Shortly before year-end, the Federal Reserve Board ("FRB") proposed several rules to manage systemic risks presented by bank holding companies with consolidated assets of $50 billion or more and by nonbank financial institutions that are designated as systemically important by the Financial Stability Oversight Council ("FSOC").1 The proposed regulation (the "Proposal") would implement the mandatory portions of sections 165 and 166 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act").2

The Proposal includes seven sets of requirements for the bank holding companies over the $50 billion mark and the (to-be-designated) systemically important nonbanks (collectively, the "covered companies"): (i) risk-based capital requirements and leverage limits,3 (ii) liquidity requirements, (iii) single-counterparty credit limits, (iv) risk management, (v) stress tests, (vi) the debt-to-equity ceiling, and (vii) early remediation.4 Portions of the risk management and stress test provisions extend to banking organizations with less than $50 billion but more than $10 billion in consolidated assets.

Highlights

As a whole, Proposal reflects a fair reading of the Act and provides a level of detail that is a two-edged sword. On the one hand, the details in the Proposal are helpful for a covered company to measure its compliance with enhanced prudential standards. On the other hand, the specifics in many of the new standards, including those relating to capital planning by nonbank covered companies, liquidity, restrictions on single-counterparty exposures, mandatory stress-testing, and early remediation, will compel all but the very largest bank holding companies to revisit their risk management systems to ensure that all of the particular requirements have been covered. Areas that warrant careful attention include:

  • Capital planning by nonbank covered companies. These companies must re-orient their financial planning to incorporate new quantitative requirements and to take account of all factors that inform capital adequacy.
  • Liquidity management. The board of directors and senior management have explicit duties to monitor and manage liquidity, including the development of specific limits on liquidity risk. Certainly covered companies already oversee and address liquidity issues at a high level, but the existing governance structures may not satisfy all of the proposed new requirements.
  • Liquidity buffer and the underlying liquidity stress test. The Proposal requires a liquidity buffer that anticipates the proposed liquidity coverage ratio under Basel III. The buffer will be composed of a limited number of highly liquid assets. The size of the buffer is to be determined by complex and virtually continuous stress tests. Covered companies typically have robust models for analyzing liquidity, but the Proposal places some critical parameters around the process that may require significant changes to those models.
  • Credit enhancements for single-counterparty exposures. The Proposal has one set of explicit requirements and one implicit set of provisions. Explicitly, the Proposal identifies how a covered company at risk of exceeding exposure limits may avoid compliance issues through the use of credit mitigants. Implicitly, because not all forms of credit enhancement under the risk-based capital rules would qualify as mitigants for the credit risk presented by counterparties, the Proposal suggests that the FRB could begin to take a narrower view of credit enhancements.
  • Double stress-testing. As directed by Dodd-Frank, the Proposal requires that both covered companies and the FRB conduct stress tests of the covered companies. Two aspects of the double-testing are important. First, because the tests use essentially the same inputs, the FRB test functions as a test of the validity of a covered company's testing process. Second, the Proposal requires that detailed stress test results be made public on a company-specific basis, which could lead to a variety of adverse market responses to the point that the responses to stress test results could create their own stress conditions for a company. The Proposal's public disclosure requirement, however, is not required by Dodd-Frank.
  • Early remediation. Although the substance of the early remediation regime may not differ in material respects from how the FRB currently supervises large bank holding companies under stress, the Proposal identifies several cause-and-effect scenarios that may result in harsher FRB responses to troubled institutions than has previously been the case.

In addition to these core issues, the Proposal discusses a few specific points that could have important operational consequences.

  • Capital. Capital adequacy is one of the highest priorities in bank supervision. For bank holding companies, however, the Proposal does not break new ground in this area. The Proposal does signal that the FRB will adopt the Basel III standards. The Proposal does not address the suggestion of at least one FRB governor that, in the course of reviewing proposed capital distributions and capital plans, the FRB will apply these standards. At the same time, the FRB proposes to require covered nonbank companies to comply with the regulatory capital standards that currently apply to bank holding companies, a requirement that may pose significant operational and compliance challenges for some, if not all, covered nonbank companies.
  • Companies that are not large U.S. bank holding companies. The Proposal treats these institutions in different ways. Foreign bank organizations ("FBOs") are excluded,5 as are, for most purposes, savings and loan holding companies.6 However, in addition to the covered companies, other institutions—bank and thrift holding companies with more than $10 billion in consolidated assets—are by statute subject to stress-test and risk committee requirements. The FRB observes that it has authority to apply enhanced standards to bank holding companies with less than $50 billion in consolidated assets, but the Proposal does not attempt to do so, apart from the statutory requirements.
  • Foreign sovereign debt. These instruments cannot be included in the "liquidity buffer"—the pool of assets each covered company must maintain for short-term liquidity. The limits on credit exposure to a single counterparty apply to investments in sovereign debt.
  • Fannie Mae and Freddie Mac securities. For "policy" reasons, this debt may be included in the liquidity buffer, although it must be discounted to reflect credit risk and volatility. The single-counterparty credit exposure limits do not apply to mortgage-backed securities issued by either of these two entities while they are operating under conservatorship.

Overview

A core system regulation requirement of Dodd-Frank is that the FRB establish prudential standards for the largest banking institutions that are more stringent than those that apply to smaller banks. The stated purpose of these enhanced requirements is to prevent or mitigate risks to U.S. financial stability that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected financial institutions. Another purpose of these standards is, in the FRB's words, "to provide incentives for covered companies to reduce their systemic footprint."

The Proposal marks the formal beginning of the standard-setting process. More will follow, including standards for FBOs and SLHCs. Section 165 authorizes the FRB to tailor standards, taking into consideration the capital structure, riskiness, complexity, financial activities (including activities), size, and any other risk factors that the FRB deems appropriate. Throughout the Proposal, the FRB notes that it will apply particular standards according to these factors, referred to by the FRB as the "systemic footprint" of a covered company. With respect to nonbank financial companies subject to enhanced standards, the FRB will assess the business model, capital structure, and risk profile of the company. Dodd-Frank does not provide for tailoring in all cases: the capital requirements in the Collins Amendment, section 171 of Dodd-Frank, apply equally to nonbank financial companies deemed systemically important as they do to bank holding companies over the $50 billion threshold.

The dates for compliance with the enhanced standards are not uniform. Although section 165 does not set a uniform compliance date, the Proposal provides two dates for compliance with most requirements in the Proposal. For companies that are covered companies on the effective date of the final rule, the deadline is the first day of the fifth full calendar quarter following the effective date. The deadline for companies that become covered after the effective date—either because they have been designated as systemically important by the FSOC or because as bank holding companies they have grown to more than $50 billion in consolidated assets—is the first day of the fifth full calendar quarter following the date on which they become covered. The compliance dates are different, however, for the enhanced risk-based capital and leverage requirements, the limits on single counterparty credit exposures, and stress testing.

The Proposal places the enhanced prudential standards in a new Regulation YY (12 C.F.R. part 252). We review each of the substantive subparts below in the order of their appearance in Regulation YY.

Risk-based Capital and Leverage (Subpart B)

The Proposal extends the existing capital requirements for covered bank holding companies to nonbank covered companies. A nonbank covered company must calculate total and Tier 1 risk-based capital and leverage ratios in the same way that bank holding companies do now. The nonbank covered company also must meet the same minimum capital requirements: four percent Tier 1 risk-based capital, eight percent total risk-based capital, and four percent leverage. Whether the balance sheet of every nonbank covered company can accommodate these requirements is an open question; the FRB requests comment on whether nonbank covered companies should be held to the same minimum capital requirements as bank holding companies.

The Proposal does not otherwise set forth new, quantitative capital requirements for all covered companies. The FRB's discussion in the Proposal7 describes a two-part process for implementing enhanced risk-based capital and leverage standards for covered companies.

First, nonbank covered companies will be subject to certain regulatory capital requirements and to the same new rules that require bank holding companies with assets of more than $50 billion to file capital plans and to conduct stress tests.8 With respect to capital standards, these companies must calculate their minimum risk-based and leverage capital requirements in accordance with the rules for bank holding companies. The companies also must hold capital sufficient to meet tier 1 and total risk-based capital ratios of four percent and eight percent, respectively, as well as a tier 1 leverage ratio of four percent. These requirements take effect on the later of the effective date of the final rule or 180 days after the date on which the FSOC determined the company to be systemically important and therefore subject to supervision by the FRB.

With respect to capital planning, the core requirement is that a plan demonstrate that the covered company is able to maintain a Tier 1 common equity ratio of at least five percent, as well as meeting all other minimum capital requirements, under both expected and stressed conditions over a nine-month planning horizon. The plan also must explain how the company will be able to continue operations during times of economic and financial stress. Much of the plan will depend on and incorporate the results of the covered company's internal stress tests. The stress tests will rely on financial data as of September 30 and on three sets of economic assumptions provided by the FRB in mid-November. A covered company must then complete its stress test and finalize the capital plan in time for submission to the FRB on January 5. The FRB will evaluate the plan, using the results of the company's own stress tests and the results of the FRB's own stress tests. The FRB will provide comments to the company by the end of March. The company then may be required to make changes to the capital plan; these changes must be completed within 30 calendar days.

In addition, the capital plan regulation requires, in some cases, advance FRB approval of capital distributions.

The date on which a covered company must begin to comply with the capital planning and stress testing requirements depends on the time period between the date on which the FSOC subjected the company to FRB supervision and September 30. September 30 is the reference date because both the capital plan and the stress tests use financial data as of that date. If a company has been designated as systemically important no less than 180 days before September 30 in a calendar year, then the company must comply with the capital planning and stress testing requirements from September 30 of that year and thereafter. By inference, if the designation is made less than 180 days before September 30, then the compliance date is September 30 of the following year.

Second, the FRB will, probably in 2014, introduce a quantitative risk-based capital surcharge for "some or all" covered companies, based on the Basel III capital surcharge framework for globally systemically important banks ("G-SIBs").9 The Basel III framework would impose surcharges in five tiers ranging from 100 to 350 basis points on approximately 30 G-SIBs. A particular G-SIB would be assigned to one of the four lower tiers (the fifth would be left empty for the time being) based on an assessment of twelve factors. The surcharge would phase in between 2016 and 2019. The G-SIBs and their assignments, however, have not been finally determined. The G-20 recently identified 29 G-SIBs, of which eight are covered companies. 26 other U.S. bank holding companies are not G-SIBs but are covered companies, and the FRB will have to make a decision on whether to impose a surcharge on them.

In its discussion of the Proposal, the FRB observes that other Basel III requirements other than the surcharge on G-SIBs and including generally higher capital requirements, a common equity requirement, conservation and countercyclical buffers, and a leverage standard (at least for internationally active banking entities), are under discussion and will be the subject of future FRB rulemakings. Given the length of the Basel III process and the emergence of some requirements already, most of the bank covered companies already will have begun to take these requirements into account in their capital planning. These requirements will present a greater challenge to nonbank covered companies as they are designated systemically important.10

The FRB appears to be planning a tiered approach to higher capital requirements—indeed, section 165(a)(2) encourages doing so—but the Proposal does not provide any substantive guidance on how the FRB might draw the lines in this area.

Liquidity (Subpart C)

The Proposal requires a far-reaching liquidity management program; several provisions are intended to increase in stringency as the systemic footprint of a covered company widens.11 The program has at least seven elements. The timing of compliance with all of these elements is subject to the presumptive first-day-of-the-fifth-quarter rule.

Corporate governance (12 CFR 252.52 - .54)

The Proposal places extensive and specific obligations on the board of directors in overseeing liquidity. Each covered company will need to take care that the board addresses these duties and documents its decision-making. Certain of the duties, but not necessarily all, may be carried out by a risk committee. We discuss the formation of the risk committee below, in connection with subpart E of the proposed Regulation YY.

The board is required to make the following decisions or take the following actions:

  • Review and approve the liquidity risk management strategies, policies, and procedures established by senior management.
  • On at least an annual basis, establish the company's liquidity risk tolerance. In doing so, the board must consider the company's capital structure, risk profile, complexity, activities, size, and any other appropriate risk-related factors.
  • On at least a semi-annual basis, review information provided by senior management to determine whether the company is managed in accordance with the established liquidity risk tolerance.
  • On at least an annual basis, review and approve the contingency funding plan. Review and approval is required as well whenever material revisions are made to the plan.

This risk committee (or a designated subcommittee) must undertake the following:

  • Review and approve the liquidity costs, benefits, and risks of each significant new business line and each significant new product. The review and approval must take place before the company implements the new line or offers the new product. The analysis must include consideration of the liquidity risk of the new business line under current conditions and under liquidity stress. This risk must be within the liquidity risk tolerance established by the board.
  • At least annually, review significant business lines and products to determine whether any has created unanticipated liquidity risk and whether the liquidity risk of each remains within the company's liquidity risk tolerance.
  • On at least a quarterly basis, conduct the following oversight tasks:
    • Review the cash flow projections (discussed below) for time periods beyond 30 days to ensure that liquidity risk is within the established tolerance.
    • Review and approve liquidity stress testing, including practices, methodologies, and assumptions. Review and approval also must take place whenever material revisions are made to the tests.
    • Review the liquidity stress testing results.
    • Approve the size and composition of the liquidity buffer.
    • Review and approve the specific limits on liquidity risk (described below).
    • Review liquidity risk management information necessary to identify, measure, monitor, and control liquidity risk and otherwise to comply with subpart C.
  • On a periodic basis, review the independent validation of the liquidity stress tests.
  • Establish procedures governing the content of senior management reports on the company's liquidity risk profile.

The FRB expects the periodic liquidity reviews and approvals to occur more frequently as market and idiosyncratic conditions warrant.

Senior management has inherent responsibility, of course, to manage the company in accordance with the decisions and recommendations of the board and the risk committee and with regulatory requirements. The Proposal identifies two aspects of these obligations; management should in turn ensure that its actions are appropriately documented. Senior management must:

  • Establish and implement strategies, policies, and procedures for managing liquidity risk. This responsibility includes oversight of all of the substantive elements of subpart C—liquidity risk management and reporting systems, cash flow projections, liquidity stress testing, the liquidity buffer, the contingency funding plan, specific limits on liquidity risk, and monitoring these procedures.
  • Regularly report to the risk committee (or its designated subcommittee) on the company's liquidity risk profile, as well as providing other necessary information to the board or the risk committee.

In addition to specifying duties of the board, risk committee, and senior management, the Proposal requires a covered company to establish an independent review function of liquidity risk management. This unit will have three responsibilities: on at least an annual basis, to review and evaluate the adequacy and effectiveness of such management; to assess compliance with both regulatory and internal requirements; and to report any noncompliance or material risk management issues to the board or the risk committee. The function must be independent of the management functions that execute funding, but otherwise the precise placement of the unit is within the company's discretion.

Liquidity buffer (12 CFR 252.57)

The one quantifiable element of the liquidity risk management process outlined in the Proposal is the liquidity buffer. The size of the buffer is based predominantly on two underlying analyses—cash flow projections and liquidity stress-testing—as well as on the company's systemic footprint. Before turning to these processes, it is helpful to consider the instruments includable (and not includable) in the buffer.

The asset pool that constitutes the buffer is limited to highly liquid and unencumbered assets that are sufficient to meet projected net cash outflows and the projected loss or impairment of existing funding sources for 30 days over a range of liquidity stress scenarios.12 The pool must be diversified by instrument type, counterparty, geographic market, and other liquidity risk identifiers. Discounts will be applied to reflect market volatility and credit risk.

While the language of the proposed regulation is general, the FRB's discussion of the buffer is specific. Eligible highly liquid assets are limited to cash, U.S. Treasuries, and other securities issued or guaranteed by the U.S. government, a U.S. government agency, or a U.S. government-sponsored entity. Notably, this portfolio would include debt issued by Fannie Mae and Freddie Mac. Non-U.S. sovereign debt and any debt issued by state or local governments in the U.S., however, are excluded. The FRB may approve other "flight-to-quality" assets for inclusion in the buffer (e.g., "plain vanilla" senor corporate debt) but only if they have low credit risk and low market risk, are traded in an active secondary two-way market with certain features,13 and historically have been purchased by investors in periods of financial distress during which market liquidity has been impaired.14

A highly liquid asset also must be unencumbered: it cannot be pledged, be used to secure, collateralize, or provide credit enhancement to any transaction, be subject to any lien or be subject to any legal or contractual restrictions on the company's ability to promptly liquidate, sell, transfer, or assign the asset. An asset designated as a hedge on a trading position is ineligible. An asset will be so designated if it is held in order to directly offset the market risk of another trading asset or group of trading assets, e.g., a corporate bond held in order to hedge a position in a corporate bond index.

Cash flow projections (12 CFR 252.55)

A detailed set of cash flow projections, both short- and long-term, is required. The Proposal calls for a robust methodology and reasonable assumptions, all of which must be documented. The projections should be dynamic rather than static and must take account of the flows resulting from assets, liabilities, and off-balance sheet exposures, as well as from contractual maturities and from new business, funding renewals, customer options, and other potential events that could affect liquidity. The projections must identify cash flow mismatches as well. The projections also must reflect the company's systemic footprint, which could entail projections at business line, legal entity or jurisdiction levels and the use of additional time horizons. The short-term projections must be updated daily and the long-term projections monthly.15

Liquidity stress testing (12 CFR 252.56)

On a monthly basis, a covered company must stress-test its cash flow projections. Given the complexity of these tests, a covered company effectively will be testing liquidity continuously. The testing is expected to follow the principles set forth in proposed guidance on stress testing that was released in June 2011.16 The company must use the results of the stress tests to determine the size of its liquidity buffer and must incorporate the results in the quantitative assessment component of its contingency funding plan. The Proposal does not specify the methodology for the tests, but it imposes four sets of requirements. A company must:

  • Incorporate a range of stress scenarios that in turn take into consideration at least the company's balance sheet exposures, off-balance sheet exposures, business lines, and organizational structure. The scenarios are required to:
    • Account for market stress, idiosyncratic stress, and combined market and idiosyncratic stresses.
    • Address the potential impact of market disruptions on the company.
    • Address the potential actions of other market participants experiencing liquidity stresses under the same market disruptions.
    • Be forward-looking and incorporate a range of potential changes in the company's activities, exposures, and risks, as well as changes to the broader economic and financial environment.
    • At a minimum, include four time horizons: overnight, 30 days, 90 days, and one year. The FRB could require additional horizons.
  • Address in a comprehensive manner, the company's activities, exposures, and risks, including off-balance sheet exposures.
  • Be tailored to, and provide sufficient detail to reflect the company's systemic footprint. Accordingly, analyses by business line, legal entity, or jurisdiction may be necessary.
  • Incorporate four conditions:
    • Only assets in the liquidity buffer—i.e., unencumbered, highly liquid assets—are available to meet funding needs in the first 30 days.
    • After 30 days, other "appropriate" funding sources may be added to the buffer assets for use as cash flow.
    • Any asset treated as a funding source must be discounted to reflect market risk and volatility.
    • Liquid assets (other than cash and securities issued by the U.S. government, a U.S. government agency, or a U.S. government sponsored entity) must be diversified by collateral, counterparty, borrowing capacity, or other liquidity risk identifiers.

Because of the frequency of the testing and the volume of data to be tested, a covered company must have in place an extensive risk management framework. A covered company must maintain management information systems and data processes sufficient to enable a company to effectively and reliably collect, sort, and aggregate data and other information relating to stress testing. Policies and procedures must outline the testing practices, methodologies, and assumptions, detail the use of each stress test, and provide for the enhancement of stress testing practices as risks change and techniques evolve. Oversight of the testing process must be sufficient to ensure that each test is designed in accordance with section 252.56 and that the stress process and assumptions are validated. Validation may be conducted internally but must be independent of the liquidity stress-testing functions and of the functions that execute funding.

Contingency funding plan (12 CFR 252.58)

A contingency funding plan is described by the FRB as a compilation of policies, procedures, and action plans for managing liquidity stress events. The plan is required to set out a covered company's strategies for addressing liquidity needs during liquidity stress events. A plan must be updated at least annually and more frequently as market and idiosyncratic events warrant. The plan must have four components:

  • Identification of stress events. This part incorporates information from liquidity stress testing. This part will consist of quantitative assessments of the impact of identified stress events on liquidity and of available funding sources (including alternative sources) during these events. Four specific types of information are necessary for this component of the contingency plan.
    • A company must identify stress events with significant effects on liquidity. These events could include deterioration in asset quality, rating downgrades, widening of credit default swap spreads, operating losses, declining financial institution equity prices, and negative press coverage.
    • The plan must assess the level and nature of the impact of various levels of stress severity, various stages for each type of event. There is no time period for disruptions; the plan should cover temporary, intermediate term and long-term events. This assessment should be used to design early warning indicators, assess potential funding needs, and to specify action plans.
    • The plan also must assess available funding sources and needs. This assessment requires an analysis of the potential loss of funding at various points in the stress event and the identification of cash flow mismatches. The FRB expects a realistic analysis of the company's cash inflows, outflows, and funds availability at different time intervals, which will enable the company measure its ability to fund operations.
    • The company must identify alternative funding sources. Discount window borrowing is acceptable, but the FRB implies that only primary credit (which is limited to healthy institutions and must be collateralized) will qualify. If a company does rely on the discount window, it must include a plan to replace this borrowing with permanent funding. The FRB expects procedures and agreements with alternative lenders to be in place before there is a need to access this funding.
  • Event management process. This process involves an action plan for responding to liquidity shortfalls during stress events (including accessing alternative funding sources), an identified "liquidity stress event management team," an explanation of how the company will invoke the plan, and a mechanism for communications internally and with the FRB, other regulators, counterparties, and other stakeholders.
  • Monitoring. A covered company must be able to identify early warning indicators and other means of monitoring stress events. Indicators may include negative publicity concerning an asset class owned by the company, potential deterioration in the company's financial condition, widening debt or credit default swap spreads, and increased concerns of the funding of off-balance sheet items.
  • Testing. The plan must provide for the periodic testing. Trial runs are necessary, with simulations to evaluate communications, coordination, and decision-making by the relevant managers. Additionally, a covered company is required to test the availability of alternative funding and its ability to access collateral to secure additional borrowing.

Specific limits (12 CFR 252.59)

The board is required to set several limits on the sources of liquidity risk. Even for large bank holding companies, the extent of the specific limits may go beyond those that an institution historically has set. The mandated limits must cover:

  • Concentrations of funding by instrument type, single counterparty, counterparty type, secured and unsecured funding, and any other liquidity risk identifiers.
  • The amount of specified liabilities that mature within various time horizons.
  • Off-balance sheet exposures and other exposures that could create funding needs during liquidity stress events.

Monitoring (12 CFR 252.60)

The Proposal requires a covered company to establish and maintain procedures for monitoring four different items:

  • The assets already pledged and unencumbered assets available to be pledged as collateral. The company must be able to calculate "in a timely manner" the value of its existing collateral positions relative to contractual requirements. Collateral monitoring also must cover levels of available collateral by legal entity, jurisdiction, and currency exposure; shifts between intraday, overnight, and term pledging of collateral; the operational and timing requirements associated with accessing collateral at its physical location.
  • Liquidity risk exposures and funding needs within and across business lines, legal entities, and jurisdictions, and intraday positions. A covered company must maintain sufficient liquidity for each significant legal entity in light of any restrictions on the transfer of liquidity between legal entities.
  • Intraday liquidity positions. These procedures must cover the monitoring of daily gross liquidity inflows and outflows, the use of collateral when necessary to obtain intraday credit, the prioritization of time-sensitive obligations, the ability to settle "less critical" obligations, controls on the issuance of credit where necessary, and the amounts of collateral and liquidity necessary to meet payment systems obligations. The FRB observes that the monitoring of these positions is generally an operational risk function, and a covered company accordingly will need to develop an integrated procedure for both operational and liquidity risk.
  • Compliance with the liquidity limits set by the company.

The FRB expects that, in order to conduct this monitoring, a covered company will need processes that aggregate data across multiple systems to develop an enterprise-wide view of liquidity risk management and to identify constraints on transferring liquidity within the organization.

Documentation (12 CFR 252.61)

A covered company has broad obligations to document all material aspects of its liquidity risk management process and its compliance with subpart C and to submit all of this documentation to the risk committee. In addition, a company must provide to the committee, the methodologies and material assumptions included in cash flow projections and liquidity stress tests, and all elements of the contingency funding plan. This material will be available to the FRB on request.

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Footnotes

1 FRB, Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies, 77 Fed. Reg. 594 (Jan. 5, 2012).

2 Pub. L. No. 111-203, 124 Stat. 1376 (July 10, 2010). The Proposal does not purport to be exhaustive, and further rulemaking is likely since the Proposal does not address all of the FRB's authority under section 165.

3 New capital and leverage requirements are not required for all systemically important financial institutions.

4 Two other requirements in section 165 already have been the subject of rulemaking. Section 165(d) requires the submission of resolution plans and credit exposure reports by covered companies. In October 2011, the FRB finalized a new Regulation QQ that addresses resolution plans (12 C.F.R. part 243), 76 Fed. Reg. 67323 (Nov. 1, 2011). A proposed rule dealing with credit exposure reports, 76 Fed. Reg. 22648 (Apr. 22, 2011), remains pending.

5 The FRB notes that it will propose an enhanced framework for FBOs shortly. In applying enhanced standards, the FRB is required by section 165(b)(2) to give due regard to the principle of national treatment and equality of competitive opportunity and to take into account the extent to which the foreign financial company is subject on a consolidated basis to home country standards that are comparable to U.S. standards. The FRB has exempted FBOs from the Proposal because of international agreements that do not contemplate all of the requirements in the Proposal, different home country approaches to bank supervision, diverse structures in the U.S., and wide variance in risk to U.S. financial stability.

6 Before issuing new capital and stress testing standards, the FRB must develop consolidated capital requirements for SLHCs.

7 The FRB's discussions or explanations of the enhanced prudential standards are located in the Supplementary Information portion of the Proposal.

8 12 C.F.R. § 225.8. See 76 Fed. Reg. 74631 (Dec. 1, 2011).

9 The FRB refers to the Basel document published in November 2011 that describes the surcharge. See BCBS, Global systemically important banks: Assessment methodology and the additional loss absorbency requirement (Nov. 2011), available at http://bis.org/publ/bcbs208.htm.

10 The Proposal contains a 180-day grace period for nonbank covered companies that are designated as systemically important after the effective date of Regulation YY. There is no such period for any institution so designated before the effective date.

11 Provisions to be tailored based on systemic footprint include the liquidity risk tolerance, the amount of detail provided in cash flow projections, liquidity stress testing, the size of the liquidity buffer, the contingency funding plan, and specific limits on potential sources of liquidity risk.

12 The buffer requirement is comparable to the liquidity coverage ratio ("LCR") now under review in the Basel III process. The FRB indicates that it will adopt the final Basel III LCR, as well as its companion, the net stable funding ratio.

13 A qualifying market must have observable market prices, committed market makers, a large number of market participants, and a high trading volume.

14 Compelling the largest participants in the capital markets to re-focus their investment strategies on a limited number of instruments will, for better or worse, drive up the price of those instruments and may well exacerbate the liquidity issues surrounding other instruments.

15 The format of the projections is set forth in note 66 to the Proposal, 77 Fed. Reg. 608.

16 See 77 Fed. Reg. 599 n.32. The proposal in June goes beyond liquidity stress-testing and covers testing for all risk management purposes.

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.

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