Affiliated but regulated: The invisible involvement of Regulation W

Regulation W, implemented through Sections 23A and 23B of the Federal Reserve Act, imposes capital-based quantitative and qualitative limitations on transactions between Federal Deposit Insurance Corporation (FDIC) insured depository institutions (IDIs) and their affiliates. An affiliate can include parent companies, sister companies, and investment funds, where an affiliate acts as an investment adviser. Regulation W aims to prevent the misuse of a bank’s resources and ensure that transactions with affiliates are conducted on market terms. It is crucial for financial institutions to understand the intricacies of Regulation W and how to navigate its complexities effectively.

The relevance of Regulation W

Since its formal adoption more than 20 years ago, Regulation W has remained a critical regulatory requirement despite significant market disruptions and regulatory changes. Originating from the Banking Act of 1933, it was designed to prevent the misuse of a bank’s resources. Over the years, amendments such as the Competitive Equality Banking Act of 1987 and the Gramm-Leach-Bliley Act of 1999 have expanded its scope. Today, Regulation W continues to be a supervisory priority, with regulators emphasizing the protection of depository institutions and demanding greater transparency and improved risk management from banks. These expectations have increased the pressure on organizations to review their Regulation W compliance programs and explore alternatives to existing practices. These alternatives can include the automation of controls and reporting.

Overcoming Regulation W hurdles: Insights for effective compliance

Compliance with Regulation W is challenging for banks, especially within complex legal entity structures. Factors such as expanding capital market activities, restructuring, capital and liquidity pressures, operational streamlining post-merger, and changes to service models exacerbate these challenges. Key obstacles also include decentralized regulatory awareness, lack of entity-specific policies, incomplete affiliate lists, outdated policies, and insufficient documentation for exemptions and market terms.

Before a bank can design an appropriate Regulation W compliance program that can appropriately mitigate the risks associated with affiliate transactions through well-designed internal controls and processes, it is important to conduct a proper analysis of the regulatory requirements and their applicability to the organization’s business transactions and products. This is one of the primary areas in which the regulators have identified failures and issues with Regulation W compliance programs, as banking entities and supporting legal entity structures become increasingly complex. Addressing these issues is crucial for modernizing compliance programs to meet regulatory expectations.

Tackling the technical

Navigating the technical complexities of Regulation W involves understanding its broad application across products, lines of business (LOBs), and control functions. Key focus areas include maintaining an accurate affiliate list, identifying potential covered transactions, ensuring proper collateral monitoring, and understanding exemptions and the attribution rule. Banks should also ensure that transactions with affiliates are conducted on market terms and that intercompany agreements comply with Regulation W requirements. By addressing these areas, banks can develop a comprehensive and effective Regulation W compliance program that mitigates regulatory risks and improves operational efficiency.

What’s on the horizon?

As banks evolve and regulatory expectations intensify, it is crucial to continually review and enhance Regulation W compliance programs. Investing in technology, formalizing governance structures, and providing comprehensive training can help build sustainable and robust compliance frameworks. By doing so, banks may be able to mitigate regulatory risks, improve operational efficiency, and ensure that Regulation W compliance becomes an integral part of their organizational culture.

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