Regulatory Framework & Requirements Flashcards

Under the EU's Digital Operational Resilience Act (DORA), which specific obligation applies to financial entities when a Critical ICT Third-Party Provider (CTPP) fails to remediate identified vulnerabilities within the agreed timeframe?

Answer: The financial entity must implement compensating controls and notify the Lead Overseer, who may exercise direct oversight powers over the CTPP.

Under DORA Article 35, when a CTPP fails to remediate deficiencies within agreed timelines, financial entities must implement compensating controls and escalate to the Lead Overseer. The Lead Overseer retains direct supervisory powers over CTPPs—including issuing recommendations and requiring corrective action—without obligating immediate contract termination. Automatic exemption and mandatory domestic transfer are not DORA provisions.

A compliance officer at a multinational bank discovers that a subsidiary in Country A—which has adopted Basel III but not the final Basel III 'endgame' revisions—is using an Internal Ratings-Based (IRB) approach approved by Country A's regulator. The parent entity in Country B has implemented the endgame revisions requiring Output Floor constraints. Which regulatory principle governs how the subsidiary's capital adequacy is evaluated at the consolidated group level?

Answer: The consolidated group must apply the parent's Output Floor at the group level, but the subsidiary may continue using its locally-approved IRB approach for solo reporting.

Basel III's Output Floor applies at the consolidated level to the banking group as a whole, while solo/sub-consolidated entities remain subject to their local regulator's approved frameworks. This dual-layer approach—group-level consolidation under the parent's jurisdiction alongside subsidiary-level local compliance—is a fundamental feature of international banking regulation. The 'most conservative line-by-line' approach is not the Basel framework's methodology, and TLAC resolution triggers are separate from capital floor calculations.

Section 13 of the Bank Holding Company Act (the Volcker Rule) prohibits proprietary trading but includes an exemption for 'market making-related activities.' Under the 2020 revised Volcker Rule, which specific condition most precisely determines whether a position qualifies for the market-making exemption rather than constituting prohibited proprietary trading?

Answer: The position size and risk profile must be designed not to exceed the near-term demands of customers, clients, counterparties, and related hedging.

The core market-making exemption test under the revised Volcker Rule (12 CFR Part 248) requires that positions not exceed 'the reasonably expected near-term demands of clients, customers, or counterparties.' This RENTD (Reasonably Expected Near-Term Demand) standard is the pivotal distinction between legitimate market-making and prohibited proprietary trading. The 60-day holding period applies to the short-term trading presumption, not the market-making exemption. Revenue history and exchange listing are not definitional requirements for the exemption.

Under the FATF's Recommendation 12 on Politically Exposed Persons (PEPs), which scenario represents the most legally complex compliance obligation that is frequently misapplied by financial institutions?

Answer: Applying PEP controls to a customer who formerly held a prominent function in an international organization, even after departure from that role.

FATF Recommendation 12 explicitly extends PEP obligations to prominent functions in international organizations (e.g., UN, World Bank, IMF). Many institutions incorrectly sunset PEP status upon departure from an international organization, failing to apply the 'once a PEP, monitoring continues' principle. The 12-month timeframe is not codified by FATF (it says 'reasonable period' without a fixed term), making option B incorrect as stated. Family/associate treatment differs by domestic vs. foreign PEP classification under R.12. The 'minor clerical position' would not meet the 'prominent public function' threshold.

The EU Market Abuse Regulation (MAR) Article 19 requires disclosure of transactions by Persons Discharging Managerial Responsibilities (PDMRs). A CFO of a listed company enters into a pre-planned trading arrangement compliant with MAR's safe harbor provisions. Three months later, the company enters a closed period due to an upcoming earnings announcement. Which action is permissible under MAR during this closed period?

Answer: The CFO must suspend all trades under the arrangement during the closed period; the issuer may grant an exception only based on exceptional circumstances such as severe financial difficulty.

MAR Article 19(11) establishes a blanket prohibition on PDMR transactions during closed periods (30 days before an announcement), with narrow exceptions granted by the issuer—not ESMA—for cases of severe financial hardship or other exceptional circumstances. A pre-planned arrangement does not automatically override closed period prohibitions under MAR (unlike Rule 10b5-1 plans in the US). The 30-day establishment requirement exists for the arrangement's insulation from MAR's general prohibition, but closed period restrictions apply independently. Notification goes to the issuer and national competent authority, not ESMA directly.

Under the U.S. Bank Secrecy Act as amended by the Anti-Money Laundering Act of 2020 (AMLA), the FinCEN beneficial ownership registry created by the Corporate Transparency Act requires reporting companies to disclose beneficial owners. Which category of entity is subject to the most nuanced exemption analysis and most commonly misclassified?

Answer: Entities that are subsidiaries of exempt entities, where the subsidiary is wholly owned or controlled exclusively by one or more exempt entities.

The subsidiary exemption under the CTA (31 U.S.C. § 5336) provides that entities wholly owned or controlled exclusively by exempt entities are themselves exempt. This is frequently misapplied because: (1) the exemption does not extend to partially-owned subsidiaries; (2) 'control' must be exercised exclusively by qualifying exempt entities with no non-exempt co-owners; and (3) the exemption is not automatic—it requires continuous qualification. The large operating company exemption (Option A) has clear numerical thresholds. SEC-registered investment advisers have their own specific exemption. Foreign pooled investment vehicles with U.S. managers involve a distinct 'foreign pooled investment vehicle' exemption category.