The Federal Reserve Board’s Proposed - Morrison &...

©

2013 M

orr

ison &

Foers

ter

LLP

| A

ll R

ights

Reserv

ed | m

ofo

.com

Global Association of Risk Professionals

The Federal Reserve Board’s Proposed

Dodd-Frank Systemic Prudential

Regulations for Foreign Banks

February 14, 2013

Presented By

Charles M. Horn

This is MoFo. 2

FBO Rules: Today’s Topics

• Genesis of the Proposed Rules

• Coverage and Effective Dates

• Intermediate Holding Companies

• Capital

• Liquidity

• Single-Counterparty Credit Limits

• Risk Management

• Stress Testing

• Debt-to-Equity Limits

• Early Remediation

• Risk Management Considerations

This is MoFo. 3

Some Defined Terms • BHCA – the U.S. Bank Holding Company Act

• Board – Federal Reserve Board

• Covered FBO – FBO with $50BB+ of consolidated worldwide assets

• Covered FNBFC – FNBFC with $50BB+ of consolidated worldwide

assets

• Covered foreign firm – Covered FBO or covered FNBFC

• DFA – Dodd-Frank Wall Street Reform and Consumer Protection Act

• FBO – Foreign banking organization as defined in Board Regulation

K.

• FNBFC – Foreign nonbank financial company

• IHC – U.S. intermediate holding company

• SIFI – Systemically important financial institution

• $10BB FBO – FBO with consolidated worldwide assets of between

$10BB and $50BB

This is MoFo. 4

Genesis of the Proposed Rules

• Proposed under DFA Sections 165,166 and 167:

• Section 165: Prudential regulation requirements for systemically

important banks.

• Section 166: Early remediation requirements for systemically

important banks and financial companies.

• Section 167: Prudential requirements for systemically important

nonbank financial companies.

• Modeled on DFA Section 165/166 rules that were

proposed in December 2011 for domestic bank holding

companies.

This is MoFo. 5


• Proposals also reflect other discrete Board concerns:

• Increased scope/complexity of FBOs’ U.S. nonbank operations.

• Availability of home country financial resources for U.S.

operations of foreign banks and financial companies.

• Availability of information on U.S. operations of foreign firms.

• Increasing use of U.S. branch/agency operations to fund home

country or offshore activities.

• The Board also took into account national treatment and

competitive equality considerations in these proposals.

This is MoFo. 6


• In short, the proposals represent the Board’s attempt to

create a workable framework for the U.S. regulation of

systemically important FBOs under the DFA, taking into

account the DFA’s statutory requirements, as well as the

Board’s stated experience with FBO supervision and risk

issues that came up during the recent financial crisis.

• The proposals are designed to address systemic risks to

the U.S. financial system posed by the U.S. operations of

FBOs and FNBFCs. Not surprisingly, therefore, the

requirements of the proposed rules are risk-based.

This is MoFo. 7

Coverage and Effective Dates

• General Coverage:

• All covered FBOs and covered FNBFCs.

• Tiered applicability of certain provisions (e.g., U.S. intermediate

holding company) based on size and tenor of U.S. operations.

• $10BB FBOs will be subject to stress testing and risk committee

requirements.

• Specific application of rule requirements to a covered FNBFC to

be determined on a case-by-case basis.

• Coverage variously determined by reference to four prior quarters

of financial reports filed on Forms FR Y-7Q (FBOs), FFIEC 002

(U.S. branches/agencies), or FR Y-9C (U.S. intermediate holding

companies).

This is MoFo. 8

Coverage and Effective Dates

• Effective Dates:

• General effective date is later of July 1, 2015 or 12 months after a

FBO or FNBFC becomes a covered foreign firm.

• There are certain requirements, such as the conditional debt-to-

equity limits, that have an earlier effective date.

• The Board may extend the effective time of one or more of the

proposed rules’ requirements in individual cases.

• Comment period on the rules closes on March 31, but a

60-day extension of the comment period already has

been requested by the major financial services trade

organizations.

This is MoFo. 9

Intermediate Holding Companies

• A covered FBO with $10BB+ of combined U.S. bank and

nonbank assets must consolidate those assets under an

IHC.

• U.S. branch and agency assets are excluded from this threshold.

• The IHC requirement applies even if the covered FBO does not

have any U.S. depository institution assets (excluding U.S.

branch/agency assets).

• The compliance date would be the later of July 1, 2015, or 12

months after a covered FBO crosses the U.S. asset threshold.

• Combined U.S. assets generally are computed for this purpose

based on four prior quarters’ Form FR Y7-Q financial data.

• IHC is established by an after-the-fact 30 day notice to the Board.

This is MoFo. 10

Intermediate Holding Companies

• Structure and Regulation of the IHC:

• All U.S. banking and nonbanking operations must be held under

the IHC, with two exceptions:

•U.S. branches and agencies of the FBO.

•BHCA section 2(h)(2) companies owned by the FBO.

• Controlling BHCA section 4(k) merchant banking investments in

U.S. companies must be held under the IHC.

• Board would allow multiple IHCs in “exceptional” cases.

• Some flexibility as to corporate form and domicile is allowed.

• IHCs of covered FBOs must have an elected and full- function

board of directors or managers.

• IHC is subject to regulation and supervision comparable to U.S.

bank holding companies, but is not subject to DFA 165/166 rules

for large domestic bank holding companies.

This is MoFo. 11

Capital

• General principles and requirements of the proposed

rules’ regulatory capital requirements:

• Beginning July 1, 2015, a covered FBO must certify and

demonstrate compliance with capital adequacy standards at the

consolidated level that are consistent with the Basel Committee

capital framework.

• U.S. branches and agencies of covered FBOs may meet U.S.

capital equivalency requirements on a consolidated basis.

• Must report specified regulatory capital elements every quarter to

the Board, including new capital elements as phased in under

Basel 3.

• Failure to meet capital requirements may result in Board

restrictions on U.S. activities or business operations.

This is MoFo. 12

Capital

• Regulatory capital requirements for IHCs:

• IHCs are subject to U.S. risk-based and leverage capital

requirements to the same extent as U.S. bank holding

companies.

• An IHC may be made subject to a risk-based capital surcharge if

the IHC is designated as a Basel Committee domestic

systemically important banking organization (“D-SIB”).

• An IHC with $50BB+ of consolidated assets must comply with

Board capital plan rule to the same extent as a covered U.S. bank

holding company (first plan would be due January 6, 2016), even

if it does not control a bank.

• IHC capital requirements also reflect Congressional mandate in

DFA section 171 (“Collins Amendment”) that top-tier U.S. holding

company subsidiaries of FBOs satisfy U.S. regulatory capital

requirements by July 2015.

This is MoFo. 13

Liquidity

• Requirements for covered FBOs with $50BB+ of

combined U.S. assets:

• Asset threshold includes U.S. branches and agencies.

• Covered FBO risk committee (see “Risk Management” below) must

review annually FBO’s liquidity risk tolerance for U.S. operations.

• U.S. chief risk officer (see “Risk Management” below) must:

• Conduct a liquidity risk tolerance, and a business strategies/products

review, of combined U.S. operations.

• Review and approve a contingency funding plan for U.S. operations.

• Review cash flow projections for U.S. operations at least quarterly;

review and approve liquidity risk management strategies, policies

and procedures; and report at least semi-annually to the U.S. and

enterprise risk committees on U.S. operations’ liquidity risk profile.

This is MoFo. 14

Liquidity • Requirements for covered FBOs with $50BB+ of

combined U.S. assets (cont.):

• Establish and maintain an independent liquidity risk management

review function. Regular (no less than annual) review is required.

• Production of comprehensive cash flow projections.

•Board might require reporting of worldwide consolidated cash

flows that are in US$.

• Conduct monthly (or more frequent as the Board may require)

liquidity stress tests that are reported to the Board.

•Separate testing of branch/agency network and IHC (if

applicable).

•Policies, procedures and controls for liquidity stress testing.

• U.S. and home country stress testing results must be promptly

(14 days) reported to the Board.

This is MoFo. 15

Liquidity

• Requirements for covered FBOs with $50BB+ of

combined U.S. assets (cont.):

• Liquidity buffer of unencumbered “highly liquid assets” for U.S.

operations.

•Separate buffers required for U.S. branch/agency network and

IHC.

•Liquidity buffer equal to external and internal “net stressed

cash flow need” over a 30-day horizon.

•U.S. branch/agency network must maintain days 1 through 14

of its liquidity buffer in the U.S.

• IHC must maintain its liquidity buffer in the U.S.

• Establish and maintain a contingency funding plan.

• Limits on sources of liquidity must be developed and maintained.

• Procedures for monitoring collateral/entity/line exposures.

This is MoFo. 16

Liquidity

• Requirements for other covered FBOs:

• Annual Basel Committee-consistent internal liquidity stress test

with results reported to the Board.

• Failure to comply with this requirement obliges the covered FBO

to limit the net aggregate amount owed by the FBO parent office

and non-U.S. affiliates to its combined U.S. operations to 25% or

less of the combined U.S. operations’ third party liabilities on a

daily basis.

This is MoFo. 17

Single-Counterparty Credit Limits

• Requirements for covered FBOs:

• 25% net credit exposure limit between IHC or combined U.S.

operations, and a single unaffiliated counterparty.

• For covered FBOs with $500BB+ of consolidated assets, a

separate and stricter net credit exposure limit with a single “major

counterparty” (generally, a bank holding company with

consolidated assets of $500BB+, and any systemically important

nonbank financial company supervised by the Board).

•The separate limit is not specified but would be “consistent”

with the more stringent limit proposed in December 2011 for

domestic bank holding companies with $500BB+ in assets

(where a 10% net credit exposure limit was proposed).

• IHCs that meet the size thresholds above are separately subject

to these requirements.

This is MoFo. 18



• A covered FBO must take into account the credit exposures of its

subsidiaries (generally defined as “controlled companies”) as well

as the credit exposures of their counterparties’ subsidiaries.

• Credit exposure limit is calculated based on the “capital stock and

surplus” of the covered FBO.

• Calculation methodology for “net credit exposure” requires the

calculation of gross credit exposures, which are then adjusted for

offsetting items including eligible collateral, guarantees, credit

derivatives and hedges.

This is MoFo. 19



• General treatment of these exposure limits is intended to be

consistent with their application to U.S. bank holding companies

as proposed in December 2011.

• Compliance with these limits on a daily basis is required.

• Systems must be developed and maintained to assure

compliance with these requirements, and changes to the same.

• Exempt counterparty exposures include:

•U.S. Government/agency exposures.

•Fannie and Freddie exposures (while in conservatorship).

•Home country sovereign exposures.

• Intraday credit exposures.

• Compliance date generally is the later of July 1, 2015, or 12

months after the FBO/IHC crosses the relevant asset threshold.

This is MoFo. 20

Risk Management

• Requirements for $10BB FBOs:

• If its is publicly traded, the FBO must certify annually to the Board

that it maintains a committee that oversees the risk management

practices of its combined U.S. operations (“risk committee”), with

at least one member with risk management expertise.

• The risk committee may be:

•A committee of the FBO’s global board of directors or

supervisory board.

•A committee of the board of an IHC.

• The certification requirement would first apply on the later of July

1, 2015 or 12 months after the FBO crosses the $10BB asset

threshold.

• Noncompliance may result in Board limits on U.S. activities in

coordination with relevant U.S. licensing authorities.

This is MoFo. 21

Risk Management


• The same risk committee and certification requirements that apply

to $10BB FBOs (regardless of whether stock is publicly traded).

• If applicable, IHC must be governed by a board of managers or

directors elected or appointed by the owners and that functions

substantially in the same manner as a U.S board of directors.

This is MoFo. 22

Risk Management

• Requirements for FBOs with $50BB+ of U.S. assets:

• The same risk committee and certification requirements that apply

to $10BB FBOs (regardless of whether stock is publicly traded).

• The FBO must appoint a U.S. chief risk officer, who must:

•Be employed by a U.S. subsidiary or U.S. office of the FBO.

•Have risk management expertise commensurate with scope

and tenor of U.S. operations.

•Be appropriately and independently compensated.

•Report directly to U.S. risk committee and global risk officer.

•Oversee regular meetings with Board supervisory staff.

•Have direct oversight over risk management policies,

procedures, systems, controls, testing, monitoring and

deficiency remediation.

This is MoFo. 23

Risk Management

• Requirements for FBOs with $50BB+ U.S. assets (cont.):

• U.S. risk committee would have a number of specific

responsibilities, including the obligation to:

•Review and approve risk management practices of U.S.

operations.

•Oversee the operation of an “appropriate” risk management

framework for the U.S. operations.

•Meet at least quarterly or more often as necessary.

•Have an understanding of risk management principles and

practices relevant to U.S. operations.

•Have at least one “independent” member.

• Noncompliance with risk management requirements may result in

Board-imposed limits on U.S. activities or business operations in

coordination with relevant U.S. licensing authorities.

• .

This is MoFo. 24

Stress Testing

• Requirements for $10BB FBOs but less than $50BB in

U.S. assets:

• Must be subject to a consolidated home country stress-testing

regime that includes either (i) an annual supervisory stress test,

or (ii) or a supervisor-reviewed annual internal stress test.

• The home country regime also must include requirements for

governance and controls of the stress testing regime.

• The FBO must conduct and pass the home country stress test.

• Separate information/reporting requirements of the sort applicable

to larger covered FBOs would not apply.

• These requirements also apply to foreign savings and loan

holding companies of $10BB+ in assets (DFA requirement).

This is MoFo. 25

Stress Testing

• Requirements for all FBOs with $10BB+ in assets but

less than $50BB in U.S. assets (cont.):

• Failure to comply with these requirements would trigger:

•An asset maintenance requirement for the FBO’s U.S.

branch/agency network of eligible assets equal to 105% of the

preceding quarter’s average value of its third party liabilities.

•An annual stress test requirement for each U.S. subsidiary not

held under an IHC (excluding section 2(h)(2) companies). This

test could be conducted separately or as part of an enterprise-

wide stress test.

This is MoFo. 26

Stress Testing

• Requirements for FBOs with $50BB+ in U.S. assets:

• Must be subject to a consolidated home country stress-testing

regime that includes either (i) an annual supervisory stress test,

or (ii) or a supervisor-reviewed annual internal stress test.

• The home country regime also must include requirements for

governance and controls of the stress testing regime.

• The FBO must conduct and pass the home country stress test.

• The FBO must report to the Board its home country stress-testing

results.

This is MoFo. 27

Stress Testing

• Requirements for FBOs with $50BB+ in U.S. assets

(cont.):

• U.S. branch/agency networks in a net “due from” position to their

foreign parent/affiliates have additional compliance and reporting

requirements.

• Information would be due by January 5 of each year.

• Confidentiality of information would be determined in accordance

with existing Board and Freedom of Information Act requirements.

This is MoFo. 28

Stress Testing

• Requirements for FBOs with $50BB+ in U.S. assets

(cont.):

• Noncompliance with requirements triggers several consequences:

•An asset maintenance requirement, under which the FBO’s

U.S. branch/agency network would have to hold “eligible

assets” equal to 108% of “third party liabilities.” “Eligible

assets” and liabilities are defined consistent with comparable

definitions of these terms in the regulations of the New York

Department of Financial Services.

•U.S. branch/agency network may be subject to intragroup

funding restrictions or liquidity requirements.

•An annual stress test requirement for each U.S. subsidiary not

held under an IHC (excluding section 2(h)(2) companies).

•The Board would have the authority to impose liquidity buffers

or intragroup funding restrictions on noncompliant FBOs.

This is MoFo. 29

Stress Testing

• Requirements for IHCs:

• IHCs with $50BB+ in assets must independently satisfy stress

test requirements for U.S. bank holding companies with $50BB+

in assets.

• IHCs with $10BB to $50BB in assets must independently satisfy

stress test requirements for U.S. bank holding companies of that

size.

This is MoFo. 30

Debt-to-Equity Limits


• A conditional debt-to-equity limit of not more than 15-to-1, upon a

determination by the U.S. Financial Stability Oversight Council

that a covered FBO poses a “grave threat” to U.S. financial

stability, and that the debt-to-equity limit is necessary to mitigate

that risk.

• The limits would be applied to any IHC and any U.S. subsidiary

(other than a section 2(h)(2) company) that is not part of an IHC

structure.

• In addition, the FBO’s U.S. branch/agency network would be

subject to a daily 108% asset maintenance requirement.

• These requirements would be effective on the effective date of the

final regulations.

This is MoFo. 31

Early Remediation


• A covered FBO’s combined U.S. operations would be subject to

early remediation triggers that progressively increase in nature

and severity, based on capital ratios, stress test results, market

indicators, and liquidity and risk management weaknesses.

• If the U.S. operations of the FBO (or IHC) are $50 billion or more,

violation of a trigger would result in non-discretionary regulatory

actions with respect to the FBO’s U.S. operations.

• IHC’s remediation trigger violations can trigger FBO remediation.

• There are four levels of early remediation:

•Level 1 (heightened supervisory review).

•Level 2 (initial remediation).

•Level 3 (recovery).

•Level 4 (recommended resolution of U.S. operations).

This is MoFo. 32

Early Remediation

• Requirements for covered FBOs (cont.):

• Remediation conditions and limitations at each remediation level

include a variety of progressively more stringent informal and

formal actions affecting U.S. operations’ capital distributions,

intragroup funding, liquidity buffers, growth restrictions, asset

maintenance requirements and U.S. executive compensation.

• Capital triggers are based on the combined regulatory capital of

the FBO’s U.S. operations.

• Unlike Levels 1 through 3, Level 4 (resolution) remediation would

be triggered only by quantitative regulatory capital deficiencies.

• Early remediation requirements for covered FBOs with $50BB+

in U.S. assets, as noted above, are nondiscretionary, but are

discretionary for covered FBOs with less than $50BB in U.S.

assets.

This is MoFo. 33

Risk Management Considerations

• Impact of the Proposed Rules

• By Class of FBO

•Covered FBOs

• IHC (if applicable), Basel capital, liquidity, single counterparty

credit limits, risk management/risk committee, stress testing,

early remediation.

• If $50BB+ of U.S. assets: enhanced liquidity and stress testing

requirements, nondiscretionary early remediation.

•$10BB FBOs: risk management (light), home country stress

testing.

• IHCs

• U.S. regulatory capital, even if it controls no bank.

• Liquidity, single counterparty credit limits, stress testing.

• If $50BB+ in U.S. assets, SIFI capital planning and stress

testing.

This is MoFo. 34


• Rules’ Impact on Intermediate Holding Companies

• Will affect a smaller subset of covered FBOs, but the impact on

those it affects may be substantial.

• Will extend to all U.S. activities of covered FBOs other than

branch and agency activities, and section 2(h)(2) companies.

• Investment banking activities

•Private fund sponsorship and investment activities

•Asset management activities

• Will increase U.S. regulatory capital levels and costs required for

these activities.

• May complicate treasury and tax planning and administration.

• Will facilitate a ring-fencing of U.S. capital, assets and operations

that will be more accessible to U.S. creditors and regulators.

This is MoFo. 35


• Impact of Regulatory Capital Requirements

• Most relevant for IHCs, which will have to comply separately with

U.S. regulatory capital requirements. This will require attention to

capital deployment and management in the U.S., but also outside

of the U.S.

• U.S. branches and agencies would not be subject to additional

capital requirements.

• Covered FBOs generally have to comply with, and certify to the

Board compliance with, Basel standards.

•Presumably not a major practical issue for most large FBOs

which are generally subject to Basel standards.

This is MoFo. 36


• Impact of Liquidity Requirements

• Covered FBOs with $50BB+ in U.S. assets must incorporate

relatively elaborate U.S. liquidity risk management processes,

including cash flow projections, liquidity stress testing,

contingency funding planning and liquidity source limits, into

general risk management activities.

• Liquidity buffer requirements (U.S. branches and agencies, and if

applicable, IHCs) will require careful financial management by the

FBO’s treasury function.

• Other covered FBOs must conduct annual liquidity stress tests;

failure to comply results in limits on exposures to offshore entities

and, therefore, funding of offshore activities.

This is MoFo. 37


• Impact of Single Counterparty Credit Limits

• Applies to covered FBOs.

• Major covered FBOs are subject to lower exposure limits to

“major counterparties”.

• The classes of counterparties exempted from these limits either

reflect a Federal Reserve Board recognition of foreign comity

principles (home country sovereign debt) or fiscal/political

judgments (U.S. and agency obligations, Freddie/Fannie

obligations).

• Exclusion of intraday exposures is a mitigating consideration.

This is MoFo. 38


• Impact of Risk Management Requirements

• Relevant to covered FBOs and publicly-traded $10BB FBOs.

• Would require those organizations to create U.S.-specific risk

management infrastructure and processes.

•U.S. risk committee.

• Covered FBOs with $50BB+ in U.S. assets would feel the impact

most.

• U.S. risk committee with a number of specific responsibilities.

• Independence requirement.

•U.S.-based U.S. risk officer with specified duties and reporting

responsibilities.

• How complicated would this be in the implementation?

This is MoFo. 39


• Impact of Stress-Testing Requirements

• Mostly relevant to covered FBOs with $50BB+ in U.S. assets,

including branch and agency assets, but excluding U.S.

intercompany transfers and exposures.

• Would require those organizations to create significant U.S.

based infrastructure and processes.

• Asset maintenance requirements (108%) if noncompliant.

• Possible intragroup funding restrictions or buffers.

• IHCs:

•$50BB+ IHCs subject to U.S. BHC SIFI requirements.

• $10BB IHCs subject to same requirements as comparable

U.S. BHCs.

• $10BB+ FBOs and SLHCs

This is MoFo. 40


• Impact of Debt-to-Equity Limits

• These limits would only apply in the case of a determination that a

FBO poses a “grave threat” to U.S. financial stability and that the

designation is necessary to address that risk.

• Hopefully of limited practical impact.

This is MoFo. 41


• Impact of Early Remediation Requirements

• These requirements would permit – and in the case of covered

FBOs, require – the Board to intervene early to regulate or limit

the U.S. activities of FBOs based on the failure to meet

qualitative, as well as quantitative, remediation benchmarks.

• But it is worth keeping in mind that the new rules give the Board

broad authority across the board to limit U.S. activities for

noncompliance with specific regulatory requirements (e.g., stress

testing, liquidity).

This is MoFo. 42


• Compliance Risk Management Issues

• The proposed rules are complex and in some respects highly

technical.

• The new rules give the Board broad authority across the board to

limit U.S. activities for noncompliance with specific regulatory

requirements (e.g., stress testing, liquidity).

• Compliance management efforts therefore will need to be robust,

but hopefully can build off of existing systems, programs, and

policies.

• Overall, noncompliance risk is relatively high.

This is MoFo. 43


• Response Issues and Strategies

• The economic and regulatory costs of the proposed rules could

be substantial in some cases, and will need to be carefully

assessed by affected FBOs.

• That being said, the impact of the proposals on FBOs will be

widely disparate, depending on the nature and tenor of a FBO’s

U.S. operations.

• For some, the proposals may raise substantive questions of

international comity, national treatment and extraterritorial

application that will surface during the comment period.

This is MoFo. 44


• Response Issues and Strategies

• FBO planning strategies:

•Review nature and scope of U.S. operations and their role in,

and consistency with, the enterprise’s strategic planning

efforts and outcomes.

•Quantify economic and regulatory costs of the proposals.

•Assess impact of the proposed rules on enterprise profitability.

•Critically consider adjustments to U.S. operations based on

the foregoing reviews.

• Mitigation strategies?

•Reconfigure or reduce size of U.S. operations (a strategic

consideration), especially capital-intensive operations.

•Move U.S. operations into the U.S. branch/agency network.

Date post:	13-Apr-2018
Category:	Documents
Upload:	vuongkiet
View:	214 times
Download:	0 times

The Federal Reserve Board’s Proposed - Morrison &...

Documents