On Jan. 23, 2018, the Federal Reserve Board (FRB) published a release announcing revisions to the Annual Report of Foreign Banking Organizations (FR Y-7) that would enable foreign banking organizations (FBOs) to certify their compliance with U.S. risk committee and home-country capital stress testing requirements under FRB Regulation YY’s enhanced prudential standards. The FR Y-7 is an annual report submitted by qualifying FBOs to provide financial, organizational, shareholder and managerial information to the FRB. The FR Y-7 must be filed within four months after the end of an FBO’s fiscal year.
The revisions to the FR Y-7 were originally proposed in December 2015 (FR Y-7 Proposal)1 and have been generally adopted as proposed. The revisions become effective beginning with FR Y-7 reports for fiscal years ending on or after March 1, 2018.
In addition to revising the FR Y-7, the release responded to public comments received on the FR Y-7 Proposal and further clarified FBO compliance obligations under Regulation YY.
Revised FR Y-7 and Regulation YY Certifications
Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act directs the FRB to establish enhanced prudential standards for bank holding companies (BHCs) and FBOs with total consolidated assets of $50 billion or more and certain designated nonbank financial companies. In addition, it sets certain standards for FBOs with total consolidated assets of $10 billion or more. In accordance with Section 165, the FRB adopted enhanced prudential standards for FBOs, including risk committee and capital stress testing requirements. These standards are set forth in the FRB’s Regulation YY (12 C.F.R. Part 252).
The revised FR Y-7 and its instructions2 add a new Report Item 5 with five subsections, (a) through (e), that require an FBO to check boxes “Yes,” “No” or “N/A” to indicate whether it has satisfied the Regulation YY risk committee and capital stress testing standards.
Capital Stress Testing Certification
Report Item 5(a): capital stress testing standards for FBOs and foreign savings and loan holding companies with total consolidated assets over $10 billion but less than $50 billion
Report Item 5(d): capital stress testing standards for FBOs with total consolidated assets of $50 billion or more but combined U.S. assets of less than $50 billion
Report Item 5(e): capital stress testing standards for FBOs with total consolidated assets of $50 billion or more and combined U.S. assets of $50 billion or more
These report items require that the FBO indicate whether it satisfies the following standards: (1) the FBO is subject on, a consolidated basis, to a capital stress testing regime by its home-country supervisor that includes (i) an annual supervisory capital stress test conducted by the relevant home-country supervisor or an annual evaluation and 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 stress testing practices by relevant management and the board of directors (or equivalent thereof); and (2) the FBO conducts such stress tests or is subject to a supervisory stress test and meets any minimum standards set by its home-country supervisor with respect to the stress tests.
Risk Committee Certification
Report Item 5(b): risk committee requirements for publicly traded FBOs with total consolidated assets of at least $10 billion but less than $50 billion
Report Item 5(c): risk committee requirements for FBOs with total consolidated assets of $50 billion or more but combined U.S. assets of less than $50 billion
These report items require that the FBO annually certify to the FRB that it maintains a committee of its global board of directors (or equivalent thereof), on a stand-alone basis or as part of its enterprise-wide risk committee (or equivalent thereof), that (i) oversees the risk management policies of the combined U.S. operations of the FBO and (ii) includes at least one member with experience in identifying, assessing and managing risk exposures of large, complex firms.
Discussion of Public Comments
The FRB’s release also discusses comments received on the FR Y-7 Proposal. Some of the key questions and responses are summarized below.
U.S. Risk Committee Configuration and Design
One commenter asked whether the U.S. risk committee must be composed entirely of members of the FBO’s global board or may be configured in other ways that take into account the size, scale and complexity of an FBO’s combined U.S. operations and more effectively utilize the expertise of personnel familiar with the risk of these operations.
The FRB responded that the FBO is not required to form a special U.S. risk committee composed of members of the FBO’s board of directors. However, the FBO’s board of directors or a committee comprised of members of the FBO’s board of directors must have primary responsibility for oversight of the risks of the combined U.S. operations. The U.S. risk committee subject to Regulation YY is not required to (though it may) directly administer the FBO’s U.S. risk management policies. The FBO may designate specific senior management officials from the FBO’s U.S. operations to be responsible for administering the U.S. risk management policies and for providing regular reports directly to the FBO’s board of directors or risk committee.
The FBO has flexibility in establishing and designing its oversight function provided that the FBO’s board of directors is informed about the risks of the FBO’s combined U.S. operations and provides the appropriate level of guidance. However, the FBO must also take appropriate measures to ensure that the risk management policies for its combined U.S. operations are implemented and that the risk committee receives sufficient information on the combined U.S. operations to allow it to carry out its responsibilities.
Two-Tiered Board Structures
A commenter requested clarification regarding how the U.S. risk committee requirement would apply to an FBO with a two-tier board structure, a common feature of FBOs in European countries. The two-tier structure generally consists of (1) a supervisory board independent from management that sets the direction of the company and oversees the company’s senior management and (2) a management/executive board that implements the company’s strategies and risk management.
The FRB stated that the purpose of the risk committee requirements is to ensure that the FBO is aware of and oversees the risks of its combined U.S. operations. This oversight function can be integrated into various board structures. In a two-tier board structure, a committee of either the supervisory board or the management/executive board (or a combination thereof) could be considered a committee of the FBO’s board of directors for purposes of the U.S. risk committee requirement. Both tiers of a two-tier board are typically involved in evaluating risk management at an FBO with the same goals as those of a single board of directors in the United States.
Home-Country Capital Stress Testing
A commenter asked whether an FBO could meet the home-country stress test requirements through satisfactory completion of an Internal Capital Adequacy Assessment Process (ICAAP). The FRB stated that if an ICAAP satisfies the underlying requirements for a capital stress test, including all applicable information requirements in Regulation YY, satisfactory completion of the ICAAP would satisfy these requirements.
The commenter also requested guidance for situations where the FBO’s home-country supervisor does not require annual stress testing. The FRB reiterated that Regulation YY requires an FBO to be subject to a stress testing regime that includes an annual supervisory stress test or annual supervisory evaluation of the FBO’s internal stress test. A stress test conducted once every two years, for example, would not satisfy this requirement.
Home-Country Capital Adequacy Requirements
Regulation YY requires an FBO to report compliance with capital adequacy measures consistent with the Basel Capital Framework concurrently with filing the FR Y-7Q (The Capital and Asset Report for Foreign Banking Organizations). A commenter asked whether filing the FR Y-7Q would satisfy the requirement to report and certify compliance with its home-country capital adequacy requirements. In addition, the commenter requested confirmation of the as-of date and frequency of such certification.
The FRB confirmed that Regulation YY does not specify the frequency or the as-of date for an FBO’s certification of compliance with its home-country capital requirements. In response, the FRB stated that an FBO’s completion of the FR Y-7Q on a quarterly basis would satisfy both the requirement to report and the requirement to certify to the FRB its compliance with capital adequacy measures consistent with the Basel Capital Framework.
Internal Liquidity Stress Testing
Regulation YY requires certain FBOs to report annually the results of an internal liquidity stress test for either the consolidated operations of the FBO or the FBO’s combined U.S. operations that incorporate three specified planning horizons (30-day, 60-day and one-year). A commenter requested guidance on how an FBO should report if its home country uses fewer or different planning horizons.
The FRB stated that if an FBO is not required to conduct an internal liquidity stress test for its consolidated operations using the three specified planning horizons in Regulation YY, it may instead choose to provide an internal liquidity stress test for just the combined U.S. operations. If an FBO does not comply with the internal liquidity stress testing reporting requirements of Regulation YY, it must limit the net aggregate amount owed by the parent or other non-U.S. affiliates to the U.S. operations to 25 percent or less of the third-party liabilities of the combined U.S. operations.
In addition, the commenter requested clarification on “results” of the internal liquidity stress tests that must be reported annually. The FRB stated that Regulation YY does not prescribe the information that must be reported to the FRB regarding the internal liquidity stress tests. However, FBOs are expected to provide sufficient information to enable the FRB to assess the liquidity position of the FBO.