On December 7, 2017, the Federal Reserve released three proposals that would increase the transparency of its stress test exercises, including the Dodd-Frank Act Stress Tests (“DFAST”) and Comprehensive Capital Analysis and Review (“CCAR”).  The proposals are comprised of: (1) enhancements to the Federal Reserve’s disclosures regarding its stress test models, (2) amendments to the Federal Reserve’s Policy Statement on the Scenario Design Framework, and (3) adoption of a new policy statement on the Federal Reserve’s approach to developing, implementing, and validating models.  Comments on the three proposals are due by January 22, 2018.

The Federal Reserve’s proposals represent a substantial step toward more transparency in stress testing, but would not provide for full disclosure of the agency’s models.  The preambles to the proposals suggest that the Federal Reserve is seeking to balance the benefits of additional disclosure, including increased public and market confidence in the stress test process, with concerns over the possibility that full disclosure would allow DFAST and CCAR participant firms to “game the system” by shifting their businesses to activities that appear to be advantaged under the models, which in turn could create systemic risk by leading to increased correlations among large firms’ asset holdings.  Each of the three proposals is discussed below.…

Continue Reading Federal Reserve Proposes to Increase Stress Test Transparency