United States: Interagency Statement on Sound Practices Concerning Complex Structured Finance Transactions

Last Updated: June 1 2004
Article by Andrew P. Cross

On May 14, 2004, five federal agencies requested public comment on a statement regarding risk management procedures to help financial institutions manage the full range of risks associated with complex structured finance transactions, including the risk that the transactions do not comply with applicable law (the "Statement"). There are two major themes to the Statement:

(1) Financial institutions are expected to bring a multi-disciplinary, comprehensive approach to the management of the credit, market, operational, legal and reputational risks associated with these types of transactions; and

(2) Financial institutions are expected to fully understand their customers’ business objectives for entering into a complex structured finance transaction. SEC Release No. 24-49695; File No. S7-22-04. Comments regarding the Statement should be received on or before June 18, 2004.

Scope of the Statement

The Statement applies to the following financial institutions:

  • National Banks supervised by the Office of the Comptroller of the Currency ("OCC");
  • Federal and State Savings Associations and Savings and Loan Holding Companies supervised by the Office of Thrift Supervision ("OTS");
  • State Member Banks and Bank Holding Companies supervised by the Board of Governors of the Federal Reserve System ("Board");
  • State Nonmember Banks supervised by the Federal Deposit Insurance Corporation ("FDIC");
  • U.S. Branches and Agencies of Foreign Banks supervised by the Board, the OCC and the FDIC; and
  • Registered Broker-Dealers and Investment Advisers supervised by the Securities and Exchange Commission ("SEC").

The Statement is primarily directed to those financial institutions that offer complex structured finance transactions. However, any financial institution listed above that is an end-user of complex structured finance products (for its own use or on behalf of its clients) should become familiar with the Statement since its business dealings with offering financial institutions may be affected by the proposed Statement. An "end-user" financial institution may also want to review its existing risk management guidelines, policies and procedures related to the use of complex structured finance products in light of the policies proposed in the Statement.

Definition of Complex Structured Finance Transactions

The guidance in the Statement addresses "complex structured finance transactions." The Statement indicates that the most important characteristic of these transactions is that they expose a financial institution to elevated levels of market, credit, operational, legal or reputational risks. The following are three other common characteristics that these transactions usually share:

  • The transactions typically result in a final product that is often non-standard and structured to meet the specific financial objectives of a customer.
  • The transactions often involve professionals from multiple disciplines within the financial institution and may have significant fees or high returns in relation to the market and credit risks associated with the transaction.
  • The transactions may be associated with the creation or use of one or more special purpose entities designed to address the economic, legal, tax or accounting objectives of the customer and/or the combination of cash and derivative products.
  • The Statement indicates that these criteria are not exclusive and should be modified or supplemented by a financial institution, as appropriate, to reflect business activities, as well as any marketplace changes.

Proposed Guidelines for Structured Finance Transactions

The Statement sets forth the following proposed guidelines for incorporating structured finance transactions into existing management procedures, controls and systems.

Role of Board of Directors and Senior Management

The Statement emphasizes that the board of directors of a financial institution is the focal point of the corporate governance system and that effective oversight by the directors and senior management is fundamental to preserving the integrity of capital markets. The following are specific recommendations as to the role of the board of directors and senior management with respect to the oversight of structured finance transactions:

The board should establish the financial institution’s thresholds for the risks associated with complex structured finance products and ensure that a sufficiently strong risk control framework is in place to guide the actions of the institution’s personnel.

The board should ensure that the financial institution has a risk control framework for complex structured finance products that includes comprehensive policies related to the elements described in the Statement.

Using guidance provided by the board, senior management should implement a risk control framework for complex structured finance transactions that includes comprehensive policies, defined roles and responsibilities and approval authorities, detailed management reporting, required documentation, and ongoing independent monitoring and testing of policy compliance. The Statement indicates that one approach to this guideline is to create a senior management risk-control committee to ensure that structured finance products that may expose the financial institution to higher levels of financial, legal and reputational risk are comprehensively and consistently managed and controlled on a firm-wide basis.

The board and senior management also should send a strong message to others in the financial institution about the importance of integrity, compliance with the law, and overall good business ethics. The financial institution’s culture and procedures should encourage personnel to elevate ethical concerns regarding a complex structured finance transaction to appropriate levels of management.

The board and senior management should ensure that incentive plans are not structured in a way that encourages employees to cross ethical boundaries when executing complex structured finance transactions.

Policies and Procedures

The Statement recommends that financial institutions that offer complex structured finance transactions should maintain a comprehensive set of formal, firm-wide policies and procedures related to these transactions. The purpose of these policies and procedures is to provide for the identification, documentation, evaluation, and control of the full range of credit, market, operational, legal and reputational risks that may be associated with these transactions. Therefore, an institution’s policies and procedures should define what constitutes a complex structured finance transaction and, at a minimum, address the following nine subject areas.

  • Transaction Approval—The policies should define the process that financial institution personnel must follow to obtain approval for complex structured finance transactions. The approval process should involve both transactors, such as personnel from the sales, marketing and trading areas, and independent control staff, such as personnel from risk management, accounting and legal areas. These policies should also clearly outline when third-party legal, accounting and/or tax professionals should be engaged to consult on the transactions.
  • New Product—The policies should establish a control process for the approval of all "new" complex structured finance products. A variety of factors may be considered in determining whether a transaction is "new." These factors include: any structural variations from existing products; whether the product is targeted at a new class of customers; pricing variations from existing products; whether the product raises additional or new legal, compliance or regulatory issues; and deviations from standard market practices. The New Product policy should also address the roles and responsibilities of all relevant financial institution personnel.
  • Reputational and Legal Risk Management—The policies should ensure that a financial institution identifies a complex structured finance transaction that has elevated levels of reputational and legal risks and appropriately manages these risks. A transaction that is identified as having heightened reputational and legal risks should be reviewed by the financial institution’s legal department and, where appropriate, by independent legal counsel. The Statement includes several examples of characteristics that may indicate that a transaction involves heightened legal and reputational risks. The policies should ensure that the customer understands the risk-return profile of a particular transaction and outline the responsibilities of financial institution personnel to analyze and document a customer’s objectives and customer-related accounting, regulatory and tax issues. In summary, the legal risk management policies should enable the financial institution to (i) assess a customer’s business objectives for entering into a transaction; (ii) analyze the economic substance of a transaction; (iii) evaluate the appropriateness of the transaction; and (iv) prevent the institution from participating in inappropriate transactions.
  • Accounting and Disclosure by Customers—The policies should ensure that financial institution staff appropriately reviews and documents the customers’ proposed accounting treatment of complex structured finance transactions, financial disclosures relating to the transactions, and business objectives for entering into the transactions. These policies are particularly important for transactions identified as involving elevated legal and reputational risks.
  • Documentation Standards—The polices should provide for the generation, collection and retention of appropriate documentation relating to all complex structured finance transactions. The documents retained should include standard legal documents, as well as any ancillary documents, such as notes from customer meetings and third-party opinions. The Statement also specifically states that the documentation polices should seek to ensure that all counterparty obligations are reduced to legally enforceable written contracts. This should include the use of term sheets, confirmations, master agreements, netting agreements and collateral agreements.
  • Reporting to the Board of Directors and Senior Management—The policies should ensure that the board of directors and senior management of the financial institution receive appropriate and timely reports concerning the complex structured finance activities of the institution.
  • Independent Monitoring, Analysis and Compliance with Internal Policies—The policies should provide for periodic independent reviews of the institution’s complex structured finance activities to ensure that the institution’s policies and controls are being implemented effectively and to identify potential compliance issues.
  • Audit—The policies should ensure effective internal audit coverage of the institution’s complex structured finance activities. The Statement notes that effective audit coverage requires a comprehensive independent audit program that is staffed with personnel that have the necessary skills and experience to understand the structured transactions and to identify and report on compliance with financial institution policy and procedures. Additionally, due to the complexity of many structured finance activities, the Statement suggests that it might be appropriate in some cases to retain outside consultants, accountants or lawyers to review the structured product area.
  • Training—The policies should ensure that financial institution personnel receive appropriate training concerning the institution’s policies and procedures governing its complex structured finance activities.


As noted in the Introduction to this Bulletin, there are two major themes to the Statement:

(1) Financial institutions are expected to bring a multi-disciplinary, comprehensive approach to the management of the credit, market, operational, legal and reputational risks associated with these types of transactions; and

(2) Financial institutions are expected to fully understand their customers’ business objectives for entering into a complex structured financial transaction.

The Statement is primarily directed to those financial institutions that offer complex structured finance transactions. However, any financial institution listed above that is an end-user of complex structured finance products (for its own use or on behalf of its clients) should become familiar with the Statement since its business dealings with offering financial institutions may be affected by the proposed Statement. An "end-user" financial institution may also want to review its existing risk management guidelines, policies and procedures related to the use of complex structured finance products in light of the policies proposed in the Statement.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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