August 7, 2024 - It’s no secret that global regulators have stepped up efforts to learn additional information about nonbank financial intermediaries (NBFIs). Over the course of the year we have seen efforts by regulators on both sides of the Atlantic to drill into interconnectivity between banks and NBFIs and to better understand valuations in private markets. Here we briefly summarize those efforts and what can be expected in the second half of the year.
US
As previously reported here and here, U.S. bank reporting on NBFIs is poised to materially increase this year. The Fed is currently consulting on updates to the Capital Assessments and Stress Testing Reports (FR Y-14A/Q/M) to capture more granular information on lending to nondepository financial institutions (NDFIs) (among other updates). The Fed’s stated objective is to correct what it has identified as a material data gap in what banks report on NDFI borrowers relative to other corporate borrowers. These new reporting items would cover four topics: 1) financial information of NDFI borrowers, 2) reporting of financial sponsors, 3) more detail on the collateral securing loans to NDFIs, including market value, and 4) reporting of fee information. (For a full review, see our previous coverage.) In addition to the NBFI-related reporting the Fed is proposing, loan covenant details are also being added as a new reported field. The proposed update will capture whether a loan covenant exists, whether the covenant has been violated and, in such instances, whether the credit agreement has been amended. Comments on the proposal are due on August 20th.
In addition to the proposal above, the U.S. Treasury and banking agencies have moved forward with certain NDFI-related updates to the Consolidated Reports of Condition and Income (Call Reports) and certain other Federal Financial Institutions Examinations Council (FFIEC) filings. The new line items disaggregate reported data and capture items like off balance sheet transactions, non-domestic office exposure and loan performance data (e.g., nonaccruals and delinquencies), and would break out loans to mortgagers, commercial and consumer lenders and private equity funds. The agencies first proposed these new data items in December 2023 with the intention that the proposed revisions would take effect for the June 30, 2024 report date. In May, the agencies announced that they were proceeding with adding the NDFI-related items, but the updates would be effective only as of the December 31, 2024 report date.
Valuation of private assets has gotten significant attention in the press this year. It has also been top of mind for the SEC. The SEC’s 2024 exam priorities identified valuation as a point of focus in its review of investment advisers, and in particular, investment advisers to private funds. Including valuation practices in its 2024 examination priorities underscores the SEC’s view that it believes valuation practices may present potentially heightened risks. It remains to be seen what comes of this year’s SEC examinations as the SEC has not yet brought any enforcement actions over private lending. Looking ahead, it is unlikely heightened interest in valuation practices is fleeting. In a Bloomberg interview this summer Gubrir Grewal, the SEC’s Chief of Examinations, called out valuation practices in private lending as a top concern and an area that will face greater scrutiny.
UK
For many months the Financial Conduct Authority (FCA) telegraphed that it would be reviewing the valuation practices and governance of its supervised asset managers. The FCA’s stated objective is to understand the quality and robustness of private market valuation practices for private assets, the integrity of the valuation process and whether decisions are well evidenced and justifiable. In March, the FCA formally announced the multi-firm review in its “Dear CEO” letter and we understand that the first round of firms have now received the FCA’s questionnaire. The review process, which will involve information requests and firm meetings will take several months to complete but the FCA’s findings may be available as soon as year-end. (See Kroll letter for further information.)
What will those findings show? We shall have to wait and see, but the Bank of England’s Financial Policy Summary and Record may be predictive. In its semi-annual report, the BOE highlighted its perceived vulnerabilities in private markets. The report reiterated that the extent of transparency around asset valuations, overall levels of leverage, and the complexity and interconnectedness of the sector made assessing the financial stability risks challenging. Therefore, BOE welcomed the FCA’s valuation review and would consider its outcome while noting that “improved transparency over valuation practices and overall levels of leverage” could serve as potential risk mitigants. The BOE also supported improved risk management practices among lenders to the private equity sector. Indeed, bank lending to PE firms was the subject of a recent thematic review by BOE’s Prudential Regulatory Authority which identified gaps in banks’ risk management frameworks for PE exposures. (See Annex to “Dear CRO” Letter for further detail.) Looking forward, BOE will release the results of the latest round of its system-wide exploratory scenario (SWES) exercise at the end of the year. The SWES exercise is designed to help BOE better understand how banks and non-banks might act during very severe shocks in financial markets, and how their responses might interact to make things worse. Taken together, it looks like regulator questions are here to stay (for now), but perhaps they will also have more answers by year-end.
It remains to be seen whether these updates will satisfactorily address the official sector’s quest for more nonbank data or if this is merely the tip of the iceberg.
