Market Risk Capital Rules: Creditworthiness Standards to Replace Credit Ratings

On December 21, 2011 the Office of the Comptroller of the Currency ("OCC"), Board of Governors of the Federal Reserve System ("Board"), and Federal Deposit Insurance Corporation ("FDIC") (collectively, the "agencies") proposed rules on market risk capital (the "December Proposal"). The primary purpose of the December Proposal is to incorporate into the current market risk rules new creditworthiness standards to be used in riskweighting certain debt and securitization positions without relying on credit ratings. Comments on the December Proposal are due by February 3, 2012.

The December Proposal substantially modifies an earlier proposal from January 2011 ("the January Proposal"). The January Proposal was an effort to bring the U.S. market risk capital rules in line with Basel II.5 Broadly, this proposal sought to modify the scope of the market risk capital rules to better reflect appropriate levels of risk, reduce procyclicality in market risk capital requirements, and increase transparency through enhanced disclosures.

Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act effectively prohibits the use of credit ratings in assessing the creditworthiness of a security or money market instrument.6 Basel II, however, relies on credit ratings in risk-weighting certain debt and securitization positions. Accordingly, the January Proposal did not include the Basel II approach to risk-weighting and, as a kind of placeholder, made no change to the treatment of these positions under the current market risk capital standards. The December Proposal provides an alternative approach (absent the credit ratings) for risk-weighting the certain traded debt and securitization positions that the January Proposal left unresolved.

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