The Federal Reserve Board (“FRB”) published in the Federal Register on December 28, 2012 proposed rules that would amend Regulation YY (Enhanced Prudential Standards) (the “Proposal”) to implement the enhanced prudential standards required to be established under section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). In addition, the Proposal addresses the early remediation framework required to be established under section 166 for foreign banking organizations (“FBOs”) with total consolidated assets of $50 billion or more and foreign nonbank financial companies supervised by the FRB. [1] The FRB stated that the proposed rules would implement the long standing policy of national treatment and maintaining equality of competitive opportunity between the U.S. operations of FBOs and U.S. banking firms. However, the proposal also would make significant incursions into the supervision of FBOs by their own home country authorities. 

The Proposal includes risk-based capital and leverage requirements, liquidity requirements, single-party credit limits, overall risk management and risk committee requirements, stress test requirements, a debt-to-equity limit for companies the FSOC has determined pose a grave threat to financial stability, and early remediation requirements. The FRB also proposes requiring FBOs with a significant U.S. presence to create an intermediate holding company (“IHC”) over their U.S. subsidiaries. The IHC requirement would not encompass branch and agency operations. An FBO or its U.S. IHC that meets any relevant asset threshold in the Proposal would be subject to the requirements applicable to that size of the company.

The FRB has proposed a phase-in period in order to give FBOs time to adjust to the proposed rules. FBOs that become subject to the rules as of July 1, 2014 will be required to meet the new standards by July 1, 2015. All public comments are due by March 31, 2013.

I.    Foreign Banking  Organization Classification

Generally, the proposed rules would impose increased risk management obligations on FBOs that pose a greater level of systemic risk to, and have a larger presence in, the U.S. financial system based on asset size. The FRB would also apply this tiered approach to different classes of IHCs and foreign nonbank financial institutions.

An FBO with $50 billion or more in total global consolidated assets and combined U.S. assets of $50 billion or more would be subject to the most stringent liquidity standards, risk management standards, stress testing requirements, and early remediation requirements. The “combined U.S. operations” of an FBO would include any U.S. intermediate holding company and its consolidated subsidiaries, any U.S. branch or agency, and any other subsidiary of  the FBO that is not held under the authority of section 2(h)(2) of the Bank Holding Company Act of 1956, as amended. 

The U.S. operations of an FBO with total consolidated assets of $50 billion or more but less than $50 billion in U.S. assets would be subject to less stringent requirements than the largest FBOs in all of the identified subject areas of enhanced prudential standards. 

Finally, the U.S. operations of an FBO or a foreign savings and loan company with global consolidated assets of more than $10 billion but less than $50 billion would be subject only to a risk management certification and limited stress testing requirements under the Proposal.

Requirements Arising from FSOC Actions

Although the FSOC has not yet designated any nonbank financial companies for supervision by the FRB, the Proposal provides that, upon a determination by the FSOC, similar enhanced prudential standards would be applied to a designated foreign nonbank financial company whose  nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company could pose a threat to the United States. In such a situation, the FRB may also determine whether to require the company to establish a U.S. intermediate holding company.

If the FSOC provides written notice of a determination that an FBO poses a grave threat to the financial stability of the United States, the U.S. IHC and any U.S. subsidiary not organized under a U.S. IHC must achieve and maintain a debt-to-equity ratio of no more than 15-to-1. The U.S. branch and agency network would be required to achieve and maintain on a daily basis eligible assets in an amount not less than 108 percent of the U.S. branch and agency network’s liabilities.

II.    Application of the Enhanced Prudential Standards

The following table summarizes of the applicable requirements under the Proposal.

Federal Reserve Board Proposed Requirements for Foreign Bank Organizations

 

Requirement Under Proposal

Foreign Bank Organization Classification

 

More than $10 Billion but Less than $50 Billion in Global Assets

 

 

$50 Billion or More in Global Assets and Less than $50 Billion in U.S. Assets

 

 

Combined U.S. Assets  of $50 Billion or More     

 

U.S. Intermediate Holding Company (Subpart K; §§ 252.200-252.204)

No requirement.

 

 

Must establish a U.S. IHC if the FBO has combined U.S. assets of $10 billion or more (excluding assets of U.S. branches and U.S. agencies).

Generally, FBO must hold its interest in any U.S. subsidiary through the U.S. IHC. Will be subject to the enhanced prudential standards of Subparts K through R.

Must establish a U.S. IHC if the FBO has combined U.S. assets of $10 billion or more (excluding assets of U.S. branches and U.S. agencies).

Generally, FBO must hold its interest in any U.S. subsidiary through the U.S. IHC. Will be subject to the enhanced prudential standards of Subparts K through R.

Risk-Based Capital and Leverage Limits (Subpart L; §§ 252.210-252.212)

No Regulation YY requirement.

FBO must certify it meets home country capital adequacy standards that are consistent with the Basel Capital Framework.

IHC must meet applicable capital adequacy standards as established for bank holding companies in Regulation Y.

FBO must certify it meets home country capital adequacy standards that are consistent with the Basel Capital Framework.

IHC must meet applicable capital adequacy standards as established for bank holding companies in Regulation Y.

IHC with total consolidated assets of $50 billion or more must comply with capital planning and distribution standards as established for bank holding companies in Regulation Y (§ 225.8).

Liquidity (Subpart M; §§ 252.220-252.231)

No Requirement.

FBO must annually report to the FRB the results of an internal liquidity stress test consistent with the Basel Committee on Banking Supervision Principles for Sound Liquidity Management and Supervision and incorporate periodic test horizons.

Failure to comply will result in a limit of 25 percent of third party liabilities on the net due from head office and non-U.S. affiliates to the U.S. operations.

U.S. risk committee and the U.S. chief risk officer must review and approve various liquidity risk factors.

Must establish an independent review function to evaluate the liquidity risk management of the combined U.S. operations.

Must establish a cash flow projection methodology and produce comprehensive cash flow projections for the U.S. operations.

Must conduct monthly stress tests of cash flow projections under specified liquidity stress scenarios. Must establish policies and procedures for its stress testing practices, methodologies and assumptions among other requirements. Report results to FRB within 14 days of completing a stress test.

FBO must maintain a specified liquidity buffer for its U.S. branch and agency network and a separate buffer for its U.S. IHC. An FBO must hold assets comprising the liquidity buffer in the United States.

FBO must establish and maintain a contingency funding plan for its combined U.S. operations that sets out the strategies for addressing liquidity needs during liquidity stress events.

FBO must establish and maintain limits on potential sources of liquidity risks.

FBO must establish and maintain procedures for monitoring the assets that it has pledged as collateral in connection with transactions to which entities in its U.S. operations are counterparties and the assets that are available to be pledged for its combined U.S. operations.

Single-Counterparty Credit Limits*  (Subpart N; §§ 252.240-252.246)

(*Major FBOs and major U.S. IHCs, defined as having total consolidated assets of $500 billion or more, are subject to more stringent credit exposure limits in the Proposal.)

No requirement.

No U.S. IHC may have an aggregate net credit exposure to any unaffiliated counterparty in excess of 25 percent of the consolidated capital of that IHC.

No FBO may permit its combined U.S. operations to have an aggregate net credit exposure to any unaffiliated counterparty in excess of 25 percent of the consolidated capital stock and surplus of that FBO.

No U.S. IHC may have an aggregate net credit exposure to any unaffiliated counterparty in excess of 25 percent of the consolidated capital stock and surplus of that IHC.

No FBO may permit its combined U.S. operations to have an aggregate net credit exposure to any unaffiliated counterparty in excess of 25 percent of the consolidated capital stock and surplus of that FBO.

The FRB has not proposed the amount of the percentage-of-capital limit of aggregate net credit exposure for a major FBO or major IHC.

Risk Management (Subpart O; §§ 252.250-252.254)

A publicly traded FBO must certify to the FRB on an annual basis that it maintains a U.S. risk committee that oversees the risk management practices of the combined U.S. operations of the company and has at least one member with risk management expertise that is commensurate with the structure, profile, complexity, activities, and size of the combined U.S. operations.

The risk committee may be a committee of the global board of the FBO or a committee of the board of the U.S. IHC (if applicable).

The FBO must certify to the FRB on an annual basis that it maintains a U.S. risk committee that oversees the risk management practices of the combined U.S. operations of the company and has at least one member with risk management expertise that is commensurate with the structure, profile, complexity, activities, and size of the combined U.S. operations.

The risk committee must be a committee of the board of the U.S. IHC, if all U.S. operations are conducted through an IHC.

If applicable, the U.S. IHC must be governed by a board of managers or directors that is elected or appointed by the owners and that operates in substantially the same manner as a company chartered under the laws of the United States.

The FBO must certify to the FRB on an annual basis that it maintains a U.S. risk committee that oversees the risk management practices of the combined U.S. operations of the company and has at least one member with risk management expertise that is commensurate with the structure, profile, complexity, activities, and size of the combined U.S. operations.

The risk committee must be a committee of the board of the U.S. IHC, if all U.S. operations are conducted through an IHC.  Must have at least one member who is not an officer or employee of the FBO.

The U.S. risk committee must review and approve risk management practices of the combined U.S. operations and oversee an appropriate risk management framework.

The U.S. chief risk officer must meet specified qualifications and is responsible for measuring, aggregating, and monitoring risks undertaken by the combined U.S. operations.

The U.S. IHC must be governed by a board of managers or directors that is elected or appointed by the owners and that operates in substantially the same manner as a company chartered under the laws of the U.S.

Stress Testing (Subpart P; §§ 252.260-252.264)

Unless otherwise determined in writing by the FRB, an FBO with more than $10 billion of assets but less than $50 billion of U.S. assets must meet U.S. asset maintenance and stress test requirements if it is not subject to an adequate stress testing regime by its home country.

 

 

Unless otherwise determined in writing by the FRB, an FBO must meet U.S. asset maintenance and stress test requirements if it is not subject to an adequate stress testing regime by its home country.

U.S. IHC with $50 billion or more of total consolidated assets must comply with the stress test requirements of Subparts F and G to the same extent and in the same manner as if it were a bank holding company.

U.S. IHC with more than $10 billion but less than $50 billion of total consolidated assets must comply with the stress test requirements of Subpart H to the same extent and in the same manner as if it were a bank holding company.

U.S. IHC with total consolidated assets of $50 billion or more must comply with the stress test requirements of Subparts F and G to the same extent and in the same manner as if it were a bank holding company.

U.S. IHC with more than $10 billion but less than $50 billion of total consolidated assets must comply with the stress test requirements of Subpart H to the same extent and in the same manner as if it were a bank holding company.

FBO, unless otherwise determined by the FRB, must meet U.S. asset maintenance and stress test requirements if it is not subject to a consolidated capital stress regime by its home country supervisor.

Early Remediation Framework Subpart R; §§ 252.280-252.285)

No Requirement.

Remediation may be triggered by an FBO or IHC’s failure to meet the Proposal’s standards relating to capital and leverage, stress tests, risk management, and liquidity.

The type of triggering event will determine the level of remediation the FBO or IHC receives and, upon completion of a review, regulatory actions may be taken against the FBO or IHC. 

Remediation may be triggered by an FBO or IHC’s failure to meet the Proposal’s standards relating to capital and leverage, stress tests, risk management, and liquidity.

The type of triggering event will determine the level of remediation the FBO or IHC receives and, upon completion of a review, regulatory actions may be taken against the FBO or IHC.   

May be subject to nondiscretionary early remediation requirements in the event of certain triggering events.


III.    Impact of the Proposal

The potential requirements of the 304 page Proposal are both voluminous and complex. Many FBOs with U.S. operations will be subject to new requirements that will force them to greatly enhance their risk management structures in the United States and drastically change the way they approach their compliance efforts. For example, an FBO will need to establish new systems and controls to identify and measure common counterparty exposures among its U.S. operations. In addition, an FBO will need controls to ensure compliance with the liquidity standards and stress testing regime as well as any associated reporting requirements. Thus, the Proposal will establish new compliance obligations in addition to a new risk management framework.
 

 
[1] As defined in the Proposal, an FBO is a foreign bank that has a banking presence in the United States by virtue of operating a branch, agency, or commercial lending company subsidiary in the United States or controlling a bank in the United States; or any company of which the foreign bank is a subsidiary. A foreign nonbank financial company supervised by the FRB is a nonbank financial company incorporated or organized in a country other than the United States that the Financial Stability Oversight Council (“FSOC”) has designated for FRB supervision. No such designations have been made.

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