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BEIJING
BRUSSELS
CHICAGO
DALLAS
FRANKFURT
GENEVA
HONG KONG
HOUSTON
LONDON
LOS ANGELES
NEW YORK
PALO ALTO
SAN FRANCISCO
SHANGHAI
SINGAPORE
SYDNEY
TOKYO
Enhanced Supervision for U.S. Operations
of Foreign Banking Organizations: The FRB
Proposal and Its Implications
Connie M. Friesen
David M. Katz
March 13, 2013
WASHINGTON, D.C.
I. Introduction
2
Background
• On December 14, 2012, the Federal Reserve Board
(the “FRB”) released a significant new proposal (the
“Proposal”) to strengthen oversight of the U.S.
operations of foreign banking organizations (“FBOs”).
• The Proposal applies to any FBO with total global
consolidated assets of $50 billion or more, but its
application to a particular FBO depends on the size
and composition of the FBO’s U.S. operations.
• If adopted substantially as proposed, the Proposal
would be the most significant change in U.S.
regulation of FBOs since the adoption of the
International Banking Act of 1978.
3
A Paradigm Shift for Bank Regulation
• The Proposal represents a paradigm shift and
indicates that the FRB has lost confidence in
traditional methods of bank supervision and
regulation.
• The Proposal represents a transition away from the
old qualitative and judgmental supervisory approach
to a more quantitative approach and requirements.
• The Proposal also represents a movement away from
principles of reliance on home country supervision to
a greater focus on host country supervision and U.S.
ring-fencing of the U.S. operations of FBOs.
4
Introduction of the New Approach:
Governor Tarullo’s Speech
• FRB Governor Daniel Tarullo explained the need for a
new approach to regulation of foreign banks in the
United States in an important speech on November
28, 2012.
• Regulation of foreign banks in the United States has
changed little over the past decade or two, despite a
significant and rapid transformation of foreign bank
operations.
• Foreign banks have moved beyond traditional lending
functions to engage in substantial, complex trading
and capital markets activities.
5
“Lending Branches” and “Funding Branches”
• The traditional model of U.S. branches as “lending
branches” well-funded by the home country Head Office
changed dramatically in the period preceding the
financial crisis.
• Reliance on less stable, short-term wholesale funding
increased significantly and many foreign banks shifted
to a “funding branch” model in which U.S. branches of
foreign banks were borrowing large amounts of U.S.
dollars to upstream to their home country operations.
• According to Governor Tarullo, assets of such “funding
branches” grew from 40 percent to 75 percent of foreign
bank branch assets between the mid-1990s and 2009.
6
Rapidly Changing Transactions and Objectives
• Short-term U.S. dollar funding raised in the United States was
used to provide long-term U.S. dollar-denominated project
and trade finance around the world and to finance non-U.S.
affiliates’ investments in U.S. dollar-denominated assetbacked securities.
• Commercial and industrial lending originated by U.S. branches
and agencies as a share of third-party liabilities declined
significantly after 2003.
• U.S. broker-dealer assets of the top ten foreign banks
increased rapidly during the past 15 years, rising from 13% of
all foreign bank third-party U.S. assets to 50% in 2011.
• Five of the top ten U.S. broker-dealers are currently owned by
FBOs.
7
New Structures to Support Supervisory Objectives
• Governor Tarullo suggested that a more uniform structure
should be required for the U.S. operations of foreign banks.
FBOs with significant U.S. operations should be required to
establish a top-tier U.S. intermediate holding company
(“IHC”) over all U.S. bank and nonbank subsidiaries.
• Capital requirements that apply to U.S. bank holding
companies should be applied to IHCs.
• While IHCs would be subject to special requirements,
Governor Tarullo also indicated that there would be
enhanced supervision of U.S. branches and agencies of
FBOs.
8
II. Overview of Proposal
9
Proposal Implements Dodd-Frank Act Provisions
• Sections 165 and 166 of the Dodd-Frank Act direct the FRB to
impose enhanced prudential standards on FBOs with total global
consolidated assets of $50 billion or more.
• Section 166 of the Dodd-Frank Act requires the FRB to establish a
regulatory framework for the early remediation of financial
weaknesses of FBOs in order to minimize the possibility that they
will become insolvent.
• The FRB notes in its introduction to the Proposal that its proposal
for IHCs is a “supplemental enhanced standard”.
• The FRB also cites the so-called Collins Amendment to the DoddFrank Act, which directs the FRB to strengthen capital standards
applied to U.S. bank holding company subsidiaries of FBOs.
10
Some Important Dates
• Proposal would be effective on July 1, 2014 and FBOs
would be required to meet new standards as of
July 1, 2015.
• Proposal includes numerous requests for comments or
responses to questions on specific items. Comment
period ends April 30, 2013.
• Proposal requires careful study and pre-planning to
assess and adapt to its capital and leverage, liquidity,
risk management, corporate governance, tax,
accounting, cost allocation and restructuring
implications.
11
Types of Requirements Included in the Proposal
• Enhanced FRB supervision of all U.S. operations of FBOs.
• Imposition of IHC requirement for FBOs with more than
$10 billion in U.S. non-branch and non-agency assets.
• Risk-based capital and leverage requirements.
• Liquidity requirements.
• Single-counterparty credit limits.
• Risk management requirements.
• Stress testing requirements.
• Debt-to-equity limitations.
• Early remediation requirements.
12
Tailored Requirements for
Different Structures and Activities
• Different requirements for:
– FBOs with total global consolidated assets of greater
than $10 billion but less than $50 billion.
– FBOs with total global consolidated assets of $50 billion
or more but less than $50 billion in combined U.S.
assets.
– FBOs with total global consolidated assets of $50 billion
or more and more than $50 billion in combined U.S.
assets.
– Note: The term “combined U.S. assets” is defined in
the Proposal to mean all U.S. assets (banking and nonbanking) unless otherwise qualified for certain purposes
to exclude U.S. branch and agency assets.
13
Application of the Proposal to U.S. Operations
• The Proposal’s focus on IHCs sometimes seems to
obscure the fact that it will also apply to U.S.
branches and agencies and to nonbank operations
whether or not included in an IHC.
• Some of the Proposal’s requirements are directed
specifically to IHCs or to U.S. branches and agencies.
• Other requirements are applied to the “combined U.S.
operations,” a term which generally means (i) any
IHC and its consolidated subsidiaries; (ii) any U.S.
branch or agency; and (iii) any other U.S. subsidiary
of an FBO that is not a section 2(h)(2) company.
14
III. Specific Provisions of the Proposal
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IHC Requirement
• One of the most controversial aspects of the Proposal is the
IHC requirement.
• IHC requirement would apply to an FBO that meets the
asset thresholds and other criteria for establishment of an
IHC regardless of whether the FBO has a bank subsidiary.
• An IHC would be subject to the same U.S. requirements on
capital, liquidity and leverage that would apply to a U.S.
domestic bank holding company.
• Imposition of IHC requirement for FBOs with more than
$50 billion in total global consolidated assets and more
than $10 billion in U.S. non-branch and non-agency assets.
16
IHC Formation Requirements
• An FBO that establishes an IHC would be required to hold
its interest in any U.S. subsidiary, other than a Section
2(h)(2) company, through the IHC.
• An FBO that forms an IHC would be required to transfer to
such IHC any controlling interest in U.S. companies
acquired pursuant to the merchant banking authority.
• An IHC would be required to have a board of directors.
• There would be an after-the-fact notice procedure for the
formation of an IHC.
• The FRB may, on a case by case basis, permit an FBO to
establish multiple IHCs or alternative organizational
structures if foreign laws or other circumstances warrant an
exception.
17
Risk-Based Capital and
Leverage Requirements for IHCs
• An IHC of an FBO would be subject to the same capital
adequacy standards, including minimum risk-based capital
and leverage requirements and restrictions associated with
applicable capital buffers, that are applicable to U.S. bank
holding companies.
• The FRB anticipates that the capital adequacy standards for
U.S. bank holding companies will incorporate Basel III
standards on the July 1, 2015 effective date.
18
New Capital Requirements and Broker-Dealers
• The capital requirements for IHCs would seem to present a
particular challenge for IHCs that do not include a bank
subsidiary.
• Broker-dealers, investment advisers and other nonbank
subsidiaries that are currently subject only to capital
requirements that might be imposed by the SEC or other
functional regulators would, under the terms of the
Proposal, be subject to bank capital requirements that were
not developed or designed for broker-dealers or other
nonbank subsidiaries.
• SEC Commissioner Dan Gallagher noted in a speech on
February 22, 2013 that a U.S. broker-dealer subsidiary of
an FBO could be required to hold more capital than would
be necessary to satisfy the SEC’s net capital rule to
maintain the same positions.
19
New Capital Requirements and Broker-Dealers (continued)
• SEC-registered broker-dealers, as an example of nonbank
subsidiaries that might be included in an IHC, are already
subject to separate capital requirements.
• The SEC has a robust and extensive capital regulatory
structure for SEC- registered broker-dealers via SEC Rule
15c3-1.
• However, the SEC’s capital regime has a fundamentally
different focus than the FRB’s capital requirements. SEC
Rule 15c3-1 is a net liquid assets test that is designed to
require a broker-dealer to maintain sufficient liquid assets
to meet all of its obligations to customers and
counterparties, and then have adequate additional
resources to wind-down its business in an orderly manner
without the need for a formal proceeding it fails financially
(that is, via a self-liquidation) and, thus, without the need
to tap into the SIPC insurance fund established under
Securities Investor Protection Act of 1970.
20
New Capital Requirements and Broker-Dealers (continued)
• U.S. bank capital requirements on the other hand are
focused on ensuring the safety and soundness of
bank operations; that is, to ensure that banks
operate in a manner to minimize risk and avoid
liquidation. Thus, bank capital requirements are not
designed to ensure that banks maintain sufficient net
liquid assets to satisfy all creditors because banks
have access to federal liquidity facilities that can be
accessed in the event the bank cannot otherwise
obtain private funding, but bank capital requirements
are designed to minimize the need to tap into those
federal liquidity facilities.
21
New Capital Requirements and Broker-Dealers (continued)
• Pursuant thereto, there are four fundamental capital regimes for
SEC-registered broker-dealers (current and proposed) and all of
these regimes are quite distinct from bank capital requirements:
– “Standard” broker-dealers
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i.
SEC Rule 15c3-1(a)(1)(i) sets forth the “basic” standard for computing
net capital and is often used by smaller broker-dealers. A brokerdealer operating under this requirement must maintain minimum net
capital equal to the greater of some specified amount (which varies
depending on the type of business in which the broker-dealer is
engaged) and 6⅔% of “aggregate indebtedness” (“AI”; that is, the
total money liabilities of a broker-dealer arising in connection with any
securities transaction whatsoever, subject to certain exceptions).
Alternatively, the broker-dealer’s aggregate indebtedness cannot
exceed fifteen times its net capital (where 1/15 equals 6-2/3%).
ii.
SEC Rule 15c3-1(a)(1)(ii) sets forth an “alternative” standard for
computing net capital and is generally used by larger broker-dealers.
A broker-dealer operating under this requirement must maintain net
capital equal to the greater of $250,000 and 2% of specified aggregate
“debit” items, subject to certain adjustments.
Broker-dealers
operating under the alternative standard, however, are not subject to
any specific AI or debt limits.
New Capital Requirements and Broker-Dealers (continued)
OTC Derivative Dealers (“OTCDDs”)
i.
OTCDDs are allowed to engage in dealer activities involving
certain OTC derivative instruments, such as swaps and OTC
options, and must maintain minimum net capital of $20 million
and minimum tentative net capital of $100 million (subject to
adjustments and deductions).
– Alternative Net Capital Broker-Dealers (“ANCBDs”)
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i.
ANCBDs are the largest broker-dealers and they have been
approved by the SEC, on a firm-by-firm basis, to use internal
value-at-risk (VaR) models to determine market risk charges for
proprietary securities and derivatives positions and to take a
credit risk charge in lieu of a 100% charge of unsecured
receivables related to OTC derivatives transactions. VaR models
are also available for OTCDDs.
ii.
ANCBDs are required to maintain minimum net capital of $500
million and minimum tentative net capital of $1 billion, although
under an SEC rule proposal an ANCBD would be required to
maintain minimum net capital of $1 billion and minimum tentative
net capital of $5 billion.
New Capital Requirements and Broker-Dealers (continued)
– Proposed Net Capital Rules for Security-Based Swap
Dealers (“SBSDs”)
i.
Under an SEC proposal, a non-bank SBSD (stand-alone
and not otherwise registered as a broker-dealer) without a
prudential regulator would be required to maintain
minimum net capital of $20 million if such SBSD does not
use internal VaR models. SBSDs that use internal VaR
models would be required, in addition to the $20 million
requirement, to maintain minimum tentative net capital of
$100 million.
• Broker-dealers are also subject to higher “minimum”
amounts by reason of various SEC “early warning”
requirements (including a proposal to raise the early
warning amount to $6 billion for ANCBDs).
24
New Capital Requirements and Broker-Dealers (continued)
• In addition, FINRA can impose additional capital
requirements on certain member firms. Pursuant to
Section 15(i)(1) of the Securities Exchange Act of
1934 (the “Exchange Act”), the States are
preeempted from imposing, among other things,
capital requirements that differ from or are in addition
to the capital requirements under the Exchange Act,
although such preemption does not, technically,
prohibit the States from imposing capital
requirements on stand-alone SBSDs.
25
New Capital Requirements and Broker-Dealers (continued)
– Proposed Net Capital Rules for Security-Based Swap
Dealers (“SBSDs”)
i.
Under an SEC proposal, a non-bank SBSD (stand-alone
and not otherwise registered as a broker-dealer) without a
prudential regulator would be required to maintain
minimum net capital of $20 million if such SBSD does not
use internal VaR models. SBSDs that use internal VaR
models would be required, in addition to the $20 million
requirement, to maintain minimum tentative net capital of
$100 million.
• Broker-dealers are also subject to higher “minimum”
amounts by reason of various SEC “early warning”
requirements (including a proposal to raise the early
warning amount to $6 billion for ANCBDs).
26
New Capital Requirements and Broker-Dealers (continued)
• In addition, FINRA can impose additional capital requirements on
certain member firms. Pursuant to Section 15(i)(1) of the
Securities Exchange Act of 1934 (the “Exchange Act”), the States
are preeempted from imposing, among other things, capital
requirements that differ from or are in addition to the capital
requirements under the Exchange Act, although such preemption
does not, technically, prohibit the States from imposing capital
requirements on stand-alone SBSDs.
• Also, registered broker-dealers are permitted to finance
themselves using satisfactory subordinated debt under Appendix
D to SEC Rule 15c3-1. Generally, a broker-dealer may borrow
funds on a subordinated basis and treat the borrowing as “good
capital” for the purposes of SEC Rule 15c3-1 (an addition to
assets and an exclusion from liabilities in the computation of net
capital), although in most cases, a broker-dealer is limited in the
amount of subordinated debt financing that it may incur
(generally, not more than 70% of its debt-equity total).
27
New Capital Requirements and Broker-Dealers (continued)
• To require a broker-dealer to adhere to a capital
framework for banks may be unworkable;
nonetheless, to date, the FRB seems committed to
imposing bank capital requirements on IHCs.
• FRB states in the Proposal that it will consult with the
SEC and other relevant regulators before it adopts a
final rule, but the Proposal seems quite prescriptive in
its approach.
• FBOs with significant broker-dealer or other nonbank
subsidiaries might want to take advantage of the
opportunity to comment on or respond to the FRB’s
questions included in the Proposal before the April 30
deadline.
28
Capital and Leverage Requirements for FBOs with Total
Global Consolidated Assets of $50 Billion or More
• FBOs with total global consolidated assets of $50 billion or more
must certify to FRB that they meet, at the consolidated level,
capital adequacy standards established by home country
supervisor that are consistent with the Basel Capital Framework
(Basel III) or are otherwise consistent with Basel III.
• The Proposal would not apply the U.S. minimum leverage ratio to
an FBO. However, when the Basel III leverage ratio is
implemented internationally in 2018, FBOs with total global
consolidated assets of $50 billion or more would need to
demonstrate compliance with the international leverage ratio.
29
Liquidity Requirements
• Generally, the Proposal imposes detailed and complex
liquidity requirements on FBOs with combined U.S.
assets of $50 billion or more.
• Such requirements are broadly consistent with those
set forth in the FRB’s December 2011 Proposal for
large U.S. bank holding companies and are based on
standards set forth in the Interagency Liquidity Risk
Policy Statement (March 2010).
• FBOs with combined U.S. assets of less than $50
billion would be subject to a more limited set of
requirements.
30
Liquidity Requirements for FBOs with
Combined U.S. Assets of Less than $50 Billion
• An FBO with combined U.S. assets of less than $50 billion
would be required to:
– Report to the FRB the results of an internal liquidity stress test
(either on a consolidated basis or for its combined U.S.
operations) on an annual basis.
– Internal stress test would need to be consistent with Basel
Committee principles for liquidity risk management and
incorporate 30-day, 90-day and one-year stress test horizons.
– An FBO that does not comply with this requirement must limit the
net aggregate amount owed by the FBO’s head office and nonU.S. affiliates to its combined U.S. operations to 25% or less of
the 3rd party liabilities of its combined U.S. operations, on a daily
basis.
31
Liquidity Requirements for FBOs with
Combined U.S. Assets of $50 Billion or More
• More burdensome liquidity requirements for FBOs
with larger U.S. operations:
– U.S. risk committee and U.S. risk officer
– Independent review
– Cash flow projections
– Liquidity stress tests
– Liquidity buffers
– Contingency funding plan
– Specific limits
– Monitoring
32
Liquidity Requirements for FBOs with
Combined U.S. Assets of $50 Billion or More
• Requirements include:
A. U.S. Risk Committee and U.S. Risk Officer Responsibilities.
• U.S. Risk Committee would review and approve the
liquidity risk tolerance for the FBO’s combined U.S.
operations at least annually.
• U.S. Risk Officer would be responsible for:
33
-
Reviewing and pre-approving the liquidity costs,
benefits and risks of each significant new U.S. business
line and each significant new product offered.
-
Reviewing approved significant business lines and
products for compliance with established liquidity risk
tolerance for combined U.S. operations at least
annually.
-
Many other review, reporting and approval
responsibilities.
Liquidity Requirements for FBOs with Combined
U.S. Assets of $50 Billion or More (continued)
B. Independent Review
● FBO would be required to maintain an independent review
function to evaluate the liquidity risk management of
combined U.S. operations.
C. Cash Flow Projections
● FBO would be required to provide cash flow projections for
combined U.S. operations that project cash flows arising
from assets, liabilities and off-balance sheet exposures over
short-term and long term time horizons.
34
Liquidity Requirements for FBOs with Combined
U.S. Assets of $50 Billion or More (continued)
D. Liquidity Stress Tests
35
•
FBO would be required to conduct monthly liquidity
stress tests of its cash flow projections separately for its
IHC and its U.S. branch and agency network.
•
FBO must establish and maintain policies and
procedures outlining its liquidity stress testing practices,
methodologies and assumptions.
•
FBO must maintain an effective system of controls and
oversight over stress test function.
Liquidity Requirements for FBOs with Combined
U.S. Assets of $50 Billion or More (continued)
E. Liquidity Buffers
●
FBO must maintain separate liquidity buffers for its U.S.
branch and agency network and its IHC, comprised of
highly liquid assets that are sufficient to meet net
stressed cash flow needs over a 30-day stressed horizon.
i. U.S. branch and agency network would be
required to maintain the first 14 days of its 30day buffer in the United States. The remainder of
the buffer could be maintained at the parent
consolidated level.
ii. IHC would be required to maintain the full 30-day
buffer in the United States.
36
Liquidity Requirements for FBOs with Combined
U.S. Assets of $50 Billion or More (continued)
F. Contingency Funding Plan
•
37
The FBO must maintain and update (at least
annually) a contingency funding plan for its
combined U.S. operations that describes strategies
for addressing liquidity needs during liquidity stress
events.
Liquidity Requirements for FBOs with Combined
U.S. Assets of $50 Billion or More (continued)
G. Specific Limits
The FBO must establish limits on potential sources of
liquidity risk, including:
38
i.
Concentrations of funding sources, by instrument
type, counterparty type, etc;
ii.
The amount of specified liabilities that mature
within various time horizons; and
iii.
Off-balance sheet exposures and other exposures
that could create funding needs during liquidity
stress events.
Liquidity Requirements for FBOs with Combined
U.S. Assets of $50 Billion or More (continued)
H. Monitoring
FBO must have procedures for:
i.
Monitoring assets pledged or available to be
pledged as collateral;
ii. Monitoring liquidity risk and funding needs
within and across significant legal entities,
business lines and currencies;
iii. Monitoring intraday liquidity risk exposure;
and
iv. Monitoring specific limits on potential sources
of liquidity risk.
39
Single-Counterparty Credit Limits
• The Proposal would establish a 25 percent net credit
exposure limit between an IHC or the combined U.S.
operations of an FBO with total global consolidated
assets of $50 billion or more and a single unaffiliated
counterparty.*
– The IHC would be prohibited from having aggregate net
exposure to any single unaffiliated counterparty in
excess of 25 percent of the IHC’s capital stock and
surplus.
– Combined U.S. operations of an FBO would be
prohibited from having aggregate net credit exposure to
any single unaffiliated counterparty in excess of 25
percent of the consolidated capital stock and surplus of
the FBO.
40
(* Includes subsidiaries)
Single-Counterparty Credit Limits (continued)
• Compliance
– An FBO must submit a monthly compliance report
demonstrating its daily compliance with the singlecounterparty credit limits.
– Noncompliance by either the IHC or the combined U.S.
operations could result in the IHC and/or the combined
U.S. operations being prohibited from engaging in any
additional credit transactions with the particular
counterparty.
41
Risk Management and
Risk Committee Requirements
• FBOs that are publicly-traded with global consolidated
assets of $10 billion or more and all FBOs with total
global consolidated assets of $50 billion or more would
be required to certify annually to the FRB that they
maintain a U.S. risk committee to oversee risk
management practices of the U.S. operations.
– Risk committee must have at least one member with
appropriate risk management expertise.
– An FBO’s enterprise-wide risk committee may serve as the
U.S. risk committee. However, if the FBO has combined
U.S. assets of $50 billion or more and operates in the U.S.
solely through an IHC, it must maintain the risk committee
at the IHC.
42
Risk Management and Risk Committee
Requirements (continued)
• FBOs with combined U.S. assets of $50 billion or
more are subject to additional risk committee
requirements.
– U.S. risk committee would be responsible for reviewing
and approving the risk management practices of the
combined U.S. operations and for overseeing the
operations of an appropriate risk management
framework.
– At least one member of the U.S. risk committee must be
independent.
– Risk management framework must be comprehensive
and consistent with the FBO’s enterprise-wide risk
management framework.
43
Risk Management and Risk Committee
Requirements (continued)
• U.S. Chief Risk Officer
– FBOs with combined U.S. assets of $50 billion or more
or its IHC must appoint a U.S. chief risk officer to be in
charge of the risk management framework and practices
for the FBO’s combined U.S. operations.
– U.S. chief risk officer would report directly to the U.S.
risk committee and the FBO’s chief risk officer and must
be employed by a U.S. branch or agency, an IHC or
another U.S. subsidiary.
– U.S. chief risk officer would have direct oversight
responsibilities for implementation of and ongoing
compliance with appropriate policies and procedures.
44
Stress Test Requirements
• Stress tests requirements would vary depending on
the size of the FBO and the scope of its U.S.
operations.
• Smaller FBOs with total global consolidated assets of
more than $10 billion, but combined U.S. assets of
less than $50 billion, must be subject to a home
country stress testing regime that meets certain
standards. Otherwise, it must meet certain U.S.
requirements, including a 105% asset maintenance
requirement for the FBO’s U.S. branch and agency
network and annual stress tests for U.S. subsidiaries
not held under an IHC.
45
Stress Test Requirements (continued)
• FBOs with combined U.S. assets of $50 billion or
more that have a U.S. branch and agency network
must meet certain stress test requirements or be
subject to additional standards imposed by the FRB:
– The FBO must be subject to and meet the minimum
standards of a consolidated home country capital stress
testing regime that is broadly consistent with U.S.
standards and includes:
i.
either an annual supervisory capital stress test conducted by the
home country supervisor or an annual review by the home
country supervisor of an internal capital adequacy stress test
conducted by the FBO; and
ii. requirements for governance and controls of the stress testing
practices by relevant FBO management and the board of
directors.
46
Stress Test Requirements (continued)
– FBOs that meet the above requirements would submit to
the FRB summary information regarding the home country
stress test activities and results.
i.
If the FBO’s U.S. branch and agency network provides,
on a net basis, funding to its parent or non-U.S.
affiliates, FBO must provide additional information
regarding annual stress test results.
– FBOs that do not meet these requirements must comply
with the following additional standards imposed by the
FRB:
i.
Asset maintenance requirement for U.S. branches and
agencies of not less than 108% of the preceding
quarter’s average value of third party liabilities.
ii.
Separate internal stress tests for any U.S. subsidiary
not held under an IHC.
iii. Intragroup funding restrictions as determined by the
FRB.
47
Debt-to-Equity Limits
• If the Financial Stability Oversight Council (the
“FSOC”) has determined that an FBO (with total
global consolidated assets of $50 billion or more)
poses a grave threat to U.S. financial stability and
determines that a debt-to-equity limit is necessary to
mitigate that risk, the Proposal would require such an
FBO to maintain:
– a debt-to-equity ratio of not more than 15-to-1 for its
IHC and any U.S. subsidiary not organized under an
IHC; and
– a 108% asset maintenance requirement for its U.S.
branch and agency network.
48
Early Remediation
• The Proposal would establish a regime for the early
remediation of the combined U.S. operations of an
FBO with total global consolidated assets of $50
billion or more, in a manner generally consistent with
the December 2011 Proposal for U.S. bank holding
companies.
• The regime is divided into four levels of remediation
that increase in stringency with respect to
remediation requirements.
• Early remediation triggers for each level are based on
one or more of the following: risk-based capital and
leverage ratios, stress test results, liquidity risk and
risk management deficiencies and market indicators.
49
IV. Implications of the Proposal
50
Major Implications
• Like the International Banking Act, the Foreign Bank
Supervision Enhancement Act and the Gramm-Leach-Bliley
Act, the Proposal would likely result in fundamental
changes in the U.S. operations of many FBOs.
• The Proposal would require enhanced attention to
compliance, risk management and corporate governance.
• The Proposal would require many FBOs to dedicate more
capital to U.S. operations and would subject FBOs to new
liquidity and leverage requirements.
• New activities of FBOs would be subject to greater
supervisory scrutiny.
• U.S. nonbank operations of FBOs would be subject to
greater scrutiny by the FRB.
51
Effects on Funding Arrangements
• Many international banks issue commercial paper,
certificates of deposit and medium-term notes in the
United States and then send some of the proceeds
back to the home country to fund operations there.
• The Proposal aims to limit such transfers; FBOs will
need to assess the effects of potential limitations and
adjust their funding programs accordingly.
52
Special Implications for Broker-Dealers
• Capital requirements for IHCs are to be calculated
with reference to requirements typically applied to
domestic U.S. bank holding companies. As noted
earlier, the FRB’s “safety and soundness” approach to
bank regulation is fundamentally different from the
SEC’s financial responsibility regulation of brokerdealers (where the latter focuses on customer
protection and orderly liquidation).
• Such calculations may present significant issues for
IHCs where the primary subsidiary is a broker-dealer.
As noted above, broker-dealers are subject to capital
requirements established by the SEC, which rule
establishes a liquid assets test or approach.
53
Special Implications for Broker-Dealers
• It is unclear how the differing capital requirements of
the SEC and FRB might be coordinated or how capital
required by the SEC will be counted towards IHC
capital requirements. It is possible that such SEC and
FRB requirements may conflict in certain respects.
• As noted earlier, for larger broker-dealers, there are
no specific debt limits/ratios under the SEC’s capital
requirements, although there are for smaller brokerdealers that are subject to AI requirements.
54
Special Implications for Broker-Dealers
• Broker-dealers are already subject to oversight by
multiple regulators, including the SEC and at least
one self-regulatory organization (SRO) that is the
designated examining authority for the broker-dealer.
SEC Rule 17d-1 requires coordination among such
multiple SRO regulators.
• Adding the FRB to the mix of regulators runs the risk
of having too many “cooks in the kitchen” that can
result in duplicative or contradictory regulatory
regimes absent careful coordination between the FRB
and the SEC.
55
Special Implications for Broker-Dealers
• Proposed U.S. Risk Officer Requirement: might
subject to such person to FINRA registration as a
FINOP (Financial and Operations Principal), if such
person can approve/manage financial funding for a
broker-dealer or review and approve contingency
plans or conduct quarterly reviews of liquidity stress
test results, cash flow projections, and size and
composition of its liquidity buffer as well as review
strategies, policies and procedures for managing
liquidity risk – all least for a broker-dealer which is a
significant subsidiary.
• U.S. Risk Committee responsible for overall risk
monitoring: should not necessarily trigger principal
registration with FINRA under NASD Notice to
Members 99-49.
56
Special Implications for Broker-Dealers
• The SEC requires that broker-dealers be subject to the
SEC’s capital requirements on a “moment to moment”
basis. FINRA also imposes capital requirements on
broker-dealers, requires that a broker-dealer appoint a
chief financial officer/FINOP and that such FINOP be
responsible for preparing detailed monthly or quarterly
unaudited financial reports.
• Subjecting broker-dealers to a different capital regime
with a fundamentally different policy/purpose could
require broker-dealers to hire additional/multiple
financial principals who are responsible for potential
conflicting requirements, and could subject brokerdealers to substantial/additional capital compliance
costs, including the need to build-out of new compliance
procedures and financial control systems.
57
Special Implications for Broker-Dealers (continued)
• One principle affirmed in 1994 by the Gramm-Leach-Bliley
Act and generally respected by federal banking and
securities regulators has been the principle of “functional”
regulation which requires federal banking regulators to
respect the primary supervisory authority of the functional
regulator, i.e., the SEC in the case of a broker-dealer.
• The Proposal assigns supervisory responsibility for IHC
capital, liquidity and leverage requirements to the FRB and
it is not clear whether the FRB would also be allowed to
inspect the books and records, generally examine or
initiate supervisory actions directly against a broker-dealer
subsidiary of an IHC.
• The Proposal notes that the FRB intends to consult with
each primary or functional regulator of a bank or non-bank
subsidiary before imposing specific prudential standards.
58
Special Implications for Broker-Dealers
• The imposition of an IHC could trigger FINRA and
other SRO approvals. For example, NASD Rule
1017(a)(4), (b) and (c) requires the filing of a formal
application with, and approval by, FINRA in respect of
any change in the equity ownership or partnership
capital of a FINRA member (broker-dealer) that
results in one person or entity directly or indirectly
owning or controlling 25% or more of the equity or
partnership capital thereof. FINRA takes the position
that NASD Rule 1017(a)(4) applies to the imposition
of a new intermediate holding company for a FINRA
member, even if the foregoing does not result in a
change in the beneficial ownership or control of the
broker-dealer. Other SROs have similar filing and
approval requirements.
59
Special Implications for Broker-Dealers
• Pursuant to FINRA Rule 8210, FINRA may have
jurisdiction to examine the books and records of an
IHC.
60
Regulation of Other
Non-Bank Subsidiaries of IHC
• The FRB notes in its explanation of the Proposal that
an IHC would provide a more uniform platform for
oversight of the U.S. operations of FBOs.
• It is unclear how the Proposal would affect the
traditional application of Regulation Y and Regulation
K to non-banking subsidiaries of FBOs.
61
V.
62
Actions to be Taken
Assessing Impact of Proposal’s Requirements
• An FBO will need to identify all of the specific
provisions of the Proposal that might be applicable to
its U.S. operations.
• An FBO will need to conduct a “gap analysis” by
assessing its current capital and leverage, liquidity,
risk management, counterparty credit limit positions
against the new requirements of the Proposal.
• Comparison of capital requirements on a cross-border
basis and including Basel III requirements as well
may prove to be a challenging but necessary
exercise.
63
Rethinking U.S. Strategy
● In addition to the specific gap analysis noted above, every FBO
should be conducting an analysis of the Proposal’s effects on its
U.S. strategy and structure.
● Questions to be considered would include:
– How will enhanced supervision affect U.S. operations
generally?
– What changes in business model will be needed as a result of
the Proposal?
– What new compliance, risk management and corporate
governance policies and procedures will be needed if the
Proposal is adopted as issued?
● While the Proposal has not yet been adopted, the changes it will
introduce are significant and an FBO should begin now to consider
how it will meet the challenges of the new regulatory regime
contemplated by the Proposal.
64
Contact Information
Connie M. Friesen
(212) 839-5507
[email protected]
David M. Katz
(212) 839-7386
[email protected]
This presentation has been prepared by Sidley Austin LLP for informational purposes only and does not constitute
legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client
relationship. Readers should not act upon this without seeking advice from professional advisers.
65
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