Transformed Security, Mortgage Putback, UBS: Compliance

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JPMorgan Chase & Co. and Bank of America Corp. are helping clients find an extra $2.6 trillion to back derivatives trades amid signs that a shortage of quality collateral will erode efforts to safeguard the financial system.

Starting next year, new rules designed to prevent another meltdown will force traders to post U.S. Treasury bonds or other top-rated holdings to guarantee more of their bets. The change takes effect as the $10.8 trillion market for Treasuries is already stretched thin by banks rebuilding balance sheets and investors seeking safety, leaving fewer bonds available to backstop the $648 trillion derivatives market.

As a solution, at least seven banks plan to let customers swap lower-rated securities that don’t meet standards in return for a loan of Treasuries or similar holdings that do qualify, a process dubbed “collateral transformation.” That’s raising concerns among investors, bank executives and academics that measures intended to avert risk are hiding it instead.

The potential reward for revenue-starved banks is an expanded securities-lending market that could generate billions of dollars in fees. JPMorgan and Bank of America, which have the biggest derivatives businesses among U.S. bank holding companies with a combined $140 trillion of the instruments, are already marketing their new collateral-transformation desks, people with knowledge of the operations said.

The list also includes Bank of New York Mellon Corp., Barclays Plc, Deutsche Bank AG, Goldman Sachs Group Inc. and State Street Corp., said the people, who asked not to be identified because they weren’t authorized to speak publicly.

Estimates for how much extra collateral participants will need range from about $500 billion to $2.6 trillion, based on data compiled by Bloomberg. U.S. regulators implementing the rules haven’t said how the collateral demands for derivatives trades will be met. Nor have they run their own analyses of risks that might be created by the banks’ bond-lending programs, people with knowledge of the matter said. Steve Adamske, a spokesman for the U.S. Commodity Futures Trading Commission, and Barbara Hagenbaugh at the Federal Reserve declined to comment.

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Compliance Policy

Mortgage Putback Threat Reduced for Lenders Under New Rules

The U.S. overseer of Fannie Mae and Freddie Mac, seeking to reduce the threat that banks will have to buy back flawed mortgages from the two firms, laid out new rules designed to spur lending and ease the housing crunch.

The changes will apply to future loans, not those that are the subject of current bank complaints that the taxpayer-owned companies are being too aggressive in forcing them to buy back loans made at the height of the housing bubble, the Federal Housing Finance Agency said yesterday in a statement.

The new system, which takes effect on Jan. 1, should give banks more certainty about future costs by flagging potentially faulty mortgages earlier, FHFA said. Fannie Mae and Freddie Mac will use data collected on the loans they buy to spot potential defects, and will review samples within three months of purchase instead of waiting until borrowers default.

Regulators including FHFA and the Federal Reserve have said that banks are shutting out otherwise eligible borrowers and demanding higher credit scores than necessary because they are afraid Fannie Mae and Freddie Mac will force them to repurchase loans if they become delinquent.

David Stevens, president and chief executive officer of the Mortgage Bankers Association, said the rules probably will give banks more confidence that they won’t be forced to buy back loans unless there are serious problems with origination.

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Feuding Dutch Politicians Agree on Toughening Banking Rules

Dutch politicians, who have clashed over the future of the euro area and austerity measures before today’s parliamentary elections, agree on one thing: toughening rules on banks.

The Labor Party, vying for first place in recent polls, favors boosting a bank tax and imposing a levy on transactions, as does the Socialist Party, currently in third place. The Liberal Party, led by Prime Minister Mark Rutte, advocates stricter supervision of new financial products, while all three back a cap on bonuses. Whoever wins will probably have to forge a coalition with at least two rivals to gain a majority.

Politicians across Europe have tapped into public ire toward banks to woo voters after governments had to rescue financial institutions in 2008 and 2009, swelling budget deficits and curbing economic growth. In the Netherlands, a central bank survey published in June found that public confidence in the “competence and integrity” of the directors of financial institutions fell in 2012, a sixth straight drop.

The Dutch for centuries have been leaders in global trade, giving the nation of 16.7 million people a banking industry that dwarfs the economy. The industry’s size was reflected in the cost of the bailouts during the financial crisis that followed the collapse of Lehman Brothers Holdings Inc. in 2008.

In the Netherlands, measures already introduced to change the financial industry include a deposit guarantee fund and blueprints for splitting off and salvaging banks’ crucial operations in a crisis. Lawmakers agreed to set up a commission to consider structural changes, possibly including a separation of consumer and investment banking.

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Regional Lenders Protest Japan Post’s Entry to Mortgage Market

Japan’s regional bank lobby opposed plans for the country’s postal savings bank to begin residential and corporate lending, saying the move would distort fair competition.

Hidetoshi Sakuma, chairman of the Regional Banks Association of Japan, criticized the plan as unfair to regional lenders.

Entry by state-owned Japan Post Bank Co., the nation’s biggest deposit holder, to the already crowded domestic mortgage market would undermine profitability for local lenders, Moody’s Investors Service said this week. Falling interest rates in Japan have done little to spur demand for loans as deflation continues to plague the world’s third-largest economy.

Sakuma is also president of Chiba Bank Ltd., the country’s third-largest regional lender by assets. His lobby, which represents 64 local banks, joins U.S. and European business groups in expressing concerns about Japan Post’s proposed business expansion.

The American Chamber of Commerce in Japan and the European Business Council last week urged the government to ensure a level playing field before permitting Japan Post Bank and Japan Post Insurance Co. to offer new products. Allowing Japan Post Bank to enter into higher-risk lending areas will harm competition and put its assets and capital at risk, they said in a joint statement on Sept. 6.

The government will discuss the impact of Japan Post’s proposal on competition, Financial Services Minister Tadahiro Matsushita said on Sept. 4.

Compliance Action

UBS Whistle-Blower Birkenfeld Gets $104 Million IRS Award

Bradley Birkenfeld, the former UBS AG banker who went to prison after telling the Internal Revenue Service how the bank helped thousands of Americans evade taxes, secured a whistle-blower award of $104 million, the largest individual federal payout in U.S. history.

Birkenfeld told authorities how UBS bankers came to the U.S. to woo rich Americans, managed $20 billion of their assets and helped them cheat the IRS. He pleaded guilty to conspiracy in 2008, a year after reporting the bank’s conduct to the Justice Department, U.S. Senate, IRS and Securities and Exchange Commission.

Birkenfeld’s attorney Stephen M. Kohn said yesterday at a news conference in Washington that he is seeking a presidential pardon for Birkenfeld, who is under home confinement. Birkenfeld left prison on Aug. 1.

Birkenfeld’s disclosures preceded UBS’s decision to pay $780 million to avoid prosecution, admit it fostered tax evasion from 2000 to 2007 and turn over data on 250 Swiss accounts. UBS later agreed to provide information on another 4,450 accounts. Since then, at least 33,000 Americans have voluntarily disclosed offshore accounts to the IRS, generating more than $5 billion.

The UBS case led to an erosion of the use of Swiss bank secrecy by wealthy Americans to cheat the IRS. At least 11 banks are under criminal investigation in the U.S. Two dozen offshore bankers, lawyers and advisers, as well as 50 American taxpayers, have been charged with crimes.

The IRS confirmed the award in a statement.

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Feinberg Disputes AIG Account That U.S. Pay Curbs Hurt Insurer

Kenneth Feinberg, who oversaw compensation for American International Group Inc. executives as part of a bailout that swelled to $182.3 billion, disputed the insurer’s account that pay curbs held back the firm.

Feinberg said in a telephone interview that the company was not hurt, which is shown because they are “thriving and repaying the taxpayer.” AIG was not “in any way at a competitive disadvantage, and I think the proof of that is in the results,” he said.

The government has recovered its full commitment of funds to AIG’s rescue as Chief Executive Officer Robert Benmosche bought back shares, helping the U.S. cut its stake to about 21 percent in a Treasury share sale this week. The New York-based insurer had bristled at the pay curbs, which will end after Treasury sells its final share.

Harvey Golub, then chairman of AIG, said in 2010 that pay limits can thwart employee-retention efforts, which “hurts the business and makes it harder to repay taxpayers.”

AIG is nearing an end to Treasury Department compensation limits as Benmosche winds down a taxpayer bailout.

The U.S. stake fell to about 16 percent from 53 percent in the largest sale of the insurer’s stock, the Treasury said yesterday. The department said it will raise $20.7 billion in the sale after underwriters bought additional shares, with AIG repurchasing $5 billion.

Treasury can restrict pay for top managers until the U.S. sells its final AIG share, said Matt Anderson, a department spokesman.

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UBS Credit-Swaps Trade System Shows Clients Like Live Prices

Credit-default swaps traders are executing more of the derivatives on an electronic UBS AG system than at any time since it was started six months ago, according to the bank.

Monthly volumes of index trading on the firm’s Price Improvement Network rose to an average $11 billion in July and August, compared with an average $7.5 billion in the four months ended in June, according to the Zurich-based lender. More than $50 billion of the swaps, tied to credit benchmarks including the Markit CDX North America Investment Grade Index and the Markit iTraxx Europe Index, traded through the end of August, UBS said.

Switzerland’s biggest bank is pushing a greater share of transactions onto the automated platform even as the industry’s two-biggest lobbying groups resist regulators seeking to mandate exchange-like systems. UBS’s platform lets customers directly post prices with a so-called order-book model where bids and offers are shown before the trade.

The Dodd-Frank Act that became law in 2010 requires most swaps to be processed by clearinghouses and traded on exchanges or similar electronic systems after the contracts complicated efforts to resolve the financial crisis four years ago. As regulators continue to write the details of the rules in Dodd-Frank, platforms are springing up to serve the evolving market.

The automated trading is a shift in a market where transactions historically have been negotiated over the phone after dealers, acting as a go-between for clients, send out indicative prices by e-mail. The dealers offer to buy a swap from a client at one price and sell the same contract to another for a higher amount, profiting from the gap known as the bid-offer spread.

In another process that banks and industry groups have more readily embraced, dealers can show negotiable prices on a request-for-quote, or RFQ, system.

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Finnish Banks Must Add Liquidity, Long-Term Funding, FSA Says

Banks in Finland need to boost liquidity and focus on adding long-term financing to comply with Basel III regulations, the Financial Supervisory Authority said.

“Finnish banks need to considerably build up their liquid funds and increase the share of long-term funding,” the Helsinki-based regulator said in a report today, citing impact assessments. Finnish banks comply with minimum solvency standards and have the required core capital, the FSA said.

Basel III global regulations aim to improve banks’ quality of capital by 2015 and ensure lenders hold adequate buffers to counter losses. Banks must also make sure they don’t rely solely on short-term capital. Some details of the banking regulations remain open, the FSA said.


German Court Backs Permanent Rescue Fund With Liability Cap

Germany’s top constitutional court rejected efforts to block a permanent euro-area rescue fund, handing a victory to Chancellor Angela Merkel, who championed the 500 billion-euro ($646 billion) bailout.

The Federal Constitutional Court in Karlsruhe dismissed motions that sought to block the European Stability Mechanism, while ruling Germany’s 190 billion-euro contribution can’t be increased without legislative approval. The court said Germany can ratify the ESM if it includes binding caveats it won’t be forced to assume higher liabilities without its consent.

The legal challenge delayed efforts by Merkel and other euro-area policy makers to stem the region’s debt crisis. Stocks and the euro rose after the ruling. Much of the effort to resolve the crisis hinges on the permanent ESM, which is designed to go into operation when the temporary European Financial Stability Facility is phased-out next year. The bailout fund would work in tandem with the European Central Bank’s bond buying to lower yields for states such as Spain and Italy.

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Jain Says Deutsche Bank Strategy Is a ‘Recalibration’

Deutsche Bank AG co-chief executive officers Anshu Jain and Juergen Fitschen spoke at a news conference in Frankfurt about the company’s strategy and business outlook, including current regulations and the bank’s global model.

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