committee (SRC), composed primarily of member agency staff in 

supervisory, surveillance, examination, and policy roles. The SRC serves as a 

forum for member agency staff to identify and analyze potential risks that may 

extend beyond the jurisdiction of any one agency.

6.4.3 Reports Required Under the Dodd-Frank Act

Prompt Corrective Action

In December 2011, the Council released a report to Congress on prompt 

corrective action (PCA). Section 202(g)(4) of the Dodd-Frank Act required 

the Council to issue a report on actions taken in response to the Government 

Accountability Office (GAO) study on PCA required by Section 202(g)(1) of the 

Dodd-Frank Act. The Council’s report discusses the existing PCA framework 

and the findings and recommendations of the GAO study. The Council’s report 

also highlights some lessons learned from the financial crisis and outlines 

actions taken that could affect PCA, as well as additional steps to modify the PCA 

framework that could be considered.

Report on Actions Taken in Response to the GAO’s Report on the NCUA

In June 2012, the Council released a report to Congress on actions taken 

in response to a GAO report on the NCUA’s supervision of corporate credit 

unions and implementation of PCA, as required by the National Credit 

Union Authority Clarification Act. The report discusses the findings and 

recommendations of the GAO study and outlines NCUA activities that relate to 

the GAO’s recommendations.

Contingent Capital

Section 115(c) of the Dodd-Frank Act requires the Council to study the feasibility, 

benefits, costs, and structure of a contingent capital requirement for nonbank 

financial companies supervised by the Federal Reserve and large, interconnected 

bank holding companies. In July 2012, the Council submitted a report to 

Congress regarding the study, as required by Section 115(c). The Council’s report 
Regulatory Developments; Council Activities 121

concludes that contingent capital instruments should continue to be an area for 

private sector innovation, and encourages the Federal Reserve and other financial 

regulators to continue to study the advantages and disadvantages of including 

contingent capital and bail-in instruments in their regulatory capital frameworks.

6.4.4 Rulemaking Coordination

As Chairperson of the Council, the Treasury Secretary is required to coordinate 

two major rulemakings under the Dodd-Frank Act.

To facilitate the joint rulemaking on credit risk retention for asset-backed 

securities, as described previously, certain member agencies participated in 

an interagency working group to develop the NPR for public comment. The 

Federal Reserve, FDIC, SEC, OCC, HUD, and FHFA issued a joint NPR on March 

30, 2011, that proposes rules to implement this requirement and represents 

a significant step toward strengthening securitization markets. The agencies 

extended the comment period for the proposed rule from June 10, 2011, to 

August 1, 2011.

The Chairperson of the Council is also required to coordinate the issuance of 

final regulations implementing the Volcker Rule, as described in Section 6.1.4. 

The Chairperson has played an active role in coordinating the agencies’ work to 

develop regulations that are comparable and provide for consistent application, 

to the extent possible. The Federal Reserve, FDIC, OCC, and SEC sought public 

comment on a proposed rule in October 2011, and the CFTC requested comment 

on a substantively identical NPR in January 2012. The comment period closed 

February 13, 2012, for the proposed rules issued by the Federal Reserve, FDIC, 

OCC, and SEC, and closed on April 16, 2012, for the CFTC’s proposed rule. 

The Chairperson of the Council continues to coordinate the development of a 

final rule.

6.4.5 Operations of the Council

The Dodd-Frank Act requires the Council to convene no less than quarterly. In 

the last year, the Council met 12 times.3 The meetings bring Council members 

together to discuss and analyze emerging market developments and financial 

regulatory issues. The Council is committed to conducting its business as openly 

and transparently as practicable, given the confidential supervisory and sensitive 

information at the center of its work. Consistent with the Council’s transparency 

policy, the Council opens its meetings to the public whenever possible. The 

Council held a public session at three of its meetings in the last year.

Approximately every two weeks, the Council’s Deputies Committee, which 

is composed of senior representatives of Council members, has convened to 

discuss the Council’s agenda and to direct the work of the SRC and the five 

other functional committees. The other functional committees are organized 

around the Council’s ongoing statutory responsibilities: (1) identifying nonbank 

financial companies and financial market utilities for designation; (2) making 

recommendations to primary financial regulatory agencies regarding heightened 

prudential standards for financial firms; (3) consulting with the FDIC on 

orderly liquidation authority and reviewing the resolution plan requirements for 
122 2012 FSOC // Annual Report

designated nonbank financial firms and the largest BHCs; and (4) collecting data 

and improving data-reporting standards.

In the last year, the Council adopted regulations implementing its Freedom of 

Information Act obligations,4 adopted hearing procedures for nonbank financial 

companies and FMUs subject to proposed designations, and passed its second 

budget. The Council also complied with its transparency policy by conducting its 

business in an open and transparent manner whenever possible.5

Financial Research Fund Assessments

Section 155 of the Dodd-Frank Act requires the Treasury, with the approval 

of the Council, to establish assessments to fund the OFR’s budget, which 

includes the expenses of the Council and the FDIC’s implementation 

expenses associated with OLA. To implement this provision, on May 21, 2012, 

the Treasury issued a final rule that establishes an assessment schedule for 

semiannual collections from bank holding companies with total consolidated 

assets of $50 billion or greater and an interim final rule that applies to nonbank 

financial companies supervised by the Federal Reserve. The first payments 

under the rule will be made on July 20, 2012.

6.4.6 Section 119 of the Dodd-Frank Act

Section 119 of the Dodd-Frank Act provides that the Council may issue 

nonbinding recommendations to member agencies on disputes about the 

agencies’ respective jurisdiction over a particular BHC, nonbank financial 

company, or financial activity or product. (Certain consumer protection matters, 

for which another dispute mechanism is provided under Title X of the Act, are 

excluded). To date, no member agency has approached the Council to resolve a 

dispute under Section 119.
Potential Emerging Threats 123

Given the inherent difficulty in predicting shocks, 

perhaps the most important line of defense is to 

reduce vulnerabilities by ensuring that institutions 

have sufficient capital and liquidity resources, sound 

risk-management practices, and strong internal 

and regulatory controls. Policy efforts can also 

strengthen financial markets’ ability to withstand 

shocks by promoting greater informational 

transparency, for example, by addressing gaps 

in the availability of data and by producing 

consolidated audit trails. Additional policy measures 

that serve to enhance robustness of markets and 

institutions include comprehensive resolution 

planning, procedures for orderly liquidation of 

insolvent institutions, constraints on concentration 

in financial services, disciplined underwriting 

standards for credit origination, and exercising 

due diligence on emerging financial products. 

Finally, markets can be made more resilient if public 

authorities can respond to financial stresses in a 

flexible and timely manner. An example would 

be the central bank’s role as lender of last resort, 

accompanied by appropriate safeguards against the 

risk of moral hazard.

The public policy goal is not to reduce financial 

market vulnerabilities to zero. Many of the key 

tasks performed by financial markets inherently 

involve a degree of vulnerability to certain kinds of 

risk. Credit provision to risky borrowers, maturity 

transformation, and the clearing of financial 

transactions are all activities that can generate 

vulnerabilities. Accordingly, the goal of public policy 

is to design regulatory and institutional frameworks 

that reduce vulnerabilities of markets, institutions, 

and infrastructures to acceptable levels, while 

allowing the financial system to continue to serve 

the needs of the real economy.

Destabilizing shocks are more likely to occur 

when markets have undergone structural changes, 

including those from technological development 

and financial innovation. These changes may be 

slow moving, occurring over a period of years. For 

7.1 Framework: Threats as a Combination 

of Shocks and Vulnerabilities

Episodes of financial disruption typically arise when 

adverse developments unforeseen by most market 

participants, commonly referred to as shocks, 

interact with financial system vulnerabilities. A 

shock that potentially threatens stability is typically 

one that induces substantial losses on a class of 

assets over a short period of time. Recent history 

provides examples of shocks that created challenges 

for financial stability, such as the bursting asset 

price bubbles in stock markets (2000) and housing 

markets (2007), rapid increases in interest rates 

(1994), defaults on sovereign debt (for example, 

Mexico in 1982 or Russia in 1998), or severe 

operational stress in financial markets (for example, 

the so-called “flash crash” of May 2010). Shocks 

can also emerge from, or be exacerbated by, the 

failure of a specific firm, infrastructure events, or 

breakdowns in market functioning that create or 

aggravate losses on a class of assets. 

Not all such disturbances necessarily affect the 

stability of the financial system or the real economy. 

However, if the financial system is particularly 

vulnerable to shocks, for example, due to excessive 

leverage or excessive use of short-term wholesale 

funding of illiquid assets, a shock could have 

extreme balance sheet consequences and threaten 

institutions with insolvency. Market participants 

in general may not know which specific firms have 

balance sheets that are most at risk, so they may 

respond by avoiding exposure to any potential 

counterparty that might be at risk of insolvency. 

The resulting attenuation of credit provision could 

lead to disorderly liquidation of assets by all affected 

firms, inducing losses in other asset classes, thereby 

spreading and magnifying the effects of the initial 

disturbance. Credit flows to the non-financial 

sector could be disrupted, reducing the pace of 

real economic activity. In extreme cases, total 

economic losses could far exceed the original drop 

in asset value. 

7 Potential Emerging Threats
124 2012 FSOC / / Annual Report

Chart 7.2.1 Sovereign Yields example, the proliferation of mortgage-backed 

securities backed by subprime mortgage debt 

occurred over approximately eight years. 

Structural changes that occur during periods 

of low volatility can be particularly problematic, 

since such low-volatility episodes can lead to 

complacency on the part of risk managers and 

may lead to riskier behaviors in search of higher 

returns. The full implications of such structural 

changes are rarely recognized in real time. 

In particular, so-called “model risk” becomes 

more of a problem as market participants fail 

to adjust their risk-management models in 

response to the structural shifts. As a result, 

market participants are likely to underestimate 

the probability of shocks and to be unprepared 

when a shock actually occurs.

7.2 Areas of Heightened Uncertainty

There are several noteworthy aspects of the 

current economic environment in which 

structural change has elevated the level of 

uncertainty. A clear instance is the trajectory of 

growth, asset prices, and institutional change 

resulting from euro area sovereign stresses. 

The introduction of the euro represented a 

significant structural change that ushered in a 

related set of new developing institutions and 

policies. Initially, the unified monetary policy 

was associated with a convergence of sovereign 

yields across euro area countries (Chart 7.2.1), 

although this was not accompanied by a full 

convergence of macroeconomic fundamentals, 

such as productivity growth. 

The financial crisis and recession of 2007-2009 

drew attention to cross-sectional differences 

in growth prospects, competitiveness, and 

default risk among euro area countries, with 

yield spreads widening for some sovereigns. 

These structural tensions were exacerbated by 

the cyclical downturn and by the fiscal burdens 

arising from bank support programs. 

Meanwhile, euro area integration on various 

fronts remained incomplete, complicating 

the crisis response. While euro area leaders 

have expressed a desire to deepen European 
Potential Emerging Threats 125

unification, there is continued uncertainty 

about how European official entities will resolve 

these fiscal strains and the extent to which euro 

area institutions may change as a result. Markets 

continue to believe that exits from the common 

currency cannot be ruled out, with attendant 

legal and other uncertainties. In particular, 

the threat of a breakup of the euro area carries 

with it redenomination risk—the risk that 

obligations due in euros will be repaid in an 

alternative, less valuable, currency.

Direct exposures of U.S. institutions to the 

most stressed euro area countries appear to be 

low (Charts 7.2.2, 7.2.3, and 7.2.4). However, 

U.S. banks, money market funds (MMFs), and 

the insurance industry have indirect exposures 

through other non-periphery countries 

and through asset markets. This generates 

heightened uncertainty about the extent to 

which evolving conditions could spill over to 

U.S. markets and institutions. 

Another key structural shift interacting with 

cyclical factors is the increased importance 

of emerging markets in global growth and 

the global financial system. The growth 

trajectories of emerging market economies 

(EMEs), notably the potential for a marked 

deceleration of growth in China as discussed 

in Section 4.4, could have a significant impact 

on growth and financial stability in the United 

States. In particular there continues to be 

uncertainty about the health and robustness of 

some of these economies, including concerns 

about banking and financial stability; the 

sustainability of regional real estate trends; the 

ability of policymakers to manage inflationary 

pressures; and the possibility of social unrest. 

The implications of these uncertainties for the 

U.S. financial system are primarily driven by the 

role of the EMEs as global providers of capital 

and as contributors to global growth. 

Uncertainty is also elevated in U.S. housing 

markets. The 30 percent decline in house prices 

since January 2006 continues to weigh on U.S. 

real estate markets, with 12 million mortgages 

having negative equity and continued high 

Chart 7.2.2 U.S. MMF Exposure to Europe

Chart 7.2.3 Large U.S. Banks’ Exposure* to Europe

Chart 7.2.4 Insurance Industry Exposure to Europe
126 2012 FSOC / / Annual Report

Chart 7.2.5 Real Private Residential Investment levels of foreclosure activity. Additional 

mortgage losses are possible over the next 

five years due to increased monthly payments 

on home-equity loans. The current sluggish 

growth in the housing sector contrasts with 

the historical post-recession patterns, where 

residential investment typically would display 

solid growth during recoveries (Chart 7.2.5). 

While there are signs of stabilization in housing 

prices, and the inventory of existing homes 

for sale has declined significantly, the overall 

weakness in the macroeconomy carries with it 

the risk of further declines in real estate prices, 

with additional stresses on household and 

institutional balance sheets.

In addition, the crisis exposed deep flaws in 

the structure of housing finance that need to 

be reformed, such as the incentives around 

securitization, the design of governmentsponsored enterprises (GSEs), and the overall 

quality of mortgage-servicing standards. 

Financial institutions continue to work 

through legacy mortgage assets and apply 

conservative credit standards to new mortgage 

activity. Given the scarcity of private capital 

in mortgage markets, federal government 

support continues to dominate the provision 

of residential mortgages. While some progress 

has been made in addressing mortgage loan 

servicing and foreclosure abuses, as well as 

gaps in protections for homeowners, lack of 

uniform servicing standards with appropriate 

safeguards for consumers, such as single points 

of contact, continue to create potential adverse 

consequences for distressed homeowners and 

their surrounding communities. The structural 

and cyclical problems of the housing finance 

market constitute a vulnerability of the financial 

system that makes the U.S. economy more 

susceptible to adverse shocks. For example, the 

effect of a slowdown in economic growth could 

be amplified by the mortgage market, leading 

to larger-than-expected declines in home prices 

and sales.

Another area of uncertainty is the fiscal policy 

outlook in the United States. A number of 

fiscal policy issues must be addressed around 
Potential Emerging Threats 127

the end of 2012, including expiration of the 

tax cuts originally enacted in 2001 and 2003, 

expiration of payroll tax cuts, expiration of 

extended unemployment benefits, the Budget 

Control Act-mandated sequester, and the need 

to raise the debt ceiling once again. As was 

the case with the debt ceiling debate in the 

summer of 2011, market volatility may increase 

as these fiscal deadlines approach, possibly 

weighing on growth. Furthermore, the longterm trajectory of U.S. fiscal policy is generally 

regarded as unsustainable, given the aging of 

the population and the likely path for health 

care expenditures. The way in which these longterm imbalances eventually will be resolved 

is unclear, representing yet another source 

of uncertainty for financial markets and the 

real economy.

7.3 Robustness of Financial 

Institutions and Markets 

While some indicators point to an increased 

level of robustness of financial institutions and 

markets over the past year, there continue to 

be areas of serious concern. The aggregate 

tier one capital ratio of domestically owned 

bank holding companies (BHCs) was 13.3 

percent of risk-weighted assets as of the first 

quarter of 2012, the highest level in more than 

10 years (Chart 7.3.1). Increased robustness 

can also be seen in the broker-dealer (BD) 

industry, which shows a sharp decline in 

leverage since 2007. Stress test results from 

the 2012 Comprehensive Capital Analysis and 

Review (CCAR) demonstrated the increase in 

capital, particularly common equity, held by 

the largest U.S. banking institutions since the 

onset of the financial crisis. Even so, 4 of the 

19 BHCs had post-stress capital ratios that fell 

below one or more regulatory minimums after 

including all planned capital distributions. 

The aggregate BHC funding profile has been 

strengthened by increased reliance on core 

deposits (Chart 7.3.2), continued reduction in 

short-term wholesale funding (Chart 7.3.3), 

and a substantial increase in the fraction of 

assets that are highly liquid. There is concern, 

however, that these funding and liquidity 

Chart 7.3.1 Aggregate BHC Capital Ratios

Chart 7.3.2 Core Deposits as a Percent of Total Liabilities

Chart 7.3.3 Short-Term Wholesale Funding
128 2012 FSOC / / Annual Report

Chart 5.2.12 CDS Spreads of 6 Large Complex BHCs developments may be short-lived implications 

of the low interest rate environment and the 

temporary unlimited coverage for non-interestbearing transaction accounts under Section 

343 of the Dodd-Frank Act, which is scheduled 

to expire on December 31, 2012.

Other indicators suggest a less sanguine view 

of U.S. financial institutions. The average 

cost of buying credit protection on the six 

largest U.S. BHCs started to rise in August 

2011, with increasing concerns about the euro 

area stability. (See Chart 5.2.12, displayed 

here for convenience.) While credit default 

swap (CDS) spreads on these BHCs have 

come down somewhat since their peak in 

November 2011, they remain above the levels 

that prevailed from mid-2009 through mid2011. Similarly, market valuations of the large 

BHCs are well below book value. Revenues 

at these institutions remain challenged by 

general market uncertainty and the low 

interest rate environment, and BHC earnings 

growth is largely dependent on non-recurring 

accounting items. In addition, approximately 

12 percent of all institutions within the 

commercial banking sector still remain on 

the FDIC’s problem bank list, accounting for 

approximately 2 percent of sectoral assets. 

Changes in financial market infrastructures 

are likely to make the derivatives market less 

vulnerable to shocks. In recent years, there have 

been substantial increases in the volume of 

swaps contracts being centrally cleared, which 

represents a significant step toward improved 

management of credit risks in these markets. 

In addition, informational transparency 

to regulators has been enhanced by the 

expansion of trade repositories (TRs). The 

availability of data from the Trade Information 

Warehouse, the TR for CDS, proved extremely 

useful to regulators in determining patterns 

of exposures to Greek sovereign default risk 

during the period leading up to the Greek 

debt restructuring in March 2012. Finally, it is 

anticipated that, pursuant to Title VII of the 

Dodd-Frank Act, many types of swaps will be 

traded on swap execution facilities (SEFs) and 
Potential Emerging Threats 129

security-based SEFs in the near future. This 

development should significantly enhance both 

pre- and post-trade transparency of price and 

volume information on executed transactions to 

swaps market participants. While the SEC and 

CFTC have not yet finalized rules relating to 

the regulation of SEFs and security-based SEFs, 

both agencies have issued detailed proposals. 

Another form of vulnerability has been 

highlighted by the failure of segregation 

procedures to fully protect customers of MF 

Global. (See Box D: MF Global Bankruptcy.)

For decades, segregation of customer funds 

has been the lynchpin of customer protection 

in futures markets. While MF Global customers 

recovered 72 percent of the value of their 

accounts for trading on U.S. futures exchanges 

within a few months of the bankruptcy, they 

lost use of those funds for critical weeks and 

are still owed hundreds of millions of dollars 

in the aggregate. MF Global customers 

trading on foreign exchanges have received 

a much lower percentage of recovery. The 

CFTC has taken steps to enhance customer 

protection and has solicited input on further 

possible actions. 

Financial reform efforts are essential in 

restoring the strength and stability of financial 

institutions and markets. Nevertheless, lessregulated institutions and markets could be 

perceived to hold competitive advantages. 

Accordingly, vulnerabilities could continue 

or increase if some participants choose to 

move business lines or activities to take 

advantage of perceived gaps or inconsistencies 

in regulation. This is particularly a concern 

when comparable financial activities are not 

subject to a comparable degree of regulatory 

stringency. This could occur, for example, if 

a lightly regulated swaps participant were to 

expand its business to approximate a full swaps 

dealership without the requisite regulatory 

oversight. The Dodd-Frank Act provides 

mechanisms to address such regulatory gaps, 

for example, by requiring oversight of all swap 

dealers and major swaps participants and 

improving regulatory oversight on nonbank 
130 2012 FSOC / / Annual Report

financial companies that could pose a threat to 

U.S. financial stability. 

7.4 Continuing Vulnerabilities in the 

Financial System

A number of characteristics of the current 

financial system continue to render it 

vulnerable to a variety of shocks and create 

the potential to amplify the destructive 

effects of such shocks. 

Different types of vulnerabilities can arise in 

financial systems. First, some vulnerabilities 

are inherent to the role that financial systems 

play in the economy. For example, maturity 

transformation (turning short-term savings 

into long-term capital investment) is an 

essential service of financial markets. But 

such transformation carries certain potential 

instabilities, such as the risk that short-term 

debt may not be rolled over or even the 

possibility of a run on a financial institution. 

Similarly, providing credit to risky borrowers is 

an important function of financial institutions. 

However, some degree of credit losses 

associated with such lending is inevitable. These 

sorts of vulnerabilities can be mitigated by 

appropriate public policy structures, including 

prudential regulation and supervision, robust 

capital and liquidity requirements, deposit and 

share insurance, orderly liquidation authority, 

and the role of the central bank as lender of last 

resort, but they cannot be fully eliminated.

A second type of vulnerability arises from 

control weaknesses in operations, risk 

management, and governance. Examples 

would include the possibility of erroneous 

trade completion in a high-speed trading 

environment, the danger of cybersecurity 

breaches, and risk-management deficiencies 

in financial institutions. Such vulnerabilities 

highlight the importance of regulatory 

measures, such as prudential capital and 

liquidity requirements and risk-management 

standards, as well as private-sector risk controls. 
Potential Emerging Threats 131

Finally, a third class of vulnerabilities is 

generated by the behavioral responses of market 

participants to financial developments, which 

could lead to undesirable vulnerabilities in the 

aggregate. An example would be the tendency 

for some investors to take on additional risk 

in a low interest rate environment in an effort 

to reach for yield. Another example would 

be the spillovers from the actions of firms in 

highly concentrated market segments or asset 

classes. Regulatory measures can be useful in 

addressing these sorts of vulnerabilities. For 

example, appropriate compensation regulation 

can deter firms from providing incentives to 

take on excessive risk. Equally important is to 

help ensure that stakeholders bear losses in 

downside scenarios and are subject to market 

discipline on an ongoing basis. 

These three types of vulnerabilities are not 

mutually exclusive: a given source of market 

vulnerability might be associated with all three 

types to varying degrees, so any classification 

of specific vulnerabilities is to some extent 

arbitrary. In the following text, we discuss 

specific vulnerabilities of each of these 

types in the current environment, with the 

vulnerabilities classified according to which 

characteristics are most predominant.

7.4.1 Inherent Vulnerabilities

Run Risk in Wholesale Short-Term Funding 

Markets

Broker-dealers (BDs) and other market 

participants typically fund some of their 

portfolio holdings and securities inventories 

using short-term funding, obtained through 

repos, commercial paper, and unsecured shortterm lending. While use of short-term wholesale 

funding has decreased overall (Chart 5.2.7, 

displayed here for convenience), the very large 

BHCs, especially those with large BD operations, 

continue to display a substantial dependence 

on short-term, less stable funding sources 

(Chart 7.4.1). Moreover, as discussed in Section 

5.2, the U.S. branches and agencies of foreign 

banks also rely heavily on short-term funding 

through MMFs and uninsured wholesale 

Chart 5.2.7 Short-Term Wholesale Funding at Largest BHCs

Chart 7.4.1 Less-Stable Funding Sources at 6 Largest BHCs
132 2012 FSOC / / Annual Report

depositors. In practice, institutions that rely 

on short-term funding must maintain strong 

short-term credit ratings. In June 2012, Moody’s 

reduced its short-term ratings by one notch for 

three large dealer banks: Barclays, Goldman 

Sachs, and Morgan Stanley. Markets will be 

monitoring the impacts of the downgrades on 

these banks’ funding models.

This continued reliance on short-term funding 

for illiquid assets can be a source of instability 

if borrowers have difficulty rolling over their 

maturing short-term debt on economically viable 

terms. This dynamic could force borrowers 

to sell long-duration assets under fire-sale 

conditions, generating a self-reinforcing negative 

feedback loop by putting downward pressure on 

prices that, in turn, stresses the balance sheets of 

a wider range of institutions. 

The vulnerabilities associated with the use of 

short-term funding for illiquid assets may be 

exacerbated by ongoing structural weaknesses 

in the tri-party repo market and in MMFs. The 

tri-party repo market relies heavily on intraday 

credit extensions from the clearing banks, 

is exposed to weaknesses in the credit and 

liquidity risk-management practices of market 

participants, and lacks a mechanism to help 

ensure orderly liquidation of tri-party repo 

collateral by creditors of a defaulting dealer. 

(See Box G: Ongoing Vulnerabilities in the 

Tri-Party Repo Market.) MMFs can be subject to 

runs if the $1.00 net asset value (NAV) is believed 

to exceed the liquidation value of the fund. 

(See Box H: Money Market Fund Responses 

to Euro Area Uncertainty.) 

7.4.2 Potential Control Weaknesses

High-Speed Trading

High-speed automated trading has become 

common in equity and derivatives markets, and is 

also spreading to markets for Treasury securities 

and foreign exchange. (See Section 5.4, Box 

F: Algorithmic and High-Frequency Trading.) 

It is likely that high-speed trading increases 

market liquidity in normal market conditions. 

However, any market in which liquidity is 
Potential Emerging Threats 133

BOX G: ONGOING VULNERABILITIES IN THE TRI-PARTY REPO MARKET

While regulators have gained much better visibility into 

the activity of the tri-party repo market in recent years, 

it remains a significant source of potential contagion. 

Despite the recent steps taken by participants to 

advance changes in the market’s infrastructure to 

mitigate key vulnerabilities, progress is taking longer 

than initially anticipated. Three specific sources of 

vulnerability remain of great concern to the Council:

•	 Heavy reliance by market participants on 

intraday credit extensions from the 

clearing banks,

•	 Weakness in the credit and liquidity risk 

management practices of many market 

participants, and

•	 Lack of a mechanism to ensure orderly 

liquidation of tri-party repo collateral by 

creditors of a defaulting dealer.

Over-reliance on intraday credit. Currently, 

tri-party repo trades “unwind” every day, meaning that 

the clearing bank returns cash to the lender’s account 

and returns collateral to the borrower’s account. Trades 

are not settled until several hours later. For several hours 

each afternoon, dealers require funding of their entire 

tri-party repo book that lenders do not provide. This 

$1.7 trillion funding need is provided by the two 

clearing banks. 

This is a potentially unstable situation. In times of market 

stress, the clearing bank faces a conflict of interest 

between its own risk-management needs and the role 

it performs as a lender to dealers experiencing funding 

problems. Given its intraday exposure to dealers, the 

clearing bank could have a strong incentive, in the face 

of a dealer’s deteriorating credit quality, to refrain from 

unwinding in order to avoid extending credit and taking 

on exposure to the dealer’s collateral. 

Poor risk management practices. Some dealers 

remain very dependent on short-term repo funding 

and are heavily exposed to rollover risk. Of particular 

concern is the use of short-term borrowing to finance 

less liquid collateral, such as asset-backed securities 

or corporate bonds. In addition, some lenders do 

not exercise sufficient rigor in setting haircuts and 

in evaluating appropriate asset types as collateral, 

particularly for less liquid assets. This can create a 

destabilizing cycle: if lenders do not feel protected by 

the haircuts they have in place, they may respond to a 

dealer stress event or rising price volatility by increasing 

haircuts sharply, further reducing the dealer’s ability to 

obtain needed funding. Instability is also intensified by 

the fact that some lenders (notably MMFs subject to 

Rule 2a-7 under the Investment Company Act) accept 

collateral that they are unable to hold and liquidate 

gradually following a default. These lenders are likely to 

pull back their funding altogether if they are subject to 

redemptions to avoid being forced to take possession 

of the collateral—further destabilizing market conditions. 

Presently, there is no process in place to prevent 

lenders from taking on collateral that they could not 

properly manage or permissibly hold outright.

Absence of a mechanism to facilitate orderly 

liquidation of a defaulted dealer’s collateral. 

A large dealer’s default could leave lenders with billions 

of dollars of collateral that they would likely seek to 

liquidate quickly. The resulting large volume of asset 

sales could depress prices, significantly impair market 

liquidity, and erode the capital of many financial firms 

through mark-to-market losses. This erosion of capital 

could, in turn, create intense pressure for holders to 

shrink their balance sheets by selling additional assets, 

creating a downward spiral. There is currently no 

mechanism in place to ensure that lenders will be able 

to liquidate the collateral of a defaulted dealer gradually 

over time in a manner that avoids this sort of fire 

sale dynamic.
134 2012 FSOC / / Annual Report

BOX H: MONEY MARKET FUND RESPONSES TO EURO AREA UNCERTAINTY 

Vulnerabilities from reliance on short-term funding can be 

compounded by structural problems with money market 

funds (MMFs). MMFs are promoted to institutional and 

retail investors as stable investments that provide cash 

on demand at a constant net asset value (NAV) of $1 

per share, very much like bank deposits. However, these 

funds are prone to runs, as investors have an incentive 

to exit a fund at $1 per share if they suspect that its 

NAV is likely to decline below $1 (that is, they expect the 

fund to “break the buck”). A clear example is the wave 

of redemptions from MMFs after the Reserve Primary 

Fund broke the buck in September 2008 because of its 

Lehman exposures. 

A more recent episode of large-scale MMF redemptions 

is the response of MMFs to increased uncertainty about 

euro area stability in June 2011. This episode provides 

an opportunity to examine potential vulnerabilities in the 

MMF industry. In June 2011, the potential for European 

bank downgrades and rising concern about the euro 

area periphery debt crisis prompted concerns about 

MMF exposures to European banks. Prime MMFs began 

experiencing substantial redemptions, with assets falling 

by $165 billion (or 5.1 percent) in June 2011 and with 

some MMFs losing as much as 20 percent of their assets 

during this period. 

MMFs were able to satisfy these redemptions with 

internally generated liquidity. (See Chart 5.3.7, 

displayed here for convenience.) In addition, while 

MMFs’ euro area exposures had generated negative press 

attention, these positions had not actually experienced 

any losses affecting the mark-to-market value of MMFs’ 

portfolios. MMFs were also better able to absorb these 

redemptions because they occurred on a steady basis 

over a period of weeks, as opposed to the sort of run on 

MMFs that occurred in 2008, where investors withdrew 

over $300 billion in a matter of days from prime MMFs, 

several of which were simultaneously experiencing markto-market losses in their portfolios. These mitigating 

circumstances allowed MMFs to absorb redemptions in 

the summer of 2011 while maintaining a stable NAV. 

Chart 5.3.7 Prime Funds Liquidity

Following this period of redemptions, MMFs rapidly 

reduced their exposure to euro area counterparties. 

For example, prime MMF exposures to French issuers 

declined from a peak of $274 billion at May 31, 2011, to 

$176 billion (or 36 percent) by July 31, 2011, and to as low 

as $48 billion by December 31, 2011. Overall euro area 

exposures of prime MMFs decreased considerably from 

nearly 30 percent of prime MMF assets to 18 percent 

of assets between May 31, 2011, and May 31, 2012 

(Chart H.1). 

While this rapid reduction in short-term dollar funding 

for euro area banks reduced MMF exposure to the debt 

crisis, it added to strains in the global financial system. For 

those institutions in which MMFs continue to invest, credit 

has been provided at shorter maturities and increasingly 

in secured form through repurchase agreements. From 

March 2011 to May 2012, the weighted average life for 

prime MMFs declined from 81 to 71 days. As of June 

2012, MMFs have a relatively small direct exposure of 

approximately $1 billion to Spanish banks, with no direct 

exposure to Italian or Greek banks. Prime MMFs also, on 

average, reduced their overall credit exposure, shifting 

portfolio assets from bank certificates of deposit into 

government debt and repos (Chart H.2). 
Potential Emerging Threats 135

Chart H.1 Prime Fund Bank Holdings

Chart H.2 Prime Fund Portfolio Composition
136 2012 FSOC / / Annual Report

provided by automated trading strategies could 

find significant amounts of liquidity suddenly 

withdrawn if those automated strategies pause 

due to changes in market conditions. Evidence 

suggests that the so-called “flash crash” of May 

2010 involved a temporary liquidity withdrawal 

of this type. Attenuated market liquidity, in 

turn, can adversely affect market functioning 

more generally. Risk controls must keep pace 

with these developments. Unfortunately, the 

risk arising from high-speed trading is difficult 

to assess because it is opaque and difficult to 

monitor (particularly in real time). 

Complex Trading Strategies and Risk 

Management

The effects of advances in technology and 

financial innovation have also resulted in 

financial firms employing trading and hedging 

strategies that rely increasingly on complex 

assumptions regarding the performance and 

interrelationships of financial instruments 

and contracts. Recent events, including the 

publicly announced trading losses at JPMorgan 

Chase (JPM), highlight the risks that can 

develop in the use of such complex strategies. 

This incident reinforces how essential it is 

that assumptions underlying trading and risk 

management models be properly validated 

and monitored on an ongoing basis to help 

ensure that risks of complex trading strategies 

are appropriately measured and understood. 

Institutions also should establish a process to 

review the effect of approved model changes to 

help ensure that such changes are appropriate.

Cybersecurity 

Cyberattacks represent an increasing threat to 

financial institutions and the infrastructure 

components on which financial systems depend 

for communicating, sharing information, 

and conducting business. The number and 

sophistication of malicious incidents continue 

to grow as business and financial institutions 

continue to adopt Internet-based commerce 

systems. Account takeovers can occur, including 

fraudulent money transfers and counterfeiting 

of stored value cards. Third-party payment 

processor breaches represent a continuing risk, 
Potential Emerging Threats 137

whereby the computer networks of large payment 

processors are targeted, potentially leading to 

financial losses and compromised personally 

identifiable information.

Cyber criminals are becoming more 

sophisticated, and attack vectors are evolving. 

Social-engineering techniques used in attempts 

to gain unauthorized access into networks 

and systems are shifting from generalized and 

random to highly targeted. Another cyber threat 

can emerge from individuals with direct access 

to core processing centers. Such individuals may 

be in a position to steal intellectual property, 

insider information, or data that can damage the 

reputation of the company. Market participants 

report that attacks targeting data and assets are 

increasingly focused on institutional aspects of 

infrastructure as opposed to retail operations. 

These types of attacks are associated with 

increased severity of potential losses and could 

be increasingly disruptive. Cyber threats also 

pose a potentially significant risk to the stability 

of financial markets through the disruption of 

critical payment, clearing, and settlement systems 

for key financial institutions. 

Robustness of Operational, Risk 

Management, and Governance Controls at 

Central Counterparties

In its 2009 meeting in Pittsburgh, the G-20 

established the goal of having standardized 

swap contracts centrally cleared by the end of 

2012. This objective was codified in Title VII 

of the Dodd-Frank Act. Central clearing of 

swaps will enhance the stability and soundness 

of over-the-counter (OTC) derivatives markets 

in a variety of ways, including improved 

counterparty risk management and multilateral 

netting of contracts. However, it could also lead 

to an increased number of financial contracts 

cleared by a relatively small number of central 

counterparty (CCP) clearinghouses, which 

mitigate counterparty credit risk between 

market participants by becoming the universal 

counterparty and providing time-specific 

settlement of transactions. As a result, these 

clearing institutions have become associated 
138 2012 FSOC / / Annual Report

with even more critical concentration of risk 

than before. 

The default of a major participant could impair 

the liquidity available to a CCP, requiring 

that liquidity for settlement be replaced from 

the CCP’s own resources if it is to meet its 

obligations in a timely fashion. The Principles 

for Financial Market Infrastructures, finalized 

this past April by the Committee on Payment 

and Settlement Systems (CPSS) and the 

International Organization of Securities 

Commissions (IOSCO), provides a set of 

international standards for CCPs and other 

financial market utilities that address these 

issues. In addition, Title VIII of the DoddFrank Act provides an enhanced regulatory 

framework for CCPs through the Council’s 

authority to designate financial market utilities 

as systemically important.

Data Standards and Analytics

The financial crisis revealed that lack of 

data standards and poor data management 

threatened financial stability in several ways. 

Those who created, collected, and relied upon 

financial data found that financial data quality 

and scope simply had not kept up with the 

increasing complexity of, and innovation in, 

modern financial markets. That was especially 

the case as financial activity migrated from 

traditional depository institutions into the 

capital and securitization markets and across 

national borders. Consequently, during the 

crisis, a lack of consistent and high-quality 

data made it difficult or impossible for some 

market participants and their regulators to 

monitor risks in trading books, gauge overall 

exposures to specific counterparties, price 

complex securities, or even assess the potential 

losses that individual firms might face due to 

falling house prices. Different data systems 

using different naming conventions made 

comparisons difficult or impossible, even within 

the same firm. Resolving a large, complex 

financial institution like Lehman Brothers was 

hobbled by the snarled nature of insufficient, 

conflicting, and inconsistent data. 
Potential Emerging Threats 139

Since then, policymakers have broadened the 

scope of data they collect and have made efforts 

to improve their quality. Examples include 

the new Form PF (for private funds) and data 

to be collected by swap data repositories and 

security-based swap repositories for swaps and 

other derivatives, as well as international efforts 

by the International Monetary Fund (IMF) 

and the Financial Stability Board (FSB) to 

close data gaps, particularly for derivatives and 

nontraditional funding activities. Yet significant 

gaps remain in both the scope and quality of 

data needed to monitor and enhance financial 

stability. More needs to be done, particularly 

in the activities that have traditionally 

resided outside the regulators’ sphere such as 

securitization markets and OTC derivatives. 

Data standards facilitate improvements in 

data quality. For instance, efforts to establish 

a global legal entity identifier (LEI) have 

made significant progress in the last year, 

including the establishment of the CFTC 

Interim Compliant Identifier (CICI) initiative, 

but work remains to be done to complete this 

important effort. The Office of Financial 

Research (OFR), established in Title I of the 

Dodd-Frank Act, is tasked with improving the 

quality of financial data and data analytics 

along multiple dimensions, including LEI 

implementation and enhancement.

7.4.3 Behavioral Vulnerabilities 

Managing Risk in a Low Interest 

Rate Environment

An unusually low rate environment, such as 

that currently in place, is prone to several 

behavioral vulnerabilities. Market participants 

may have an incentive to take on additional 

leverage, credit risk, and duration risk in an 

effort to boost yields. While increased risk 

taking is one possible transmission mechanism 

for expansionary policies, such reach for 

yield behavior without appropriate risk 

management could leave many participants with 

portfolios that are more vulnerable to adverse 

market moves. 
140 2012 FSOC / / Annual Report

The tendency to reach for yield may be 

especially pronounced for entities such as 

pension funds or insurance companies that face 

a stream of quasi-fixed nominal liabilities. For 

example, the investment yield for life insurers 

in aggregate is only around 1.1 percentage 

points above the minimum yield needed to 

maintain policyholder reserves, leaving these 

insurers with a relatively small margin of error. 

Hedge funds also may have an incentive to 

reach for excess yield if they manage to specific 

hurdle rates expected by their investors or if 

the value of their fund is considerably below 

the high-water mark that would trigger a large 

payout. In addition, money market funds may 

have an incentive to increase their risk profiles, 

especially if the low interest rates do not provide 

sufficient yield to cover their expenses.

We do not see much evidence of such behaviors 

currently. Risky assets do not exhibit signs of 

overvaluations associated with widespread 

reach-for-yield behavior. If anything, measures 

of risk premia for equities and corporate bonds 

are very wide by historical standards. However, 

indicators of such behaviors should be watched 

carefully, including leverage, contractual terms, 

borrower characteristics, the use of levered 

instruments for funding, issuance of “covenant 

lite” loans, and the rate of original issue, 

CCC-rated high-yield bonds (Chart 7.4.2).

Eventually, interest rates will move up to 

more normal levels. If market participants are 

adequately prepared for such an increase in 

rates, and if this increase occurs gradually, 

it is unlikely that financial stability would be 

adversely affected. However, a rapid increase 

in interest rates could be disruptive. For 

example, interest rates could increase rapidly 

following a loss in investor confidence in the 

sustainability of U.S. fiscal policy. It is unclear 

how well prepared fixed income markets are 

to the possibility of such rapid interest rate 

movements. Those especially vulnerable would 

be market participants with highly leveraged 

carry-trade positions. It is important to 

recognize that while any institution in isolation 

can insulate itself from movements in interest 

Chart 7.4.2 Credit Quality of High-Yield New Issues
Potential Emerging Threats 141

rates via swaps and derivatives, these contracts 

are in zero net supply in the aggregate. As 

a result, some market participants must be 

exposed to interest rate risk. 

Moral Hazard Issues for Large, Complex 

Financial Institutions

Behavioral vulnerabilities of large, complex 

financial institutions could increase with the 

complexity and size of these institutions. These 

vulnerabilities occur because an expectation 

of government support could generate more 

risk taking by institutions that are perceived 

as too big or too complex to fail. Indeed, 

many observers interpret actions taken by 

government authorities during the recent crisis 

as evidence that the public sector provides an 

implicit guarantee to large complex financial 

institutions. Such beliefs, if widespread, 

could lead to increased concentration in 

financial services and greater risk taking by 

those institutions deemed protected, as the 

implicit government guarantee reduces market 

discipline. The result could be higher overall 

risk in financial markets with attenuated 

risk management.

Large financial institutions continue to have 

a high degree of operational complexity and 

interconnectedness. These complexities may 

reflect the diverse lines of businesses and 

locations in which these firms operate, but 

lead to legal structures with activities spread 

over hundreds, and in some cases thousands, 

of subsidiaries (Chart 7.4.3). Market 

participants could believe that the complexity 

and interconnectedness of these companies 

could make them harder to resolve and induce 

further likelihood of government support 

in a stress environment. Such beliefs could 

therefore promote continued moral hazard 

problems for such complex financial entities.

In addition, there may continue to be 

perceptions that some institutions may 

receive special treatment by virtue of their 

size. Such beliefs could be exacerbated 

by greater concentration in the financial 

services industry. The financial industry 

Chart 7.4.3 Complex Financial Institutions in 2012
142 2012 FSOC / / Annual Report

has become increasingly concentrated for 

decades, a trend enhanced in part by such 

legislative developments as the Riegle-Neal 

Interstate Banking and Branching Efficiency 

Act of 1994 permitting interstate branching, 

and the Gramm-Leach-Bliley Act, enacted 

in 1999, that allowed affiliations among 

commercial banks, investment banks, and 

insurance companies. This trend continued 

through the crisis (Chart 7.4.4) in part due 

to acquisitions of failing firms. As of the 

first quarter of 2012, the 10 largest banks 

held 52 percent of industry assets, worth 

approximately 47 percent of GDP, compared 

with 45 percent of industry assets, worth 

approximately 40 percent of GDP at the end 

of 2006. Notwithstanding this trend towards 

greater concentration, the U.S. banking system 

remains significantly less concentrated than 

that of most developed countries.

These moral hazard problems are partially 

addressed by raising capital requirements. 

An additional important priority is to develop 

credible and robust failure resolution 

procedures for large complex institutions—

procedures that would allow the institution to 

be liquidated or restructured, as appropriate, 

with minimal damage to the markets as a 

whole. The FDIC is authorized to resolve 

certain failing financial companies under 

the Dodd-Frank Act and has developed a 

resolution strategy for such firms that will 

promote financial stability by minimizing 

contagion and requiring accountability by 

forcing the firms’ shareholders and creditors 

to bear losses. 

The credit rating agencies appear to have 

recognized that the Dodd-Frank Act limits 

the ability of the government to provide 

extraordinary support to shareholders 

and creditors of large complex financial 

institutions. This recognition can be seen in 

the reduced uplift the major rating agencies 

incorporate into the long-term ratings for 

a number of large financial institutions, 

many of which have been downgraded or 

Chart 7.4.4 Assets of the 10 Largest Depository Institutions
Potential Emerging Threats 143

Chart 7.4.5 Moody’s BHC Systemic Support Uplift assigned a negative rating outlook as a result 

(Chart 7.4.5). However, a degree of ratings 

uplift still remains for the largest banks, 

typically 1 to 2 notches for large bank holding 

companies and 2 to 3 notches for large bank 

subsidiaries. In addition, there is evidence that 

market-derived indicators of credit quality 

tend to be lower than the levels assigned by 

ratings agencies (Chart 7.4.6). While ratings 

agencies typically report uplifts only for 

long-term ratings, these uplifts also support 

the short-term ratings that help firms access 

short-term unsecured wholesale funding. 

Vulnerabilities can arise when a financial 

institution’s funding model depends in part 

on the belief that the government will provide 

support, rather than only on the intrinsic 

strength of the institution and its portfolio. Chart 7.4.6 S&P Current Actual Rating & Market 

Derived Signal*

Appendix A 145

Appendix A 

Designation of Systemically Important Financial Market Utilities

On July 18, 2012, the Financial Stability Oversight Council (Council) designated 

eight financial market utilities (FMUs) as systemically important under Title VIII 

of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act). 

The designated FMUs are:

•	 The Clearing House Payments Company L.L.C. (PaymentsCo) on the 

basis of its role as operator of the Clearing House Interbank Payments 

System (CHIPS)

•	 CLS Bank International (CLS Bank or CLS)

•	 Chicago Mercantile Exchange, Inc. (CME)

•	 The Depository Trust Company (DTC)

•	 Fixed Income Clearing Corporation (FICC)

•	 ICE Clear Credit LLC (ICE Clear Credit)

•	 National Securities Clearing Corporation (NSCC)

•	 The Options Clearing Corporation (OCC)

Title VIII provides four specific factors the Council must take into consideration 

when determining whether an FMU is, or is likely to become, systemically 

important.1 These factors are also incorporated with more detail provided in 

the Council’s regulations regarding the designation of FMUs.2 The four specific 

factors are (A) the aggregate monetary value of transactions processed by the 

FMU; (B) the aggregate exposure of the FMU to its counterparties; (C) the 

relationship, interdependencies, or other interactions of the FMU with other 

FMUs or payment, clearing, or settlement activities; and (D) the effect that the 

failure of or a disruption to the FMU would have on critical markets, financial 

institutions, or the broader financial system. Title VIII also requires the Council 

to take into consideration any other factors that the Council deems appropriate. 

The Council believes that the four identified factors provided an appropriate 

basis for making determinations, and thus the Council did not explicitly rely on 

any other factors. 

This appendix provides a description of each FMU, as well as an analysis of its 

systemic importance based on the factors listed here. Each FMU received a letter 

on May 22, 2012 informing it that the Council had proposed its designation and 

providing it with the same rationale for the Council’s determination provided 

in this appendix. This appendix does not, however, include any confidential 

data that were part of the Council’s analysis, though such confidential data 

were included in the May 22 letters to each FMU. The FMUs each had 30 days 

to request a hearing if they disagreed with the proposed determination of the 

Council or the Council’s proposed findings of fact, but no FMU requested such 
146 2012 FSOC // Annual Report

a hearing. Accordingly, the Council has unanimously voted in favor of final 

designations on the following FMUs based on the analyses described here:

A. The Clearing House Payments Company L.L.C.

Description of the Clearing House Payments Company L.L.C.

PaymentsCo, a Delaware corporation, is the legal person that operates CHIPS, 

which is a multilateral system operated for the purpose of transferring payments 

among its 52 participants. Therefore, PaymentsCo, as a person that operates a 

multilateral system whose purpose is transferring payments among financial 

institutions, meets the definition of FMU set out in Title VIII.3

CHIPS is the only private sector system in the United States for settling largevalue U.S. dollar payments continuously throughout the day. Large-value 

payment systems play a key role in financial markets by providing a means for 

banks to discharge payment obligations related to important financial market 

activities such as money market and commercial transactions. Payments settled 

by such systems are often high in value and require secure, reliable, and timely 

settlement. For example, two banks might use a large-value payment system to 

settle a time-sensitive interbank loan. For commercial transactions, a corporation 

may instruct its bank to use a large-value payment system to make critical 

payments to its suppliers.

Large-value payments settled over CHIPS often represent the U.S. dollar sides 

of transfers between U.S. money center banks and foreign banks operating in 

the United States, such as foreign exchange and Eurodollar transactions. CHIPS 

traffic also includes an increasing share of payments for transactions such as the 

adjustment of correspondent balances and payments associated with commercial 

transactions, bank loans, and securities transactions.

The 52 CHIPS participants are U.S. commercial banks, foreign banks with offices 

in the United States, and one private banker. These participants constitute some 

of the largest banks in the world by asset size and include bank subsidiaries of 

22 financial institutions considered to be global systemically important financial 

institutions by the Financial Stability Board.4 Participants also send and receive 

payments over CHIPS on behalf of thousands of customers, including a large 

number of correspondent banks. U.S. depository institutions account for a 

substantial percentage of all value sent. Forty participants are headquartered 

outside the United States.

An important feature of CHIPS is that it can bilaterally and multilaterally net 

payments for settlement, which permits CHIPS to settle its daily average of 

payments with a fraction of funding. A disruption to CHIPS could therefore have 

a multiplier effect on the liquidity needs of participants.

Participants do not bear credit risk within CHIPS, as they do not extend credit 

to each other over the system. They do, however, bear liquidity risk. Because 

payment messages in the CHIPS queue are not guaranteed to settle, participants 

may not receive, either during the day or at the end of the day, payments they 
Appendix A 147

are expecting to receive over CHIPS. Liquidity risk is high during the end-of-day 

settlement process when participants have a final expected position that depends 

on other participants meeting their final funding requirements. If a participant 

fails to fulfill its final funding requirement, CHIPS will net and release as many 

of the payments remaining in the queue as possible and then delete the rest 

from the system. The participants that were expecting to receive those deleted 

payments must then arrange to receive that liquidity outside of CHIPS.

Analysis of Systemic Importance

(A) Aggregate monetary value of transactions processed by CHIPS

The volume and value of payments settled over CHIPS demonstrate the high 

degree to which the U.S. banking system relies on CHIPS to facilitate significant 

financial flows, particularly those involving transfers between U.S. money center 

banks and foreign banks operating in the United States. As context for the value 

of payments settling through CHIPS, every two weeks, CHIPS settles payments 

equivalent to the gross domestic product of the United States. 

Settlement volumes and values. CHIPS, settling $1.6 trillion on average a day, has 

a substantial share by volume and value in the U.S. large-value payments market. 

A significant percentage of CHIPS volume is sent or received by participants on 

behalf of third parties that are not participants. At least 7,500 third parties are 

listed in the database that CHIPS maintains to facilitate the routing of payments 

straight through to their end beneficiaries.

Funding. The average and peak total participant funding for the CHIPS 

account at the Federal Reserve Bank of New York (FRBNY) per day in 2011 was 

substantial, with a significant portion being supplied by a small group of funding 

agents acting on behalf of nonfunding participants. Total funding is low relative 

to the value of payments settled over CHIPS because the bilateral and multilateral 

netting feature of the system allows for a high leverage of liquidity compared to a 

pure real-time gross settlement system, where payments are settled individually as 

they are submitted.

(B) Aggregate exposure of CHIPS to its counterparties 

Credit exposures. There are no credit exposures within CHIPS, and there is 

no obligation to ensure the settlement of queued payments. Payment messages 

are not settled until they are released from the CHIPS queue, and all payment 

messages that are released are fully funded and settled with finality in real time.

Liquidity exposures. CHIPS does not bear liquidity exposures to its 

counterparties because it does not guarantee settlement of any payment messages 

that are not fully funded. While this feature, which is inherent to the design and 

rules of CHIPS, eliminates liquidity risk to the system, participants bear liquidity 

risk arising from unsettled payments in the queue. Participants are further 

exposed to liquidity risk because the funds used to settle payment messages 

over CHIPS are held in the CHIPS account at FRBNY as opposed to in the 

participants’ own accounts.
148 2012 FSOC // Annual Report

Liquidity exposures for CHIPS participants are high because payment messages 

in the CHIPS queue are not guaranteed to settle. There is a possibility that 

participants may not receive, either during the day or at the end of the day, 

payments they are expecting to receive over CHIPS. This risk decreases over the 

course of the day because of the intraday finality of settled payments, but there 

is inherent liquidity risk in the end-of-day process, when participants must meet 

their final funding requirements and CHIPS must successfully execute payouts.

Settlement of the payments remaining in the queue at the end of the day 

is dependent on all participants successfully meeting their final funding 

requirements, which, on average, is in the billions of dollars. If some participants 

do not fulfill their final funding requirement, CHIPS will settle as many 

remaining payments as possible and then delete the rest from the system 

unsettled. There has been only one instance where a participant failed to meet 

its final funding requirement, resulting in payment messages worth $7.3 billion 

failing to settle over CHIPS. 

Since that disruption, the typical value of the payments settled at the end of the 

day has fallen to less than 1 percent of total daily value, yet that amount is still 

sizeable. If a large proportion of those payments failed to settle because of a 

disruption caused by the failure of one or more participants to make a final payin, it could put liquidity pressure on the intended recipients of those payments, 

which would need to make up that liquidity outside of CHIPS. Following the 

completion of final funding, a disruption impairing the ability of CHIPS to make 

payouts could trigger more significant disruptions to the liquidity positions of 

participants. In 2011, the daily average and peak of total CHIPS payouts at the 

end of the day were significant.

Under either disruption scenario, participants might have to borrow funds in the 

market late in the day to replace the payments or payouts not received in order 

to meet their payment obligations outside of CHIPS or Federal Reserve account 

balance requirements such as required reserves. This could be particularly 

challenging for a participant with more limited access to U.S. dollar funding 

markets, such as a bank in a weakened condition. For any participant, obtaining 

replacement funding late in the day could prove difficult or costly, as the liquidity 

of funding markets such as the Fed funds and repo markets declines toward the 

end of the business day.

(C) Relationships, interdependencies, or other interactions of CHIPS with other FMUs 

or payment, clearing, or settlement activities

The structure of participation in CHIPS indicates a tight, interdependent network 

of institutional relationships and payment flows, such that a disruption could 

reverberate throughout the financial system. Participants rely heavily on CHIPS 

to settle significant U.S. dollar financial flows each day, including transactions 

related to third-party activity for thousands of additional institutions. Activity 

underlying CHIPS payments spans foreign exchange, trade finance, remittance, 

correspondent banking, securities, and bank funding.
Appendix A 149

Concentration of participants and degree of tiering. CHIPS activity is highly 

concentrated with a small number of participants accounting for a relatively large 

percentage of the value of the payment messages sent and received. Funding for 

CHIPS is further concentrated with a small number of participants representing a 

majority of the funding. 

Although no FMUs depend on CHIPS directly, the participants that send and 

receive the most value over CHIPS and contribute the most funding are also 

some of the most active participants by value in CLS Bank, DTC, FICC, NSCC, 

CME, ICE Clear Credit, and OCC. The liquidity problems caused by a disruption 

to CHIPS might therefore adversely affect the payment activities of CHIPS 

participants over those FMUs. Conversely, payment obligations arising within 

those other FMUs that were expected to settle over CHIPS could be disrupted. 

Interdependencies indirectly link CHIPS not only to other FMUs and payment, 

clearing, and settlement activities, but also to the third-party customers that are 

the originators or beneficiaries of payments settled over CHIPS. Participants 

submit a majority of their CHIPS traffic by volume on behalf of one of 

thousands of third-party customers. Examples of third-party customers include 

affiliates and branches of CHIPS participants, other financial institutions, and 

nonfinancial corporations. Because of the scope and nature of these customers, 

a disruption to CHIPS could have a broader impact on both the financial system 

and the real economy than might be assumed from consideration of only the 

direct participants.

(D) Effect that the failure of or disruption to CHIPS would have on critical markets, 

financial institutions, or the broader financial system

Market effects of a failure of or long-term disruption to the functioning of 

CHIPS. There are two types of disruption to CHIPS that could have significant 

effects on critical markets, financial institutions, and the broader financial 

system. First, a disruption triggered by the failure of one or more participants to 

make a required pay-in at the end of the day could cause several billion dollars 

of payments not to settle over CHIPS, creating liquidity shortfalls for some 

participants and their customers late in the day. Second, a disruption triggered 

by an operational problem with CHIPS could cause significantly higher amounts 

of payments not to settle over CHIPS. An operational disruption could also cut 

off participants’ access to the funds in the CHIPS account, which could be a 

significant amount by the end of the day.

The typical value of the payments settled at the end of the day is sizeable and 

varies based on market conditions and the amount of supplemental funding 

contributed by participants during the day. If one or more participants failed to 

make a required pay-in at the end of the day, a portion of those payments would 

not settle over CHIPS. As a result, the participants and their customers expecting 

to receive those payments would need to make them up outside of CHIPS and 

could, therefore, face liquidity shortfalls late in the day.

In the case of an operational disruption to CHIPS, participants could use the 

Fedwire Funds Service to settle payments. Their ability to do so would depend 
150 2012 FSOC // Annual Report

on each participant’s access to Fedwire, internal system capabilities, and access 

to sufficient intraday liquidity. In particular, the availability of liquidity varies 

by institution, such that some participants might need access to additional 

liquidity in order to reroute their CHIPS traffic. At a minimum, that increased 

liquidity demand could create incentives for participants to delay sending 

large outgoing payments over Fedwire until they first received large incoming 

payments. Delayed settlement of those outgoing payments could in turn delay 

the settlement of all downstream payments reliant on those funds, likely causing 

liquidity problems to spread.

Effects of a short-term disruption to the FMU. Depending on its timing, an 

operational disruption to CHIPS could leave participants without access to 

the increasingly significant amounts of liquidity held in the CHIPS account. 

As discussed under Consideration (B), the value of funds held in the CHIPS 

account rises steadily throughout the day, with the funds returned to participants 

as payouts at the end of day. A disruption that prevented CHIPS from making 

payouts at the end of the day could cause significant liquidity shortages for 

participants at a time of day when liquidity in funding markets may be least 

available. This is particularly true for the subset of CHIPS participants that 

do not have access to intraday credit from a Federal Reserve Bank. These 

participants might need to seek funding in the Fed funds and repo markets, 

where, as discussed previously, liquidity declines towards the end of the business 

day. Further, liquidity in these markets would likely be especially tight under 

the stressed market conditions surrounding a failure of or disruption to CHIPS. 

Without this funding late in the day, participants might not be able to meet their 

payment obligations outside of CHIPS or meet Federal Reserve account balance 

requirements, such as reserve requirements.

Under either scenario, a disruption to CHIPS could reverberate throughout the 

financial system, affecting the thousands of institutions worldwide that may be 

reliant on payments settled over CHIPS. As discussed under Consideration (A), 

CHIPS settles a sizeable overall share in the U.S. large-value payments market. 

Furthermore, a significant portion of the volume of payment messages sent over 

CHIPS is sent or received on behalf of one of thousands of third-party customers. 

In addition to disrupting third-party customers, as discussed under Consideration 

(C), a disruption to CHIPS might also indirectly disrupt other FMUs in the U.S. 

financial sector through the channel of shared participants.

Conclusion

Large-value payment systems such as CHIPS play a key role in financial markets 

by providing a means for banks to discharge payment obligations related to 

important financial market activities. CHIPS is a particularly large system, settling 

$1.6 trillion on average a day representing a significant percentage of the value 

of the U.S. dollar large-value payment market. A disruption to CHIPS could 

significantly increase the amount of unsettled payments in the CHIPS queue, 

disrupt the ability of participants to manage their CHIPS traffic, and sufficiently 

alter the payment and funding patterns over CHIPS so as to cause liquidity 

disruptions affecting all participants, including 22 global systemically important 

institutions, and potentially spread to their customers and to other FMUs and 
Appendix A 151

the broader financial system. The resulting widespread liquidity shortage could 

prove difficult or costly to ameliorate, particularly if the disruption were to cut 

off access to the funding in the CHIPS account and to occur at the end of the day 

amid already stressed market conditions.

Taking into consideration the significant value and proportion of large-value 

payments that settle over CHIPS, the increased liquidity required to reroute those 

payments to settle outside of CHIPS, and the risk to other FMUs and downstream 

financial institutions and nonfinancial companies that rely on those payments 

to settle, it is the assessment of the Council that a failure of or disruption to 

CHIPS could increase the risk of significant liquidity problems spreading among 

financial institutions or markets and thereby threaten the stability of the financial 

system of the United States. For the reasons set out here, the Council has 

determined that PaymentsCo should be designated as a systemically important 

FMU pursuant to Title VIII of the Act.

B. CLS Bank International

Description of CLS Bank International

CLS Bank, a legal person chartered by the Board of Governors of the Federal 

Reserve System under the Edge Act, operates a multilateral system that settles 

foreign exchange (FX) transactions among its financial institution members.5

Therefore, CLS Bank meets the definition of FMU set out in Title VIII of the Act.6

The FX market is one of the largest and most liquid global financial markets 

with an average aggregate daily value settled of 8.0 trillion U.S. dollar equivalent 

(USDE).7 The FX market plays a pivotal international role in determining the 

relative value of a currency, providing liquidity to the international banking 

system, and facilitating cross-border trade and investment. Because of its 

importance, the FX market has long been a focus of attention by finance 

ministries, central banks, and banking supervisors.

The FX market is an over-the-counter (OTC) market with globally dispersed 

participants that connect local trading centers into a liquid, global market. The 

three largest trading centers are located in the United Kingdom, the United 

States, and Japan respectively, although a number of other countries also host 

major centers. Due to the dispersion of market participants, the FX market is 

also a 24-hour market with large volumes of cross-border transactions. The three 

major instruments in the FX market are spot, forward, and FX swaps, which 

collectively account for approximately 94 percent of FX market activity. These 

instruments are typically considered part of the short-term international money 

market, serving as critically important cross-currency funding tools for a wide 

variety of participants. Settlement risk is the primary risk in the FX market and is 

a key source of systemic risk. 

CLS Bank is the sole multi-currency settlement system of its kind, offering both 

liquidity savings and settlement risk mitigation across all major currencies, and 

the only one that operates on a global basis across all the major currencies.8

CLS Bank settles an average daily value of 4.77 trillion USDE, representing 68 
152 2012 FSOC // Annual Report

percent of FX market activity in CLS Bank-eligible currencies and products. The 

CLS Bank system links thousands of institutions, including many of the largest 

banks, investment companies, and nonfinancial corporations, both domestic 

and foreign. Through CLS Bank, these institutions are able to reduce their 

settlement risk in the FX market through the use of payment-versus-payment 

(PVP) settlement.9 CLS Bank is also used by and uses a number of other FMUs 

to settle multi-currency payment flows. Among other potential effects, a failure 

of or disruption to the functioning of CLS Bank could substantially increase 

participants’ liquidity risk and reintroduce significant settlement risk among 

institutions in the FX market.

Analysis of Systemic Importance

A) Aggregate monetary value of transactions processed by CLS Bank

CLS Bank settles a significant and increasing volume and value of activity in 

the FX market. Through its services, CLS Bank significantly reduces settlement 

risk and provides substantial liquidity savings through its use of multilateral net 

funding. If the volumes and values settled by CLS Bank continue to grow, CLS 

Bank’s role in the FX market, and market participants’ reliance on CLS Bank, will 

become even more significant.

Settlement volumes and values. CLS Bank estimates that it settles, by value, 

68 percent of FX market activity in eligible currencies and products. In 2011, 

CLS Bank settled an average daily gross volume of 820,600 sides and an average 

aggregate daily value of 4.77 trillion USDE. In addition, through PVP settlement, 

CLS Bank mitigated a substantial amount of the settlement risk associated with 

the average daily gross volume settled. In 2011, CLS Bank settled a peak daily 

gross volume of 1,957,417 sides; on its peak settlement value day, March 19, 2008, 

CLS Bank settled approximately 10.3 trillion USDE.

In 2011, U.S. dollar transactions settled at CLS Bank accounted for a substantial 

amount of the average daily gross settlement volume and the average aggregate 

daily settlement value. In addition, U.S.-based settlement members accounted for a 

significant portion of the average aggregate daily value settled in 2011 at CLS Bank.

In 2011, the volume and value of transactions settled at CLS Bank increased by 

4.7 percent and 15.5 percent, respectively, from 2010. Since 2007, the volume of 

transactions processed by CLS Bank has grown at a compound annual rate of 

22 percent, with U.S. dollar transaction volumes growing at a compound annual 

rate of 23 percent. In addition, since 2007, the value of transactions processed by 

CLS Bank has grown at a compound annual rate of 7.3 percent, with the value 

of U.S. dollar transactions growing at a compound annual rate of 7.2 percent. In 

comparison, from 2007 through 2010, the total value of the FX market grew at a 

compound annual rate of 3.7 percent. 

Funding. Members fund and defund their multi-currency accounts at CLS Bank 

through 17 real-time gross settlement (RTGS) systems, including the Federal 

Reserve’s Fedwire Funds Service for U.S. dollar payments. Funding occurs on a 

multilateral net basis, which provides substantial netting efficiencies. In order to 
Appendix A 153

smooth out the liquidity needs of its members, CLS Bank permits its members 

and their nostro agents to pay in over a five-hour funding window. 

B) Aggregate exposure of CLS Bank to its counterparties 

Although CLS Bank has a robust risk management framework, it is still exposed 

to significant credit and liquidity risk.

Credit exposures. CLS Bank may extend credit to its members in the form of 

haircut-adjusted short positions, which are collateralized by a member’s long 

positions and capped at the aggregate short position limit (ASPL) for each 

settlement member. ASPLs vary among members based on an assessment of each 

member’s credit, liquidity, and operational capabilities.10

Based on the ASPL for each settlement member, CLS Bank’s maximum potential 

credit exposure is in the billions of USDE.11 Though these exposures are 

collateralized by haircut-adjusted long positions, as a result of extreme exchange 

rate volatility, CLS Bank may have insufficient liquidity and incur financial losses, 

which it would allocate to its surviving members.

Liquidity exposures. In the event that a settlement member fails to pay in the 

currency required to cover a short position by the end of the funding window, 

CLS Bank will attempt to swap the failing member’s remaining long positions 

for the currency required to fulfill CLS Bank’s payout obligations. As a result, 

CLS Bank has obtained committed lines of liquidity across the 17 currencies that 

are eligible for settlement. U.S. dollar liquidity is provided by a group of U.S. 

depository institutions, each of which is also a settlement member. 

In the case of a single member pay-in failure, the peak liquidity that CLS 

Bank would require from its committed liquidity providers is equivalent to the 

maximum ASPL. Provided that its currency haircuts are sufficient to mitigate 

market risk, CLS Bank’s committed lines of liquidity should be sufficient to 

complete payouts in the appropriate currency, even if the failing member is a 

liquidity provider in the required currency. However, if CLS Bank’s currency 

haircuts are insufficient to absorb a significant depreciation in the value of the 

members’ long positions relative to the value of their short positions, CLS Bank’s 

liquidity needs may exceed its committed liquidity lines, and CLS Bank may incur 

financial losses. Further, in the event that its liquidity providers are unwilling 

or unable to provide the committed liquidity, CLS Bank will credit its affected 

member(s) in an alternate currency, which its members may choose to receive 

as a payout or hold overnight at CLS Bank, thereby shifting liquidity risk to its 

member(s) and potentially resulting in liquidity disruptions to U.S. and foreign 

financial markets.

C) Relationships, interdependencies, or other interactions of CLS Bank with other 

FMUs or payment, clearing, or settlement activities

CLS Bank settlement activity is highly concentrated amongst its largest members. 

In addition, CLS Bank is highly interconnected with a number of other FMUs 

and trade repositories. These relationships and interdependencies increase the 
154 2012 FSOC // Annual Report

potential for a disruption at CLS Bank to spread to other participants, FMUs, 

markets, and throughout the U.S. financial system.

Concentration of participants and degree of tiering. The value of instructions 

settled by CLS Bank is highly concentrated among the largest of its 63 members. 

Further, third-party settlement activity is highly concentrated among a group 

of members. Since the value of instructions settled in CLS Bank is highly 

concentrated, a disruption to one large member would have a significant impact 

on the risks faced by CLS Bank (see factor (D) for the impact of a failure to pay 

by one or more participants). However, the inclusion of the largest FX market 

participants in CLS Bank ensures that a significant proportion of the FX market 

is settled at CLS Bank using its PVP risk mitigating features.

In 2011, 27 of CLS Bank’s 63 members were active in submitting instructions on 

behalf of third parties, though the majority of activity was concentrated among a 

few institutions. In aggregate, third-party transactions represent approximately 11 

percent of the aggregate value settled by CLS Bank. In addition, the three largest 

U.S.-based third-party service providers account for more than 48 percent of total 

third-party activity. 

Dependencies of other FMUs and trade repositories on CLS Bank. CLS 

Bank settles non-PVP instructions for The Warehouse Trust Company’s Trade 

Information Warehouse (TIW), which is a subsidiary of DTCC, as well as the 

CME, ICE Clear Europe, Eurex, and LCH.Clearnet. Specifically, CLS Bank settles 

FX futures-related payments for the CME and ICE Clear Europe, and credit 

derivative-related payments for TIW, Eurex, and LCH.Clearnet. Settlement at CLS 

Bank provides operational and funding efficiencies for these FMUs and trade 

repositories. The link with the TIW is particularly notable, as it allows payments 

for OTC credit derivatives, which are calculated and bilaterally netted across 

participants, to be directly submitted for settlement at CLS Bank. 

D) Effect that the failure of or disruption to CLS Bank would have on critical markets, 

financial institutions, or the broader financial system

A failure of or long-term disruption to CLS Bank may significantly increase 

settlement risk and liquidity demands in the FX market. In turn, these 

developments may reduce FX market activity and the flow of funds in U.S. and 

foreign financial markets and to the broader economy.

Market effects of a failure of or long-term disruption to the functioning of 

CLS Bank. In addition to potentially transmitting credit risk to its members via 

loss allocation, a failure of or long-term disruption to CLS Bank may result in a 

reversion to non-PVP settlement and therefore reintroduce significant credit risk 

to the FX market. Because CLS Bank is the sole global multi-currency settlement 

system that eliminates FX settlement risk across all major currencies, a failure 

of or long-term disruption to CLS Bank would require members to settle FX 

transactions through non-PVP settlement arrangements, including bilateral 

gross settlement, bilateral net settlement, and “on-us” settlement. A reversion 

to non-PVP settlement arrangements could reintroduce a substantial amount 

of settlement risk to the FX market daily. As a result, members would initially 
Appendix A 155

experience a sudden increase in settlement risk that may significantly exceed 

counterparty settlement limits set by their internal credit risk management 

function and may have to suddenly and drastically reduce their trading activity 

to stay under prudent counterparty settlement limits. Alternatively, members 

would need to collect large amounts of collateral from counterparties or accept 

significantly higher levels of counterparty credit risk that may exceed their capital.

A reduction in trading activity would reduce the flow of funds between CLS 

Bank participants, including domestic and foreign banks, investment companies, 

and nonfinancial corporations, and would impair FX market liquidity. As FX 

instruments are typically considered part of the short-term international money 

market, a reduction of FX market liquidity would seriously disrupt cross-border 

funding markets. As a result, the impact of a failure of or long-term disruption 

to CLS Bank would be felt in U.S. and foreign financial markets, as well as in 

the broader economy. Further, in the absence of PVP settlement, a failure of 

an FX market participant would expose counterparties to significant credit risk 

that could lead to additional failures of, or an erosion of confidence in, other 

FX market participants. In addition, because CLS Bank settles transactions 

both directly and indirectly for thousands of institutions, including banks, 

investment companies, and nonfinancial corporations, the failure of CLS 

Bank or a disruption of its settlement services could have a crippling impact on 

international trade with adverse second-order effects on the real economy and 

U.S. financial stability.

In the absence of CLS Bank and multilateral net funding in the FX market, 

members would be required to provide additional liquidity to complete 

settlement, thereby increasing liquidity demands on market participants. As such 

funding may occur in stressed market conditions and require access to large and 

alternative sources of liquidity at short notice, there could be significant liquidity 

disruptions to financial markets. In particular, since the U.S. dollar accounts for 

a substantial percentage of settlement value at CLS Bank, demands for additional 

U.S. dollar liquidity may be substantial and could have a significant impact on 

major U.S.-based banks and the U.S. financial system. Assuming that members 

revert to bilateral gross settlement in the absence of CLS Bank, liquidity needs 

would increase substantially, therefore providing another incentive for members 

of CLS Bank to significantly reduce their trading activity and the flow of funds 

between CLS Bank participants.

In addition to a reduction in FX market activity and an increase in liquidity 

demands, the absence of CLS Bank would require that non-PVP settlement 

arrangements absorb an additional average daily volume of 795,000 sides. A 

sudden increase in the volume of non-PVP transactions, however, may result 

in immediate operational challenges due to capacity constraints, potentially 

preventing a significant volume of FX transactions from settling in a timely 

fashion and thereby spreading liquidity risk among participants and their 

counterparties. Further, to the extent that a failure of or disruption to the 

functioning of CLS Bank results in non-PVP settlement, the relevant RTGS 

systems would experience sudden increases in the volume and value of 

instructions settled. In the United States, for example, the Fedwire Funds Service 
156 2012 FSOC // Annual Report

and CHIPS may be required to absorb a significant amount in additional U.S. 

dollar payment activity daily.

CLS Bank also provides settlement of payments related to credit derivatives and FX 

futures for multiple FMUs, both domestic and foreign. These FMUs benefit from 

funding efficiencies and straight-through processing by settling at CLS Bank and, 

in the short term, the absence of CLS Bank would be disruptive to these FMUs, 

as they would have to reroute payments over the relevant RTGS systems. Based on 

data compiled by the Federal Reserve Board, the U.S.-based members of CLS Bank 

are also members in several other FMUs. In the event that CLS Bank is unable to 

complete settlement and these members are unable to obtain timely settlement of 

their payment instructions through alternative settlement arrangements, liquidity 

disruptions may be transmitted to other key FMUs and markets.

Effects of a short-term disruption to the FMU. In the event that an operational, 

market, or funding-related event results in a short-term disruption to CLS Bank, 

CLS Bank would be required to defer settlement, but may be able to complete 

settlement before the end of the settlement day. Settlement, however, is heavily 

dependent on the closing times of the RTGS systems used to transfer funds to 

and from members’ multi-currency accounts at CLS Bank and may require an 

extension of the operating hours of certain RTGS systems on which CLS Bank 

is dependent. Further, CLS Bank currently estimates that the largest single 

settlement member pay-in failure (in terms of its aggregate impact on the 

settlement of transaction at CLS Bank) would result in a significant percentage 

of transactions not settling. As a result, members would need to settle these 

transactions on a non-PVP basis outside of CLS Bank, thereby increasing the 

amount of settlement risk in the FX market significantly. In a pay-in failure 

situation, however, surviving members would receive additional pay-in calls, which, 

if met, would significantly reduce the value of unsettled transactions at CLS Bank.

In the event of a large single member default, CLS Bank could issue additional 

pay-in calls across the surviving members to fund additional liquidity.12 As such 

funding may occur in stressed market conditions and require access to large and 

alternative sources of liquidity at short notice, there could be significant liquidity 

disruptions to financial markets. Further, as most additional funding will occur 

in U.S. dollars when U.S. markets are closed (between 3 a.m. and 6 a.m. ET), the 

impact on the financial system of the United States could be more severe.

The peak liquidity that CLS Bank could require from its committed liquidity 

providers is equivalent to the maximum ASPL. Provided that its currency 

haircuts are sufficient to mitigate market risk, CLS Bank’s committed lines of 

liquidity should be sufficient for CLS Bank to satisfy its payout obligations in 

the appropriate currency, even if the failing member is a liquidity provider in 

the required currency. However, if additional members fail to fully satisfy the 

additional pay-in calls that result from the original pay-in failure, then CLS Bank’s 

liquidity needs may exceed its committed liquidity lines. As a result, CLS Bank may 

be unable to meet its payout obligations, in which case it would pay an equivalent 

amount in an alternate currency and transfer its liquidity risk to its members.
Appendix A 157

Conclusion

CLS Bank is the sole global multi-currency settlement system of its kind, offering 

both liquidity savings and settlement risk mitigation across all major currencies. 

A failure of or long-term disruption to CLS Bank would have negative effects on 

both its members and the FX market, resulting in significant credit, liquidity, 

and operational disruptions. These effects would likely spill over into U.S. and 

global financial markets, as the FX market is critical to meeting cross-currency 

funding needs of global financial institutions. Further, PVP settlement in the FX 

market continues to be encouraged by central banks, market regulators, and other 

authorities in order to reduce settlement risk. Should the growth in the values 

and volumes settled by CLS Bank persist, perhaps due to the continued growth of 

the FX market and the inclusion of additional participants, settlement currencies, 

and settlement sessions, CLS Bank will assume an even more dominant role in the 

FX market. In the absence of alternative settlement arrangements offering both 

settlement risk mitigation and liquidity savings across a similar set of FX products 

and currencies, CLS Bank’s expansion will reduce overall risk but also concentrate 

the risk associated with a potential disruption to or failure of CLS Bank.

Based on the significant values and volumes of FX market activity settled at CLS 

Bank, the extensive network of financial and nonfinancial institutions that depend 

on CLS Bank, the dependence of other critical FMUs on CLS Bank to effect 

settlement, and the lack of substitutes offering both settlement risk mitigation and 

liquidity savings, the Council has determined that CLS Bank should be designated 

as a systemically important FMU pursuant to Title VIII of the Act. 

C. Chicago Mercantile Exchange, Inc.

Description of Chicago Mercantile Exchange, Inc.

CME is a subsidiary of CME Group, Inc. (CME Group), a public company. CME, 

through its U.S. clearing division (CME Clearing), provides clearing services 

among futures commission merchants (which are included in the definition of 

financial institution in Section 803 of the Act) and between futures commission 

merchants (FCMs) and customers. Therefore, CME meets the definition of FMU 

set out in Title VIII.13

CME is one of the largest central counterparty clearing services providers in 

the world, clearing 96 percent of the entire market for U.S. futures, options 

on futures, and commodity options.14 CME clears all contracts traded on the 

designated contract markets (DCMs)15 owned by CME Group, namely the Chicago 

Mercantile Exchange (CME DCM), Board of Trade of the City of Chicago, Inc. 

(CBOT), the New York Mercantile Exchange (NYMEX), and the Commodity 

Exchange, Inc. (COMEX). In addition, CME offers clearing services for the global 

OTC market through, inter alia, CME ClearPort. 

CME provides central counterparty clearing services for futures, options, and 

swaps that can be used by market participants for a variety of purposes. Products 

cleared by CME range from commodity futures, which are essential to price 

discovery and liquidity for the underlying commodities, to interest rate swaps 

(IRS) and equity index contracts, which can be used as hedges or as investments 
158 2012 FSOC // Annual Report

themselves. CME clears the largest and most liquid futures contracts based on 

the Standard & Poor’s (S&P) 500 Index, Eurodollar, U.S. Treasury securities, 

and energy products, as well as IRS. CME functions as the central counterparty 

to market participants and clears a large number of transactions supported by 

significant collateral. As a central counterparty, CME stands between its members 

for every transaction cleared, serving as the seller to every buyer and the buyer to 

every seller. In effect, members substitute CME’s credit for each other’s credit. 

While the purpose of the contracts cleared by CME can vary, all such contracts 

initially expose the participants on both sides of the contract to credit risk. 

By guaranteeing to each counterparty that the other side of the contract will 

be fulfilled, CME acts as a central counterparty to mitigate such risks. CME 

collects margin from each of its clearing members to offset the risks of a clearing 

member’s contracts and nets margin calls across all of each member’s contracts. 

On average, CME clears contracts with a notional value in the trillions of U.S. 

dollars and maintains collateral deposits averaging in the billions of U.S. dollars. 

Analysis of Systemic Importance

A) Aggregate monetary value of transactions processed by CME

Number of transactions processed, cleared or settled. In 2011, CME cleared an 

average daily gross volume in the millions of futures and options contracts and 

average daily notional amounts in the millions of U.S. dollars for OTC CDS and 

OTC USD IRS; in the millions of euros for OTC euro IRS; and in the millions 

of pound sterling for OTC GBP IRS. CME cleared a peak daily gross volume in 

the millions of contracts and peak daily notional amounts in the billions of U.S. 

dollars of OTC CDS and OTC USD IRS, in the billions of euros of OTC euro IRS, 

and in the billions of pound sterling of OTC GBP IRS.

Value of transactions processed, cleared or settled. In 2011, CME cleared 

contracts with an average daily gross notional value in the trillions of U.S. dollars 

and average daily gross notional values in the millions of U.S. dollars of OTC 

CDS; millions of U.S. dollars of OTC USD IRS; millions of euros of OTC euro 

IRS; and millions of pounds sterling of OTC GBP IRS. The peak daily gross value 

of the contracts CME cleared was in the trillions of U.S. dollars for futures and 

options, billions of U.S. dollars for OTC CDS, billions of U.S. dollars for OTC 

USD IRS, billions of euros for OTC euro IRS, and billions of pound sterling for 

OTC GBP IRS.

Value of other financial flows. For all listed derivatives, except cleared OTC IRS 

and cleared OTC CDS, the average daily flow of funds (average daily variation 

margin plus change in average daily initial margin) in 2011 was in the billions 

of U.S. dollars, with a peak in the billions of U.S. dollars on August 8, 2011. The 

peak daily open interest was in the millions of U.S. dollars on August 25, 2011.

B) Aggregate exposure of CME to its counterparties 

Credit exposures. The period-end aggregate value of all collateral posted as of 

December 30, 2011, was in the billions of U.S. dollars. On December 30, 2011, 

the member guaranty fund requirement across all three guaranty funds was $4.5 

billion, CME designated capital across the guaranty funds was $300.0 million, 
Appendix A 159

and the consolidated initial margin requirement was billions of U.S. dollars. For 

2011, CME’s guaranty fund held average deposits of $3.8 billion, with a peak value 

of $4.5 billion. 

CME maintains minimum coverage of 99 percent for a liquidation period of one 

day for futures, 99 percent for a liquidation period of five days for OTC IRS, and 

99 percent for a liquidation period of five days for OTC CDS.

The average aggregate daily value of collateral (after haircuts) posted to CME was 

in the billions of U.S. dollars. The peak aggregate dollar value of collateral (after 

haircuts) posted to CME was in the billions of U.S. dollars on June 2, 2011. For 

the 12 months ended December 30, 2011, the average intraday variation margin 

at CME was in the billions of U.S. dollars. The peak intraday variation margin at 

CME for all listed derivatives, excluding cleared OTC IRS and cleared OTC CDS, 

was in the billions of U.S. dollars on September 22, 2011. 

For the 12 months ended December 30, 2011, the average daily value of initial 

margin at CME was in the billions of U.S. dollars. The peak daily value of initial 

margin at CME was in the billions of U.S. dollars on June 1, 2011. 

It is anticipated that with the introduction of mandatory clearing for swaps, 

clearing volume and open interest will significantly increase, and margin on 

deposit and exposure will increase proportionally.

Liquidity resources. On December 30, 2011, the amount of liquidity resources 

(including only cash and U.S. Treasury and agency notes) at CME was in the 

billions of U.S. dollars, with billions of U.S. dollars of liquidity resources on June 

2, 2011. As of December 30, 2011, the total value of lines of credit from banks or 

others was several billion U.S. dollars. 

Liquidity exposures. For the 12 months ended December 30, 2011, the average 

daily variation margin CME paid to clearing members was in the billions of U.S. 

dollars. The peak daily variation margin CME paid to clearing members was 

in the billions of U.S. dollars on August 8, 2011. The largest intraday variation 

margin collect was in the billions of U.S. dollars on October 27, 2011.

C) Relationships, interdependencies, or other interactions of CME with other FMUs or 

payment, clearing, or settlement activities

Participants. CME has a total of 64 clearing members, including futures 

commission merchants (some of which are also broker-dealers), bank affiliates, 

and proprietary trading firms. Twenty-nine of CME’s clearing members are foreign 

clearing members (including U.S. operations of non-U.S. entities). CME’s clearing 

members include some of the largest banking and brokerage firms in the world. 

Other FMUs. CME has a cross-margining agreement with OCC, which is dually 

registered as a Derivatives Clearing Organization (DCO) and as a securities 

clearing agency. The average amount of margin subject to the cross-margining 

agreement is in the millions of U.S. dollars. CME also has a cross-margining 

arrangement with FICC, which generated a savings of millions of U.S. dollars 
160 2012 FSOC // Annual Report

on December 30, 2011 for clearing firms. In addition, CME has a mutual offset 

arrangement with Singapore Exchange Ltd. The mutual offset arrangement with 

Singapore Exchange Ltd. enables market participants to open a futures position 

in one of the following five contracts on one exchange and liquidate it on the 

other: Eurodollars, Euroyen TIBOR, Yen- and Dollar-Denominated Nikkei 225 

futures, and E-micro S&P CNX Nifty (Nifty 50) futures. 

Trading platforms. CME provides clearing services for the CME, CBOT, 

NYMEX, and COMEX exchanges that are all part of CME Group. CME also 

provides clearing services for the Green Exchange, a DCM that offers trading 

in environmental futures and options, and for Eris Exchange, LLC, a DCM that 

offers trading in IRS futures. The Dubai Mercantile Exchange, an energy-focused 

commodities exchange regulated by the Dubai Financial Services Authority, 

clears all of its trades through NYMEX, which outsources its clearing operations 

to CME Clearing.

Other external service providers. CME uses the following platforms: Bloomberg, 

Javelin, Tradeweb, Marketwire, Icelink, CME Globex, CME Clearport, and the 

CME’s physical trading floor. In addition, CME uses the services of the following 

companies: ION, Sungard, WTD, FFastFill, ATEO, and Whentech. CME also 

maintains settlement bank relationships.

Average daily value of flows and other transactions with key financial 

institutions. For the 12-month period ended December 30, 2011, the average daily 

value of flows with key financial institutions was in the billions of U.S. dollars. 

Average daily value of trades and other transactions on key trading platforms. 

CME’s average daily value of trades was in the millions of U.S. dollars.

D) Effect that the failure of or disruption to CME would have on critical markets, 

financial institutions, or the broader financial system

Role of CME in the market served. In 2011, CME cleared 96 percent of the total 

U.S. futures and CFTC-regulated options market volume.16

Availability of substitutes. While several other clearinghouses clear products 

that may be viewed as serving as substitutes for some of the products cleared by 

CME, it would be impractical, in the short term, for another clearinghouse to 

substitute for CME.

Concentration by product type. As mentioned, CME clears 96 percent of all U.S. 

futures, options on futures, and commodity options volume. 

Financial Data/Metrics. On December 30, 2011, CME had in the billions of U.S. 

dollars in cash and cash equivalents, in the billions of U.S. dollars in government 

securities, in the millions of U.S. dollars in valued securities, in the billions 

of U.S. dollars in letters of credit, and in the millions of U.S. dollars in escrow 

deposits of contracts.
Appendix A 161

Clearinghouses reduce the costs and operational risks of clearing and settlement 

among multiple market participants by mitigating counterparty risk, settling 

or netting participants’ obligations, or providing other clearing services or 

arrangements that mutualize or transfer credit risk among participants. CME 

houses one of the largest clearinghouses worldwide. 

The primary trigger of a default by CME would be a default by one or more 

clearing members with extraordinary losses in excess of CME’s default resources. 

While such a default could conceivably result from circumstances local to 

those members, a default scenario would more likely be associated with a 

disruption to the markets more generally, including scenarios such as historically 

extraordinary volatility, extreme changes to normal price correlations, and acute 

reductions in liquidity. 

An alternative trigger of a default by CME would be a failure by one of its 

settlement banks, in particular its concentration bank, because a substantial 

portion of CME’s financial resources, as well as those of its members, are on 

deposit with these banks. Thus, if those financial resources were to suddenly 

become unavailable, CME’s operations would be adversely affected to a 

considerable extent. 

In addition, a CME default could result from a failure to maintain a generally 

sound financial condition, such as a failure to maintain sufficient capital or other 

financial resources against its general business risk or against the risk of one or 

more clearing member defaults. 

As discussed previously, it would be impractical, in the short term, for another 

clearinghouse to substitute for CME. Moreover, even if swap transactions were 

replaced on a bilateral basis, if the market had moved since the trades were 

submitted to CME, it is unclear how the original counterparties would reinstate 

the original bilateral transaction. In addition, it could be difficult or impossible 

to reinstate the original transactions bilaterally if they were made on a trading 

platform. Because multilateral netting reduces the exposure of a clearinghouse’s 

members to each other, the de-netting of positions resulting from a CME 

default would immediately increase counterparty risk, which could have serious 

consequences for market participants, including exposure to credit risk and 

demand for collateral. 

Furthermore, netting provides a market benefit in that the margin required to 

collateralize the exposure of a portfolio is generally smaller than collateralizing 

its individual components, because the prices of the portfolio’s components 

are often correlated. Central counterparty netting is more powerful, as each 

member’s obligations to every other member can be netted and offset.17

Moreover, in the bilateral market, if A wishes to neutralize, e.g., a long exposure 

to B, A would typically enter into a transaction with a short exposure to another 

counterparty, e.g., C. This would offset A’s market risk, but would leave A with 

credit risk to each of B and C. In a cleared market, if A has cleared a transaction 

with a long exposure and enters into a cleared transaction with an offsetting 
162 2012 FSOC // Annual Report

short exposure, those exposures would be offset, leaving A with neither market 

nor credit risk.

Thus, the amount of collateral posted in a set of bilateral transactions to obtain 

the same level of protection that could be obtained through clearing would likely 

increase exponentially, thereby leading to some combination of a substantial 

increase in required collateral (with a consequent drain in liquidity), an increase 

in the number and exposure of uncollateralized transactions (creating greater 

exposures from further failures), and a decrease in the total number of transactions 

that are entered into (based on a reduction of credit, which would likely have a 

deleterious impact on the financial activity that those transactions hedge). 

In addition, any disruption in the clearing or trading of these products would 

likely severely impede price discovery, which would result in both a decrease in 

market efficiency and a loss of liquidity for these products.

Moreover, there would likely be a negative impact on any economic activity that 

presupposes the protection of hedging activity.18 For example, livestock producers 

that do not want to take on the risk of changing prices in the cash markets may 

abandon production entirely if they cannot use the futures market to lock in 

a price ahead of actual merchandising, and those that do choose to continue 

production may face an uneven playing field against other competitors, thereby 

effectively making them not competitive in the global markets. 

Similarly, a natural gas producer might use a futures contract to set a price now 

for gas that it will sell in the future to avoid being exposed to the possibility of 

lower prices. Without the protection of hedging, natural gas producers may 

reduce production activities to lower their price exposures. As hedging activities 

decrease, products become difficult to price and, without clear and competitive 

prices, the markets for those products become less liquid. As liquidity decreases 

in a market, market participants will likely demand additional collateral and, as 

the amount of available capital decreases, there will be an increased demand for 

credit, which, in an unstable market environment, will be difficult to obtain.

As positions move to the uncleared, bilateral market and are de-netted, settled 

and replaced, operational risks and costs would likely increase, thereby decreasing 

the number of reliable and readily available hedging opportunities. As a result, 

financial institutions and other market participants may reduce their investment 

activities, which could further stress the U.S. financial markets.

Finally, the contagion effect of a CME default if it were to lack sufficient resources 

to make timely payments obligations on variation margin could severely disrupt 

operations at other clearinghouses because of a crisis of confidence that 

interrupts the orderly functioning of the market and/or because of the impact 

that the loss of funds would have on an entity’s ability (or willingness) to pay (1) 

losses owed to other DCOs, (2) increased collateral requirements for offsetting 

losing positions, (3) deposits in pension fund cash accounts or (4) bank financing 

charges. Essentially, the failure of CME would create enormous uncertainty about 

the status of initiated transactions as well as the financial positions of its clearing 
Appendix A 163

members and their customers and could jeopardize the orderly functioning of 

other DCOs and the U.S. financial markets as a whole.

Conclusion

The data reviewed by the Council indicate that CME processes a significant 

volume of high-dollar-value transactions on a daily basis for critical U.S. 

markets.19 Moreover, it is questionable whether finding a substitute for CME’s 

products is a viable short-term solution. Accordingly, even the shortest disruption 

of CME could disrupt clearing for a variety of futures and options transactions 

and could effectively freeze the futures and options markets, thereby creating 

liquidity and credit problems in the U.S. futures markets. The loss of central 

counterparty clearing in the products CME clears would increase collateral 

demands exponentially, resulting in a corresponding drain of liquidity.

A CME failure could also have an adverse impact on price discovery, which 

could, in turn, lead to inefficient markets and a correlated increase in liquidity 

problems. Finally, the contagion effect of a CME failure could impose material 

financial losses on CME’s clearing members and other market participants (such 

as customers) and could lead to increased liquidity demands and credit problems 

across financial institutions, especially those that are active in the futures and 

options markets. Where these financial institutions are active in multiple U.S. 

markets, this contagion effect would have a broader impact and, as the markets 

experience growing stress, would likely lead to increased demand for credit, 

which would, in turn, likely lead to less liquidity. Thus, the Council believes that 

a significant disruption or failure of CME could have a major adverse impact 

on the U.S. financial markets, the impact of which would be exacerbated by 

the limited number of clearing alternatives currently available for the products 

cleared by CME. Accordingly, a failure or disruption of CME would likely have a 

significant detrimental effect on the liquidity of the futures and options markets, 

clearing members, which include large financial institutions, and other market 

participants, which would, in turn, likely threaten the stability of the broader U.S. 

financial system.

For the reasons set out here, the Council has determined that CME should be 

designated as a systemically important FMU pursuant to Title VIII of the Act. 

D. The Depository Trust Company

Description of The Depository Trust Company

DTC is an FMU as defined in Title VIII of the Act because it manages or operates a 

multilateral system for the purpose of clearing and settling securities transactions 

among financial institutions and between financial institutions and DTC.20

DTC serves as the central securities depository (CSD) for substantially all 

corporate and municipal debt and equity securities available for trading in 

the United States. DTC is a wholly owned subsidiary of DTCC and is generally 

administered as an industry-owned utility on an at-cost basis.
164 2012 FSOC // Annual Report

DTC provides depository services and asset servicing for a wide range of security 

types such as money market instruments (MMIs), equities, warrants, rights, 

corporate debt and notes, municipal bonds, government securities, asset-backed 

securities (ABS), and collateralized mortgage obligations. DTC’s custodial 

services include the safekeeping, record keeping, book entry transfer, and pledge 

of securities among its participants. DTC substantially eliminates the physical 

movement of securities by providing book-entry deliveries of securities, which 

transfer the ownership of securities electronically among broker-dealers on 

behalf of the beneficial owners of the securities. In addition to processing bookentry transfers, including those trades cleared through the NSCC, DTC provides 

services to securities issuers, such as maintaining current ownership records and 

distributing payments to shareholders. In 2011, DTC maintained custody and 

ownership records for approximately $39.5 trillion in securities.

DTC has 298 full service members and 72 limited service members. DTC 

members include U.S. broker-dealers, U.S. and non-U.S. banks or trust companies 

(including a trust company having limited powers), non-U.S. CSDs, U.S. 

government-sponsored enterprises (GSEs), and FRBNY. DTC direct participants 

include some of the largest banks in the world by asset size, and include affiliates 

of 25 of the 29 financial institutions considered to be globally systemically 

important.21 Trades that DTC settles for NSCC are executed on more than 50 

trading venues (including all U.S. securities exchanges and alternative trading 

systems) and with other domestic and foreign clearing agencies. 

Analysis of Systemic Importance

A) Aggregate monetary value of transactions processed through DTC

In 2011, DTC processed millions of book-entry securities deliveries and settled 

transactions with a substantial value. Average daily gross volume was 804,502 

deliver orders, payment orders, and pledges, with an average daily gross 

transaction value of approximately $573 billion. The peak daily gross number of 

transactions processed by DTC in 2011 was 1.24 million on June 29, 2011. In 2011, 

the average daily gross value of transactions processed by DTC was $573 billion, 

$339 billion of the total being MMIs and $234 billion of the total being other 

securities. The peak daily gross value of transactions processed by DTC in 2011 

was equal to $728.8 billion on August 12, 2011.

The average aggregate credit balance paid to participants as a result of the day’s 

settlement activity in the end-of-day cross-endorsed DTC-NSCC settlement was 

equal to $32.8 billion in 2011, with a peak aggregate credit balance payment of 

$78.3 billion on August 1, 2011. The average daily value of scheduled payments 

of dividend and principal and interest (P&I) payments due on DTC-eligible 

securities in 2011 was $10.1 billion. The peak daily value of these P&I payments in 

2011 was $41.0 billion. 

B) Aggregate exposure of DTC to its counterparties 

DTC is the central securities depository for the United States and is responsible 

for the safekeeping, custody, and certain ownership records of $39.5 trillion of 

securities as of December 31, 2011. As of December 31, 2011, total contributions 

to DTC’s participants fund equaled approximately $1.76 billion. The participants 
Appendix A 165

fund is available to secure participants’ obligations and certain liabilities of DTC, 

should they occur, such as when a participant fails to perform required payment 

or securities delivery obligations. DTC’s participants fund supports the clearance 

and settlement of a substantial portion of all corporate and municipal debt, 

equity securities, ABS, exchange-traded funds (ETFs), and MMIs available for 

trading in the United States. 

DTC extends intraday credit to its participants by allowing them to have net 

funds debit balances, which helps to facilitate the settlement process. These net 

debits are capped at a maximum of $1.8 billion per legal entity and $3 billion per 

affiliated family of participants. Through the various processes described here, 

DTC requires all transactions to be fully collateralized by its participants and 

therefore considers Value at Risk (VaR) not to apply to its operations.

DTC’s liquidity resources are limited to a committed, secured line of credit and 

the value of assets held in the participants fund—including certain assets of the 

defaulting participant held in anticipation of settlement. DTC’s line of credit, 

established with a syndicate of 31 banks, totaled $1.9 billion as of December 31, 

2011. DTC also maintained uncommitted credit lines totaling Can$150 million 

with a participant to support Canadian settlement during 2011. Further, a $50 

million shared uncommitted credit line with NSCC and DTCC is maintained with 

a participant to support potential short-term operating cash requirements. In 2011, 

the peak liquidity exposure to a single affiliated family of counterparties was $3 

billion, which is the maximum net debit limit permitted for any participant family. 

DTC rules require such exposures to be fully collateralized in each instance. 

C) Relationships, interdependencies, or other interactions of DTC with other FMUs or 

payment, clearing, or settlement activities 

DTC’s operations and the current market structure for securities trading 

and clearing involve significant interdependence between DTC and other 

FMUs, settlement banks, clearing members, credit facility lenders, custodians, 

exchanges, cross-margining entities, and pricing vendors. For example, NSCC—

which provides clearance, settlement, and central counterparty services for nearly 

all broker-to-broker equity and corporate and municipal debt trades executed 

on major U.S. exchanges and other equity trading venues—relies on an interface 

with DTC to settle obligations via the book-entry movement of securities. 

Throughout the day, the debits and credits in a DTC participant’s settlement 

account are netted to calculate, at any time, the net debit balance or net credit 

balance for the account. At end-of-day settlement, DTC and NSCC net the 

settlement balances of each DTC participant that is also a member of NSCC.

DTC maintains relationships with a number of other internationally important 

FMUs as well. In particular, DTC has established the Canadian-Link service 

with CDS Clearing and Depository Services, Inc. (CDS, Inc.), which enables 

DTC participants to clear and settle two categories of securities transactions: (1) 

cross-border Canadian dollar securities transactions with participants of CDS, 

Inc. and (2) intra-DTC Canadian dollar securities transactions with other DTC 

participants. DTC also has established accounts at two non-U.S. CSDs, namely 

Clearstream Bank AG in Germany and SIS SegaInterSettle AG in Switzerland. 
166 2012 FSOC // Annual Report

Non-U.S. CSDs with DTC accounts include: (1) CREST Nominees Ltd. (an 

affiliate of Euroclear) in the U.K. and Ireland; (2) Caja de Valores, S.A. in 

Argentina; (3) Tel Aviv Stock Exchange Clearing House (TASECH) in Israel; 

(4) Monte Titoli, S.p.A. in Italy; (5) Japan Securities Depository Center, Inc.; 

(6) Central Depository (Pte.) Ltd. in Singapore; and (7) Hong Kong Securities 

Clearing Company Limited. In addition, BM&F BOVESPA in Brazil and CDS, 

Inc. have pledgee accounts at DTC in order to receive U.S. securities collateral 

at DTC. Notably, however, the level of activity by CSD participants at DTC is 

insignificant in comparison to total DTC activity.

DTC has also formed a relationship with Omgeo, which provides global trade 

confirmation and trade matching systems for institutional trades. Trades by 

institutional investors are affirmed in Omgeo’s trade confirmation and tradematching systems, and the compared trade details are then passed on directly 

to DTC’s settlement system for settlement on a delivery-versus-payment/receiptversus-payment (DVP/RVP) basis.

D) Effect that the failure of or disruption to DTC would have on critical markets, 

financial institutions, or the broader financial system

The immediate effects of a failure of or a disruption to the functioning of DTC 

would include a major disruption to the markets for which DTC is the central 

securities depository as well as financial losses for many of DTC’s participants. A 

disruption to DTC’s services would first lead to complete or partial disruption of 

a significant amount in gross transaction value settled by DTC and to dividend, 

interest, and certain principal payments made on a daily basis. Such a disruption 

similarly would completely or partially disrupt the additional $23.8 billion 

average daily net settlement obligations that NSCC’s Continuous Net Settlement 

system instructs at DTC on behalf of NSCC and its members. The markets would 

be impacted further by an inability to access or trade some or all of the $39.5 

trillion in securities for which DTC acts as custodian. The absence of DTC’s 

services could also delay or prevent payment of dividends, principal, and interest 

to investors that own securities serviced by DTC. If a failure or disruption was 

triggered by losses to DTC, those losses might be shared by and cause stress to 

other FMUs, such as NSCC, with which it has a cross-guarantee agreement.

In addition, a failure or a disruption to the functioning of DTC would likely 

result in significant spillover effects on the rest of the U.S. economy, reducing the 

amount of credit available generally, reducing the value of household savings and 

corporate reserves, affecting the financing activities of corporations, destabilizing 

U.S. money market funds, and reducing the availability of secured credit. 

Conclusion

DTC plays an important role in financial markets in particular because it holds in 

its custody substantially all corporate debt and equity securities available for trading 
Appendix A 167

in the United States. Accordingly, a failure or disruption to the functioning of 

DTC could:

•	 Directly and negatively affect an enormous dollar value of financial assets 

held in custody and a substantial dollar value and volume of financial 

transactions in equity and debt markets;

•	 Impose material direct losses on participants and their customers for 

whom DTC acts as custodian;

•	 Cause liquidity or credit problems resulting from its failure or disruption 

to spread quickly and broadly among financial institutions and other 

markets; and

•	 Have cumulative negative effects on U.S. domestic equity and debt 

markets, financial institutions, and the broader financial system that 

are substantial in their own right and so severe as to create a risk that 

liquidity and credit problems experienced could spread among financial 

institutions and other markets and, therefore, threaten the stability of the 

financial system.

Accordingly, it is the assessment of the Council that a failure of or a disruption 

to DTC could increase the risk of significant liquidity problems spreading 

among financial institutions or markets and thereby threaten the stability of the 

financial system of the United States. For the reasons set out here, the Council 

has determined that DTC should be designated as a systemically important FMU 

pursuant to Title VIII of the Act.

E. Fixed Income Clearing Corporation

Description of Fixed Income Clearing Corporation

FICC is an FMU as defined in Section 803(6)(A) of the Act because it manages 

or operates a multilateral system for the purpose of clearing and settling 

securities transactions among financial institutions and between financial 

institutions and FICC.22

FICC plays a prominent role in the fixed income market as the sole clearing 

agency in the United States acting as a central counterparty (CCP) and provider 

of significant clearance and settlement services for cash settled U.S. Treasury 

and agency securities and the non-private label mortgage-backed securities 

(MBS) markets. FICC is a wholly owned subsidiary of DTCC and is generally 

administered as an industry-owned utility on an at-cost basis.

FICC is made up of two divisions, the Government Securities Division (FICC/

GSD) and Mortgage Backed Securities Division (FICC/MBSD), each providing 

clearing services in a different portion of the fixed income market. FICC/

GSD provides clearing, settlement, risk management, central counterparty 

services, and a guarantee of trade completion for (1) U.S. Treasury bills, notes, 

bonds, Treasury inflation-protected securities (TIPS), and Separate Trading of 

Registered Interest and Principal Securities (STRIPS); and (2) Federal agency 

notes, bonds, and zero-coupon securities that are book-entry, Fedwire eligible, 

and non-mortgage backed (collectively, U.S. government and agency securities). 
168 2012 FSOC // Annual Report

FICC/GSD accepts buy-sell transactions, repurchase and reverse repos, and 

Treasury auction purchases in several types of U.S. government securities. In 

2011, the two divisions cleared transactions valued at $1.1 quadrillion on a gross 

basis and $64.8 trillion on a gross basis, respectively.

FICC/MBSD is the only centralized clearing facility in the non-private label MBS 

market. FICC/MBSD provides clearing, netting, settlement, risk management, 

and pool notification services to major market participants trading in passthrough MBS issued by the Ginnie Mae (GNMA), Freddie Mac, and Fannie Mae. 

FICC/MBSD also processes options trades for “to-be-announced” transactions. 

On April 2, 2012, FICC/MBSD began providing central counterparty services and 

a guarantee of trade completion for MBS.

Both FICC/GSD and FICC/MBSD have relationships with more than 100 

participants. FICC/GSD’s members include the nation’s major brokers and 

dealers, as well as a wide range of entities that trade U.S. government securities. 

FICC/GSD’s direct members include some of the largest banks in the world by 

asset size and include affiliates of 23 of the 29 financial institutions considered to 

be globally systemically important.23 FICC/MBSD’s participants generally include 

the following: (a) banks and trust companies, (b) dealers, (c) inter-dealer brokers, 

(d) government securities issuers, (e) registered investment companies, and (f) 

unregistered investment pools. 

A distinguishing characteristic of FICC is the wide range of risks it faces and 

its ability to manage those risks. As a CCP, FICC faces credit risk, liquidity risk, 

custody and investment risks, and operational risk. FICC uses a combination of 

risk management tools to some of these risks to ensure it can meet its obligations. 

These tools include (1) membership standards with regard to financial resources 

and operational capacity, (2) collection of collateral deposits to meet clearing 

fund requirements and mark-to-market payments in the form of margin, and 

(3) close out and loss allocation procedures designed to facilitate an orderly 

liquidation in the event of a member default.

Another important feature of FICC is that it uses multilateral netting through 

which FICC/GSD and FICC/MBSD are able to reduce significantly the value of 

securities and payments that must be exchanged each day. A disruption to FICC 

could therefore have a multiplier effect on the liquidity needs of participants.

Analysis of Systemic Importance

A) Aggregate monetary value of transactions processed through FICC

In 2011, FICC/GSD processed 40.5 million transactions in U.S. government and 

agency securities worth $1.1 quadrillion on a gross basis. Through multilateral 

netting, FICC/GSD reduced the value of financial obligations requiring 

settlement in 2011 from $1.1 quadrillion to $230 trillion. In 2011, FICC/MBSD 

processed MBS transactions worth approximately $64.8 trillion, which through 

multilateral netting was reduced in value to $3 trillion. 

On an average day in 2011, FICC/GSD cleared 120,780 purchases and sales 

of U.S. government securities, 39,156 repo transactions, and 1,122 GCF repo 
Appendix A 169

transactions, which in aggregate were reduced to 24,515 net obligations daily. 

The peak daily gross number of trades for these three categories was 255,241 

purchase and sales, 44,238 repo transactions, and 1,636 GCF repo transactions, 

respectively. Peak aggregate netted obligations were 28,464 on July 29, 2011. 

Daily trading volume at FICC/MBSD averaged 10,556 compared sides in 2011. 

The daily gross number of compared sides at FICC/MBSD peaked at 30,237 on 

October 6, 2011. 

In 2011, the average daily gross value of trades compared by FICC/GSD was 

$893.7 billion for sales and purchases of U.S. government securities, $1.7 trillion 

for repos, and $796 billion for GCF repo transactions. The average daily net value 

settlement in all three categories was $921 billion for FICC/GSD, and the average 

daily funds only settlement (FOS) was $1.0 billion. The daily gross value of sales 

and purchases of U.S. government securities in 2011 peaked at $1.6 trillion on 

August 9, 2011. For repos and GCF repo transactions, the daily gross value of 

trades peaked at $1.9 trillion and $1.2 trillion, respectively. These peaks occurred 

on August 3, 2011, and September 8, 2011, respectively. The peak total of netted 

transactions in 2011 for FICC/GSD was $999.4 billion on July 29, 2011, and FOS 

peaked at $2.6 billion on August 10, 2011. FICC/MBSD compared, on average, 

$284.7 billion worth of transactions each day in 2011. FICC/MBSD’s comparisons 

of trade par value peaked at $988.2 billion on October 6, 2011. 

FICC/GSD’s peak increase in daily total clearing fund deposits in 2011 equaled 

$0.5 billion on August 10, 2011. The average daily total of funds only settlement 

debit was $0.3 billion, and funds only settlement debits peaked at $1.8 billion on 

August 10, 2011. FICC/MBSD’s average daily gross mark-to-market change for 

2011, including changes in average daily initial margin, was $3.4 billion, and its 

daily variation margin (mark to market) peaked at $10.4 billion on January 6, 2011.

B) Aggregate exposure of FICC to its counterparties 

In 2011, FICC/GSD maintained a clearing fund that averaged $11.1 billion, while 

FICC/MBSD maintained a participants fund that averaged $7.7 billion. The sizes 

of these funds peaked at $25.0 billion for FICC/GSD on March 22, 2011 and $15.2 

billion for FICC/MBSD on March 22, 2011. The average daily VaR estimates at a 

99 percent confidence level for FICC/GSD in 2011 was $6.2 billion. The average 

VaR for FICC/MBSD in 2011 was $5.0 billion. All of the collateral in the two 

funds was held in cash and in U.S. government and agency securities. 

FICC/GSD has liquidity needs for day-to-day securities settlement, daily funds 

settlement obligations, and in the event of member default. FICC/MBSD, by 

contrast, in 2011, had liquidity needs only for daily funds settlement obligations, 

as it did not begin acting as central counterparty until April 2012. FICC/GSD’s 

liquidity resources include the following: (1) the cash portion of the clearing 

fund; (2) the cash that would be obtained by entering into repo transactions 

using the eligible securities portion of the clearing fund (Treasury securities, 

agency securities guaranteed by the U.S. government, and certain U.S. agency/

GSE pass-through securities); and (3) the cash that would be obtained by entering 

into repos using the securities underlying transactions that would have been 

delivered to the defaulting member had it not defaulted. In addition, FICC/GSD 
170 2012 FSOC // Annual Report

could receive funds from its cross-margining and cross-guaranty arrangements 

if its resources proved insufficient to cover losses stemming from a member’s 

default. FICC/GSD does not maintain any committed lines of credit.

In 2011, FICC/GSD’s peak liquidity exposure to a single counterparty totaled $111 

billion. In 2011, FICC/MBSD’s peak liquidity exposure to a single counterparty 

totaled $25 billion. This exposure was required to be covered by the settlement 

obligations of other FICC/MBSD participants or through use of the FICC/MBSD 

participants fund. For the year ended December 31, 2011, FICC/GSD had an 

average of $10.6 billion in liquidity resources, which was comprised of $3.7 billion 

in cash and $6.9 billion in U.S. Treasury and agency securities. FICC/MBSD had 

an average of $7.1 billion in liquidity resources in 2011, of which $3.5 billion was 

in cash and $3.6 billion was in U.S. Treasury and agency securities. 

C) Relationships, interdependencies, or other interactions of FICC with other FMUs or 

payment, clearing, or settlement activities 

FICC/GSD has formed relationships with other market participants to mitigate 

the risks attending the potential default of a mutual participant. FICC/GSD has 

established a cross-margining arrangement with CME, and FICC has established 

a multilateral cross-guaranty agreement with both the OCC and FICC’s affiliates, 

NSCC and DTC, to cover certain obligations of a common defaulting member 

to the extent of available resources of the member. FICC/GSD has also formed 

a relationship with NYPC, a U.S. futures clearing corporation, to allow joint 

clearing members to cross-margin certain positions cleared at FICC/GSD with 

certain positions cleared at NYPC in a “one pot” margin portfolio.

FICC/GSD has only two clearing banks, JPMorgan Chase and Bank of New York 

Mellon. These two entities are critically important to FICC for GCF repos and 

security settlement processing. FICC/GSD also relies on FRBNY, both to issue 

U.S. Treasury securities and to collect and pay margin deposits. Payments to and 

from FICC/MBSD are made via DTC’s sub-account at FRBNY. 

In addition, FICC’s parent company, DTCC, provides significant services to 

FICC pursuant to a service agreement, including internal audit, corporate 

communications, corporate and regulatory compliance, executive services, 

finance, administration services, and legal services.

D) Effect that the failure of or disruption to FICC would have on critical markets, 

financial institutions, or the broader financial system

A failure of or a disruption to the functioning of FICC/GSD would be broad and 

severe. First, it could cause a complete or partial disruption of the substantial 

number and value of transactions typically pending to be cleared and settled 

through FICC/GSD in a two-day settlement cycle. Additionally, FICC/GSD 

members could face financial losses equal to the average net value of transactions 

guaranteed by FICC/GSD over the two-day settlement cycle, due to the full or 

partial absence of the FICC/GSD trade guarantee. These potential losses would 

be compounded by liquidity pressures due to at least a temporary limitation on 

a member’s ability to access collateral in the clearing and participant funds. As 
Appendix A 171

of December 31, 2011, the approximate values of such contributions were $11.1 

billion for FICC/GSD and $6.5 billion for FICC/MBSD.

There would also be a disruption to new trading activity in U.S. government 

securities and MBS markets. Because there are no other clearing agencies 

providing services similar to those of FICC, trades would need to be settled on a 

bilateral basis.

In addition, a failure of or a disruption to the functioning of FICC would likely 

result in significant spillover effects on the rest of the U.S. economy, reducing 

the amount of credit available generally, drawing assets away from other 

productive uses, reducing the value of corporate reserves and household savings, 

destabilizing U.S. money market funds, and negatively affecting financing 

activities of the U.S. government and GSEs. 

Conclusion

FICC plays an important role in financial markets due to the high gross notional 

value of the trades FICC/GSD and FICC/MBSD clear and the efficiencies 

they provide through multilateral netting of trades and payments among their 

members. In particular, because FICC/GSD is the sole clearing agency in the 

United States acting as a central counterparty for cash-settled U.S. government 

and agency securities, and FICC/MBSD is the predominant provider of clearance 

and settlement services for U.S. MBS markets, a failure or disruption to the 

functioning of FICC could:

•	 Directly and negatively affect an enormous dollar value and volume of 

financial transactions in the U.S. government securities and MBS markets;

•	 Impose material direct losses on FICC counterparties and create 

new demands for liquidity and new credit problems among financial 

institutions and others that rely on such markets for credit or liquidity;

•	 Cause liquidity or credit problems resulting from its failure or disruption 

to spread quickly and broadly among financial institutions and other 

markets; and

•	 Have cumulative negative effects on U.S. government and MBS markets, 

financial institutions, and the broader financial system that are substantial 

in their own right and so severe as to create a risk that liquidity and credit 

problems experienced could spread among financial institutions and 

other markets and, therefore, threaten the stability of the financial system.

Accordingly, it is the assessment of the Council that a failure of or a disruption 

to FICC could increase the risk of significant liquidity problems spreading 

among financial institutions or markets and thereby threaten the stability of the 

financial system of the United States. For the reasons set out here, the Council 

has determined that FICC should be designated as a systemically important FMU 

pursuant to Title VIII of the Act. 
172 2012 FSOC // Annual Report

F. ICE Clear Credit LLC

Description of ICE Clear Credit LLC

ICE Clear Credit is a Delaware limited liability company and an indirect 

subsidiary of Intercontinental Exchange, Inc., a Delaware corporation. ICE Clear 

Credit provides central counterparty clearing services to direct participants that 

are financial institutions, as well as to indirect market participants (customers). 

Therefore, ICE Clear Credit is an FMU as set out in Title VIII of the Act.24

ICE Clear Credit clears a majority of the CDS products in the United States that 

are eligible for clearing by a central counterparty. ICE Clear Credit currently 

clears 46 North American CDS contracts (Index Contracts), 132 single-name 

components of North American CDS contracts (Single-Name Contracts), and 

four foreign sovereign CDS contracts (Sovereign Contracts).25 Specifically, ICE 

Clear Credit clears all of the active North American CDS indices for the 5-year 

and 10-year tenors, and—save for certain financials—the most liquid U.S. single 

names in the CDS market. Of the products that are accepted for clearing by ICE 

Clear Credit, as of December 31, 2011, ICE Clear Credit cleared approximately 66 

percent of all bilateral trades where both the buyer and the seller are ICE Clear 

Credit clearing participants. In addition, ICE Clear Credit is currently the only 

clearinghouse worldwide that clears foreign sovereign CDS. Since 2009, ICE Clear 

Credit has cleared over 300,000 CDS transactions whose notional value is in the 

trillions of U.S. dollars.26

ICE Clear Credit has a total of 27 clearing members, 14 of which are financial 

or banking groups and 9 of which are non-U.S. domiciled. ICE Clear Credit’s 

clearing members include some of the largest financial institutions designated as 

G-SIFIs by the Financial Stability Board.

Irrespective of whether a CDS is being used to hedge risk or take on exposure to 

certain credit markets, as a bilateral contract between two market participants, 

a CDS creates credit and liquidity risk exposure between the counterparties to 

the CDS contract. For centrally cleared CDS contracts, ICE Clear Credit reduces 

these risks by serving as a central counterparty, interposing itself between the 

two original bilateral counterparties. Additionally, ICE Clear Credit improves 

market transparency and functioning by establishing robust daily settlement 

prices for the CDS trades that it clears, which periodically its members are 

required to stand behind, as well as monitoring and reporting open positions 

among clearing members.

Analysis of Systemic Importance

A) Aggregate monetary value of transactions processed by ICE Clear Credit

Number of transactions processed, cleared or settled. In 2011, ICE Clear Credit 

cleared an average daily gross volume of 821 Index Contracts, 1,145 Single-Name 

Contracts, and 397 Sovereign Contracts. ICE Clear Credit cleared a peak daily 

gross volume of 7,222 Index Contracts, 14,708 Single-Name Contracts, and 5,680 

Sovereign Contracts. 
Appendix A 173

Value of transactions processed, cleared or settled. In 2011, ICE Clear Credit 

cleared contracts with an average daily gross notional value in the billions of 

dollars in each of Index Contracts, Single-Name Contracts, and Sovereign 

Contracts. The peak daily gross notional values of the contracts ICE Clear Credit 

cleared were in the hundred billion dollar range for each of Index Contracts, 

Single-Name Contracts, and Sovereign Contracts.

Value of other financial flows. For all listed derivatives, the average daily flow of 

funds (average daily mark-to-market valuation plus change in average daily initial 

margin) was in the millions of dollars for initial margin and in the hundred million 

dollar range for adjusted mark-to-market, and for all intraday fees (adjusted markto-market, upfront fee, coupon plus credit event). The peak daily flow of funds was 

over a billion dollars for initial margin and in the hundreds of millions of dollars 

for adjusted mark-to-market and for all intraday fees (adjusted mark-to-market, 

upfront fee, coupon plus credit event). The peak daily open interest was in the 

hundreds of billions for each of Index Contracts and Single-Name Contracts, and 

in the tens of billions of dollars range for Sovereign Contracts.

B) Aggregate exposure of ICE Clear Credit to its counterparties 

Credit exposures. During 2011, the average size of ICE Clear Credit’s guaranty 

fund was in the billions of U.S. dollars, with a peak size of billions of U.S. dollars. 

It is anticipated that following the implementation of a clearing requirement for 

swaps, clearing volume and open interest will significantly increase, and margin 

on deposit and exposure will increase proportionally.

Liquidity resources. The average amount of liquidity resources (including only 

cash and U.S. Treasury and agency notes) at ICE Clear Credit was billions of U.S. 

dollars, with a peak amount in the billions of U.S. dollars. As of December 31, 

2011, the total value of lines of credit from banks or others was millions of dollars. 

Liquidity exposures. The average aggregate daily dollar value of payouts by ICE 

Clear Credit to clearing members was in the millions of U.S. dollars, with a peak 

in the millions of U.S. dollars. The peak liquidity need with a single counterparty 

was in the millions of U.S. dollars.

C) Relationships, interdependencies, or other interactions of ICE Clear Credit with 

other FMUs or payment, clearing, or settlement activities

Participants. ICE Clear Credit has a total of 27 clearing members,27 14 of which 

are financial or banking groups and 9 of which are non-U.S. domiciled. ICE Clear 

Credit’s clearing members include some of the largest banking and brokerage 

firms in the world.

Other FMUs. ICE Clear Credit does not have any relationships with other FMUs, 

other than its affiliate relationships.

Trading platforms. ICE Clear Credit clears OTC swaps (all cleared CDS 

transactions are executed bilaterally) and therefore does not have a relationship 

with any trading platforms. However, it is expected that ICE Clear Credit will 
174 2012 FSOC // Annual Report

begin clearing transactions executed on DCMs or swap execution facilities with 

the commencement of CDS trading through such venues.

Other external service providers. ICE Clear Credit uses The Clearing 

Corporation for license fee and management services and ICE for technology and 

management services. 

Average daily value of flows and other transactions with key financial institutions. 

ICE Clear Credit does not have any flows with unaffiliated key financial institutions 

other than its clearing members, settlement banks, and repo counterparties. 

Average daily value of trades and other transactions on key trading platforms. 

ICE Clear Credit clears OTC swaps and therefore does not have a relationship 

with any trading platforms.

Average daily value of services provided and other transactions with other 

external service providers not captured. ICE Clear Europe uses ICE Clear Credit 

for technology and management services.

D) Effect that the failure of or disruption to ICE Clear Credit would have on critical 

markets, financial institutions, or the broader financial system

Role of ICE Clear Credit in the market served. In 2011, of the North American 

Index and Single-Name CDS market CDS products that ICE Clear Credit accepts 

for clearing, ICE Clear Credit cleared approximately 66 percent of all bilateral 

trades where both the buyer and the seller are ICE Clear Credit Clearing 

participants. It is also the only clearinghouse worldwide that clears foreign 

sovereign CDS.

Availability of substitutes. Currently, no other DCOs clear the breadth of 

products cleared by ICE Clear Credit. Accordingly, it is impracticable to expect 

that one could continue clearing ICE Clear Credit’s CDS products immediately or 

in the short term following a disruption of ICE Clear Credit’s operations. 

Concentration by product type. ICE Clear Credit is currently the only 

clearinghouse worldwide that clears foreign sovereign CDS. In addition, ICE 

Clear Credit clears all of the active North American CDS indexes for the 5-year 

and 10-year tenors, and—save for certain financials—the most liquid U.S. single 

names in the CDS market.

Financial Data/Metrics. On December 30, 2011, ICE Clear Credit had in the 

billions of U.S. dollars in cash and cash equivalents and in the billions of U.S. 

dollars in government securities.

ICE Clear Credit reduces systemic risk in the CDS market in a number of ways. 

First, ICE Clear Credit lowers counterparty risk exposures among market 

participants through the novation of CDS contracts. Second, ICE Clear Credit 

lowers the likelihood of a default leading to a financial contagion of defaults 

across major CDS counterparties by maintaining substantial financial resources 

to manage the default of its two largest clearing members. Third, ICE Clear 
Appendix A 175

Credit reduces credit, liquidity, and operational risk by facilitating the timely 

settlement of trade-related payment obligations. ICE Clear Credit is one of the 

largest clearers of CDS transactions worldwide. 

The primary trigger of a default by ICE Clear Credit would be a default by one 

or more clearing members with extraordinary losses in excess of ICE Clear 

Credit’s default resources. While such a default could conceivably result from 

circumstances local to those members, a default scenario would more likely be 

associated with a disruption to the markets more generally, including scenarios 

such as extreme volatility, extreme changes to normal price correlations, and 

acute reductions in liquidity. ICE Clear Credit may be more exposed to such 

circumstances than other central counterparties, because it has significant 

exposure to credit default swaps, which have jump-to-default risk. 

An alternative trigger of a default by ICE Clear Credit would be a failure 

of its settlement bank or one of ICE Clear Credit’s overnight reverse repo 

counterparties, because a substantial portion of ICE Clear Credit’s financial 

resources are on deposit with such entities. Thus, if those financial resources were 

to suddenly become unavailable, ICE Clear Credit’s operations would be adversely 

affected to a considerable extent. In addition, an ICE Clear Credit default could 

result from a failure to maintain a generally sound financial condition, such as 

a failure to maintain sufficient capital or other financial resources against its 

general business risk or against the risk of one or more clearing member defaults. 

An ICE Clear Credit failure, or a disruption in the functioning of its clearing 

services, would effectively mean the immediate loss of the dominant clearing 

platform for the credit default products it clears. This disruption would likely 

expose ICE Clear Credit’s clearing members and other market participants 

to credit and liquidity risks. The significant margin deposits held by ICE 

Clear Credit could lead to a period wherein affected entities may be unable to 

access, or in a worst case scenario would lose, the collateral they posted with 

the clearinghouse. Furthermore, if ICE Clear Credit does not have sufficient 

financial resources to satisfy its obligations to surviving market participants, 

the ability of those participants to meet other financial obligations could be 

adversely impacted. An ICE Clear Credit failure or disruption of its services could 

directly pose credit and liquidity risk to other financial market infrastructures, 

which include depositories, other clearinghouses, custodians, DCMs, trade 

repositories, and swap execution facilities. Since many of ICE Clear Credit’s 

clearing members are G-SIFIs, a disruption or failure could indirectly pose credit 

and liquidity issues to every major market in the United States, every significant 

market participant in the United States, and all significant financial market 

infrastructures in the United States. 

In the event of an ICE Clear Credit failure, it is unlikely in the short term that 

a substitute could take over ICE Clear Credit’s clearing operations. Moreover, 

market participants would have to post substantially more collateral to enter 

into transactions in a bilateral space and obtain the same level of protection 

or exposure than they would through ICE Clear Credit. For example, in 

the bilateral market, if A wishes to neutralize, e.g., a long exposure to B, A 
176 2012 FSOC // Annual Report

would typically enter into a transaction with a short exposure to another 

counterparty, e.g., C. This would offset A’s market risk, but would leave A with 

credit risk to each of B and C that A would need to collateralize. Furthermore, 

the margin required to collateralize the exposure of a portfolio is generally 

smaller than collateralizing its individual components because the prices of 

the portfolio’s components are often correlated. Central counterparty netting 

is more powerful, as each member’s obligations to every other member can 

be treated as one portfolio that is netted and offset.28 There could also be an 

increase in the number and exposure of uncollateralized transactions (creating 

greater exposures from further failures) and a decrease in the total number of 

transactions. This would likely have a deleterious impact on the financial activity 

that relates to those transactions. 

In addition, any disruption in the clearing of these products would likely impede 

the price discovery benefit of central counterparty clearing, which would result in 

a decrease or loss of liquidity for these products and lead to market opacity. Large 

aggregate exposures to counterparties under CDS contracts could be hidden 

in opaque markets until the bankruptcy of a major CDS market participant is 

imminent. The circumstances of such an event, which figured prominently in 

the recent U.S. financial crisis, could have additional consequences on the ability 

of U.S. financial institutions to obtain credit. Bank lending could freeze until 

such time as market participants’ CDS exposure can be adequately priced and 

it becomes clear market participants are able to honor contract obligations in a 

stressed financial environment.

Furthermore, not only would price discovery and liquidity be impacted by such an 

event, but there also would likely be a negative impact on any economic activity 

that presupposes the protection of hedging activity. Assume, for example, that a 

large U.S. based financial institution (FI1) hedged its exposure to the corporation 

A corporate bonds it purchased by buying CDS protection from another financial 

institution, and the trade was then cleared at ICE Clear Credit. If any of ICE 

Clear Credit’s members default and ICE Clear Credit does not have, and cannot 

obtain, sufficient financial resources to maintain operations, this CDS protection 

would no longer be active. If corporation A were then to suddenly default, FI1 

could have a large loss on the corporation A bonds; a loss that, but for ICE Clear 

Credit’s failure, should have been hedged by the CDS. As positions move to the 

bilateral market and are de-netted, settled, and replaced, operational risks and 

costs would likely increase, thereby decreasing the number of reliable and readily 

available hedging opportunities. As a result, financial institutions and other 

market participants may reduce their investment activities, which could further 

stress the U.S. financial markets. 

In addition, an ICE Clear Credit failure or disruption would pose a substantial 

adverse impact to the CDS market for the products cleared by ICE Clear Credit. 

Market participants would likely experience substantial uncertainty around, 

and possibly outright loss of their CDS positions at ICE Clear Credit. Market 

participants would no longer be able use CDS to manage credit risk without 

increasing bilateral counterparty credit risk. This, in turn, is likely to cause 

a loss of confidence in the CDS market in general. For holders of the debt of 
Appendix A 177

reference entities to CDS, those participants may be forced to sell large amounts 

of securities at potentially fire-sale prices if their CDS protection ceases to exist. 

Market participants that transact with any reference entity and use CDS to hedge 

credit risk may be forced to reduce or cease financial and other transactions with 

those entities. Banks or other users of index CDS as broad-based, macroeconomic 

hedges to credit risk may need to quickly sell securities or reduce lending activity 

in order to comply with capital requirements in the absence of CDS hedging 

benefits. Market participants that use sovereign CDS to hedge direct exposures 

to those countries, indirect exposures to entities domiciled in those countries or 

overall country risk may be forced to quickly sell securities and reduce or cease 

financial and other transactions with those entities. All of these effects represent 

the substantial risk of contagion from a disruption in the CDS market. 

Finally, the contagion effect of an ICE Clear Credit default, if it were to lack 

sufficient resources to make timely payments for mark-to-market obligations, 

could severely disrupt operations at other clearinghouses because of a crisis 

of confidence that interrupts the orderly functioning of the market and/or 

because of the impact that the loss of funds would have on an entity’s ability 

(or willingness) to pay (1) losses owed to other DCOs, (2) increased collateral 

requirements for offsetting out-of-the money positions, (3) deposits in pension 

fund cash accounts, or (4) bank financing charges. Essentially, the failure of ICE 

Clear Credit would create enormous uncertainty about the status of initiated 

transactions, as well as the financial positions of its clearing members and their 

customers, and could jeopardize the orderly functioning of clearing members, 

other DCOs, and the U.S. financial markets as a whole.

Based on its review of the information set forth here, the Council recognizes 

that ICE Clear Credit currently clears a specific range of the total credit 

derivatives market.29 ICE Clear Credit also has a membership of 27 clearing 

members, including 14 financial or banking groups. Accordingly, when viewed 

narrowly the effects of a failure or disruption of ICE Clear Credit could be 

considered to affect a finite number of the world’s largest financial institutions, 

each of which has, theoretically, immediate access to the bilateral markets for 

CDS products and various other sources of credit and liquidity in the event of 

such a failure or disruption.

However, the immediate loss of a clearing platform for most of the products 

cleared by ICE Clear Credit would effectively lead to at least a temporary 

disruption of the CDS market for these products as the market infrastructure 

through which positions are established, maintained, and closed out would be 

gone. This, together with the increased risks and costs in the bilateral markets, 

would create great uncertainty about the capacity of already strained markets to 

accommodate any anticipated corresponding liquidity needs, which would likely 

lead to increased credit and liquidity problems for market participants. As these 

risks and costs increase, institutions may reduce their investment activities due to 

a lack of reliable and readily available hedging opportunities, which could further 

stress the U.S. financial markets. 
178 2012 FSOC // Annual Report

Moreover, under rules recently promulgated by the CFTC30 and equivalent rules 

being considered by the SEC pursuant to the Act, ICE Clear Credit will likely be 

required to expand its membership base to include smaller financial institutions 

and permit the direct involvement of buy-side firms for the first time. These 

new regulatory standards will also result in numerous financial institutions 

being required to clear trades with other financial institutions when clearing is 

offered by one or more FMUs and thereby increase their practical reliance on 

ICE Clear Credit in a manner consistent with the policy direction established by 

the Act. Thus, and especially upon these new standards taking effect, a failure 

or disruption of ICE Clear Credit would necessarily involve a broader segment 

of the financial community and have a wider impact on the financial system of 

the United States than would have been true in the recent past. These more 

widespread effects reinforce the Council’s conclusion that a failure or disruption 

to the functioning of ICE Clear Credit could create or increase the risk of 

liquidity and credit problems spreading among financial institutions or markets 

and thereby threaten the stability of the financial system of the United States. 

Conclusion

The data reviewed by the Council indicate that ICE Clear Credit processes highdollar-value transactions on a daily basis for critical U.S. financial markets31 and 

holds large amounts of collateral on deposit. Coupled with the unique nature 

of CDS and the attendant jump-to-default risk that has to be managed, as well 

as the size and nature of ICE Clear Credit’s clearing members, a significant 

disruption to or failure of ICE Clear Credit could create instability in the U.S. 

CDS and securities markets. Moreover, there are currently no substitute DCOs for 

many of ICE Clear Credit’s products. The loss of central counterparty clearing 

in the products ICE Clear Credit clears would increase collateral demands 

exponentially, resulting in a corresponding drain of liquidity. 

An ICE Clear Credit failure could also have an adverse impact on price discovery, 

which could, in turn, lead to inefficient markets and a correlated increase in 

liquidity problems. Finally, the contagion effect of an ICE Clear Credit failure 

could impose material financial losses on ICE Clear Credit’s clearing members 

and other market participants (such as customers) that could lead to increased 

liquidity demands and credit problems across financial institutions. Where these 

financial institutions are active in multiple U.S. markets, this contagion effect 

would have a broader impact and, as the markets experience growing stress, 

would likely lead to increased demand for credit, which would, in turn, likely 

lead to less liquidity. Thus, the Council believes that a significant disruption or 

failure of ICE Clear Credit could have a major adverse impact on the stability of 

the U.S. financial markets, the impact of which would be exacerbated by the lack 

of clearing alternatives currently available for many of the products cleared by 

ICE Clear Credit. Accordingly, a failure or disruption of ICE Clear Credit would 

likely have a significant detrimental effect on the liquidity of the swaps markets 

and impose significant financial losses on clearing members, which include large 

financial institutions and other market participants, which would, in turn, likely 

threaten the stability of the broader U.S. financial system.
Appendix A 179

For the reasons set out here, the Council has determined that ICE Clear Credit 

should be designated as a systemically important FMU pursuant to Title VIII of 

the Act. 

G. National Securities Clearing Corporation

Description of National Securities Clearing Corporation

NSCC is a FMU as set out in Title VIII of the Act because it manages or operates a 

multilateral system for the purpose of clearing and settling securities transactions 

among financial institutions and between financial institutions and NSCC.32

NSCC plays a prominent role in providing clearance, settlement, and CCP 

services for nearly all broker-to-broker equity and corporate and municipal 

debt trades executed on major U.S. exchanges and other equity trading venues. 

NSCC is a wholly owned subsidiary of DTCC and is generally administered as an 

industry-owned utility on an at-cost basis.

NSCC provides clearing, settlement, risk management, central counterparty 

services and a guarantee of completion for virtually all broker-to-broker trades 

involving equity securities, corporate and municipal debt securities, American 

depository receipts (ADRs), ETFs, and unit investment trusts (UITs). Clearance 

and settlement generally occurs through NSCC’s Continuous Net Settlement 

(CNS) system, under which all eligible compared and recorded transactions for 

a particular settlement date are netted by issue into one net long (buy) or net 

short (sell) position. NSCC guarantees the settlement of matched trades and, as 

a CCP, is the legal counterparty to all of its members’ net settlement obligations. 

NSCC’s CCP services reduce its members’ costs and risks associated with securities 

transfers. In 2011, NSCC, on a gross basis, cleared 20.9 billion equity, corporate and 

municipal bond, ADR, ETF, and UIT trades worth $220.7 trillion on a gross basis.

NSCC has 187 full service members and 647 limited service members. NSCC 

members consist of registered broker-dealers, or banks or trust companies 

(including a trust company having limited powers) that are members of the 

Federal Reserve System or are supervised and examined by state or federal 

authorities having supervision over banks or registered clearing agencies. NSCC 

direct members include some of the largest banks in the world by asset size and 

include affiliates of 24 of the 29 financial institutions considered to be globally 

systemically important.33 Trades that NSCC clears and settles for its members are 

executed on more than 50 trading venues for which it provides services (including 

all U.S. securities exchanges and alternative trading systems) and with other 

domestic and foreign clearing agencies.

A distinguishing characteristic of NSCC is the wide range of risks it faces and 

its ability to manage those risks. As a CCP, NSCC faces credit risk, liquidity risk, 

custody and investment risks, and operational risk. NSCC uses a combination 

of risk management tools to mitigate some of these risks to ensure it can meet 

its obligations. These tools include (1) membership standards with regard to 

financial resources and operational capacity, (2) collection of collateral deposits 

to meet clearing fund requirements and mark-to-market payments in the form
180 2012 FSOC // Annual Report

of margin, and (3) close out and loss allocation procedures designed to facilitate 

an orderly liquidation in the event of a member default.

Another important feature of NSCC is that it uses multilateral netting through 

which NSCC is able to reduce significantly the value of securities and payments 

that must be exchanged each day. A disruption to NSCC could therefore have a 

multiplier effect on the liquidity needs of members.

Analysis of Systemic Importance

A) Aggregate monetary value of transactions processed through NSCC

In 2011, NSCC cleared $220.7 trillion worth of trades on a gross basis, which 

represented nearly all broker-to-broker equity and debt trades executed on the 

major U.S. exchanges and most other equity trading venues. 

On an average trading day in 2011, NSCC cleared 83 million securities trades. 

The peak daily gross number of trades in 2011 was 199 million trades on August 

8, 2011, with peak netted obligations equal to 204,000 trades. The historic peak 

day for trades occurred on October 10, 2008, when NSCC cleared 209.4 million 

transactions. In 2011, the average daily gross value of transactions settled by 

NSCC was $883 billion, with average aggregate netted obligations of $23.8 billion. 

The peak daily gross value of trades in 2011 was equal to $1.9 trillion on August 8, 

2011, with the peak daily netted obligation equal to $78 billion. 

The average daily value of mark-to-market contributions to and distributions 

from NSCC’s clearing fund for 2011 was $408.5 million. The peak daily value of 

contributions to and distributions from NSCC’s clearing fund was $4.4 billion on 

August 9, 2011.

B) Aggregate exposure of NSCC to its counterparties 

In 2011, the average daily size of the NSCC clearing fund requirement was $3.9 

billion and the peak size of the NSCC clearing fund requirement was $10.2 billion 

(on August 9, 2011). The average daily VaR estimate at a 99 percent confidence 

level for NSCC in 2011 was $2.9 billion, and the peak VaR for NSCC was $6.3 

billion on August 12, 2011. Using the scenario of a default of NSCC’s largest 

participant family, NSCC’s peak daily liquidity exposure to a single counterparty 

in 2011 was $13 billion. In 2011 the average daily value of all collateral posted 

to NSCC, including excess deposits, was $5.1 billion, and the peak value of 

all collateral posted to NSCC was $11.9 billion (on August 9, 2011). All of the 

collateral in the clearing fund was held by NSCC in cash and U.S. government 

and agency securities. 

NSCC seeks to maintain sufficient liquidity to enable it to settle transactions 

in the default of the member-family to which NSCC has the largest aggregate 

settlement exposure over the three days between the time when its guarantee 

is issued, generally one day following the trade date (T+1), and final settlement 

(T+3). NSCC’s liquidity resources are limited to a line of credit, its retained 

earnings, and the value of assets held as collateral, including certain securities of 

the defaulting member delivered in anticipation of settlement. NSCC’s liquidity 

facility is a $6.2 billion committed line of credit through a syndicated loan facility. 
Appendix A 181

The amount of funds available to NSCC under the committed credit facility 

is limited not only by the overall size of the facility, but also by the amount of 

assets available to NSCC to pledge as collateral to lenders supporting the facility. 

NSCC is also required to contribute up to 25 percent of its retained earnings 

in the event the clearing fund and other collateral is not sufficient to cover a 

loss. NSCC’s retained earnings were $151 million as of December 31, 2011. For 

2011, the average daily amount of NSCC’s liquidity resources held in cash and 

U.S. Treasury and agency securities was $4.7 billion. The peak amount of such 

liquidity resources was $7.9 billion. 

C) Relationships, interdependencies, or other interactions of NSCC with other FMUs 

or payment, clearing, or settlement activities 

NSCC’s CNS system relies on an interface with its affiliate DTC for the bookentry movement of beneficial ownership of securities through securities accounts 

established at DTC to settle obligations. CNS short positions (i.e., obligations 

to deliver) are compared against members’ DTC accounts to determine issue 

availability. If securities are available, they are transferred from the NSCC 

member’s account at DTC to NSCC’s account at DTC. The allocation of CNS long 

positions (i.e., obligations to receive) to receiving NSCC members is processed 

in an order determined by an algorithm built into the system. Securities are 

automatically allocated to NSCC members’ long positions as the securities are 

received by NSCC. 

 Throughout the day, the debits and credits in a DTC participant’s settlement 

account are netted to calculate, at any time, the net debit balance or net credit 

balance for the account. At end-of-day settlement, DTC and NSCC net the 

settlement balances of each DTC participant that is also a member of NSCC. After 

end-of-day netting with NSCC (also known as cross-endorsement), DTC reports 

final figures for each DTC participant. Because each DTC participant must settle 

through a “Settling Bank,” there is a “roll-up” for each Settling Bank which is a 

net-net balance payable from or to such Settling Bank. Payments are made to and 

from DTC’s account at FRBNY through the Federal Reserve National Settlement 

Service System. Payments are made to and from NSCC on the National 

Settlement System through the FRBNY sub-account of DTC. DTC and NSCC are 

also parties to a netting contract and limited cross-guaranty agreement.

CDS Clearing and Depository Services Inc. (CDS, Inc.), the Canadian central 

securities depository and central counterparty, is a full service member of NSCC, 

as well as a participant of DTC. This relationship enables CDS, Inc. participants 

to clear and settle OTC trades with U.S. broker-dealers through sponsored 

accounts maintained by CDS, Inc. with DTC and NSCC and entitles them to 

the privileges of direct membership in both organizations. However, CDS, Inc. 

participants are not members of DTC and NSCC and therefore must look only to 

CDS, Inc. for satisfaction of clearance and settlement obligations. Thus, if a CDS, 

Inc. participant defaults on its obligation to DTC or NSCC, CDS, Inc. is required 

to meet that obligation. CDS, Inc. mitigates its exposure to potential losses by 

requiring participants to commit collateral to CDS, Inc. in amounts equivalent to 

those required as collateral by NSCC and DTC.
182 2012 FSOC // Annual Report

NSCC receives transactions on exercises and assignments of options from OCC 

that are cleared and settled through NSCC. NSCC and OCC rely on one another 

for coverage of certain risks through a Third Amended and Restated Options 

Exercise Settlement Agreement between them (the Accord). The arrangement is 

designed to facilitate the settlement of the underlying securities upon the exercise 

or assignment of such options by mitigating duplicative margin requirements. 

The Accord provides for a two-way guaranty between OCC and NSCC of the 

mark-to-market amounts for options transactions for which NSCC has guaranteed 

completion in the event of a mutual participant’s failure. The failure of OCC 

to meet its obligations under that agreement, and vice versa, could impair the 

ability of the parties to ensure access to adequate margin with respect to a failing 

participant that is a common member of both NSCC and OCC. Additionally, 

there is an agreement with OCC providing for the settlement of exercises and 

assignments of options on securities cleared and settled through NSCC in the 

event of a mutual participant’s failure.

In addition, NSCC’s parent company, DTCC, provides significant services to 

NSCC pursuant to a service agreement, including internal audit, corporate 

communications, corporate and regulatory compliance, executive services, 

finance, administration services, and legal services.

D) Effect that the failure of or disruption to NSCC would have on critical markets, 

financial institutions, or the broader financial system

The primary effect of a failure of or a disruption to the functioning of NSCC 

would be a disruption to the settlement of the $3.5 trillion in notional value of 

transactions typically pending to be cleared and settled through NSCC on an 

average day. Additionally, initiating new trades would be difficult at best due to 

the lack of any clearing agencies offering similar services. Given the enormous 

efficiencies of multilateral netting provided by NSCC, bilateral settlement of 

transactions at current normal volumes would not be practical. 

A failure of or a disruption to the functioning of NSCC would have several other 

likely effects. Members of NSCC could experience financial losses or liquidity 

shortages due to NSCC’s inability to honor its central counterparty obligations 

and due to members’ inability to access clearing fund contributions. There 

would also be financial and operational stresses placed on other FMUs such as 

DTC and OCC, which have closely related operations. Additionally, if bilateral 

gross settlement of NSCC-cleared trades were attempted, DTC’s capacity could 

be overwhelmed as it experiences enormous increases in values and volumes 

of transactions. 

In addition, a failure or a disruption to the functioning of NSCC would likely 

result in significant spillover effects on the rest of the U.S. economy, reducing the 

amount of credit available generally, drawing assets away from other productive 

uses, reducing the value of household savings, and affecting the financing 

activities of corporations and municipalities. 
Appendix A 183

Conclusion

NSCC plays an important role in financial markets due to the high gross 

notional value of the trades NSCC clears and the efficiencies it provides through 

multilateral netting of trades and payments among its members. In particular, 

because NSCC clears and settles virtually all broker-to-broker equity and 

corporate and municipal debt securities transactions in the United States and 

supports more than 50 trading venues for which it provides services (including all 

U.S. securities exchanges and alternative trading systems), a failure or disruption 

to the functioning of NSCC could:

•	 Directly and negatively affect an enormous dollar value and volume of 

financial transactions in equity and debt markets;

•	 Impose material direct losses on NSCC counterparties and create 

new demands for liquidity and new credit problems among financial 

institutions and others that rely on such markets for credit or liquidity;

•	 Cause liquidity or credit problems resulting from its failure or disruption 

to spread quickly and broadly among financial institutions and other 

markets; and

•	 Have cumulative negative effects on U.S. domestic equity and debt 

markets, financial institutions, and the broader financial system that 

are substantial in their own right and so severe as to create a risk that 

liquidity and credit problems experienced could spread among financial 

institutions and other markets and, therefore, threaten the stability of the 

financial system.

Accordingly, it is the assessment of the Council that a failure of or a disruption to 

NSCC could increase the risk of significant liquidity problems spreading among 

financial institutions or markets and thereby threaten the stability of the financial 

system of the United States. For the reasons set out here, the Council determined 

that NSCC should be designated as a systemically important FMU pursuant to 

Title VIII of the Act.

H. The Options Clearing Corporation

Description of The Options Clearing Corporation

The Options Clearing Corporation (OCC) is an FMU as defined in Title VIII 

of the Act because it manages or operates a multilateral system for the purpose 

of clearing and settling securities transactions among financial institutions and 

between financial institutions and OCC.34

OCC is the predominant clearing organization for U.S. options markets. OCC 

provides its clearing members with clearing and settlement services that eliminate 

the need for individual counterparties to bilaterally exchange option premiums 

and collect and maintain margin on a daily basis. These services increase 

the speed and efficiency of trading and settlement while reducing members’ 

operational expenses. Additionally, OCC acts as a central counterparty for certain 

options and other derivatives therefore reducing credit risk for its members.
184 2012 FSOC // Annual Report

OCC’s clearing members serve institutional investors, professional traders, and 

retail customers. OCC currently has approximately 120 clearing members, which 

comprise some of the largest domestic and foreign financial institutions including 

banks, broker-dealers, futures commission merchants, investment advisers, and 

investment funds. OCC’s members include some of the largest banks in the world 

by asset size and include affiliates of 17 of the 29 financial institutions considered 

to be globally systemically important.35

The primary services that OCC provides relate to the clearing and settlement 

of options and futures. The types of options cleared include those on equities, 

indices, currency, and commodities though equity options accounted for 

approximately 93 percent of total clearing volume. OCC is the sole issuer and 

settling agent for all stock options, equity index options, and single-stock futures 

listed on U.S. exchanges. 

When OCC accepts a trade for clearing, it becomes a central counterparty for the 

transaction and therefore is subject to credit risk resulting from the transactions 

it clears. OCC mitigates the risk from these transactions by collecting margin 

collateral from its members and by maintaining a clearing fund. However, it is 

still exposed to market risk should it be necessary to liquidate collateral as well as 

model risk that exists relating to the methodology used to calculate margin calls. 

Analysis of Systemic Importance

(A) Aggregate monetary value of transactions processed through OCC

OCC also cleared stock lending transactions covering a total of 7.3 billion shares 

in 2011. The dollar value and volume of options transactions handled by OCC 

includes substantially all of the equity options traded on U.S. options exchanges. 

In 2011, OCC cleared an average daily gross volume of 18.1 million option 

contracts, 152,000 futures contracts and 29 million stock loan shares. The peak 

daily gross volume for OCC in 2011 was approximately 41.5 million option 

contracts, 383,000 futures contracts and 89.3 million stock loan shares. OCC’s 

average month-end open interest for 2011 was 305 million option contracts and 

960,000 futures contracts. Daily open interest peaked at approximately 386 

million option contracts on August 19, 2011 and 1.2 million futures contracts on 

December 16, 2011. 

In 2011, the average daily gross value of premium exchanged by OCC was $5.95 

billion for option contracts and $1.2 billion for stock loan transactions. The peak 

daily gross value of premium exchanged during 2011 was $20.3 billion for options 

contracts and $3.1 billion for stock loan transactions, respectively. The average 

notional value of open interest for contracts cleared by OCC in 2011 was $3.3 

trillion based on month-end data.

OCC processed an average of $1.2 billion in daily changes in initial and variation 

margin payments in 2011, and the peak daily initial and variation margin 

payments processed by OCC was $22.1 billion on August 8, 2011. 
Appendix A 185

(B) Aggregate exposure of OCC to its counterparties 

As of December 31, 2011, OCC held $76.3 billion in margin deposits on behalf 

of its clearing members, $57.3 billion of which consisted of cash and other 

underlying securities accepted as margin by OCC and approximately $19 billion 

of which consisted of equity and index option escrow deposits accepted in lieu 

of margin. As of December 31, 2011, OCC also maintained a clearing fund for 

options and futures clearing activity totaling $2.9 billion. All of the collateral in 

the clearing fund was held in the form of cash and U.S. Treasury securities.

In 2011, the average aggregate daily value of collateral (after haircut) posted to 

OCC was $89.8 billion. OCC’s VaR estimate at a 99 percent confidence level was 

on average $15 billion in 2011, and the average collateral required to be deposited 

with OCC to cover that exposure was $33.6 billion. The daily average size of the 

OCC clearing fund in 2011 was $2.8 billion, and the remaining $53.4 billion in 

collateral deposits consisted of mark-to-market charges to cover changes in the 

value of option positions and stock and index option contracts held in escrow 

in lieu of margin. The average collateral coverage ratio for OCC during 2011 

was 135 percent based on the ratio of valued collateral (not including option 

collateral held in escrow) over estimated margin requirements, using monthend data over a 12-month period. The aggregate dollar value of collateral (after 

haircut) posted to OCC peaked at $123.7 billion on August 9, 2011. In 2011, the 

peak VaR was $35.7 billion, the peak collateral requirement was $63.5 billion, and 

the peak clearing fund requirement was $3.4 billion. 

OCC’s liquidity resources include the defaulting member’s collateral, the assets 

in the clearing fund, and a $2 billion secured line of credit.36 The amount of 

funds available to OCC under the committed secured credit facility is constrained 

not only by the overall size of the facility, but also by the amount of assets that 

OCC can pledge as collateral to lenders supporting the facility, which is limited 

to the securities in OCC’s clearing fund. OCC’s bylaws give it the authority to 

use a defaulting clearing member’s margin and clearing fund deposits to obtain 

temporary liquidity for purposes of meeting obligations arising out of (1) the 

default or suspension of a clearing member or any action taken by OCC in 

connection therewith or (2) the failure of any bank or any clearing organization 

to perform any obligation owed to OCC. In addition, OCC may use such assets 

to borrow or otherwise obtain funds through any means determined to be 

reasonable by its Chairman, Management Vice Chairman, or President of the 

Corporation in his or her discretion (including, without limitation, pledging such 

assets as security for loans and/or using such assets to effect repurchase, securities 

lending, or other transactions). OCC rules provide, among other things, that 

upon the suspension of a clearing member, OCC shall promptly liquidate, in the 

most orderly manner practicable, all of the clearing member’s margin. 

For 2011, the average amount of OCC’s liquidity resources held in cash and 

U.S. Treasury and agency notes was $12 billion, and the peak amount of liquid 

resources was $25.8 billion. The peak liquidity exposure OCC experienced 

with a single counterparty occurred on September 19, 2011, when the exposure 

totaled $3 billion. OCC did not provide information regarding the average peak 

exposure to individual members during the course of 2011.
186 2012 FSOC // Annual Report

(C) Relationships, interdependencies, or other interactions of OCC with other FMUs 

or payment, clearing, or settlement activities 

OCC’s operations and the current market structure for listed options trading 

and clearing involve significant interdependence between OCC, other FMUs, 

settlement banks, clearing members, credit facility lenders, custodians, 

exchanges, cross-margining entities, and pricing vendors. 

OCC maintains two active cross-margin relationships with the CME and ICE 

Clear U.S. OCC clearing members use these cross-margin relationships to realize 

the benefits of net settlement across the securities and futures markets, as well 

as billions of dollars of savings on clearinghouse margin requirements. OCC’s 

average margin amount in 2011 subject to these cross-margining arrangements 

was approximately $2.3 billion.

OCC is party to a multilateral cross-guaranty agreement with DTC, FICC, and 

NSCC, which provides for the sharing of residual close-out proceeds from 

a defaulting member between these clearing agencies in the event that one 

clearinghouse is in an excess position and another is in a shortfall position. 

In addition, OCC maintains an agreement with NSCC that governs the loss or 

profit sharing resulting from the settlement of exercised or assigned options of 

a common defaulting member. That arrangement is designed to facilitate the 

settlement of the underlying securities upon the exercise or assignment of such 

options by mitigating duplicative margin requirements.

DTC, in its role as a securities depository, provides services to OCC clearing 

members, including the ability to pledge collateral held in DTC accounts to 

OCC for collateral purposes. The most prevalent form of collateral—valued 

securities—is pledged to OCC in this manner. DTC also provides the operational 

support for securities lending transactions to be executed in both the bilateral 

stock loan program and the AQS Market Loan platform.

(D) Effect that the failure of or disruption to OCC would have on critical markets, 

financial institutions, or the broader financial system

Should there be a failure of or disruption to the functioning of OCC, the 

immediate effects could be manifested in two primary forms. The first is direct 

financial stress placed on clearing members who would be at least temporarily 

unable to access margin collateral and clearing fund deposits. Additionally, there 

could be a complete or partial disruption of the $3.3 trillion in average notional 

value of open interest for which OCC is issuer and guarantor as well as a sudden 

decrease in options trading activity in the markets for which OCC is the sole 

clearing agent due to increased risk and decreased efficiency in OCC’s absence. 

As of December 31, 2011, OCC held $57.3 billion in margin deposits on behalf 

of its clearing members, $2.9 billion in clearing fund deposits, and $19 billion 

in equity and index option escrow deposits accepted in lieu of margin. A failure 

of or disruption to the functioning of OCC could temporarily limit participants’ 

access to these deposits in the short term and possibly result in losses of the $19 

billion of escrow deposits.
Appendix A 187

In addition, in the event OCC is no longer available as an issuer and guarantor, 

options cleared and settled through OCC may have to be replaced, to the extent 

practicable, including through entering into transactions in the underlying 

instruments, with an average replacement value of approximately $3.3 trillion. In 

the event such a disruption were to occur, settlement of many future transactions 

in options contracts currently cleared by OCC could be required to occur on a 

bilateral basis between the parties to the respective transactions in a daily average 

amount of $5.95 billion. The same is true of stock loan transactions with an 

average daily gross value of $1.2 billion.

In addition, a failure or disruption to the functioning of OCC would likely result 

in significant spillover effects on the rest of the U.S. economy, reducing the 

amount of credit available generally, drawing assets away from other productive 

uses, disrupting the markets for securities and indexes underlying options cleared 

by OCC, reducing the value of household savings, and reducing the ability of 

corporations to use options to manage risks. 

Conclusion

OCC is the sole clearing agency providing clearance and settlement services for 

U.S.-listed options. A failure or disruption of OCC could:

•	 Directly and negatively affect significant dollar value and volume of 

financial transactions in options and futures markets;

•	 Impose material direct losses on OCC counterparties and create 

new demands for liquidity and new credit problems among financial 

institutions and others that rely on options markets for risk management 

and other purposes;

•	 Cause liquidity or credit problems resulting from its failure or disruption 

to spread quickly and broadly among financial institutions and other 

markets; and

•	 Have cumulative negative effects on U.S. domestic options and futures 

markets, financial institutions, and the broader financial system that 

are substantial in their own right and so severe as to create a risk that 

liquidity and credit problems experienced could spread among financial 

institutions and other markets.

Accordingly, it is the assessment of the Council that a failure of or a disruption to 

OCC could increase the risk of significant liquidity or credit problems spreading 

among financial institutions or markets and thereby threaten the stability of the 

financial system of the United States. For the reasons set out here, the Council 

has determined that OCC should be designated as a systemically important FMU 

pursuant to Title VIII of the Act.

Glossary 189

Glossary

Adjustable-Rate Mortgage A mortgage that allows for the periodic adjustment of the interest 

rate on the basis of changes in a specified index or rate.

Agency Mortgage-Backed 

Security

A mortgage-backed security issued or guaranteed by federal 

agencies or government-sponsored enterprises.

Asset-Backed Commercial 

Paper (ABCP)

Short-term debt that has a fixed maturity of up to 270 days and 

is backed by some financial asset, such as trade receivables, 

consumer debt receivables, or auto and equipment loans 

or leases.

Asset-Backed Security (ABS) A term debt instrument that is collateralized by specific financial 

assets, such as credit card receivables or auto loans, and that 

makes payments based on the performance of these assets.

Auction Rate Security (ARS) A debt security, often issued by municipalities, in which the yield 

is reset regularly via a Dutch auction.

Bank for International 

Settlements (BIS)

An international financial organization that serves central banks 

in their pursuit of monetary and financial stability, helping foster 

international cooperation in those areas and acting as a bank 

for central banks.

Bank Holding Company (BHC) Any company that has direct or indirect control of one or more 

banks and is regulated and supervised by the Federal Reserve in 

accordance with the Bank Holding Company Act of 1956.

Basel Committee on Banking 

Supervision (BCBS)

The Basel Committee on Banking Supervision (BCBS) develops 

and issues international standards on bank capital adequacy. 

In 1988, the BCBS introduced a capital measurement system 

commonly known as the Basel Capital Accord, or Basel I. In 

2004, the BCBS issued a revised capital adequacy framework 

titled “International Convergence of Capital Measurement and 

Capital Standards: A Revised Framework,” which is commonly 

referred to as the New Accord, or Basel II. Following the financial 

crisis, the BCBS developed new global standards for the banking 

system that are collectively referred to as Basel III.

Broad Dollar Index A weighted average of the foreign exchange values of the U.S. 

dollar against the currencies of a large group of major U.S. trading 

partners. The index weights, which change over time, are derived 

from U.S. export shares and from U.S. and foreign import shares.
190 2012 FSOC // Annual Report

Broker-Dealer (BD) An entity that is engaged in the business of buying and selling 

securities for itself and others.

Central Counterparty An entity that is interposed between the initial participants to 

a bilateral transaction and becomes the buyer to every seller 

and the seller to every buyer of a specified set of contracts or 

financial instruments.

Clearing Bank A commercial bank that facilitates payment and settlement of 

financial transactions, such as check clearing or matching trades 

between the sellers and buyers of securities and other financial 

instruments and contracts.

Clearinghouse (Derivatives 

Clearing Organization or 

Clearing Agency)

An entity through which financial institutions agree to 

exchange payment instructions or other financial obligations 

(e.g., securities). The institutions settle for items exchanged 

at a designated time based on the rules and procedures of 

the clearinghouse. In some cases, the clearinghouse may 

assume significant counterparty, financial, or risk management 

responsibilities for the clearing system.

Clearing House Interbank 

Payments System (CHIPS)

An automated clearing system used primarily for international 

payments. This system is owned and operated by The Clearing 

House and engages Fedwire Funds Service for settlement.

Collateralized Mortgage 

Obligation (CMO)

A type of mortgage-backed security. CMOs are bonds that 

represent claims to specific cash flows from large pools of home 

mortgages. The streams of principal and interest payments on 

the mortgages are distributed to the different classes of CMO 

interests, known as tranches, according to a complicated deal 

structure. Each tranche may have different principal balances, 

coupon rates, prepayment risks, and maturity dates (ranging from 

a few months to 30 years).

Commercial Bank A chartered and regulated financial institution authorized to take 

deposits from the public, obtain deposit insurance from the FDIC, 

and engage in certain lending activities.

Commercial Mortgage Backed 

Security (CMBS)

A security that is collateralized by a pool of commercial 

mortgage loans and that makes payments that are based on the 

performance of those loans.

Commercial Paper (CP) Short-term (maturity typically up to 270 days), unsecured 

corporate debt.
Glossary 191

Committee on the Global 

Financial System

Monitors developments in global financial markets for central 

bank governors. The Committee on the Global Financial System 

has a mandate to identify and assess potential sources of stress 

in global financial markets, to further the understanding of the 

structural underpinnings of financial markets, and to promote 

improvements to the functioning and stability of these markets. 

The Committee on the Global Financial System also oversees the 

collection of the BIS international banking and financial statistics..

Committee on Payment and 

Settlement Systems (CPSS)

A committee of central banks hosted by the BIS that sets 

standards for payment and securities settlement systems.

Core Deposits Deposits that are stable, lower cost, and reprice more slowly than 

other deposits when interest rates change. Core deposits are 

typically funds of local customers who also have a borrowing or 

other relationship with the bank.

Credit Default Swap (CDS) A bilateral over-the-counter contract in which one party agrees 

to make a payment to the other party in the event of a specified 

credit event, in exchange for one or more fixed payments.

Credit Rating Agency A private company that evaluates the credit quality of debt 

issuers, as well as their issued securities, and provides ratings 

on the issuers and those securities. Many credit rating agencies 

are nationally recognized statistical rating organizations, the 

largest of which are Fitch Ratings, Moody’s Investors Service, and 

Standard & Poor’s.

Credit Union A member-owned, not-for-profit cooperative financial institution 

formed to permit members to save, borrow, and obtain related 

financial services. All federally chartered credit unions and most 

state-chartered credit unions provide federally insured deposits 

and are regulated by the NCUA.

Dark Pool A trading network that matches the orders of multiple buyers and 

sellers for a financial instrument without displaying quotations to 

the public.

Debt Valuation Adjustment (DVA) A decrease in the mark-to-market value of a bank holding 

company’s liability that is booked as a profit.

Defined Benefit Plan A retirement plan that uses a predetermined formula to calculate 

the amount of a participant’s future benefit.

Defined Contribution Plan A retirement plan in which the amount of the employer’s annual 

contribution is specified.
192 2012 FSOC // Annual Report

Depository Institution A financial institution that is legally permitted to accept deposits 

from individuals. Depository institutions include savings banks, 

commercial banks, savings and loan associations, and 

credit unions.

Discount Window The Federal Reserve facility for extending credit directly to 

eligible institutions.

Farm Credit System A government-sponsored enterprise created by Congress and 

composed of a network of borrower-owned financial institutions 

that provide credit to farmers, ranchers, residents of rural 

communities, agricultural and rural utility cooperatives, and 

other eligible borrowers. The Farm Credit System is the largest 

agricultural lender in the United States and is regulated by the 

Farm Credit Administration.

Federal Financial Institutions 

Examination Council (FFIEC)

An interagency body that prescribes uniform principles, 

standards, and report forms for the federal examination of 

financial institutions by the Federal Reserve, the FDIC, the NCUA, 

the OCC, and the CFPB. The FFIEC makes recommendations to 

promote uniformity in the supervision of financial institutions. The 

State Liaison Committee (SLC) serves as a voting member. The 

SLC includes representatives from the Conference of State Bank 

Supervisors, the American Council of State Savings Supervisors, 

and the National Association of State Credit Union Supervisors. 

Fedwire Funds Service A real-time gross settlement system owned and operated by the 

Federal Reserve Banks that offers participants the ability to send 

and receive time-critical payments for their own account or on 

behalf of their clients.

Fedwire Securities Service A book-entry securities transfer system operated by the Federal 

Reserve Banks that provides participants safekeeping, transfer, 

and delivery-versus-payment settlement services.

FICO Score A measure of a borrower’s creditworthiness based on the 

borrower’s credit data; developed by the Fair Isaac Corporation.

Financial Market Infrastructure A multilateral system among participating financial institutions, 

including the operator of the system, used for the purposes of 

recording, clearing, or settling payments, securities, derivatives, 

or other financial transactions. Financial market infrastructures 

exist in many financial markets to support and facilitate the 

transferring, clearing, or settlement of financial transactions.
Glossary 193

Financial Market Utility (FMU) Subject to certain exclusions, the Dodd-Frank Act defines an FMU 

as “any person that manages or operates a multilateral system 

for the purpose of transferring, clearing, or settling payments, 

securities, or other financial transactions among financial 

institutions or between financial institutions and the person.”

Fiscal Consolidation Government policy aimed at reducing government deficits and the 

pace of debt accumulation.

Fiscal Year Any 12-month accounting period. The fiscal year for the federal 

government begins on October 1 and ends on September 30 of 

the following year; it is named after the calendar year in which 

it ends.

Futures Commission Merchants 

(FCM)

Individuals, associations, partnerships, corporations, and trusts 

that solicit or accept orders for the purchase or sale of any 

commodity for future delivery on or subject to the rules of any 

exchange and that accept payment from or extend credit to those 

whose orders are accepted.

General Obligation Bond A type of municipal bond backed by the full faith and credit of the 

governmental unit that issues the bond.

Government-Sponsored 

Enterprise (GSE)

A corporate entity that has a federal charter authorized by law but 

that is a privately owned financial institution.

Gross Domestic Product (GDP) The broadest measure of aggregate economic activity, measuring 

the total value of all final goods and services produced within a 

country’s borders during a specific period.

The Group of Twenty Finance 

Ministers and Central Bank 

Governors (G-20)

An international forum established in 1999 to bring together 

officials of systemically important industrialized and developing 

economies to discuss key issues in the global economy.

Household Debt Service Ratio An estimate of the ratio of debt payments to disposable personal 

income. Debt payments consist of the estimated required 

payments on outstanding mortgage and consumer debt.

Interest Rate Risk Management Management of the exposure of an individual’s or an institution’s 

financial condition to movements in interest rates.

International Association of 

Insurance Supervisors (IAIS)

International organization that represents insurance regulators 

and supervisors in 190 jurisdictions worldwide. The IAIS issues 

global insurance principles, standards and guidance papers to 

promote effective insurance supervision.
194 2012 FSOC // Annual Report

International Organization of 

Securities Commissions (IOSCO)

An international organization of securities market regulatory 

agencies that sets standards for securities markets.

International Swaps and 

Derivatives Association (ISDA)

A trade association of over-the-counter derivatives participants. 

The ISDA Master Agreements standardized derivative terms to 

simplify netting and reduce legal risks for market participants.

Investment-Grade Bond A bond whose rating is among the highest in creditworthiness as 

measured by credit rating agencies.

Large Bank Holding Company Any bank holding company (BHC) that files the FR Y-9C. All 

BHCs with total consolidated assets of $500 million or more are 

required to file. Before March 2006, the threshold was $150 

million. BHCs meeting certain additional criteria determined by 

the Federal Reserve may be required to file regardless of size.

Leveraged Buyout An acquisition of a company in which the buyer uses borrowed 

funds for a significant portion of the purchase price.

Loan-to-Value Ratio (LTV) The ratio of the amount of a loan to the value of an asset, 

typically expressed as a percentage. This is a key metric when 

considering the financing of a mortgage.

Marketable Debt Obligations that can be bought and sold on public 

secondary markets.

Mark-to-Market The process by which the reported value of an asset is adjusted 

to reflect its market value.

Maturity Transformation A condition in which a financial intermediary issues shorter-term 

liabilities to fund longer-term assets.

Model Risk Risk related to using an incorrect model specification. For 

example, misspecification can result from programming errors, 

technical errors, data issues, or calibration errors.

Money Market Fund (MMF) A type of mutual fund that is required by law to invest in low-risk 

securities and pays dividends that generally reflect short-term 

interest rates. MMFs typically invest in government securities, 

certificates of deposit, commercial paper, or other highly liquid 

and low-risk securities.

Mortgage-Backed Security (MBS) An asset-backed security backed by a pool of mortgages. 

Investors in the security receive payments derived from the 

interest and principal payments on the underlying mortgages.
Glossary 195

Mortgage Servicer A company that acts as an agent for mortgage holders by 

collecting and distributing mortgage cash flows. Servicers 

also handle defaults, modifications, settlements, and 

foreclosure proceedings.

Municipal Bond A bond issued by states, cities, counties, local governmental 

agencies, or certain instrumentalities of the state.

Mutual Fund A type of investment company that issues redeemable securities, 

which the fund generally stands ready to buy back from investors 

at their current net asset value. Also called an open-end 

investment company or open-end fund.

Nationally Recognized Statistical 

Rating Organization

A credit rating agency that is registered with the SEC as a 

nationally recognized statistical rating organization.

Over-the-Counter (OTC) A method of trading that does not involve an organized exchange. 

In over-the-counter markets, participants trade directly with each 

other, typically through voice or computer communication.

Payday Lenders Lenders that make small, short-term loans to households, with 

the loan repayment due in full on the borrower’s pay day.

Personal Consumption 

Expenditures (PCE)

A measurement of the goods and services purchased 

by households.

Personal Savings Rate Personal savings as a percentage of disposable personal income.

Prudential Regulation Regulation aimed at ensuring the safe and sound operation of 

financial institutions, set by both state and federal authorities.

Public Company Accounting 

Oversight Board (PCAOB)

A nonprofit corporation established by Congress that oversees the 

audits of public companies to protect the interests of investors 

and further the public interest in the preparation of informative, 

accurate, and independent audit reports. PCAOB also oversees 

the audits of broker-dealers.

Public Debt Cumulative amounts borrowed by the Treasury Department or the 

Federal Financing Bank from the public or from another fund or 

account. The public debt does not include agency debt (amounts 

borrowed by other agencies of the federal government).

Q4/Q4 Fourth quarter over fourth quarter. A way of computing the rate 

of growth of a statistic over a calendar year by comparing the 

statistic’s value in the fourth quarter of the year with its value in 

the fourth quarter of the previous year.
196 2012 FSOC // Annual Report

Ratings Uplift The difference between the stand-alone credit rating assigned by 

a credit rating agency to an issuer, based on that issuer’s intrinsic 

financial strength, and the higher credit rating that considers the 

possibility of implicit external (e.g., government) support.

Receiver A custodian appointed to maximize the value of the assets of a 

failed institution or company and to settle the liabilities.

Repurchase Agreement (Repo) A transaction in which one party sells a security to another party 

while agreeing to repurchase it from the counterparty at some 

date in the future at an agreed price.

Reserves Funds that a depository institution holds against specified 

deposit liabilities.

Residential Mortgage-Backed 

Security (RMBS)

A security that is collateralized by a pool of noncommercial, 

residential mortgage loans and makes payments that are based 

primarily on the performance of those loans.

Revenue Bond A type of municipal bond backed by revenue from the project the 

bond finances.

Revolving Credit A lending arrangement whereby a lender commits to provide 

a certain amount of funding to a borrower on demand. The 

borrower may generally borrow and repay the committed funding 

at any time over the term of the agreement.

Risk-Based Capital An amount of capital, based on the risk-weighing of various asset 

categories, that a financial institution should hold to protect 

against adverse developments.

Securities Lending The temporary transfer of securities from one party to another for 

a specified fee and term in exchange for collateral in the form of 

cash or securities.

Securitization A financial transaction in which assets such as mortgage loans 

are pooled, and securities representing interests in the pool 

are issued.

Self-Regulatory Organization 

(SRO)

An organization that has the authority to regulate its members 

by establishing and enforcing rules and standards regarding its 

members’ conduct.

Short-Term Wholesale Funding Large-value, short-term funding instruments, exceeding 

deposit insurance limits, that are typically issued to institutional 

investors. Examples include large checkable and time deposits, 

financial open market paper, and repurchase agreements.
Glossary 197

Supervisory Capital Assessment 

Program (SCAP)

A stress test, conducted from February to May 2009, designed to 

estimate the capital needs of U.S. bank holding companies with 

assets exceeding $100 billion under an adverse macroeconomic 

scenario; it was administered by the Federal Reserve, OCC, 

and FDIC.

Supervisory Information Generally refers to reports of examination and inspection, 

operating and condition reports, and any information derived 

from, relating to, or contained in them, and information gathered 

by agencies responsible for supervising financial institutions in 

connection with any investigation or enforcement action.

Temporary Liquidity Guarantee 

Program (TLGP)

A program implemented in October 2008 by the FDIC through a 

systemic risk determination to provide liquidity to the banking 

industry by restoring banks’ access to funding markets and by 

stabilizing bank deposits. The program had two components: the 

Debt Guarantee Program and the Transaction Account Guarantee 

(TAG) Program.

Term Asset-Backed Securities 

Loan Facility (TALF)

A Federal Reserve funding facility that issued loans with terms 

of up to five years to holders of eligible asset-backed securities 

(ABS). TALF was intended to assist the financial markets in 

accommodating the credit needs of consumers and businesses 

by facilitating the issuance of ABS collateralized by a variety of 

consumer and business loans. TALF was also intended to improve 

the market conditions for ABS more generally. The program 

began operating in 2009. 

Thrift A financial institution that ordinarily possesses the same 

depository, credit, financial intermediary, and account 

transactional functions as a bank but that is chiefly organized 

and primarily operates to promote savings and home mortgage 

lending rather than commercial lending. Also known as a savings 

bank, a savings association, or a savings and loan association.

Time Deposits Deposits that the depositor, generally, does not have the right to 

withdraw funds before a designated maturity date without paying 

an early withdrawal penalty. A certificate of deposit is a 

time deposit.

Tri-Party Repo A repurchase agreement in which a third-party agent, such as a 

clearing bank, acts as an intermediary to facilitate the exchange 

of cash and collateral between the two counterparties. In addition 

to providing operational services to participants, the tri-party 

agents in the U.S. tri-party repo market extend large amounts of 

intraday credit to facilitate the daily settlement of tri-party repos.
198 2012 FSOC // Annual Report

Troubled Asset Relief Program 

(TARP)

A government program to address the financial crisis, authorized 

by the Emergency Economic Stabilization Act of 2008, allowing 

the government to purchase or insure up to $700 billion in assets 

and equity from financial institutions.

Underwriting Standards Terms, conditions, and criteria used to determine the extension of 

credit in the form of a loan or bond.

Yield Curve A curve mapping the relationship between bond yields and their 

respective maturities.
Abbreviations 199

Abbreviations

ABCP Asset-Backed Commercial Paper

ABS Asset-Backed Security

ADR American Depository Receipt

AIFP Automotive Industry Financing Program

AIG American International Group

ANPR Advance Notice of Proposed Rulemaking

ARS Auction Rate Security

ASPL Aggregate Short Position Limit

AUM Assets Under Management

BAC Bank of America

BBA British Bankers’ Association

BCBS Basel Committee on Banking Supervision

BD Broker-dealer

BEA Bureau of Economic Analysis

BFI Business Fixed Investment

BHC Bank Holding Company

BIS Bank for International Settlements

BLS Bureau of Labor Statistics

C Citigroup

C&I Commercial and Industrial

CBO Congressional Budget Office

CCAR Comprehensive Capital Analysis and Review
200 2012 FSOC // Annual Report

CCP Central Counterparty

CD Certificate of Deposit

CDS Credit Default Swap

CFPB Consumer Financial Protection Bureau

CFTC Commodity Futures Trading Commission

CHIPS Clearing House Interbank Payments System

CICI CFTC Interim Compliant Identifier

CLS CLS Bank International

CMBS Commercial Mortgage-Backed Security

CME Chicago Mercantile Exchange

CMO Collateralized Mortgage Obligation

CNS Continuous Net Settlement

CP Commercial Paper

CPP Capital Purchase Program

CPPI Commercial Property Price Index

CPSS Committee on Payment and Settlement Systems

CRE Commercial Real Estate

CSD Central Securities Depository

CU Credit Union

DCM Designated Contract Market

DCO Derivatives Clearing Organization

DOJ U.S. Department of Justice

DTC Depository Trust Company

DTCC Depository Trust and Clearing Corporation
Abbreviations 201

DVA Debt Valuation Adjustment

E&S Equipment and Software

EBA European Banking Authority

ECB European Central Bank

EFSF European Financial Stability Facility

EMBI+ Emerging Markets Bond Index Plus

EME Emerging Market Economies

ESM European Stability Mechanism

ETF Exchange Traded Fund

EU European Union

FAQ Frequently Asked Questions

FASB Financial Accounting Standards Board

FCM Futures Commission Merchant

FDIC Federal Deposit Insurance Corporation

FFIEC Federal Financial Institutions Examination Council

FFS Federal Funds Sold

FHA Federal Housing Administration

FHFA Federal Housing Finance Agency

FICC Fixed Income Clearing Corporation

FICO Fair Isaac Corporation

FINRA Financial Industry Regulatory Authority

FIO Federal Insurance Office

FMU Financial Market Utility

FOS Funds Only Settlement
202 2012 FSOC // Annual Report

FRB Federal Reserve Board

FRBNY Federal Reserve Bank of New York

FSA Financial Services Authority

FSB Financial Stability Board

FSOC Financial Stability Oversight Council

FX Foreign Exchange

FXPB Foreign Exchange Prime Brokers

G-20 The Group of Twenty Finance Ministers and Central Bank Governors

G-SIB Globally Systemically Important Bank

GAO Government Accountability Office

GBP British Pound Sterling

GCF General Collateral Finance

GDP Gross Domestic Product

GM General Motors

GNMA Ginnie Mae

GS Goldman Sachs

GSA Green Street Advisors

GSD Government Securities Division

GSE Government-Sponsored Enterprise

G-SIFI Globally Systemically Important Financial Institution

HAMP Home Affordable Modification Program

HARP Home Affordable Refinance Program

HFT High-Frequency Trading

HUD U.S. Department of Housing and Urban Development
Abbreviations 203

IAIS International Association of Insurance Supervisors

IASB International Accounting Standards Board

ICE IntercontinentalExchange

IFRS International Financial Reporting Standards

IMF International Monetary Fund

IOSCO International Organization of Securities Commissions

IPO Initial Public Offering

IRS Interest Rate Swap

ISDA International Swaps and Derivatives Association

JPM JPMorgan Chase

LEI Legal Entity Identifier

LIBOR London Interbank Offered Rate

LSOC Legal Segregation with Operational Commingling

LTRO Longer-term Refinancing Operations

LTV Loan-to-Value Ratio

MBS Mortgage-Backed Security

MBSD Mortgage-Backed Securities Division

MFG MF Global

MHA Making Home Affordable

ML LLC Maiden Lane LLC

ML II Maiden Lane II LLC

ML III Maiden Lane III LLC

MMF Money Market Fund

MMI Money Market Instrument
204 2012 FSOC // Annual Report

MOL Maximum Obligation Limitation

MS Morgan Stanley

MVC Model Validation Council

NAIC National Association of Insurance Commissioners

NAV Net Asset Value

NBER National Bureau of Economic Research

NCUA National Credit Union Administration

NDF Non-deliverable Forward

NFIB National Federation of Independent Business

NMS National Market System

NPR Notice of Proposed Rulemaking

NSCC National Securities Clearing Corporation

NYPC New York Portfolio Clearing

OCC Office of the Comptroller of the Currency

OCC The Options Clearing Corporation (only in Appendix A)

OFR Office of Financial Research

OITP Other Important Trading Partners

OLA Orderly Liquidation Authority

ORSA Own Risk and Solvency Assessment

OTC Over-the-Counter

OTS Office of Thrift Supervision

P&I Principal and Interest

PCA Prompt Corrective Action

PCAOB Public Company Accounting Oversight Board
Abbreviations 205

PCE Personal Consumption Expenditures

PFMI Principles for Financial Market Infrastructures

PVP Payment-versus-Payment

Q4/Q4 Fourth Quarter over Fourth Quarter

QRM Qualified Residential Mortgages

REIT Real Estate Investment Trust

Repo Repurchase Agreement

RESPA Real Estate Settlement Procedures Act

RMBS Residential Mortgage-Backed Security

ROA Return on Assets

RTGS Real Time Gross Settlement

RWA Risk-Weighted Assets

S&P Standard & Poor’s

SCAP Supervisory Capital Assessment Program

SEC Securities and Exchange Commission

SEF Swaps Execution Facility

SIFMA Securities Industry and Financial Markets Association

SIPA Securities Investor Protection Act

SIPC Securities Investor Protection Corporation

SLHC Savings and Loan Holding Company

SLOOS Senior Loan Officer Opinion Survey

SMP Securities Markets Programme

SRC Systemic Risk Committee

SRO Self-Regulatory Organization
206 2012 FSOC // Annual Report

STIF Short Term Bank Common and Collective Investment Funds

STRIPS Separate Trading of Registered Interest and Principal Securities

TAG Transaction Account Guarantee

TALF Term Asset-Backed Securities Loan Facility

TARP Troubled Asset Relief Program

TILA Truth in Lending Act

TIPS Treasury Inflation-Protected Securities

TIW Trade Information Warehouse

TLGP Temporary Liquidity Guarantee Program

TR Trade Repositories

UIT Unit Investment Trust

USD U.S. Dollar

USDA U.S. Department of Agriculture

USDE U.S. Dollar Equivalent

VA Department of Veterans Affairs

VaR Value at Risk

VRDO Variable Rate Demand Obligations

WAL Weighted Average Life

WAM Weighted Average Maturity

WFC Wells Fargo Company

WFE World Federation of Exchanges

YTD Year to Date
Notes on the Data 207

Notes on the Data

Except as otherwise indicated, data cited in this report is as of July 6, 2012.

Glossary of Certain Government Data Sources

Bank Holding Company Performance Report (BHCPR): Report of financial information produced for select 

top-tier bank holding companies and published by the Federal Reserve.

Flow of Funds: Data release compiled and published by the Federal Reserve.

FR 2004: Report of market activity for primary dealers in U.S. government securities published by the 

Federal Reserve.

FR Y-9C: Consolidated financial statement for domestic bank holding companies published by the 

Federal Reserve.

SLOOS: Survey of senior loan officers on bank lending practices published by the Federal Reserve Board.

Academic Papers Cited in This Report

Copeland, Adam M., Antoine Martin, and Michael Walker. “The Tri-Party Repo Market before the 2010 

Reforms,” Federal Reserve Bank of New York Staff Reports, 2010, No. 477.

Bech, Morten L., Antoine Martin, and James McAndrews. “Settlement Liquidity and Monetary Policy 

Implementation—Lessons from the Financial Crisis,” Federal Reserve Bank of New York Economic Policy Review 18, 

March 2012, No. 1.

Other 

Bloomberg data: © 2012 Bloomberg Finance L.P. All rights reserved. Used with permission. 

Certain data was obtained through Haver Analytics. 

iMoneyNet data made available for use by iMoneyNet subscribers and press, all others please contact 

iMoneyNet for subscription information.

Inside Mortgage Finance, 2012 Mortgage Statistical Annual Copyright 2012. www.insidemortgagefinance.com.

® Markit makes no warranty, expressed or implied, as to accuracy, completeness or timeliness, or as to the 

results to be obtained by recipients of the products and services described herein, and shall not in any way be 

liable for any inaccuracies, errors or omissions herein. 

© 2012, Markit Group Limited. All rights reserved. Any unauthorized use, disclosure, reproduction or 

dissemination, in full or in part, in any media or by any means, without the prior written permission of Markit 

Group Limited is strictly prohibited.

Moody’s data provided by Moody’s Investors Service.

The Risk Management Association’s Aggregate Data Survey (2000–2012).

List of Charts 209

Chart 4.1.1 Change in Real Gross Domestic Product...................................................................23

Chart 4.1.2 Change in Real Personal Consumption Expenditures..................................................24

Chart 4.1.3 Personal Saving Rate .............................................................................................24

Chart 4.1.4 Private Housing Starts............................................................................................24

Chart 4.1.5 Net Change in Payroll Employment...........................................................................26

Chart 4.1.6 Civilian Unemployment Rate ....................................................................................26

Chart 4.1.7 Labor Force Participation Rate ................................................................................26

Chart 4.1.8 Long-Term Unemployment......................................................................................27

Chart 4.2.1 Nonfinancial Corporate Credit Market Debt to Net Worth.............................................27

Chart 4.2.2 Financial Ratios for Nonfinancial Corporations............................................................27

Chart 4.2.3 Bond Issuance by Nonfinancial Firms .......................................................................28

Chart 4.2.4 Corporate Bond Spreads........................................................................................28

Chart 4.2.5 Bank Business Lending Standards and Demand........................................................28

Chart 4.2.6 Nonfinancial Corporate Bond Default Rate.................................................................29

Chart 4.2.7 Noncurrent Commercial & Industrial (C&I) Loans........................................................29

Chart 4.2.8 CMBS New Issuance..............................................................................................29

Chart 4.2.9 Noncorporate Assets..............................................................................................30

Chart 4.2.10 Noncorporate Credit Market Debt to Net Worth .........................................................30

Chart 4.2.11 Net Borrowing by Nonfinancial Noncorporate Businesses............................................30

Chart 4.2.12 Bank Business Lending Standards and Demand........................................................31

Chart 4.2.13 Small Businesses’ Difficulty Obtaining Credit .............................................................31

Chart 4.2.14 Household and Nonprofit Balance Sheets.................................................................31

Chart 4.2.15 Share of Owners’ Equity in Household Real Estate .....................................................32

Chart 4.2.16 Household Debt Service Ratio.................................................................................32

Chart 4.2.17 Household Financial Obligations Ratio ......................................................................32

Chart 4.2.18 Nonmortgage Consumer Credit Flows......................................................................33

Chart 4.2.19 Average Amount of Revolving Credit Available ...........................................................33

Chart 4.2.20 Credit Card Delinquency Rates by Credit Score..........................................................33

Chart 4.2.21 Applications for Credit ............................................................................................34

Chart 4.3.1 Net Debt Outstanding as a Percent of GDP ...............................................................34

Chart 4.3.2 Federal Unified Budget Surplus................................................................................34

Chart 4.3.3 Federal Debt Held by the Public...............................................................................35

Chart 4.3.4 Interest Outlays and Average Maturity of U.S. Public Debt ...........................................35

Chart 4.3.5 Change in State and Local Government Debt ............................................................35

Chart 4.3.6 Change in State Tax Revenue..................................................................................36

Chart 4.3.7 Change in Local Tax Revenue .................................................................................36

List of Charts
210 2012 FSOC // Annual Report

Chart 4.3.8 Municipal Bond Issuance by Type ............................................................................36

Chart 4.3.9 Municipal Tax-Exempt Bond Yield Ratios...................................................................37

Chart 4.3.10 ARS and VRDO Funding of Long-Term Muni Bonds....................................................37

Chart 4.4.1 Real GDP Growth ..................................................................................................38

Chart 4.4.2 Developed Market Economies GDP Growth...............................................................38

Chart 4.4.3 Euro Area GDP Growth...........................................................................................38

Chart 4.4.4 ECB Liquidity Providing Operations...........................................................................40

Chart 4.4.5 Euro-Dollar Implied FX Swap Basis ..........................................................................41

Chart 4.4.6 Total Swap Line Amount Outstanding .......................................................................41

Chart 4.4.7 Emerging Market Economies GDP Growth ................................................................42

Chart 4.4.8 Net International Financial Flows to EMEs..................................................................42

Chart 4.4.9 Change in Total Chinese Social Financing .................................................................43

Chart 5.1.1 Federal Debt Outstanding Held by Public..................................................................45

Chart 5.1.2 Yield Curve ...........................................................................................................45

Chart 5.1.3 Foreign Holders of U.S. Federal Debt .......................................................................45

Chart A.1 S&P Downgrade of U.S. Debt: Flight to Quality..........................................................46

Chart A.2 S&P Downgrade of U.S. Debt: Effect on Equities .......................................................46

Chart 5.1.4 Euro Area 10-Year Yield Spreads to German Debt......................................................47

Chart B.1 Greece: Average Bond Price and CDS......................................................................48

Chart B.2 Greece: Debt Exchange..........................................................................................48

Chart 5.1.5 10-Year Sovereign Debt Yields ................................................................................51

Chart 5.1.6 Emerging Market Bond Spreads..............................................................................51

Chart 5.1.7 Price Changes in Selected Equities Indices................................................................52

Chart 5.1.8 Global Equities ......................................................................................................52

Chart 5.1.9 U.S. Corporate Bond Spreads—Investment Grade ....................................................52

Chart 5.1.10 U.S. Dollar Exchange Rates.....................................................................................53

Chart 5.1.11 Commodities.........................................................................................................54

Chart 5.1.12 Farm Land Prices and Value of Crop Yield ................................................................54

Chart 5.1.13 Agricultural Real Estate Debt Outstanding .................................................................54

Chart 5.1.14 Large Bank Holding Company Liability Structure........................................................55

Chart 5.1.15 Wholesale Cash Investors.......................................................................................55

Chart 5.1.16 Retail Deposits vs. Short-Term Wholesale Funding .....................................................55

Chart 5.1.17 Estimated Value of the Repo Market.........................................................................57

Chart 5.1.18 Tri-Party Repo Collateral Distribution ........................................................................58

Chart 5.1.19 Commercial Paper Outstanding ...............................................................................58

Chart 5.1.20 Value of Securities on Loan.....................................................................................59

Chart 5.1.21 Securities Lending Cash Reinvestment .....................................................................59

Chart 5.1.22 National Repeat Sales Home Price Indices................................................................60

Chart 5.1.23 Mortgages with Negative Equity...............................................................................60

Chart 5.1.24 Mortgage Delinquency and Foreclosure....................................................................60
List of Charts 211

Chart 5.1.25 Foreclosure Pipeline...............................................................................................61

Chart 5.1.26 Median Credit Score at Mortgage Origination ............................................................61

Chart 5.1.27 HARP Refinancings................................................................................................62

Chart 5.1.28 Mortgage Originations............................................................................................63

Chart 5.1.29 Issuance of RMBS .................................................................................................63

Chart 5.1.30 GSE Net Income and Losses...................................................................................63

Chart 5.2.1 Aggregate BHC Pre-Tax Income ..............................................................................64

Chart 5.2.2 Change in Tier 1 Common Ratios for Aggregate U.S. BHCs ........................................65

Chart 5.2.3 Change in Tier 1 Common Ratios for 19 Largest BHCs ..............................................65

Chart 5.2.4 U.S. Unemployment Rate: Actual vs. Stress Scenarios................................................65

Chart 5.2.5 Initial and Stressed Tier 1 Common Capital Ratios.....................................................66

Chart 5.2.6 Consolidated Liquidity Ratio for Top 50 BHCs............................................................66

Chart 5.2.7 Short-Term Wholesale Funding at Largest BHCs................................................66, 131

Chart 5.2.8 Change in Tier 1 Common Ratios for BHCs < $50B..................................................67

Chart 5.2.9 BHC Dividends and Repurchases.............................................................................67

Chart 5.2.10 Return on Average Assets.......................................................................................68

Chart 5.2.11 Price-to-Book Ratio of 6 Large Complex BHCs..........................................................69

Chart 5.2.12 CDS Spreads of 6 Large Complex BHCs .......................................................... 69, 128

Chart 5.2.13 FDIC-Insured Failed Institutions................................................................................69

Chart 5.2.14 Commercial Bank and Thrift Pre-Tax Income .............................................................70

Chart 5.2.15 Commercial Property Price Indices ..........................................................................70

Chart 5.2.16 Concentration of Credit Union Assets .......................................................................70

Chart 5.2.17 Federally Insured Credit Union Income......................................................................71

Chart 5.2.18 Credit Union Fixed Rate Real Estate and Long-Term Assets.........................................71

Chart 5.2.19 U.S. Branches and Agencies of Foreign Banks: Assets...............................................72

Chart 5.2.20 U.S. Branches and Agencies of Foreign Banks: Liabilities............................................72

Chart 5.3.1 Life and Other Insurance: Capital and Income............................................................73

Chart 5.3.2 Life Insurers: Impact of Low Rate Environment...........................................................73

Chart 5.3.3 Commercial Mortgage Origination by Lender Type .....................................................74

Chart 5.3.4 Property and Casualty Insurance: Capital and Income ................................................75

Chart 5.3.5 Money Market Mutual Fund Assets by Fund Type ......................................................75

Chart 5.3.6 Institutional vs. Retail Money Market Fund Assets......................................................75

Chart 5.3.7 Prime Funds Liquidity.....................................................................................76, 134

Chart 5.3.8 MMF WAL ............................................................................................................76

Chart 5.3.9 Gross Yield of 5 Outlier MMF Families......................................................................76

Chart 5.3.10 Aggregate Broker-Dealer Assets and Leverage..........................................................77

Chart 5.3.11 Broker-Dealer Revenues.........................................................................................77

Chart 5.3.12 Consumer Loans Outstanding .................................................................................77

Chart 5.3.13 Business Loans Outstanding ...................................................................................80

Chart 5.3.14 Real Estate Investment Trust (REIT) Assets................................................................80
212 2012 FSOC // Annual Report

Chart 5.3.15 Mutual Fund Flows by Asset Class (2011 to 2012 Q1)................................................80

Chart 5.3.16 Mutual Fund Taxable Bond Flows (2011 to 2012 Q1) .................................................81

Chart 5.3.17 Retirement Funds by Type.......................................................................................81

Chart 5.3.18 Public and Private Pension Funding Level..................................................................81

Chart 5.3.19 U.S. Private Equity AUM .........................................................................................82

Chart 5.3.20 U.S. Private Equity AUM by Strategy ........................................................................82

Chart 5.3.21 Change in Hedge Fund AUM...................................................................................82

Chart 5.3.22 Hedge Fund Performance by Strategy......................................................................83

Chart 5.3.23 Growth in ETF Assets and Number of Funds .............................................................83

Chart E.1 TARP Bank Support Program Status........................................................................84

Chart E.2 AIG Investments Committed and Returned................................................................85

Chart 5.4.1 Average Trade Size—U.S. Equities..........................................................................86

Chart 5.4.2 Average Daily Volume Shares by Venue ....................................................................87

Chart 5.4.3 U.S. Equities Share Volume.....................................................................................87

Chart 5.4.4 Regional Market Share of Trades.............................................................................87

Chart F.1 HFT % Use in Various Asset Classes........................................................................88

Chart 5.4.5 Annual Payment Clearing Volumes...........................................................................90

Chart 5.4.6 Annual Payment Clearing Values..............................................................................90

Chart 5.4.7 Fedwire Funds Daylight Overdrafts...........................................................................90

Chart 5.4.8 Deciles of Fedwire Value Time Distribution ................................................................91

Chart 5.4.9 Reserve Balances..................................................................................................91

Chart 5.4.10 Global OTC and Exchange-Traded Derivatives Growth.................................................91

Chart 5.4.11 Global Exchange-Traded Derivatives.........................................................................92

Chart 5.4.12 Exchange-Traded Derivatives Globalization ................................................................92

Chart 5.4.13 SwapClear Volume.................................................................................................92

Chart 5.4.14 Outstanding SwapClear Volumes .............................................................................93

Chart 5.4.15 ICE Clear Credit .....................................................................................................93

Chart 5.4.16 ICE Clear Europe ...................................................................................................93

Chart 5.4.17 Interest Rate Derivatives .........................................................................................94

Chart 5.4.18 CDS and Other Credit Derivatives.............................................................................94

Chart 7.2.1 Sovereign Yields.................................................................................................. 124

Chart 7.2.2 U.S. MMF Exposure to Europe ..............................................................................125

Chart 7.2.3 Large U.S. Banks’ Exposure to Europe ...................................................................125

Chart 7.2.4 Insurance Industry Exposure to Europe...................................................................125

Chart 7.2.5 Real Private Residential Investment ........................................................................126

Chart 7.3.1 Aggregate BHC Capital Ratios...............................................................................127

Chart 7.3.2 Core Deposits as a Percent of Total Liabilities..........................................................127

Chart 7.3.3 Short-Term Wholesale Funding..............................................................................127

Chart 7.4.1 Less-Stable Funding Sources at 6 Largest BHCs.....................................................131

Chart H.1 Prime Fund Bank Holdings....................................................................................135
List of Charts 213

Chart H.2 Prime Fund Portfolio Composition..........................................................................135

Chart 7.4.2 Credit Quality of High-Yield New Issues...................................................................140

Chart 7.4.3 Complex Financial Institutions in 2012....................................................................141

Chart 7.4.4 Assets of the 10 Largest Depository Institutions.......................................................142

Chart 7.4.5 Moody’s BHC Systemic Support Uplift....................................................................143

Chart 7.4.6 S&P Current Actual Rating & Market Derived Signal.................................................143

Endnotes 215

Endnotes

Section 6

1 Insured depository institutions, Farm Credit System institutions, Fannie Mae, Freddie Mac, and the 

Federal Home Loan Banks are not subject to resolution under the OLA. 

2 In the case of a failing insurance company, the company is resolved under the relevant state’s 

liquidation or rehabilitation process rather than under the FDIC’s receivership process. Special procedures also apply to the resolution of failing financial companies that are broker-dealers.

3 The Council met on August 8, 2011; September 15, 2011; October 11, 2011; October 31, 2011; 

November 11, 2011; December 5, 2011; December 21, 2011; February 1, 2012; April 3, 2012; May 

22, 2012; June 11, 2012; and July 18, 2012.

4 The Freedom of Information Act regulation is available online at www.fsoc.gov.

5 The transparency policy is available online at www.fsoc.gov.

Appendix A

1 12 U.S.C. § 5463(a) (2).

2 12 CFR 1320.10.

3 See 12 U.S.C. § 5462(6).

4 The list of globally systemically important financial institutions, as determined by the Financial Stability Board, is available at www.financialstabilityboard.org/publications/r_111104bb.pdf

5 12 U.S.C. § 611 et seq. (section 25A of the Federal Reserve Act). 

6 See 12 U.S.C. § 5462(6).

7 See Bank for International Settlements, Triennial Central Bank Survey, Report on global foreign 

exchange market activity in 2010 (Triennial Survey) (December 2010). The Bank for International 

Settlements reports average daily FX market turnover as 3.98 trillion USDE, which is the sum of one 

side of each FX transaction in 2010. For the purpose of comparability with statistics provided by 

CLS Bank, this value has been doubled and reported as the average aggregate daily value settled in 

the FX market. 

8 CLS Bank currently settles transactions in 17 currencies: the Australian dollar, British pound, Canadian dollar, Danish krone, euro, Hong Kong dollar, Israeli shekel, Japanese yen, Mexican peso, New 

Zealand dollar, Norwegian krone, Singapore dollar, South African rand, South Korean won, Swedish 

krona, Swiss franc, and U.S. dollar.

9 By settling the two sides of an FX transaction simultaneously, on a PVP basis, CLS Bank substantially reduces settlement risk to institutions using its services. 

10 An ASPL of zero would require that settlement members prefund transactions before settlement 

can take place.

11 The maximum potential credit exposure is calculated as the sum of each settlement member’s 

ASPL and assumes that each member reaches its ASPL at the same time. 

12 Members are not required to meet all additional pay-in calls, though non-compliance may result 

in some of their trades not settling at CLS Bank on settlement date and would be considered a 

multiple member pay-in failure. 

13 See 12 U.S.C. § 5462(6). However, because DCMs are expressly excluded from the definition 

of an FMU (the Act specifically states that “the term ‘financial market utility’ does not include – (i) 
216 2012 FSOC // Annual Report

designated contract markets...”), the activities of CME’s designated contract markets fall outside of 

this definition.

14 CFTC staff calculation based on volume (based on the number of contracts cleared). The underlying data for the calculation is taken from publicly available data compiled by the Futures Industry 

Association (FIA). See note 16. 

15 DCMs are CFTC-regulated markets for the trading of contracts for sale of a commodity for future 

delivery or commodity options. Essentially, they are boards of trade (or exchanges) that operate 

under the regulatory oversight of the CFTC, pursuant to Section 5 of the Commodity Exchange Act.

16

US Futures & Options Volume

Number of contracts traded and/or cleared

2011

CME Group 3,386,986,678

ICE Futures US 107,287,467

CBOE Futures Exchange 12,040,074

Chicago Climate Futures Exchange 84,580

NYSE Liffe US 20,898,174

US Total 3,527,296,973

CME Group % of total 96%

17 For example, a central counterparty will net member A’s long exposure in oil (formerly to B) and A’s 

short exposure in natural gas (formerly to C), in determining A’s collateral requirements.

18 Generally speaking, hedging activities result in more efficient markets and, ultimately, lower costs 

for consumers.

19 The futures and options markets play critical roles in the U.S. financial system because they provide 

two important functions. First, market participants such as grain merchants, energy firms, and portfolio 

managers use futures and options to reduce the risk to their business associated with volatile prices. 

Second, the futures and options markets provide the economy with price discovery (meaning they 

help determine the price level for commodities), and because futures prices are determined by supply 

and demand, the prices discovered through these markets offer valuable economic information that 

determines how (and how much of) these commodities are produced and consumed.

20 See 12 U.S.C. § 5462(6).

21 The list of globally systemically important financial institutions, as determined by the Financial 

Stability Board, is available at www.financialstabilityboard.org/publications/r_111104bb.pdf.

22 See 12 U.S.C. § 5462(6).

23 The list of globally systemically important financial institutions, as determined by the Financial 

Stability Board, is available at www.financialstabilityboard.org/publications/r_111104bb.pdf.

24 See 12 U.S.C. § 5462(6).

25 This data is as of May 2, 2012. For a complete list of all of ICE Clear Credit’s clearing eligible 

products, see www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Clearing_Eligible_Products.xls.

26 See ICE Surpasses $15 Trillion Milestone in Global CDS Clearing at http://ir.theice.com/releasedetail.cfm?ReleaseID=545362.

27 As of May 10, 2012, ICE Clear Credit’s clearing members were: Bank of America, N.A., Barclays 

Bank PLC, Barclays Capital Inc., BNP Paribas, BNP Paribas Securities Corp., Citibank N.A., Citigroup Global Markets Inc., Credit Suisse International, Credit Suisse Securities (USA) LLC, Deutsche 

Bank AG, London Branch, Deutsche Bank Securities Inc., Goldman, Sachs & Co., Goldman Sachs 

International, HSBC Bank USA, N.A., HSBC Securities (USA) Inc., JPMorgan Chase Bank, National 

Association, J.P. Morgan Securities LLC, Merrill Lynch International, Merrill Lynch, Pierce, Fenner 

& Smith, Incorporated, Morgan Stanley Capital Services LLC, Morgan Stanley & Co. LLC, Nomura 
Endnotes 217

International PLC, Nomura Securities International, Inc., Société Générale, The Royal Bank of Scotland plc, UBS AG, London Branch, and UBS Securities LLC.

28 For example, a central counterparty will net member A’s long exposure in one CDS index (formerly 

to B) and A’s short exposure in a different, but risk-related CDS index (formerly to C), in determining 

A’s collateral requirements.

29 According to the Bank for International Settlements, “Amounts outstanding with central counterparties...increased to about 17% of the total market at end-June 2011, after reaching 15% at endDecember 2010.” The BIS report is available at: www.bis.org/publ/otc_hy1111.pdf.

30 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (Nov. 8, 

2011).

31 The CDS market plays a critical role in the U.S. financial system for financial market institutions 

because it facilitates lending and corporate finance activity among such participants, which can be 

crucial in a tight credit environment. In addition, just as equity investors use indexes (such as the 

S&P 500) to hedge against broad market moves, credit indexes serve a similar purpose for credit 

investors (protecting assets) and issuers (locking in advantageous issue levels).

32 See 12 U.S.C. § 5462(6).

33 The list of globally systemically important financial institutions, as determined by the Financial 

Stability Board, is available at www.financialstabilityboard.org/publications/r_111104bb.pdf.

34 See 12 U.S.C. § 5462(6).

35 The list of globally systemically important financial institutions, as determined by the Financial 

Stability Board, is available at www.financialstabilityboard.org/publications/r_111104bb.pdf.

36 A portion of the clearing fund assets must be used to collateralize the secured line of credit and 

will not be available in addition to the credit itself if the line of credit is drawn upon.

Financial Stability Oversight Council

1500 Pennsylvania Avenue, NW 

Washington, D.C. 20220 

www.fsoc.gov