The comment period has now closed on the controversial proposed rule (FBO Proposal) of the Board of Governors of the Federal Reserve System (Board) implementing Sections 165 and 166 of the Dodd-Frank Act (Dodd-Frank) for foreign banking organizations (FBOs) and foreign nonbank financial companies supervised by the Board.

If the FBO Proposal becomes final in the manner proposed, it will mark a sea change in the regulation of the U.S. operations of FBOs, by requiring FBOs with $50 billion or more in total global consolidated assets and $10 billion or more in total U.S. nonbranch assets to form an intermediate holding company (IHC) for almost all of their U.S. subsidiaries.

In our view, the IHC requirement likely exceeds the Board's legal authority in implementing Sections 165 and 166 of Dodd-Frank, has the tendency to increase, rather than reduce, financial instability in the United States and globally, threatens other adverse effects, and does not effectively respond to the developments that the Board perceives in the U.S. operations of FBOs and in international banking regulation generally.

In addition, by signaling concern with the ability of home country supervisors to cooperate on issues relevant to the regulation of cross-border banking organizations, the IHC requirement threatens to lead to retaliation against U.S. banking organizations with significant international operations, thus making the IHC requirement relevant to U.S. banking organizations as well as FBOs.

We have filed a comment letter with the Board advancing these arguments, which we summarize below. A link to our comment letter is included here[1] and at the end of this Alert.

As a matter of statutory interpretation, the IHC requirement reflects the following failings:

  • The IHC requirement is imposed as a blanket requirement on all FBOs that meet the FBO Proposal's asset thresholds, and does not reflect consideration of the factors set forth in Section 165(b)(3) of Dodd-Frank that call for differentiating FBOs on the basis of their systemic risk, nonfinancial activities and affiliations, and predominant lines of business.

  • The IHC requirement ignores the mandate of Congress in Section 165(b)(2) of Dodd-Frank that the Board give due regard to the principle of national treatment and take into account the extent to which a particular FBO is subject on a consolidated basis to comparable home country prudential standards.

  • In other sections of Dodd-Frank, Congress authorized, and even required, the Board to require the establishment of IHCs for entities other than FBOs, but only in limited circumstances, indicating that a blanket IHC requirement is not an appropriate interpretation of Section 165.

  • Congress explicitly instructed the Board to consult with foreign counterparts to encourage "comprehensive and robust" supervision of systemically significant firms in Section 175(c) of Dodd-Frank.

  • To the extent the IHC requirement is an indirect means of regulating the capital of the U.S. broker-dealer subsidiaries of FBOs, it conflicts with Section 5(c)(3) of the Bank Holding Company Act, which Congress did not amend in Dodd-Frank, despite amending other subsections of Section 5.

As a matter of policy, the IHC requirement will tend to increase financial instability and threaten other adverse effects, some of which are, under other provisions of federal banking law, adverse effects the Board is explicitly charged with avoiding:

  • By interfering with the ability of an FBO to allocate capital and liquidity in a manner it determines most efficient, the IHC requirement will negatively influence the availability of credit, thereby inhibiting economic growth. It would be ironic if restrictive Board regulatory policy undermined expansionary Board monetary policy and thereby prolonged recessionary tendencies.

  • By trapping capital and liquidity in a U.S. IHC, the IHC requirement will interfere with the ability of an FBO to respond most effectively at a time of crisis, as the capital and liquidity needs of an international organization will not always be greatest in the United States.

  • By imposing a discriminatory and costly restructuring mandate on FBOs, the IHC requirement may invite retaliation against internationally active U.S. banking organizations by non-U.S. jurisdictions.

  • By raising questions about the commitment of foreign regulators to supervise their banking institutions in a manner consistent with U.S. financial stability, the IHC requirement threatens to fan the flames of protectionist regulation.

  • By imposing substantial transaction and tax costs on FBOs, the IHC requirement will likely result in some FBOs curtailing their U.S. operations, leading to decreased competition and an increased concentration of banking and financial resources in the United States.

  • The IHC requirement will result in increased capital charges being imposed on traditionally less risky assets, which may provide incentives for FBOs to shift their U.S. asset mix to riskier assets that promise greater returns.

The IHC requirement is also an overbroad response to what the Board views as changed business practices at the U.S. operations of FBOs; in particular, it does not at all address what the Board itself views as the most destabilizing practice – an overreliance on short-term dollar funding used to support FBOs' non-U.S. operations.

Due to the controversial nature of the FBO Proposal, the Board is likely to have received numerous and detailed comments, including from foreign supervisory bodies. It is hoped that reflection on the public record will lead the Board to a more tailored application of Sections 165 and 166 of Dodd-Frank, one that gives appropriate consideration to the factors that Congress required the Board to consider in implementing those sections, and one that focuses on the specific financial stability risks raised by particular FBOs with U.S. operations.