On December 14, 2012, the Board of Governors of the Federal Reserve System (FRB) proposed regulations under Section 165 and Section 166 of the Dodd-Frank Act to increase the oversight of U.S. operations of foreign banking organizations (FBOs) – foreign banks that maintain a U.S. branch or agency office. The proposed regulations follow on the heels of FRB Governor Daniel K. Tarullo’s speech on November 28, 2012, announcing the FRB’s intent to adopt such regulations.
In proposing the regulations, the FRB cites the increasing complexity of FBOs in the United States and the attendant risks that such FBOs pose to U.S. financial stability. In particular, the proposal would require FBOs with a significant U.S. presence to create a single intermediate holding company (IHC) over all of their U.S. nonbank subsidiaries. FBOs would also be required to maintain stronger capital and liquidity positions in the United States. With certain exceptions, the proposed rules would apply to FBOs having total global consolidated assets of $50 billion or more, while more stringent standards would apply to such FBOs that also have U.S. assets exceeding certain thresholds.
The proposed measures include:
· U.S. intermediate holding company requirement – An FBO with both $50 billion or more in global consolidated assets and $10 billion or more in U.S. assets (excluding assets held in U.S. branches or agency offices) generally would be required to organize its U.S. subsidiaries (including any U.S. depository institution subsidiary) under a single U.S. IHC. The IHC would be subject to the prudential requirements of the proposed regulation (rather than the prudential requirements applicable to U.S. bank holding companies) but would be subject to reporting and inspection as if it were a U.S. bank holding company. The FRB stated that such a structure would allow for the “consistent supervision and regulation” of the U.S. operations of FBOs, and would help facilitate the resolution of failing U.S. operations of a foreign bank if needed.
· Risk-based capital and leverage requirements – IHCs would be subject to the same risk-based and leverage capital standards as applicable to U.S. bank holding companies. Given (i) the scheduled phase-out of the FRB’s policy statement waiving capital requirements for U.S. intermediate bank holding companies (known as “SR 01-01”) and (ii) Section 171 of Dodd-Frank, which requires bank holding companies to meet the capital requirements applicable to depository institutions (known as the “Collins Amendment”), FBOs that are required to establish IHCs may be obligated to inject substantial additional capital into their U.S. operations. The FRB stated that the capital requirements, in addition to bolstering the consolidated capital positions of the IHCs, would also “promote a level playing field among all banking firms operating in the United States.” IHCs with $50 billion or more in consolidated U.S. assets also would be subject to the FRB’s capital planning rule.
· Basel compliance – FBOs with global consolidated assets of $50 billion or more would be required to establish that the FBO meets the minimum capital standards required under the Basel Capital Framework, as amended from time to time, and would be required to report its risk-based and leverage ratios to the FRB on a quarterly basis.
· Liquidity risk management requirements – With respect to FBOs having combined U.S. assets of $50 billion or more, the FBO’s U.S. operations would be required to meet enhanced liquidity risk-management standards. Such FBOs would be required to establish a U.S. risk committee responsible for establishing annual liquidity tolerances. In addition, such FBOs would be required to have a U.S. chief risk officer, whose responsibilities would include: evaluating the liquidity implications of new U.S. business lines or products, annually reviewing the liquidity implications of significant existing business lines, reviewing and approving a liquidity “contingency funding plan” meeting certain prescribed requirements, assessing various liquidity measures on a quarterly basis, reviewing strategies and policies and procedures, and reporting on a semi-annual basis to the risk committee. Such FBOs would also be required to conduct annual independent assessments of its liquidity risk management practices, and to prepare and maintain comprehensive cash flow projections for its U.S. operations.
· Liquidity stress testing and liquidity buffers – With respect to FBOs having combined U.S. assets of $50 billion or more, the FBO must conduct monthly liquidity stress tests applicable to its U.S. operations, which tests must meet certain standards prescribed in the proposal. These FBOs also must report to the FRB any results from liquidity stress tests and any liquidity buffers imposed by home country regulators. These FBOs would be required to maintain separate 14-day and 30-day liquidity buffers with respect to both its U.S. IHC and its U.S. branches and agencies (although the minimum buffers for the IHC and the branches/agencies, respectively, would be calculated somewhat differently). Such FBOs would also be required to adopt a contingency funding plan, establish certain internal liquidity-related risk limits (such as funding concentration limits, liability maturity schedules, off-balance sheet exposures, and intra-day exposures), engage in liquidity monitoring, and monitor liquid assets pledged as collateral.
· Liquidity stress testing requirements for other FBOs – FBOs having $50 billion or more in global assets, but less than $50 billion in U.S. assets, would be required to conduct Basel-compliant liquidity stress testing on an annual basis and report those results to the FRB. A FBO that does not comply with this requirement must limit the net aggregate amount owed by the FBO’s head office and its non-U.S. affiliates to the combined U.S. operations to 25% or less of the third party liabilities of its combined U.S. operations.
· Single-counterparty credit limits – FBOs having $50 billion or more in global assets would be required to comply with separate single-counterparty credit limits applicable to the IHC and to the FBO generally. The IHC limit (applicable to exposures of the IHC and its consolidated subsidiaries) would be 25% of the IHC’s capital stock and surplus. The FBO limit (applicable to exposures by its U.S. operations collectively, including the IHC as well as the FBO’s branches, agencies, and insured depository institutions) would be 25% of the FBO’s capital stock and surplus. Notably, exposures to sovereign entities (other than U.S. sovereign, U.S. agency and GSE obligations) would be subject to these counterparty credit limits. FBOs would be required to file monthly reports with the FRB to evidence compliance with these requirements. FBOs with consolidated assets of $500 billion or more would be subject to more stringent (although yet undefined) counterparty credit limits. The counterparty credit limit provision would contain an “attribution rule,” deeming an exposure to a third party to be an extension to a counterparty, to the extent that the proceeds of the transaction are used for the benefit of, or transferred to, that counterparty.
· U.S. risk committees – FBOs with consolidated global assets of $10 billion or more would be required to establish board-level risk committees if the shares of the FBO are publicly traded. FBOs with assets of $50 billion or more would be required to establish risk committees, regardless whether the shares are publicly traded. At least one member of the risk committee must have risk management experience. For FBOs having an IHC, the risk committee must be established at the IHC board committee level. For FBOs not having an IHC, the risk committee function may be performed by an enterprise-wide risk committee or as a committee of the global board of directors.
· Risk management requirements – FBOs with consolidated global assets of $50 billion or more would be required to adhere to certain risk management requirements. In particular, the proposed regulation would require the appointment of a U.S. chief risk officer reporting to both the U.S. risk committee and the FBO’s global chief risk officer; this U.S. chief risk officer must be either an employee of the IHC, a U.S. branch or agency, or another U.S. subsidiary of the IHC. U.S. risk committees of such FBOs must have at least one member who is independent of IHC or FBO management. The risk committee would be responsible for reviewing and approving the risk management operations of the combined U.S. operations of the FBO, and for overseeing the operation of an appropriate risk management framework for the combined U.S. operations of the FBO.
· Capital stress testing – IHCs with assets of $10 billion or more (but less than $50 billion) would be required to conduct annual company-run stress tests. IHCs with assets of $50 billion or more would be required to conduct semi-annual company-run stress tests and would be subject to annual supervisory stress testing. In both instances, the stress testing requirements would be comparable to those applied to similarly sized U.S. bank holding companies. In addition to the foregoing, FBOs with consolidated global assets of $50 billion or more would be required to report to the FRB results of stress testing conducted by its home country supervisor, provided such stress testing is comparable to that required by the FRB on U.S. bank holding companies. FBOs that are not subject to an appropriate home country stress testing regime or do not report results by home country supervisors would be subject to a heightened 108% asset maintenance requirement with respect to their U.S. branch and agency network, would be required to conduct annual stress testing of the U.S. operations, and would be subject to FRB-imposed restrictions on intercompany funding as well as liquidity buffer requirements with respect to their U.S. branch and agency network. FBOs with consolidated global assets of $10 billion or more (but less than $50 billion) would also be subject to report to the FRB information regarding stress testing conducted by its home country supervisor and, if the stress testing is not comparable or the results are not reported, the FBO would be subject to similar ramifications (including annual company-run stress testing of U.S. operations and a 105% asset maintenance requirement).
· Debt-to-equity limits – If the FSOC determines that a FBO poses a grave threat to the financial stability of the United States and that the imposition of a debt-to-equity requirement is necessary to mitigate such risk, the FBO would be subject to a 15-to-1 debt-to-equity limit, applicable to its IHC or, if it is not required to have an IHC, to each U.S. subsidiary. In addition, such FBOs must maintain a 108% asset maintenance ratio with respect to their U.S. branches and agency offices. Unlike other aspects of the proposed rule, the debt-to-equity requirements would become effective when the regulation is adopted in final form (subject to up to two 90-day discretionary extensions).
· Early remediation requirements – FBOs with consolidated global assets of $50 billion or more would be subject to early remediation requirements. The proposed triggers would be based on capital, stress tests, risk management, liquidity risk management, and market indicators, as set forth in the proposed rule. The proposed rule provides for four levels of remediation of increasing severity, although the proposed rule permits more tailored remediation for FBOs having U.S. assets of less than $50 billion.
The FRB’s proposed phase-in period would mandate that FBOs with global consolidated assets above the applicable thresholds as of July 1, 2014, comply with the new standards on July 1, 2015, with an earlier date established for the debt-to-equity requirements.
The comment period will remain open until March 13, 2013.