Keywords: federal reserve, prudential standards, foreign banking organizations, FBOs

On December 14, 2012, the Board of Governors of the Federal Reserve System (FRB) released a 300-page proposed rule (the Proposal) that would implement Sections 165 and 166 of the Dodd-Frank Wall Street Consumer Protection Act (Dodd-Frank Act) for foreign banking organizations (FBOs).1 The Proposal would impose heightened prudential requirements (including capital, liquidity, single counterparty credit limits, risk management, stress testing, and early remediation) on the US operations of foreign banking organizations having global consolidated assets of $50 billion or more. However, certain standards would apply to FBOs with consolidated assets of $10 billion or more, regardless of the size of their US operations.2

The Proposal represents a significant departure from FRB's long-standing tailored approach to supervising the US operations of FBOs, which relies significantly on consolidated supervision by home-country authorities in accordance with international standards and the willingness and ability of the FBO to support its US operations under various conditions. Under the current supervisory framework, FBOs generally have enjoyed substantial flexibility in how they structure their US operations (e.g., direct branching, direct or indirect ownership of bank and nonbanking subsidiaries), an approach intended to facilitate cross border banking and increase the global flow of capital and liquidity. Congress established this framework both to implement the policy of national treatment, which was characterized in its classic formulation in the International Banking Act of 1978 (IBA), as amended, as "parity of treatment in like circumstances," as well as in recognition of the structures that US banks preferred for their own global operations. Such a framework also promoted the efficient allocation of capital and liquidity within global organizations operating on a cross-border basis.

The financial crisis of 2008 has resulted in a re-evaluation of this framework. Although the FRB has acknowledged that the United States did not suffer a destabilizing failure of foreign banks, the concern that the absence of liquidity or specific capital in local markets could make such operations more vulnerable to economic disruptions led to a re-evaluation of the historic approach to foreign bank that is reflected in the Proposal.

Sections 165 and 166 of the Dodd-Frank Act directed the FRB to impose enhanced prudential standards on FBOs having global consolidated assets of $50 billion or more. Because of the difficulties it anticipates in monitoring compliance with those standards at the level of the consolidated FBO, the FRB is proposing to require a uniform organizational structure for the US operations of the largest FBOs, a US intermediate holding company (IHC), on which the enhanced standards would be imposed. These enhanced standards are intended to increase the resilience of the US operations of FBOs to stressed conditions and to minimize the risk posed to the US financial system in the event of the FBO's failure.

The proposed enhanced prudential standards are lengthy, complex, often ambiguous, and likely to be controversial. The good news is that, consistent with the intent of the Congress in the IBA, the FRB is not seeking to force foreign banks to "roll up" their US branches and agencies (US branches) into separately incorporated subsidiaries that are part of the IHC. However, the requirement that larger FBOs establish IHCs, which was not required or even considered by the Congress in the Dodd-Frank Act, will likely lead to inefficiencies and greater costs. Moreover, even FBOs with consolidated global assets of as little as $10 billion and minimal US operations will be subjected to US imposed stress testing and governance requirements, and could face additional restrictions.

For these reasons, the Proposal as a whole raises serious policy concerns, including whether it may encourage foreign governments to impose similar or even more burdensome requirements on the non-US operations of US banks, and undermine efforts to develop common global standards, such as the Basel Committee on Banking Supervision's (BCBS) proposed capital and liquidity standards, as well as development of an effective cross-border resolution regime. In addition, the Proposal could adversely affect the US economy if it leads FBOs to scale back or even eliminate their US operations, or makes them less efficient.

Despite the FRB's cautions to the contrary, the Proposal also provides some insight into how the FRB's thinking may have evolved concerning several key aspects of its December 2011 proposal that would impose similar enhanced prudential standards on US bank holding companies (2011 Domestic Proposal).

The proposed enhanced prudential standards generally would take effect on July 15, 2015. Although the various size thresholds under the Proposal would be based on an average of the FBO's total consolidated assets for the prior four consecutive quarters, the delayed effective date may nevertheless provide some FBOs with assets near the proposed thresholds with incentives to try to ensure that they fall (and remain) below those thresholds on the effective date.

This update provides an overview of the key components of the FRB's Proposal and highlights significant issues for consideration. The comment period for the Proposal ends on March 31, 2013.

US Intermediate Holding Company Requirement

The Proposal generally would require any FBO that has (i) $50 billion or more of consolidated global assets and (ii) at least $10 billion in assets in US subsidiaries to organize its US subsidiaries under a single IHC. This IHC would then be subject to the Proposal's enhanced prudential standards and early remediation requirements. Key highlights and considerations relating to the IHC proposal include the following:

  • Calculation of $10 Billion Threshold. For purposes of calculating the threshold, US subsidiaries would be defined using the Bank Holding Company Act (BHCA) definition of control and would include all US subsidiaries regardless of where they might currently be held in the global organization (including presumably through a US branch). The calculation would include US subsidiaries held through merchant banking authority and presumably non-US subsidiaries held through US subsidiaries (on a consolidated US basis). US subsidiaries held through the Section 2(h)(2) BHCA authority would not be included. In addition, assets reflecting inter-affiliate transactions between US subsidiaries would be excluded. Assets held in US branches of foreign banks would be excluded from the calculation of the $10 billion in US assets. FRB plans to monitor closely any attempts to shift assets from US subsidiaries to US branches to avoid the IHC threshold (or other aspects of the Proposal such as enhanced local capital standards), although it notes that any such transfers would be constrained by a number of factors, including legal restrictions on the kinds of assets that can be booked in US branches. In addition to challenging the concept of required use of IHCs, comment letters could recommend that the threshold for establishment of an IHC be set higher on the basis that in other contexts (e.g., resolution plan requirements), the FRB has implicitly acknowledged that companies with assets of $10 billion are unlikely to have systemic implications for the US financial system. Comment letters could also point out that the IHC requirement is contrary to policy in other jurisdictions that permit US banks to operate subsidiary businesses without establishing an intermediate holding company. Finally, commenters may wish to object to use of the BHCA control standard in this context, since its broad scope and lack of objectivity will likely raise practical problems in achieving compliance with the IHC requirement for certain subsidiaries.
  • Covered US Subsidiaries. The same US subsidiaries included in the calculation of the $10 billion threshold would be required to be held under the IHC. This could create tax and other legal issues with respect to restructuring current holdings. In addition to US bank subsidiaries, all US nonbank subsidiaries (other than 2(h)(2) companies), such as broker-dealers, finance companies, and insurance companies, would be held under the IHC. Likewise, special purpose entities (SPEs) and other transaction-related subsidiaries would have to be structured through the IHC. There is no indication that subsidiaries held through US branches would be excluded, even though the assets of the US branches would be excluded from the threshold calculation. Comment letters should address any concerns in this regard, including transition and grandfathering arrangements where reasonable.
  • Flexibility. In general recognition that the IHC requirement may not fit in all cases, the Proposal would give the FRB flexibility in "exceptional" circumstances to permit an FBO to use an "alternative organizational structure" based on the FBO's "activities, scope of operations, structure, or similar considerations." For example, multiple IHCs could be permitted for an FBO controlling more than one foreign bank with US operations, or where home-country laws prohibit use of a single US holding company. This flexibility could also be important to FBOs that own other major non-US financial services firms that are operated separately from the FBO's foreign bank subsidiaries. Comment letters could address additional specific areas where flexibility is needed to accommodate legal, regulatory, and tax considerations.
  • Regulatory Requirements. In addition to meeting the enhanced prudential standards, the IHC would be subject to reporting and recordkeeping requirements currently applicable to bank holding companies. To the extent that the IHC would also be a domestic bank holding company (BHC) subject to the FRB's Section 165 enhanced prudential standards for large domestic banking organizations, the enhanced prudential standards for IHCs would apply, rather than the domestic counterparts. The FRB may provide further guidance on various other regulatory requirements that will apply to IHCs.
  • Legal Authority. Nothing in the Dodd- Frank Act specifically requires or mandates use of IHCs. However, the FRB is relying on its broad authority under the Dodd-Frank Act to supervise foreign banks with more than $50 billion in global assets, as well as its other broad sources of statutory authority over foreign banks, to justify adoption of the IHC requirement.
  • Effective Date. The threshold calculations would be made as of July 1, 2014, and the IHC would be required to be established by July 1, 2015, unless the FRB extends that period in writing. Existing US holding company structures could be used.
  • Notice Requirement. The FRB would require an after-the-fact notice of the establishment of the IHC. The Proposal does not address procedures relating to establishment of a de novo IHC over am existing US bank.

Risk Based Capital and Leverage Requirements

The Proposal would supplement the FRB's traditional approach of relying primarily on consolidated capital requirements measured under home-country standards when assessing the capital adequacy of FBOs seeking to expand or establish US operations with one requiring allocation of local capital specifically to the US holding companies of the largest US bank and nonbank subsidiaries of foreign banks. Key highlights and considerations relating to the proposed enhanced capital requirements for foreign banks include the following:

  • Rationale. Among the key factors cited by the FRB for the proposed enhanced capital requirements are: (i) an increased focus on the risk to US financial stability posed by the US operations of the largest foreign banking organizations, (ii) increased doubts about the ability and willingness of parent FBOs to support their US operations during periods of stress, and (iii) incentives for home and host countries to restrict cross-border intra-group capital flows when global banking organizations face financial difficulties, due to the difficulties in developing an effective cross-border resolution regime for global foreign banks. Points that are likely to be made by commenters are that ring-fencing of US subsidiary operations through the imposition of host-country capital requirements interferes with capital allocations within global firms, is contrary to the cooperative intent behind the development of international capital standards, and is contrary to the approach taken by most other jurisdictions.
  • IHCs. Any FBO required to establish an IHC would be required to ensure that the IHC maintained sufficient local capital to comply with all US capital requirements as if the IHC were a US BHC (i.e., even if the FBO does not control a US bank subsidiary). These requirements would include the general US risk-based capital requirements (currently based on Basel I but likely to be replaced by the July 2015 effective date of this Proposal by the pending US proposal to implement Basel III), and, as applicable, the "advanced approaches" risk-based requirements (which would be modified under the pending US Basel III proposals) and "market risk" requirements. The US leverage capital requirement would not apply to the IHC, although it would be expected to meet the Basel III leverage standard when it takes effect.
  • Large IHCs. IHCs with $50 billion or more in consolidated assets also would be subject to the FRB's capital plan rules and required to submit an annual capital plan demonstrating the ability of the IHC to maintain capital above the required minimum ratios under both baseline and severely stressed conditions over at least nine quarters or face restrictions on its ability to make capital distributions. Large IHCs determined to be systemically important in the United States also could be subject to additional capital surcharges.
  • FBOs Not Subject to IHC Requirement. FBOs with at least $50 billion in consolidated global assets, but not required to establish an IHC, would have to certify to the FRB that they met consolidated home-country risk based capital requirements "consistent with" the global Basel III framework (taking into account available transition periods). Covered FBOs from countries that have not adopted Basel III would have to "demonstrate" to FRB that their capital is in fact "consistent" with Basel III standards. Covered FBOs also will be required to certify or otherwise demonstrate compliance with the international leverage ratio under Basel III, which is scheduled to take effect in 2018. Consistent with its existing policy, the FRB is not proposing to require covered FBOs to meet the current 4 percent US leverage ratio in the interim; however, it has specifically requested comment on that issue. The Proposal is vague, perhaps deliberately so, as to how home-country deviations from the global Basel III framework will be taken into account for these purposes. The FRB would have discretion to limit the US activities or operations of any covered FBOs that could not satisfy these enhanced capital requirements.
  • Reports. All FBOs with at least $50 billion in consolidated assets would be required to file an expanded FR Y-7Q on a quarterly basis. Currently, only those FBOs that are FHCs are required to file quarterly rather than annually.

Liquidity Requirements

The Proposal would implement a set of specific liquidity requirements for FBOs with consolidated global assets of $50 billion or more. The requirements differ significantly for FBOs with combined (branch, agency, and IHC or subsidiary operations) US assets of less than $50 billion as compared to those with combined assets of more than $50 billion. Key aspects of the Proposal are highlighted below:

  • FBOs with Combined US Assets Less Than $50 Billion. Under the Proposal,FBOs with $50 billion or more in totalconsolidated assets, but whose combined USassets are less than $50 billion, would berequired to report to the FRB annually on theresults of internal liquidity stress testing foreither the consolidated operations of the FBOor its combined US (branch, agency, and IHCor subsidiary) operations conducted inaccordance with BCBS principles for liquidityrisk management and incorporating 30-day,90-day, and one-year test horizons. Failure tocomply would result in the FBO having tomaintain its combined US operations in a netdue-to funding position or a net due fromfunding position with non-US affiliatedentities equal to not more than 25 percent ofthe third-party liabilities of its combined USoperations on a daily basis.
  • FBOs with Combined US Assets of $50 billion or More. For FBOs with totalconsolidated assets of $50 billion or more andcombined US assets of $50 billion or more,the liquidity-management, testing, andreporting obligations would be much moreextensive. These requirements would applyacross the FBO's US operations – both branchand agency networks and the IHC. For thiscategory of FBO, the Proposal contemplates aliquidity management framework thatfeatures: (i) active involvement on the part ofthe institution's risk committee and chief riskofficer in the management of liquidity risk;(ii) regular cash flow projections; (iii) monthlyliquidity stress testing; (iv) the maintenanceof a buffer of highly liquid assets primarily inthe United States to cover cash flow needsunder stressed conditions; (v) themaintenance of a contingency funding plan;(vi) specific limits on funding sources; and(vii) collateral monitoring.
  • Framework for Managing Liquidity Risk. As explained in greater detail in theRisk Management and Risk CommitteeRequirements section, below, the Proposalrequires FBOs with consolidated global assetsof $50 billion or more and combined USassets of $50 billion or more to establish a riskcommittee and to appoint a chief risk officer.The risk committee would be responsible for setting the liquidity risk tolerance of the FBO's US operations. The chief risk officer would have responsibilities for implementing the FBO's liquidity risk framework including (i) approving the liquidity costs, benefits, and risks of each significant new business line engaged by the US operations and each significant new product offered, managed, or sold through the US operations before the company implements the business line or offers the product, and (ii) approving the size and composition of the liquidity buffer.
  • Monitoring Requirements. FBOs with combined US assets of $50 billion or more would be required to monitor liquidity risk related to collateral positions of the US operations, liquidity risks across the US operations, and intraday liquidity positions for the combined US operations. The Proposal also requires monitoring of collateral positions in order to enable weekly calculation of the assets of the combined US operations that are pledged as collateral for an obligation or position and the assets that are available to be pledged. In addition, FBOs with combined US assets of $50 billion or more would be required to establish and maintain an independent (of management) review function to evaluate the adequacy and effectiveness of the liquidity risk management of the combined US operations.
  • Comprehensive Cash Flow Projections. The Proposal would require FBOs with combined US assets of $50 billion or more to produce short- and long-term projections of cash flows arising from assets, liabilities, and off-balance sheet exposures and identify and quantify discrete and cumulative cash flow mismatches over these time horizons.
  • Liquidity Stress Test Requirements. FBOs with combined US assets of $50 billion or more would be required to conduct monthly stress tests of the IHC and the US branch network. The results of these monthly stress tests would be provided to the FRB. FBOs would also be required to provide the FRB with a summary of the results of any liquidity stress test and the amount of any liquidity buffers required by home-country regulators.
  • Liquidity Buffer. The US branch network and the IHC would each be required to maintain a separate liquidity buffer consisting of high-quality liquid assets equal to net stressed cash flow needs over a 30 day stressed horizon. Net stressed cash flow needs would include separate calculations of both external (i.e., unaffiliated third parties) and internal (i.e., head office and affiliates) net cash flows (intended to minimize the ability of FBOs to rely on intra-group cash flows to meet external cash flow needs).3 The calculation methodology for internal net stressed cash flows would be designed to provide an FBO with incentives to minimize maturity mismatches between its US operations and its head office and affiliates. In the case of an IHC, all liquid assets used to meet the buffer would have to be held in the United States (cash assets could not be held at an account of an affiliate of the IHC). US branches would be required to hold liquid assets in the United States sufficient to cover net stressed cash flow needs for at least the first 14 days of the stress test horizon (again, cash could not be held at an affiliate). However, for days 15 through 30 of the stress test horizon, the US branch network would be permitted to maintain the liquidity buffer outside the United States, provided the FBO could demonstrate, to the satisfaction of the FRB, ready availability and access to those assets by the US branch network.
  • Liquidity Buffer Composition. Only highly liquid, unencumbered assets would be included in a liquidity buffer, including cash or securities issued or guaranteed by the US government. Other assets could be included if the FBO can demonstrate to the satisfaction of the FRB that the asset has low credit risk and low market risk, is traded in an active secondary two-way market, and is a type of asset that investors historically have purchased in periods of financial market distress (flight to quality) such as certain "plain vanilla" corporate bonds. An asset is considered unencumbered if (i) the asset is not pledged, does not secure, collateralize, or provide credit enhancement to any transaction, and is not subject to any lien, or, if the asset has been pledged to a Federal Reserve Bank or a US government-sponsored enterprise, the asset has not been used, (ii) the asset is not designated as a hedge on a trading position under the FRB's market risk rule, and (iii) there are no legal or contractual restrictions on the ability of the company to promptly liquidate, sell, transfer, or assign the asset.
  • Contingency Funding Plan. The FBO would be required to establish and maintain a contingency funding plan for its combined US operations. The plan would have to be commensurate with the complexity and profile of the US operations and specific to US legal entities, including the US branch network and the IHC. The objective would be to provide a plan for responding to a liquidity crisis, to identify alternative sources that the US operations can access during liquidity stress events, and to describe steps that would be taken to ensure that the company's sources of liquidity are sufficient to fund its operating costs and meet its commitments while minimizing additional costs and disruption. The four components of the plan would consist of (i) quantitative assessment, (ii) event management procedures, (iii) monitoring procedures, and (iv) testing requirements.
  • Specific Concentration Limits. The Proposal would require FBOs with combined US assets of $50 billion or more to establish and maintain limits on concentrations of funding by instrument type, single counterparty, counterparty type, secured and unsecured funding, and other liquidity risk identifiers such as the amount of specified liabilities that mature within various time horizons and off balance sheet exposures that could create funding needs during liquidity stress events.

Single‐Counterparty Credit Limits

To limit risk from the failure of an individual firm, the single-counterparty credit limits would cap the credit exposure of an IHC and the combined US operations of an FBO with $50 billion or more in global consolidated assets to any unaffiliated counterparty, with more stringent requirements placed on the IHCs and FBOs with the largest US presence. Key highlights and considerations relating to the proposed single-counterparty credit limits rule include:

  • Credit Exposure Limited to 25 Percent of Regulatory Capital. The Proposal wouldprohibit an IHC or the combined USoperations of an FBO with $50 billion or morein global consolidated assets from havingaggregate net credit exposure to any singleunaffiliated counterparty above 25 percent ofthe IHC's capital stock and surplus or above25 percent of the FBO's consolidated capitalstock and surplus. Under the Proposal,"capital stock and surplus" for IHCs would bedefined as the sum of the company's totalregulatory capital as calculated under the risk-basedcapital adequacy guidelines applicableto that IHC under the Proposal, and thebalance of the allowance for loan and leaselosses of the IHC not included in tier 2 capitalunder those guidelines. For FBOs withoutIHCs, due to differences in internationalaccounting standards, FBO capital stock andsurplus would be defined as the totalregulatory capital of such company on aconsolidated basis, as determined accordingto the enhanced capital requirements of theProposal, and would not reflect the balance of the allowance for loan and lease losses not included in tier 2 capital. The FRB has requested comment on whether alternative methods of calculating capital stock and surplus should be considered, including a stricter alternative tied to tier 1 common equity.
  • More Stringent Limit Imposed on Largest IHCs and FBOs. The Proposalwould impose a more stringent limit(somewhere between 10 percent and 25percent) on aggregate net credit exposuresbetween "major" IHCs or "major" FBOs (IHCsand FBOs with total consolidated assets of$500 billion or more) and "major"counterparties (a BHC or FBO with totalconsolidated assets of $500 billion or more,and any nonbank financial companysupervised by the FRB). This limit, notspecified in the Proposal, would be consistentwith the limit established for major US BHCsand US nonbank financial companiessupervised by the FRB. The 2011 DomesticProposal contained a 10 percent limit for thispurpose, which was strongly criticized inindustry comment letters. Thus, the FRB'sdecision not to include a specific limit in theProposal appears to reflect itsacknowledgement that greater flexibility isneeded. The FRB may amend the Proposal toconform to any international standard thatmay be adopted for limiting large exposurelimits for banking organizations. The FRB hasalso requested comment on whether it shouldadopt a more nuanced approach (along thelines of the 12-factor approach to determinethe systemic importance of a global bankingorganization proposed by the BCBS proposalon capital surcharges) to determining whichIHCs and FBOs should be considered majorIHCs or major FBOs.
  • Definition of Credit Exposure. Credit exposures include: (i) all extensions of credit to a counterparty, including loans, deposits, and lines of credit; (ii) all repurchase agreements, reverse repurchase agreements, and securities borrowing and lending transactions with a counterparty; (iii) all guarantees, acceptances, or letters of credit (including endorsement or standby letters of credit) issued on behalf of a counterparty; (iv) all purchases of or investments in securities issued by the counterparty; (v) credit exposure to a counterparty in connection with a derivative transaction, as well as credit exposure to a reference entity, where the reference asset is an obligation or equity security of a reference entity; and (vi) any other similar transaction that the FRB determines to be a credit exposure for these purposes.
  • Calculation of Aggregate Net Credit Exposure. Aggregate net credit exposurewould generally be determined by calculatingthe FBO's gross credit exposure (together withthe exposure of its subsidiaries) and applyingadjustments (e.g., by taking into accounteligible collateral, eligible guarantees, eligiblecredit and equity derivatives, other eligiblehedges, and the effect of bilateral nettingagreements on securities financingtransactions). Calculation of gross and netcredit exposure under the Proposal generallywould be the same as under the 2011Domestic Proposal. Notably, despitesignificant criticism of the "current exposuremethod" for measuring derivatives exposure,the Proposal would continue to mandate itsuse by FBOs for measuring derivativesexposure for derivatives subject to qualifying master netting agreements. However, in recognition of the fact that a qualifying netting agreement applicable to a US branch may cover exposures of other FBO offices, FBOs would be permitted to use a "gross valuation methodology" applicable to derivatives not subject to a qualifying master netting agreement. Aggregate net credit exposure would have to be calculated on a daily basis, and monthly compliance reports submitted to the FRB. In the event of noncompliance, the Proposal generally would prohibit a covered IHC or the combined US operations of an FBO from engaging in additional credit transactions with the counterparty.
  • Definition of "Subsidiary." In calculating its aggregate net credit exposure to a counterparty, an IHC or FBO with $50 billion or more in global consolidated assets would be required to include the exposures of its US subsidiaries to the counterparty. Likewise, credit exposure to a counterparty would include exposures to any subsidiaries of that counterparty. Under the Proposal, a company would be a subsidiary if it is directly or indirectly controlled by another company. A company would control another company if it: (i) owns or controls with the power to vote 25 percent or more of a class of voting securities of the company; (ii) owns or controls 25 percent or more of the total equity of the company; or (iii) consolidates the company for financial reporting purposes. This definition of control is more limited than that of the BHCA and the FRB's Regulation Y, and would generally exclude funds and special purpose vehicles that are sponsored or advised by a covered IHC or combined US operations of an FBO.
  • Attribution Rule. The Proposal would require that an IHC, or, with respect to its combined US operations, an FBO with $50 billion or more in global consolidated assets, should treat a transaction with any person as a credit exposure to a counterparty to the extent that the proceeds of the transaction are used for the benefit of, or transferred to, that counterparty.
  • Government and Other Exemptions. The Proposal would cover credit exposures to persons, companies, foreign sovereign entities, and US state and local governments. The Proposal would exempt credit exposures to the US federal government (including its agencies, as well as Fannie Mae and Freddie Mac, while those entities are under conservatorship or receivership) as well as the FBO's home country sovereign. In addition, intraday credit exposures to a counterparty would be exempted, to help minimize the effect of the Proposal on the payment and settlement of financial transactions. The FRB may make other exemptions it determines are in the public interest and are consistent with the purposes of the Proposal.

Risk Management and Risk Committee Requirements

The Proposal would require FBOs that are publicly traded with total consolidated assets of $10 billion or more and all FBOs with total consolidated assets of $50 billion or more, regardless of whether their stock is publicly traded, to establish a risk committee to oversee their US operations. FBOs with total consolidated assets of $50 billion or more, and combined US assets of $50 billion or more, also would be required to appoint a US chief risk officer who would be responsible for implementing and maintaining a risk management framework for the company's combined US operations. These standards generally align with those proposed for domestic bank holding companies in December 2011, adjusted to some extent to take into account the specific structures of FBOs.

  • Organizational Alternatives. The US risk committee requirement could be satisfied if it is organized as a committee of the global board of directors or as a committee of the board of directors of the IHC. Thus, except as noted below, the US risk committee would not be required to be located in the United States. If the US risk committee is a committee of the global board, it could be organized on a standalone basis or as part of the enterprise-wide risk committee. However, an FBO with combined US assets of $50 billion or more that conducts operations in the United States solely through an IHC (i.e., no direct branches) would be required to maintain its US risk committee at the IHC level in the United States.
  • US Risk Committee Requirements. Whether organized at the parent or IHC level, at least one member of the risk committee must have risk management expertise commensurate with the capital structure, risk profile, complexity, activities, and size of the FBO's combined US operations. In addition, the level of expertise among committee members should be commensurate with the complexity and profile of the company.
  • Responsibilities of the US Risk Committee. The risk committee wouldoversee the operation of the risk managementframework, and that framework would berequired to correspond to the size, complexity,capital structures, activities, and risk profile ofthe FBO. The framework would have toinclude: (i) policies and procedures relating torisk management governance, riskmanagement practices, and risk controlinfrastructure for the combined US operationsof the FBO; (ii) processes and systems foridentifying and reporting risks and riskmanagement deficiencies; (iii) processes andsystems for monitoring compliance with thepolicies and procedures; (iv) processesdesigned to ensure effective and timelyimplementation of corrective actions toaddress risk management deficiencies;(v) specification of management's andemployees' authority and independence tocarry out risk management responsibilities;and (vi) integration of risk managementcontrol objectives in the management goalsand the compensation structure of thecombined US operations.
  • Additional Requirements for FBOs with Combined US Operations of $50 Billion or More. FBOs with combined US operationsof $50 billion or more would be required toappoint a US chief risk officer in charge ofoverseeing and implementing the riskmanagement framework of the company'scombined US operations. These FBOs alsowould be required to appoint at least oneindependent member to the risk committeewho is not, or has not been, an officer oremployee of the FBO or its affiliates duringthe previous three years, or a member of theimmediate family of a person who is, or hasbeen in the last three years, an executiveofficer of the FBO or its affiliates. Thisrequirement would apply regardless of wherethe US risk committee is located.
  • Risk Officer Requirements. All FBOs would be required to have risk management expertise commensurate with the capital structure, risk profile, complexity, activity, and size of the combined operations of the FBO. The risk officer would be required to be compensated at a level that ensures objective assessment of the risk taken by the company's combined US operations, and would report directly to the US risk committee and the company's global risk officer (though alternative reporting structures could be approved by the FRB on a case-by-case basis).
  • Risk Officer Responsibilities. The risk officer would be responsible for overseeing the development of processes and systems for identifying and reporting risks and risk management deficiencies and ensuring that risk management deficiencies are resolved in a timely manner. In addition, the responsibilities of a risk officer would include overseeing the regular provision of information to the US risk committee, the global chief risk officer, and the FRB. The risk officer would be expected to oversee regularly scheduled meetings, including special meetings with the FRB, to assess compliance with risk management responsibilities, as well as the implementation of and ongoing compliance with appropriate polices and procedures relating to risk management governance, practices, and risk controls of the combined US operations.

Stress Test Requirements

The Proposal would seek to adapt for FBOs the requirements of stress testing rules currently applicable to US bank holding companies. IHCs with total consolidated 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 tests. The Proposal also would apply stress testing requirements to US branches by first evaluating whether the home-country supervisor for the FBO conducts a stress test and, if so, whether the stress testing standards applicable to the consolidated FBO in its home country are broadly consistent with the US stress testing standards. If the US branches are net funders of head office and other affiliates, the FBO would have to provide additional information concerning home country stress test results in order to satisfy the FRB that its capital under stressed conditions would be adequate to ensure it could continue to support its US operations. Even FBOs with between $10 billion and $50 billion in consolidated assets would have to be subject to home-country stress testing, or face asset maintenance restrictions on its US branches.

  • Stress Test Requirements for IHCs with Combined US Assets of $50 Billion or More. An IHC with total consolidated assetsof $50 billion or more would be required toconduct two company-run stress tests peryear, with one test using scenarios providedby the FRB (the annual test) and the otherusing scenarios developed by the company(the mid-cycle test). The IHC would berequired to file a regulatory report containingthe results of the annual test by January 5 andto publicly disclose a summary of the resultsbetween March 15 and March 31 each year.The mid-cycle results would have to be filedby July 5 and disclosed publicly in summaryform between September 15 and September30. Concurrently with the IHC's annualcompany-run stress test, the FRB wouldconduct a supervisory stress test usingscenarios identical to those provided for theannual company-run stress. The FRBwould disclose a summary of the results nolater than March 31 of each calendar year.
  • Stress Test Requirements for FBOs with Combined US Assets of $50 Billion or More. The US branch network of an FBOwith combined US assets of $50 billion ormore would be subject to a consolidatedcapital stress testing regime that includeseither (i) an annual supervisory capital stresstest conducted by the FBO's home-countrysupervisor or (ii) an annual evaluation andreview by the FBO's home country supervisorof an internal capital adequacy stress testconducted by the FBO. In either case, thehome-country stress testing regime wouldhave to set forth requirements for governanceand controls of the stress testing practices byrelevant management and the board ofdirectors of the FBO. FBOs would be obligatedto submit information to the FRB regardingthe results of home-country stress tests,including: (i) a description of the types of risksincluded in the stress test; (ii) a description ofthe conditions or scenarios used in the stresstest; (iii) a summary description of themethodologies used in the stress test;(iv) estimates of the FBO's projected financialand capital condition; and (v) an explanationof the most significant causes for the changesin regulatory capital ratios. Significantly, if theUS branch network is in a net due fromposition to the FBO, calculated as the averagedaily position from a given October- to-October period, the FBO would be required toreport additional information to the FRB onits stress tests, including: (i) a detaileddescription of the methodologies used in thestress test; (ii) detailed information regardingthe organization's projected financial andcapital position over the planning horizon;and (iii) any additional information the FRB deems necessary to evaluate the FBO's ability to absorb losses in stressed conditions.
  • FBO Failure to Comply with Stress Test Requirements. In the event an FBO withcombined US assets of $50 billion or morefails to meet the stress test requirements listedabove, the FRB would require its US branchnetwork to maintain eligible assets (as definedunder New York law) equal to 108 percent ofthird-party liabilities, i.e., an assetmaintenance requirement. Additionally, theFBO would be required to conduct an annualstress test of any US subsidiary not held underan IHC (other than a 2(h)(2) company),separately or as part of an enterprise-widestress test, to determine whether thesubsidiary has capital necessary to absorblosses as a result of adverse economicconditions, and to report summaryinformation about the results to the FRB onan annual basis. In addition, the FRB couldimpose intra-group funding restrictions onthe US operations of the FBO or could imposeincreased local liquidity requirements.
  • Stress Test Requirements for FBOs with Total Consolidated Assets of More than $10 Billion. An FBO with totalconsolidated assets of $10 billion or morewould be subject to a consolidated capitalstress testing regime that includes either anannual supervisory capital stress testconducted by the company's supervisor or anannual evaluation and review by thecompany's home-country supervisor of aninternal capital adequacy stress testconducted by the company. Such an FBOwould not be subject to separate informationrequirements imposed by the FRB relating tothe results of stress tests. Failure to meet thisrequirement would result in the FRBrequiring the branch and agency network tomeet a 105 percent asset maintenancerequirement (lower than the 108 percentrequirement above due to the more limitedrisk this category of FBO poses to the USeconomy). Companies that do not satisfy thisstress test requirement would be required to(i) conduct an annual stress test of anysubsidiary not held under an IHC (except2(h)(2) companies), either separately or aspart of an enterprise-wide stress test, todetermine whether the subsidiary has thecapital necessary to absorb the results ofadverse economic conditions and (ii) submit a report on the test to the FRB on anannual basis.

Early Remediation Framework

The Proposal would establish a mandatory early remediation regime for US operations of foreign banks with $50 billion or more in consolidated global assets.

FBOs with $50 Billion or More in Global and US Assets. These FBOs would be subjectto a mandatory early remediation regimeprecipitated by triggers linked to capital ratios,stress test results, market-based indicators, andrisk management weaknesses for both the IHCand the parent FBO.The remediation could involve four phases:(i) heightened supervisory review (Level 1), inwhich supervisors conduct a targeted review ofthe FBO's US operations to determine if itshould be moved to the next level ofremediation; (ii) initial remediation (Level 2), inwhich an FBO's US operations are subject to aninitial set of remediation measures, includingrestrictions on growth, acquisitions, and capitaldistributions; (iii) recovery (Level 3), in whichan FBO's US operations are subject to aprohibition on growth, acquisitions, and capitaldistributions, restrictions on executivecompensation, requirements to raise additionalcapital, and additional requirements on a case-by-case basis; and (iv) recommended resolution(Level 4), in which the FRB would considerwhether the FBO's US operations warranttermination or resolution based on the financialdecline of the combined US operations, thefactors set forth in Section 203 of the Dodd-Frank Act's Orderly Liquidation Authority (danger of default, adverse effect on financial stability in the United States, no private sector alternative, etc.), and any other relevant factors.

FBOs with $50 Billion or More in Global Assets and Less Than $50 Billion in US Combined Assets. The FRB would alsoconsider these remediation levels in dealing withFBOs that have $50 billion or more in globalconsolidated assets, but less than $50 billion incombined US assets, on a case-by-case,discretionary basis. In exercising this authority,the FRB would consider the activities, scope ofoperations, structure, and risk to US financialstability posed by the FBO.

The Proposal provides a detailed approach toapplying these triggers and the remediationlevels to the IHC and the US branches of theaffected FBO. The FRB has also provided a two pagechart (see Tables 2-3, attached)summarizing the Proposal. Other highlights ofthe early remediation proposal include thefollowing:

  • Market-Based Indicators. The FRB is considering whether to use market-based indicators as a trigger for early remediation. This could include the use of equity-based indicators (e.g., expected default frequency, market equity ratio, option-implied volatility, and certain debt-based indicators such as credit default swaps and subordinated debt spreads). At this time, the FRB is only considering the use of market-based indicators to trigger the Level 1 heightened supervisory measures.
  • US Branches. In Level 2 remediation, US branches would be required to maintain a net due-to position to the head office and to non-US affiliates. The US branch network would also be required to maintain its entire liquid asset buffer in the United States. This liquidity requirement would cease to apply were the FBO to become subject to Level 3 remediation.
  • Enforcement Action. An FBO that is subject to Level 2 remediation would be required to enter into a non-public memorandum of understanding or other enforcement action acceptable to the FRB.
  • Replacement of Officers and Directors. In Level 3 remediation, the FRB could require the IHC to replace its board of directors or require the IHC to dismiss senior executive officers.
  • Current FRB Authority. The proposed remediation regime would supplement, not replace, the range of supervisory tools that the FRB currently uses in dealing with financial stress in the US operations of foreign banks.

Effective Date/Timing of Compliance

  • As discussed below, FBOs generally will be required to meet the enhanced standards under the Proposal by July 1, 2015.
  • For FBOs that have global total consolidated assets of $50 billion or more as of July 1, 2014, the enhanced prudential standards detailed in the Proposal (as applicable, based on the relevant asset thresholds, including the requirement to establish an IHC) would apply starting July 1, 2015.
  • FBOs that meet the applicable asset thresholds and become subject to the prudential requirements after July 1, 2014 would be required to establish an IHC, and would become subject to the enhanced prudential standards (other than stress test requirements and the capital plan rule) 12 months after they reach the consolidated asset threshold of $50 billion.
  • Stress testing and the capital plan rule would apply in October of the year after an FBO must establish an IHC (i.e., October 2016 for those FBOs required to establish an IHC by July 1, 2015).
  • The proposed debt-to-equity limits, which apply if the Financial Stability Oversight Council determines that an FBO with total consolidated assets of $50 billion or more poses a grave threat to the financial stability of the United States, would apply on the effective date of the final rule.
  • A covered FBO must comply with the enhanced prudential standards detailed in the Proposal until its global consolidated (and, as applicable, US) assets remain below the applicable asset thresholds for four consecutive calendar quarters, or until the FBO no longer maintains a US banking presence.
  • A US branch network would be permitted to calculate the liquidity buffer for days 15 to 30 of the stressed horizon based only on external stressed cash flow needs, since, as discussed below, the buffer may be maintained at the parent level.

Table 1: Scope of Application for FBOs

Global Assets

U.S. Assets

SUMMARY OF REQUIREMENTS THAT APPLY

Approx. # of FBOs per category4

> $10 billion and < $50 billion

n/a

  • Have a U.S. risk committee5(can be part of head office governance structure) or face discretionary restrictions on US activities/operations
  • Meet home country stress test requirements that are broadly consistent with U.S. requirements or comply with 105% asset maintenance requirement for US branches/agencies

29

> $50 billion

< $50 billion

All of the above, plus:

  • Meet home country risk‐based capital standards that are broadly consistent with global Basel III standards (including transition periods)
  • Single‐counterparty credit limits (tied to capital of parent in case of branches/agencies; local capital for IHCs)3
  • Subject to an annual company‐run liquidity stress test requirement (per BCBS standards) for consolidated FBO or combined US operations only ("noncompliance" results in cap on funding to head office and affiliates of 25% of third party liabilities)
  • Subject to discretionary DFA section 166 early remediation requirements for failure to meet specified standards
  • Subject to U.S. intermediate holding company (IHC) requirements (even if BHC):
    • Required to form U.S. IHC if non‐branch U.S. assets exceed $10 billion. All U.S. IHCs are subject to U.S BHC capital requirements, including potential G‐SIB surcharges
    • U.S. IHC with assets between $10 and $50 billion subject to DFA Stress Testing Rule (company‐run stress test)

84

> $50 billion

> $50 billion

All of the above, plus:

  • U.S. IHC with assets >$50 billion subject to capital plan rule and all DFA stress test requirements (CCAR, requiring submission of annual plan to FRB demonstrating ability to meet minimum risk‐based capital ratios on stressed basis in order to avoid restrictions on capital distributions)

  • U.S. IHC and branch/agency network subject to monthly liquidity stress tests (including 30‐day stressed liquidity buffer) and separate in‐country liquidity requirements (branch/agency network can maintain portion of buffer at head office if demonstrates to FRB ready availability/access)
  • U.S. risk committee must oversee more formal risk management framework for US operations, meet at
  • least quarterly, and have at least 1 independent member and FBO must have U.S. Chief Risk Officer located in the US who performs designated functions
  • Subject to non‐discretionary DFA section 166 early remediation requirements

23

Table 2: Early Remediation Triggers for Foreign Banking Organizations

Table 3: Remediation Actions for Foreign Banking Organizations

Footnotes

1 Foreign banking organizations are defined as foreign banks with US banking operations (including US branches, agencies and bank subsidiaries) and their parent companies. The Proposal is available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20121214a.pdf .

2 See Table 1, attached, which is an expanded version of the chart in the Proposal that summarizes the scope of the application of the Proposal's requirements to FBO

3 Approximate number of foreign banking organizations as of September 30, 2012.

4 Applies to FBO's with less than $50 billion in assets only if publicly traded.

5 Foreign banking organizations with assets of $500 billion or more and U.S. IHCs with assets of $500 billion or more would be subject to stricter limits.

Published on December 20, 2012.

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