Introduction

On December 14, 2012, the Board of Governors of the Federal Reserve System (Federal Reserve) proposed new rules regarding oversight of foreign banking organizations (FBOs) doing business in the United States.1 The Notice of Proposed Rulemaking (FBO NPR) implements the requirements of sections 165 and 166 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) regarding enhanced prudential standards and early remediation requirements for FBOs. The proposed enhanced prudential standards discussed in more detail below are:

  • Risk-Based Capital Requirements and Leverage Limits
  • Liquidity Requirements
  • Single-Counterparty Credit Limits
  • Risk Management and Risk Committee Requirements
  • Stress Test Requirements
  • Debt-to-Equity Limits

The FBO NPR had been anticipated because enhanced prudential standards and early remediation requirements proposed in December 2011 (the 2011 NPR) did not apply to most FBOs.2 The FBO NPR also proposes measures not required by Dodd-Frank. These additional measures were not anticipated by foreign banks until a November speech by Federal Reserve Governor Daniel Tarullo, in which he signaled that the proposal would include measures such as the intermediate holding company requirement discussed below.3

The intermediate holding company requirement, together with some of the enhanced supervision requirements, such as the capital and liquidity requirements, will likely require large FBOs with significant U.S. operations to put more capital and resources at the U.S. level rather than being able to rely on the strength of the parent balance sheet in its home country.

The Federal Reserve is proposing a July 1, 2015, effective date. The comment period is scheduled to end on March 31, 2013.

Summary

Consistent with section 165 of Dodd-Frank, the FBO NPR is generally applicable to any FBO (generally defined as a foreign bank that (i) operates a branch or agency office in the United States, or (ii) owns a commercial lending company or bank in the United States) with $50 billion or more in total global assets. However, additional measures are proposed that would apply to institutions based on total U.S. assets, such as the intermediate holding company requirement for FBOs with $10 billion or more in U.S. assets (excluding branches and agencies of the foreign bank), or that FBOs with $50 billion or more in U.S. assets comply with most of the same enhanced prudential standards applicable to U.S. domiciled bank holding companies with $50 billion or more in assets. The table below summarizes the breakdown of which measures apply to which institutions.  

Click here to view table.

The Federal Reserve’s proposed measures include:

Requirement to Form a U.S. Intermediate Holding Company

  • Generally, an FBO with total global consolidated assets of $50 billion or more and $10 billion or more in U.S. assets (excluding assets held by a U.S. branch or agency) must organize its U.S. subsidiaries under a single U.S. intermediate holding company.
    • FBOs with combined U.S. assets (excluding assets held by a U.S. branch or agency) of less than $10 billion would not be required to form a U.S. intermediate holding company, even if total global assets exceed $50 billion.
  • U.S. intermediate holding company would be subject to enhanced prudential standards on a consolidated basis, but U.S. branches and agencies of an FBO may continue to operate outside of the U.S. intermediate holding company.

Risk-Based Capital Requirements and Leverage Limits

  • All U.S. intermediate holding companies would be subject to the same risk-based capital and leverage standards applicable to U.S. bank holding companies.
  • U.S. intermediate holding companies with total consolidated assets of $50 billion or more would be subject to the Federal Reserve’s capital plan rule governing capital distributions.
  • FBOs with total global consolidated assets of $50 billion or more would be required to certify compliance with capital adequacy standards established by the applicable home country supervisor on a consolidated basis and that those standards are consistent with the Basel Capital Framework.

Liquidity Requirements

  • The U.S. operations of an FBO with combined U.S. assets of $50 billion or more would be required to meet liquidity risk management standards, conduct internal liquidity stress tests, and maintain a 30-day buffer of highly liquid assets.
  • The U.S. branches and agencies of an FBO would be required to maintain the first 14 days of their 30-day buffer in the United States and would be permitted to meet the remainder of the requirement at the parent consolidated level. The U.S. intermediate holding company would be required to maintain the full 30-day buffer in the United States.
  • An FBO with total global consolidated assets of $50 billion or more but combined U.S. assets of less than $50 billion would be required to report annually to the Federal Reserve the results of an internal liquidity stress test (either on a consolidated basis or for its combined U.S. operations).

Single-Counterparty Credit Limits

  • The FBO NPR would limit the credit exposure of both a U.S. intermediate holding company and the combined U.S. operations of an FBO to a single unaffiliated counterparty.
    • The NPR proposes a general limit of 25% of regulatory capital for credit exposure to a single counterparty, and a more stringent limit for credit exposure of a major U.S. intermediate holding company or the combined U.S. operations of a major FBO to a major counterparty (major organizations are generally defined as those having $500 billion or more in total consolidated assets).
    • The FBO NPR does not propose a specific limit involving major firms, but indicates that the more stringent limit would be aligned with the limit adopted for major domestic bank holding companies and nonbank systemically important institutions.
  • The proposed counterparty credit limits would include exposures to foreign sovereign governments and U.S. state and local governments; however, exposures to the U.S. federal government or an FBO’s home country sovereign would be exempt from the limit.

Risk Management and Risk Committee Requirements

  • FBOs with total global consolidated assets of $10 billion or more would be required to certify that they maintain a U.S. risk committee.
  • An FBO with combined U.S. assets of $50 billion or more would be subject to additional U.S. risk committee requirements and a requirement to appoint a U.S. chief risk officer.

Stress Test Requirements

  • A U.S. intermediate holding company would be subject to the Federal Reserve’s stress testing rules as if it were a U.S. bank holding company.
  • An FBO with total global consolidated assets of $10 billion or more must be subject to a home country stress testing regime that is broadly consistent with the Federal Reserve’s stress testing for U.S. bank holding companies or would be subject to additional requirements to help ensure the capital adequacy of its U.S. operations.

Debt-to-Equity Limits

  • The FBO NPR includes a provision required by section 165(j) of Dodd-Frank that an FBO with total global consolidated assets of $50 billion or more must maintain a debt-to-equity ratio of no more than 15-to-1, upon a determination by the Financial Stability Oversight Council (FSOC) that such company poses a grave threat to the financial stability of the United States and that the imposition of such requirement is necessary to mitigate the risk that such company poses to the financial stability of the United States.

Early Remediation

  • The FBO NPR would specify early remediation triggers for FBOs with $50 billion or more in total global consolidated assets and mandatory remediation for institutions with $50 billion or more in total U.S. assets, based on regulatory capital ratios, stress test results, market-based indicators, and risk management weaknesses that are consistent with the 2011 NPR.
    • Heightened supervisory review (Level 1), in which Federal Reserve examiners conduct a targeted review of the FBO’s U.S. operations to determine if it should be moved to the next level of remediation;
    • Initial remediation (Level 2), in which an FBO’s U.S. operations are subject to an initial set of remediation measures, including restrictions on growth and capital distributions;
    • Recovery (Level 3), in which an FBO’s U.S. operations are subject to a prohibition on growth and capital distributions, restrictions on executive compensation, requirements to raise additional capital, and additional requirements on a case-by-case basis; and
    • Recommended resolution (Level 4), in which the Federal Reserve would consider whether the U.S. operations of the FBO warrant termination or resolution based on the financial decline of the combined U.S. operations and other relevant factors.

Discussion

The requirement to form a U.S. intermediate holding company has captured much of the early headlines on the FBO NPR and some consternation among foreign banks doing business in the United States.4

While Dodd-Frank did not require the use of intermediate holding companies for FBOs, the statute encouraged their use in other contexts.5 Some might also view this requirement as an outgrowth of current Federal Reserve supervisory polices on the consolidated supervision of large FBOs that own U.S. banks reflected in a 2008 SR letter.6 While the current policies leave an FBO free to structure its U.S. operations in any manner the FBO chooses, the Federal Reserve’s supervision of an FBO’s U.S. banking operations and any other operations, such as insurance or broker-dealer activities, is often conducted as if there were an effective intermediate holding company in the United States.

The intermediate holding company requirement also appears to be a counter-response to restructuring undertaken by some FBOs in response to the so-called Collins Amendment to Dodd-Frank.7 The Collins Amendment’s minimum capital requirements for almost all depository institution holding companies nullified the Federal Reserve’s policy of allowing a qualifying intermediate bank holding company owned by an FBO to rely on the capital at its parent level rather than requiring mid-tier company itself to comply with Federal Reserve capital adequacy guidelines.8 Some FBOs reorganized their structure to remove the intermediate BHC rather than to infuse additional capital into it. If the intermediate holding company requirement is implemented in the final rule, FBOs that rid themselves of their intermediate holding companies will be required to reverse those reorganizations and to hold additional levels of capital at the U.S. intermediate holding company.

As noted above, the comment period runs until March 31, 2013.