Banking Agencies Propose A More Tiered Approach To Large Foreign Bank Supervision - Financial Services

On April 8, 2019, the federal banking agencies (the "Agencies") released two proposals¹ (the "Tailoring Proposals") which, if adopted, would further tailor the approach to supervision of large foreign banking organizations (FBOs) with respect to application of (i) enhanced prudential standards (EPS); (ii) the regulatory capital rule; (iii) the liquidity coverage ratio rule; and (iv) the proposed net stable funding ratio rule. Under the Tailoring Proposals, FBOs with less than $50 billion in total consolidated assets ² would no longer be subject to EPS. FBOs with a limited U.S. presence (i.e., less than $100 billion in combined U.S. assets³) would generally be subject to the same EPS currently required by Federal Reserve's Regulation YY but with altered thresholds for applicability. For FBOs with a more significant U.S. presence, the proposals would establish categories for the application of requirements based on size and certain other risk-based indicators. These categories would parallel the tailored framework proposed for the supervision of large domestic banking organizations released in November 2018.⁴

The supplementary information to the Tailoring Proposals provides background information and a detailed discussion of the proposed changes, suggestions of alternative approaches, and questions from the Agencies for public comment. Without proposing a rule, the Agencies also seek comment on whether standardized liquidity requirements should be imposed on U.S. branches and agencies of FBOs with a significant U.S. presence. The Agencies have offered two approaches for comment: one that is consistent with the LCR rule and another that would require an FBO to maintain a certain percentage of its aggregate U.S. branch and agency network assets in liquid assets. Comments on the Tailoring Proposals are due by June 21, 2019.

BACKGROUND

In the post-financial crisis reforms, the Federal Reserve adopted Regulation YY pursuant to Section 165 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") to implement EPS for large banking organizations. With respect to FBOs, the application of EPS is currently tiered by an institution's asset size with different requirements applicable to the following categories:

FBOs with total consolidated assets of more than $10 billion but less than $50 billion
- with additional standards for publicly traded FBOs in the same size range;
FBOs with $50 billion or more in total consolidated assets and combined U.S. assets of less than $50 billion; and
FBOs with $50 billion or more in total consolidated assets and combined U.S. assets of $50 billion or more.⁵

Also under the Dodd-Frank Act, the Agencies imposed, and have proposed, greater capital and liquidity standards for large banks through the 2013 adoption of revisions to the regulatory capital rule;⁶ the 2014 adoption of the LCR rule;⁷ and the 2016 proposed rule to implement the NSFR requirement.⁸ The Capital and Liquidity Proposal would apply these standards to FBOs using a similar tiered approach to the one used in the EPS Proposal.

THE TAILORING PROPOSALS

The Tailoring Proposals are a result of ongoing efforts by the Agencies to identify areas where additional regulatory tailoring may be warranted. In addition, certain tailoring and changes to the scope of regulations are required by amendments to the Dodd-Frank Act that were recently adopted through the passage of S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the "Regulatory Relief Act").⁹

Notably, the Tailoring Proposals would maintain the current requirement for any FBO with $50 billion or more in U.S. non-branch assets¹⁰ to establish an intermediate holding company ("IHC"), or designate an existing subsidiary as an IHC.¹¹ If required to establish an IHC, FBOs must hold their entire ownership interest in any U.S. subsidiary (subject to limited exclusions) through the IHC.

EPS for FBOs with a Limited U.S. Presence

For FBOs with a limited U.S. presence (i.e., less than $100 billion in combined U.S. assets), the EPS Proposal relies solely on an evaluation of the FBO's size, both in terms of global operations and U.S. operations, to determine applicability of heightened supervisory requirements. As further described below, for FBOs with a limited U.S. presence, the EPS Proposal would generally apply the same standards as currently articulated in the Federal Reserve's Regulation YY, but would raise the threshold of applicability for most of the requirements. Among other things, the EPS Proposal would exempt smaller institutions from all coverage and apply liquidity and capital standards only to FBOs with total consolidated assets of $250 billion or more.

FBOs with Less Than $50 Billion in Total Consolidated Assets

FBOs with less than $50 billion in total consolidated assets would not be subject to EPS. In contrast with the current framework, FBOs with total consolidated assets greater than $10 billion but less than $50 billion would no longer be subject to home country stress test requirements or, even if they are publicly traded, required to maintain a U.S. risk committee.

FBOs with Total Consolidated Assets of At Least $50 Billion but Less Than $100 Billion

The only EPS that would apply to FBOs with total consolidated assets of at least $50 billion but less than $100 billion is the risk committee requirement. These FBOs would continue to be required to annually certify to the Federal Reserve that they maintain a committee of their global board of directors (or its equivalent) on a standalone basis or as part of its enterprise-wide risk committee that (1) oversees the risk management policies of the FBO's combined U.S. operations; and (2) includes at least one member having experience in identifying, assessing, and managing risk exposures of large, complex firms.

FBOs with Total Consolidated Assets of $100 Billion or More

Under the EPS Proposal, FBOs with total consolidated assets of $100 billion or more that have a limited U.S. presence would generally be subject to the requirements currently applicable to FBOs under Subpart N of Regulation YY, with certain distinctions.

First, all FBOs with total consolidated assets of $100 billion or more and combined U.S. assets of less than $100 billion would be subject, on a consolidated basis, to a capital stress testing regime by their home-country supervisor that meets certain standards. These FBOs would be required to conduct such stress tests, or be subject to supervisory stress tests, and to meet any minimum standards set by the home-country supervisor. Under the EPS Proposal, all FBOs in this category must be subject to such stress tests at least on a biennial basis, while those with total consolidated assets of $250 billion or more would be required to be subject to the stress test requirements on an annual basis.

The extent of the risk committee and risk management requirements for these FBOs depends on the size of their U.S. operations. FBOs with total consolidated assets of $100 billion or more and combined U.S. assets of less than $50 billion would be required to comply with the same U.S. risk committee requirement described above for FBOs with total consolidated assets of at least $50 billion but less than $100 billion.

However, under the EPS Proposal, FBOs with total consolidated assets of $100 billion or more and combined U.S. assets of at least $50 billion but less than $100 billion must continue to adhere to the more detailed risk committee and risk management requirements contained in Subpart N of Regulation YY. These FBOs would continue to be required to maintain a U.S. risk committee that "approves and periodically reviews the risk management policies of the combined U.S. operations...and oversees the risk-management framework of such combined U.S. operations." And, under the EPS Proposal, the risk management framework for such FBOs "must be commensurate with the structure, risk profile, complexity, activities, and size of its combined U.S. operations and consistent with its enterprise-wide risk management policies."¹² Other detailed risk committee and risk management requirements would apply, including those related to membership on the U.S. risk committee, the scope of the risk management framework and the appointment of a U.S. chief risk officer, among other things.

Finally, FBOs with a limited U.S. presence but with total consolidated assets of $250 billion or more would be subject to additional standards. Such FBOs would be required to meet capital adequacy standards on a consolidated basis that are established by their home country supervisors and consistent with the regulatory capital framework published by the Basel Committee on Banking Supervision. They also would be required to report the results of an internal liquidity stress test on an annual basis.

FBOs with a Significant U.S. Presence

Under the Tailoring Proposals, once an FBO has combined U.S. assets of $100 billion or more (i.e., a "significant U.S. presence"), the tailored approach shifts from solely size-based to a combination of size and other risk-based indicators. The risk-based indicators are designed to assess the risk the FBO poses to the U.S. financial system and include: cross-jurisdictional activity;¹³ total nonbank assets¹⁴; weighted short term wholesale funding;¹⁵ and off-balance sheet exposure.¹⁶

FBOs with a significant U.S. presence would generally be subject to the EPS currently set forth in Subpart O of Regulation YY, with distinctions based on the categories described below. Other requirements that apply to these FBOs include certain capital requirements for their IHCs and depository institution subsidiaries (stress testing, risk-based capital, leverage capital) and single-counterparty credit limits. These requirements would also be tiered depending on the FBO's category.

The document titled "Presentation Materials for Prudential Standards for Foreign Banking Organizations," which was published by the Federal Reserve together with the Tailoring Proposals, includes, among other things, a visual chart outlining the proposed capital and other requirements that would be imposed on FBOs under each category.¹⁷

Note that while the thresholds used by the Tailoring Proposals to categorize FBOs and IHCs are similar (as described below), different requirements may be applicable to FBOs and IHCs of the same category.

Category II

The most stringent requirements for FBOs are those imposed under Category II. Category II standards would apply to FBOs that have (1) $700 billion or more in average combined U.S. assets; or (2) $75 billion or more in average cross-jurisdictional activity and $100 billion or more in average combined U.S. assets.

The same thresholds for application of Category II standards to FBOs are used to classify IHCs under Category II, except where a measure is based on average combined U.S. assets for FBOs, it is based on average total consolidated assets for IHCs.

Category III

The next most stringent requirements for FBOs are those imposed under Category III. Category III standards would apply to FBOs that do not qualify for Category II standards but have (1) $250 billion or more in average combined U.S. assets; or (2) $100 billion in average combined U.S. assets and at least (a) $75 billion in average total nonbank assets; (b) $75 billion in average weighted short term wholesale funding; or (c) $75 billion in average off-balance sheet exposure.

The same thresholds for application of Category III standards to FBOs are used to classify IHCs under Category III, except where a measure is based on combined U.S. assets for FBOs, it is based on total consolidated assets for IHCs.

Category IV

Finally, the least stringent requirements for FBOs that have a significant U.S. presence are those imposed under Category IV. Category IV standards would apply to FBOs that do not qualify for Category II or III standards and have $100 billion or more in average combined U.S. assets.

IHCs would qualify for Category IV standards if they do not qualify for Category II or Category III standards and have $100 billion or more in average total consolidated assets.

Footnote

1 The proposal related to EPS (the "EPS Proposal") was released by the Board of Governors of the Federal Reserve System ("Federal Reserve"). The proposal related to the regulatory capital rule, the LCR rule, and the proposed NSFR rule (the "Capital and Liquidity Proposal" and, together with the EPS Proposal, the "Tailoring Proposals") was released jointly by the Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC and, together with the OCC and Federal Reserve, the "Agencies"). Press release announcing the Tailoring Proposals, which includes links to the proposals.

2 Total consolidated assets for an FBO is the total consolidated assets as reported on the FR Y-7Q. Total consolidated assets for an IHC is the total consolidated assets as reported on the FR Y-9C.

3Combined U.S. assets "means the sum of the consolidated assets of each top-tier U.S. subsidiary of the FBO (excluding any section 2(h)(2) company, if applicable) and the total assets of each U.S. branch and U.S. agency of the FBO, as reported by the FBO on the FR Y-7Q.

4 The Agencies proposed rules were published in the Federal Register on November 29, 2018 and December 21, 2018 which, if adopted, would tailor the supervisory approach to supervision of large domestic banking organizations. Client alert discussing the domestic banking organization proposals. Domestic banking organization proposals.

5 12 C.F.R. part 252.

6 12 C.F.R. part 217.

7 12 C.F.R. part 249.

8 Net Stable Funding Ratio: Liquidity Risk Measurement Standards and Disclosure Requirements, 81 Fed Reg. 35123 (June 1, 2016).

9 Client alert on the Regulatory Relief Act.

10 Non-branch assets are equal to the sum of the consolidated assets of each top-tier U.S. subsidiary of the FBO (excluding any section 2(h)(2) company (i.e., a company held pursuant to Section 2(h)(2) of the Bank Holding Company Act of 1956) and DPC branch subsidiary (i.e., any subsidiary of a U.S. branch or agency acquired, or formed to hold assets acquired, in the ordinary course of business and for the sole purposes of securing or collecting debt previously contracted in good faith by that branch or agency), if applicable). 12 C.F.R. § 252.152(b)(2).

11 Under the Tailoring Proposals, IHCs would be subject to EPS, capital and liquidity requirements based on a tiered approach that parallels the approach proposed for FBOs and domestic banking organizations.

12 If the FBO operates in the United States solely through an IHC, the U.S. risk committee would be required to be a committee of the board of directors (or its equivalent) of the IHC. If the FBO operates through a branch and agency network, the U.S. risk committee could be a committee of the global board of directors (or its equivalent) or of the IHC board of directors (or its equivalent). In either case, the U.S. risk committee could be a standalone risk committee, or a joint committee with the enterprise-wide or IHC risk committee, as applicable.

13 For an IHC, cross-jurisdictional activity would be "equal to the sum of cross-jurisdictional claims and cross-jurisdictional liabilities of the U.S. intermediate holding company, as reported on the FR Y-15." For an FBO, cross-jurisdictional activity would be "equal to the sum of cross-jurisdictional claims and cross-jurisdictional liabilities of the combined U.S. operations of the foreign banking organization, as reported on the FR Y-15."

14 Total nonbank assets for an IHC are the total nonbank assets as reported on the FR Y-9LP. Total nonbank assets for an FBO are the sum of (1) the assets of the FBO's nonbank U.S. subsidiaries (including those held under an IHC) excluding Section 2(h)(2) companies; and (2) the FBO's equity investments in unconsolidated subsidiaries, excluding equity investments in any section 2(h)(2) companies.

15 Weighted short-term wholesale funding means the weighted short-term wholesale funding as reported on the FR Y-15.

16 Off-balance sheet exposure for an IHC is the total exposure as reported on the FR Y-15 minus the total consolidated assets of the IHC for the same calendar quarter. Off-balance sheet exposure for an FBO is the total exposure of combined U.S. operations as reported on the FR Y-15 minus the combined U.S. assets of the FBO for the same calendar quarter.

17 Presentation Materials for Prudential Standards for Foreign Banking Organizations.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.