Federal Reserve Board Proposes Rule Establishing Common Equity Surcharge on U.S. Global Systemically Important Banks
On December 9, the Board of Governors of the Federal Reserve System (the “FRB”) issued a Notice of Proposed Rulemaking (the “Proposed Rule”) to establish risk-based capital surcharges for systemically important U.S. bank holding companies (“BHCs”). The Proposed Rule implements for these U.S. BHCs the framework developed by the Basel Committee on Banking Supervision (“BCBS”) and published by the Financial Stability Board (the “FSB”) (the “Basel G-SIB Framework”) for assessing a common equity surcharge on certain global systemically important banks (“G-SIBs”).1 Like the Basel G-SIB Framework, the Proposed Rule establishes an indicator-based approach for determining which BHCs are U.S. G-SIBs and the amount of the risk-based capital surcharge that will be applied to each G-SIB.2 The Proposed Rule, however, would result in higher surcharges than under the Basel G-SIB Framework, with expected surcharges ranging from 1.0% to 4.5%, as compared to 1% to 2.5% under the Basel G-SIB Framework, and includes a new indicator to address the perceived risks of short-term wholesale funding (the “STWF Score”). The Proposed Rule generally follows the Basel G-SIB Framework in approach by implementing the charge as an extension of the capital conservation buffer that can only be satisfied with Common Equity Tier 1 (“CET1”) capital. The Proposed Rule also retains the surcharge calculation from the Basel G-SIB Framework (referred to as “Method 1”), but uses it as a floor. Under the alternative calculation approach in the Proposed Rule (referred to as “Method 2”), the STWF Score replaces the “substitutability” systemic indicator in the Basel G-SIB Framework. The Preamble to the Proposed Rule notes that this change is designed to “address the G-SIB’s susceptibility to failure” by increasing the surcharge based on a G-SIB’s short-term wholesale funding use rather than its substitutability, as a “more effective means of requiring a G-SIB to internalize the externalities it imposes on the broader financial system and reduce its probability of failure.” Short--2- Bank Capital Requirements December 14, 2014 term wholesale funding sources would include secured funding transactions, unsecured wholesale funding transactions (excluding operational deposits), certain asset exchanges, short positions in securities, and retail brokered deposits and brokered sweep deposits (each as defined in the U.S. Liquidity Coverage Ratio Rule, the “LCR Rule” 3 ), risk-weighting the sources of short-term wholesale funding by type and maturity in a grid approach. Based on year-end 2013 data, the FRB estimates that G-SIB surcharges under the Proposed Rule would apply to eight U.S. top-tier BHCs, presumably those that were previously identified by the BCBS. The surcharge under the Proposed Rule would be phased in beginning on January 1, 2016, to become fully effective on January 1, 2019, consistent with the implementation time frame for the capital conservation buffer. The Proposed Rule has substantial potential consequences beyond its four corners. In particular, the surcharge will, in effect, be added to the Total Loss Absorbency Capacity requirement for G-SIBs recently proposed by the Financial Stability Board and expected to be the subject of FRB rulemaking in the near future. In addition, the adverse impact of certain overly broad definitions in the LCR Rule will now be even greater. It also remains to be seen how the surcharge will relate to the CCAR process. The Annex to this memorandum provides a more detailed description of the Basel G-SIB Framework. OBSERVATIONS AND IMPLICATIONS The FRB proposes to implement the Basel G-SIB Framework under Section 165 of the Dodd-Frank Act. Although the FRB notes that the Proposed Rule modifies the Basel G-SIB Framework “to reflect systemic risk concerns specific to the funding structures of large U.S. bank holding companies,” the Preamble does not explain the U.S.-specific concern or demonstrate the increased probability of failures. FRB Governor Tarullo expressed hope that, in time, the BCBS will join it in addressing short-term wholesale funding concerns by changing the Basel G-SIB Framework to address the perceived systemic risk associated with this type of funding. In the meantime, however, the Proposed Rule would have a significant impact on U.S. BHCs identified as G-SIBs. The FRB’s Proposed Rule, together with other regulatory capital requirements, would result in significant additional regulatory capital requirements for U.S. BHCs identified as G-SIBs. The FRB staff asserted its belief that nearly all of the eight BHCs would already meet their G-SIB surcharges on a fully phased-in basis, and all eight would be ready to meet their surcharges over the proposed three-year phase-in period. On a fully phased-in basis in January 2019, the capital requirements would be: minimum total capital ratio and capital conservation buffer of 10.5% plus the applicable G-SIB surcharge of 1% to 4.5% – i.e., 11.5% to 15% of risk-weighted assets (“RWAs”); minimum tier 1 capital ratio and conservation buffer of 8.5% plus the applicable G-SIB surcharge for a total of 9.5% to 13%; and minimum CET1 capital ratio and conservation buffer of 7% plus the applicable G-SIB surcharge for a total of 8% to 11.5%. -3- Bank Capital Requirements December 14, 2014 The FRB plans to analyze in the coming year whether some or all of the G-SIB surcharge should be incorporated into the post-stress minimum capital requirements of the FRB’s capital plan and stress test rules.4 The Proposed Rule is only one part of the FRB’s plan to address reliance by BHCs on short-term wholesale funding. In addition to the steps already taken in implementing the LCR Rule, the FRB also plans to address the perceived risk of this type of funding through the net stable funding ratio (“NSFR”) and margin requirements on securities financing transactions. FRB Chair Janet Yellen specifically noted that the Proposed Rule may not provide sufficient incentive for G-SIBs to change funding behavior—that is, to rely on more stable forms of funding—in order to ensure that firms internalize fire sale externalities. Chair Yellen also encouraged the FRB staff to address concerns relating to externalities in future proposals, including margin requirements on securities financing transactions, that would apply to firms in the financial sector more broadly. In response to questions about the competitive effects of the Proposed Rule, the FRB staff noted that the primary goal of the Proposed Rule is increased financial stability. With respect to competitiveness, however, the FRB staff suggested that the Proposed Rule will even the playing field in the United States between small and medium-sized banking organizations on the one hand and the largest banking organizations on the other, but did not discuss how this playing field is currently uneven or whether Section 165 standards may be used to achieve that objective. The FRB staff also noted that U.S. G-SIBs “always have the option to reduce their systemic footprint” to avoid or reduce any competitive harm, but did not address whether this response could be exercised without loss of revenue and earnings and credit availability. The Proposed Rule would not apply to U.S. BHCs that are subsidiaries of non-U.S. banking organizations—for example, intermediate holding companies that foreign banks with $50 billion or more in non-branch U.S. assets are required to establish under the FRB’s enhanced prudential standard rules adopted pursuant to Section 165 of the Dodd-Frank Act earlier this year. THE PROPOSED RULE AND SIGNIFICANT DEVIATIONS FROM THE INTERNATIONALLY AGREED G-SIB SURCHARGE FRAMEWORK Although the Proposed Rule would adopt much of the Basel G-SIB Framework5 for purposes of designating U.S. G-SIBs, its Method 2 generally produces higher surcharge levels for U.S. G-SIBs, including through the incorporation of a U.S. G-SIB’s use of short-term wholesale funding sources in calculating the systemic indicator score. The key elements of the Proposed Rule are discussed below. Identification of a U.S. G-SIB Under the Proposed Rule, each U.S. top-tier BHC with total consolidated assets of $50 billion or more that is not a subsidiary of a non-U.S. banking organization would determine annually whether it is a G-SIB by using the five categories and corresponding 12 weighted indicators that measure global systemic importance under the Basel G-SIB Framework. The categories and systemic indicators (described in greater detail in Annex A) are as follows. These are consistent with the factors the Federal Reserve uses for the Dodd-Frank financial stability analysis in the context of merger and acquisition transactions. Size: total exposures Interconnectedness: intra-financial system assets, intra-financial system liabilities, and securities outstanding Substitutability: assets under custody, payments activity, and underwritten transactions in debt and equity markets-4- Bank Capital Requirements December 14, 2014 Complexity: notional amount of over-the-counter derivatives, level 3 assets and trading and available-for-sale securities Cross-jurisdictional activity: Cross-jurisdictional claims and cross-jurisdictional liabilities For U.S. BHCs, the values for each systemic indicator are taken from each BHC’s most recent Banking Organization Systemic Risk Report (FR Y-15)6 and converted into scores in a manner consistent with the Basel G-SIB Framework methodology. Based on currently available data, the Preamble notes that there is a “significant gap” between the eight BHCs that would currently be identified as U.S. G-SIBs and all other BHCs. Indeed, the FRB notes that the non-G-SIB BHC with the highest aggregate systemic indicator score received a score that was approximately one-third of that of the U.S. G-SIB with the lowest aggregate systemic indicator score warranting G-SIB designation. Although the systemic indicators adhere to the Basel Framework, the FRB requests comment on whether any changes are needed to the indicators, including as to: whether modifications to the intra-financial system assets and intra-financial system liabilities indicators (or additional indicators) might more appropriately measure the interconnectedness associated with securities financing transactions and over-the-counter derivatives exposures; how, if at all, collateral and netting arrangements should be reflected in the intra-financial system assets and intra-financial system liabilities measures; the advantages and disadvantages of including exposures over which firms do not have control— such as the amount of their securities owned by other financial firms—in the intra-financial system assets and intra-financial system liabilities measures; and whether any other financial instruments should be measured by the trading and available-for-sale systemic indicator and the reasons for including any additional instruments in that measure. Computing the Applicable U.S. G-SIB Surcharge The Proposed Rule establishes two methodologies for calculating the capital surcharge. Method 1 adheres to the Basel G-SIB Framework, and Method 2 modifies the Basel G-SIB Framework to increase the systemic indicator score and include the STWF Score, designed to replace the Basel G-SIB Framework’s substitutability factor with a factor measuring short-term wholesale funding in relation to total risk-weighted assets. A U.S. G-SIB would be subject to the greater of the two resulting surcharges. The Preamble suggests that, in most instances, a U.S. G-SIB would be subject to the higher surcharge calculated under Method 2. This would not be the case only if a G-SIB with a high substitutability score had low systemic indicator scores in all other categories under Method 1. A chart comparing the range of applicable surcharges under Method 1 and Method 2 is provided below. As reflected in the chart, although Method 1 actually produces much higher surcharges in the upper score ranges, Method 2 produces much higher scores, which more than offsets the surcharge differential. -5- Bank Capital Requirements December 14, 2014 Systemic Indicator Score (“Buckets”) Method 1 Surcharge (Basel G-SIB Framework) Method 2 Surcharge7 (FRB Superequivalence) Less than 130 0.0 percent 0.0 percent 130-229 1.0 percent 1.0 percent 230-329 1.5 percent 1.5 percent 330-429 2.0 percent 2.0 percent 430-529 2.5 percent 2.5 percent 530-629 3.5 percent 3.0 percent 630-729 4.5 percent (from this point, continue to increase 1.0 percentage point for every 100 basis point increase in score over the 530-629 bucket) 3.5 percent 730-829 4.0 percent 830-929 4.5 percent 930-1029 5.0 percent 1030-1129 5.5 percent 1130 or greater 5.5 percent (from this point, continue to increase 0.50 percentage point for every 100 basis point increase in score over the 1030-1129 bucket) Method 1 The proposed Method 1 surcharge adheres to the Basel G-SIB Framework’s method of calculating the equity surcharge based on the five categories of systemic indicators noted above. As under the Basel GSIB Framework, in the event a U.S. G-SIB’s total systemic indicator score increased beyond the fifth bucket, the Proposed Rule would require a 1% increase in the Method 1 surcharge for each 100 basis point bucket at and above the current 530-629 basis point bucket. Just as under the Basel G-SIB Framework, the Proposed Rule uses an indefinite number of buckets to provide the FRB with the ability to assess an appropriate Method 1 surcharge should a U.S. G-SIB materially increase its systemic importance. Method 2 Under Method 2, a U.S. G-SIB would calculate its scores for size, interconnectedness, complexity and cross-jurisdictional activity in the same manner as under Method 1. However, the substitutability systemic indicator used in the Method 1 calculation would be replaced with a quantitative measure of the G-SIB’s use of short-term wholesale funding, or its STWF Score. This, plus the “doubling” feature discussed below, would, in almost all cases, produce substantially higher scores under Method 2 for U.S. G-SIBs.-6- Bank Capital Requirements December 14, 2014 The application of a STWF Score addresses the “systemic risks associated with short-term wholesale funding use,” on the theory that the use of short-term wholesale funding generally increases a BHC’s probability of default by making the BHC vulnerable to short-term creditor runs and thereby increasing the risk that the firm’s significant stress or failure will give rise to fire sale externalities for other firms.8
Although the substitutability category would be used under the Proposed Rule to determine whether a given BHC qualifies as a G-SIB, that category would be replaced by the STWF Score indicator in calculating the applicable equity surcharge for G-SIBs under Method 2. The STWF Score (explained in greater detail below) would be based on a G-SIB’s average use of shortterm wholesale funding sources over a calendar year, with different sources of such funding weighted according to the varying degrees of risk associated with each source. The G-SIB would divide the aggregate components of the STWF Score by the G-SIB’s average RWAs over the same calendar year (from the lower of its standardized or advanced approaches risk-based capital ratios) and apply a fixed conversion factor to the measure of short-term wholesale funding to normalize the STWF Score’s value relative to the other systemic indicators. The G-SIB would then multiply its scores for size, interconnectedness, complexity and cross-jurisdictional activity by two and then add the STWF Score to the result of that calculation to arrive at the Method 2 score. This doubling of the total score for the Basel G-SIB Framework’s retained factors generally, together with substituting the STWF Score for the Basel GSIB Framework’s substitutability factor, would result in higher surcharges than under Method 1. As under Method 1, the Method 2 surcharge would include an indefinite number of buckets in order to give the FRB the ability to assess an appropriate surcharge should a G-SIB’s systemic indicator score exceed the cutoff of the highest bucket, thus strongly disincentivizing score increases. Under the Proposed Rule, the Method 2 surcharge would increase in increments of 0.5 percentage points per additional 100 basis point bucket at and above its current maximum of 1130. By contrast, the Method 1 surcharge increases in increments of 1.0% per additional 100 basis point bucket above its current maximum of 630. The Preamble notes that the bucket structure would be modified for Method 2 because the significantly higher systemic indicator scores that result from the Method 2 calculation would otherwise result in a surcharge that is larger than necessary to appropriately address the risks posed by the G-SIB’s systemic nature. Measuring a BHC’s Use of Short-Term Wholesale Funding Components of short-term wholesale funding The first step for a U.S. G-SIB to compute its STWF Score would be to determine, on a consolidated basis, the amount of its short-term wholesale funding sources with a remaining maturity of less than one year for each business day of the preceding calendar year. The Proposed Rule would use the applicable provisions from the LCR Rule and the items reported on the FR 2052a9 to define the components of -7- Bank Capital Requirements December 14, 2014 short-term wholesale funding. The Proposed Rule includes the following sources of short-term wholesale funding for purposes of the STWF Score: funds that the G-SIB must pay under each secured financing transaction, other than an operational deposit, with a remaining maturity of one year or less; funds that the G-SIB must pay under each unsecured wholesale funding transaction, other than an operational deposit, with a remaining maturity of one year or less; the fair market value of all assets that the G-SIB must return in connection with transactions where it has provided a non-cash asset of a given liquidity category to a counterparty in exchange for non-cash assets of a higher liquidity category, where the G-SIB and the counterparty agreed to return the assets to each other at a future date (a “Covered Asset Exchange”); the fair market value of all assets that the G-SIB must return under transactions where it has borrowed or otherwise obtained a security which it has sold (“Short Positions”); and all brokered deposits and all brokered sweep deposits held at the G-SIB provided by a retail customer or counterparty. The presence of full or partial deposit insurance coverage does not affect whether funding is designated as short-term wholesale funding. In the FRB’s view (which is not explained in any detail), these forms of funding pose run risks even when deposit insurance is present. The FRB requests comment on whether the following additional types of funding should be included as components of short-term wholesale funding: operational deposits,10 weighted at 25 percent (which, as described below, is the same weighting applied to secured funding transactions secured by a level 1 liquid asset); exposures attributable to derivatives transactions, in particular, in cases where the firm has the ability to rehypothecate collateral received in connection with derivative transactions; under this alternative proposal, the weighting of these exposures could be determined based on the counterparty or type of derivative transaction; and exposures arising from sponsoring a structured transaction; under this alternative proposal, the weighting of these exposures would be determined based on the liquidity characteristics of the assets of the issuing entity. The NPR also requests comment on whether wholesale deposits included in a G-SIB’s unsecured wholesale funding amount should reflect any offsetting amounts from the release of assets held in segregated accounts. Weighting of short-term wholesale funding components Once a G-SIB has identified its sources of short-term wholesale funding, the second step of computing the STWF Score is to apply the Proposed Rule’s weighting system grid. The weighting system is designed to take into account the varying levels of systemic risk associated with the different funding sources comprising a G-SIB’s short-term wholesale funding amount. A G-SIB would be required to place each source of its short-term wholesale funding into one of four “remaining maturity” buckets and to distinguish each source by the type of asset backing it, if any. To determine the remaining maturity of a -8- Bank Capital Requirements December 14, 2014 short-term wholesale funding source, a G-SIB would be required to assume that a short-term wholesale funding source matures according to the LCR Rule’s provisions for determining maturity, including the provisions that require non-maturing transactions to be treated as maturing within 30 days.11 The following table summarizes the Proposed Rule’s weighting system. Component of short-term wholesale funding (“STWF”) Remaining Maturity of 30 days or less Remaining Maturity of 31 to 90 days Remaining Maturity of 91 to 180 days Remaining Maturity of 181 to 365 days Secured funding transaction secured by a Level 1 liquid asset 25 percent 10 percent 0 percent 0 percent (1) Secured funding transaction secured by a level 2A12 liquid asset; (2) Unsecured wholesale funding where the customer or counterparty is not a financial sector entity or consolidated subsidiary of a financial sector entity; (3) Brokered deposits and brokered sweep deposits provided by a retail customer or counterparty; (4) Covered Asset Exchanges involving the future exchange of a level 1 liquid asset for a level 2A liquid asset; and (5) Short positions where the borrowed security is either a level 1 or level 2A liquid asset 50 percent 25 percent 10 percent 0 percent (1) Secured funding transaction secured by a level 2B liquid asset; and (2) Covered Asset Exchanges and Short Positions (other than those described above) 75 percent 50 percent 25 percent 10 percent (1) Unsecured wholesale funding where the customer or counterparty is a financial sector entity or a consolidated subsidiary of a financial sector entity; and (2) Any other component of STWF 100 percent 75 percent 50 percent 25 percent Calculating the STWF Score After calculating its weighted short-term wholesale funding amount, the G-SIB would divide that amount by its average RWAs.13 The G-SIB would then multiply this ratio (that is, STWF Amount/RWAs) by a fixed conversion factor of 17514 to weight the short-term wholesale funding amount, in the absence of an associated aggregate global indicator, such that its score accounts for approximately 20 percent of the Method 2 score (that is, the same weight as the other systemic indicators within Method 2). It is worth noting that, unlike the other indicator scores, the STWF Score is not measured relative to other G-SIBs.-9- Bank Capital Requirements December 14, 2014 The Proposed Rule calculates a G-SIB’s short-term wholesale funding amount as a percentage of its average RWAs in order to scale, in a firm-specific manner, a BHC’s use of short-term wholesale funding such that the systemic risks associated with a firm’s use of short-term wholesale funding will be comparable regardless of the business model of a given BHC. Thus, whether a BHC is predominantly engaged in trading operations, combines large trading operations with large commercial banking activities or uses short-term wholesale funding to fund securities inventory, the STWF Score as a percentage of RWAs is designed to help ensure that two BHCs that use the same amount of short-term wholesale funding would be required to hold the same dollar amount of additional capital regardless of differences in business models. Despite this effort to treat different business models comparably, the broad range of funding that is deemed to be short-term wholesale funding under the Proposed Rule is itself likely to have a greater impact on banking organizations with business models not aligned with those of traditional commercial banks. The NPR requests comment on the following alternative methods to calculate the STWF Score: To use alternative methods to reflect the use of short-term wholesale funding, e.g., by calculating the applicable surcharge by using short-term wholesale funding as a scaling factor for the Method 1 surcharge (that is, Method 2 Surcharge = STWF Factor x Method 1 Surcharge); and To use alternative denominators other than average RWAs, for example, short-term wholesale funding considered as against the aggregate short-term wholesale funding amount for all G-SIBs, consistent with the Basel G-SIB Framework. EXTENSION OF THE CAPITAL CONSERVATION BUFFER Like the Basel G-SIB Framework, the G-SIB surcharge under the Proposed Rule would extend the capital conservation buffer in the banking agencies’ Basel III-based regulatory capital rule used to determine the U.S. G-SIB’s maximum payout ratio.15 Under the regulatory capital rule, a banking organization is required to maintain capital sufficient to meet a minimum CET1 requirement of 4.5%, a minimum tier 1 capital requirement of 6%, and a minimum total capital requirement of 8%. In addition to these minimums, if a banking organization wishes to avoid limits on its capital distributions and certain discretionary bonus payments, it must hold an additional capital conservation buffer composed of CET1 capital of not less than 2.5% of RWA. This capital conservation buffer is currently divided into quartiles associated with increasingly stringent limitations on capital distributions and certain discretionary bonus payments. Under the Proposed Rule, each of the four quartiles of the capital conservation buffer would be expanded by adding the equivalent of one-fourth of the applicable G-SIB surcharge to the required buffer amount for that quartile.16 The table below summarizes the total regulatory capital levels for U.S. G-SIBS required by the combination of these capital requirements.-10- Bank Capital Requirements December 14, 2014 IMPLEMENTATION AND TIMING If a U.S. BHC reports total consolidated assets of $50 billion or more on its FR Y-9C as of June 30 of a given year, that BHC would be required under the Proposed Rule to begin calculating its aggregate systemic indicator score by December 31 of that calendar year. If identified as a G-SIB, the BHC would calculate its applicable surcharge under both Method 1 and Method 2, and the resulting surcharge would become applicable to the G-SIB—as an extension of its capital conservation buffer—one full year later, on January 1 of the second calendar year. The proposed implementation schedule for the Proposed Rule’s G-SIB surcharge is aligned with the filing schedule of the FR Y-15 report on which a BHC reports the indicator values that comprise its aggregate systemic indicator score as of the end of the prior calendar year. The FRB intends to propose modifications to the FR Y-15 to require disclosure of information pertaining to G-SIB’s short-term wholesale funding. Although the Proposed Rule would generally use a full calendar year of short-term wholesale funding data to compute a G-SIB’s STWF Score for the Method 2 surcharge calculation, BHCs have not previously been required to calculate or retain data related to their short-term wholesale funding scores. As such, the FRB’s Proposed Rule would measure the G-SIB’s STWF Score for: (1) the G-SIB surcharge calculated by December 31, 2015 based on quarterly average data from the third quarter of 2015 and (2) the G-SIB surcharge calculated by December 31, 2016 based on quarterly average data from the third and fourth quarters of 2015, in order to facilitate implementation of the Method 2 surcharge on the same timeline as the Method 1 surcharge. To comply with the Proposed Rule, a BHC identified as a G-SIB would be required to retain information to calculate its STWF Score beginning on July 1, 2015. The NPR seeks comments on whether the FRB should consider staggering the effectiveness of the Method 1 and Method 2 surcharges such that G-SIBs would be able to use a year’s worth of short-term wholesale funding data to compute their short-term wholesale funding scores. The NPR’s phase-in period was also chosen to align with the phase-in of the capital conservation buffer, the countercyclical capital buffer and the phase-in of the Basel G-SIB Framework. The table below summarizes the total regulatory capital levels for U.S. G-SIBS required by the combination of these capital requirements.-11- Bank Capital Requirements December 14, 2014 Jan. 1, 2016 Jan. 1, 2017 Jan. 1, 2018 Jan. 1, 2019 Capital conservation buffer 0.625% 1.25% 1.875% 2.5% G-SIB surcharge 25% of applicable GSIB surcharge 50% of applicable GSIB surcharge 75% of applicable GSIB surcharge 100% of applicable GSIB surcharge Minimum CET1 capital ratio + capital conservation buffer + applicable G-SIB surcharge 5.125% + 25% of applicable GSIB surcharge 5.75% + 50% of applicable GSIB surcharge 6.375% + 75% of applicable GSIB surcharge 7.00% + 100% of applicable GSIB surcharge Minimum tier 1 capital ratio + capital conservation buffer + applicable G-SIB surcharge 6.625% + 25% of applicable GSIB surcharge 7.25% + 50% of applicable GSIB surcharge 7.875% + 75% of applicable GSIB surcharge 8.5% + 100% of applicable GSIB surcharge Minimum total capital ratio + capital conservation buffer + applicable G-SIB surcharge 8.625% + 25% of applicable GSIB surcharge 9.25% + 50% of applicable GSIB surcharge 9.875% + 75% of applicable GSIB surcharge 10.5% + 100% of applicable GSIB surcharge Periodic Review The Basel G-SIB Framework currently provides for annual reassessment of a G-SIB’s (or potential GSIB’s) systemic importance score, to provide an incentive for banks to alter their profile in ways that will reduce their systemic importance. Similarly, under the FRB’s Proposed Rule, the FRB will reassess a BHC’s systemic indicator score on an annual basis. Other Related Changes The FRB proposes to revise the terminology used to identify firms subject to the enhanced supplementary leverage ratio standards under the recently-issued final rule imposing such standards on certain bank holding companies and their subsidiary depository institutions to reflect the proposed G-SIB surcharge framework. Specifically, the FRB proposes to replace the use of the “covered BHC” definition in the enhanced supplementary leverage ratio rule with firms identified as G-SIBs using the methodology of the Proposed Rule. The eight U.S. top-tier BHCs that are covered BHCs under the enhanced supplementary leverage ratio rule’s definition are the same eight BHCs that would be identified as G-SIBs under the Proposed Rule.-12- Bank Capital Requirements December 14, 2014 ANNEX A Under the Basel G-SIB Framework, G-SIBs are subject to an additional equity surcharge, referred to as a “loss absorbency requirement,” to be implemented through an extension of the Basel III capital conservation buffer. The Basel G-SIB Framework provides an indicator-based approach for determining when a capital surcharge will be applied. The indicator-based approach is comprised of five categories: crossjurisdictional activity, size, interconnectedness, substitutability/financial institution infrastructure, and complexity. Other than size, each of the categories is composed of either two or three equally weighted “indicators” which refer to specific types of activities that BCBS associates with global systemic importance. The results of the indicator-based approach may be adjusted, to a limited extent and in rare circumstances, to reflect supervisory judgment. The following table presents the twelve indicators, and their corresponding weights, used to calculate a firm’s systemic importance score under the Basel G-SIB Framework and the systemic indicator score under the Proposed Rule’s Method 1 calculation. Category Systemic Indicator Indicator Weight Size Total exposures 20% Interconnectedness Intra-financial system assets 6.67% Intra-financial system liabilities 6.67% Securities outstanding 6.67% Substitutability17 Payment activity 6.67% Assets under custody 6.67% Underwritten transactions in debt and equity markets 6.67% Complexity Notional amount of over-thecounter (“OTC”) derivatives 6.67% Trading and available-for-sale (“AFS”) securities 6.67% Level 3 assets 6.67% Cross-Jurisdictional Activity Cross-jurisdictional claims 10% Cross-jurisdictional liabilities 10% Total for 12 indicators across 5 categories: 100%-13- Bank Capital Requirements December 14, 2014 The Basel G-SIB Framework uses formal criteria to determine the “denominator” sample of banks (the “Bank Sample”) used to calculate an individual bank’s indicator-based systemic importance score: (1) the 75 largest global banks, identified by the Basel Committee based on the financial year-end Basel III leverage ratio (“Exposure Measure”), (2) banks designated as G-SIBs in the previous year and (3) banks added to the sample by national supervisors using supervisory judgment in accordance with specified criteria. The aggregate indicator scores of the banks included in the Bank Sample are used as the denominator in the systemic importance score calculation for each individual bank. Each of the resulting values for a given bank for the indicators above would be divided by the corresponding aggregate global indicator amount for the Basel G-SIB Framework’s Bank Sample released annually by the BCBS, converted from Euros to U.S. Dollars and published by the FRB. The resulting quotient for each indicator would then be multiplied by the prescribed weighting factor and then multiplied by 10,000 to reflect the result in basis points. The following example formulas illustrate the application of the calculation methodology: [(Intra-financial system assets x .0667) x (Intra-financial system liabilities x .0667) x (Securities Outstanding x .0067)] = Interconnectedness Indicator [(Interconnectedness Indicator x .20 Indicator Weight) / BCBS Aggregate Systemic Indicator Amount] x 10,000 = Interconnectedness Indicator Score Interconnectedness Indicator Score + Size Score + Substitutability Score + Complexity Score + Cross-Jurisdictional Activity Score = Aggregate Systemic Indicator Score under Basel G-SIB Framework As illustrated, a BHC would sum the weighted values for the 12 systemic indicator scores to determine its aggregate systemic indicator score and whether that score is greater than or equal to the 130 basis point cutoff for classification as a G-SIB. This approach largely reflects the methodology of the Basel G-SIB Framework. The Revised G-SIB Framework assesses a progressive CET1 surcharge of between 1% and 3.5% on banks that qualify as G-SIBs. Bucket thresholds using cutoff scores for each of the five buckets are used to fix the common equity surcharge to be applied to each G-SIB as a percentage of RWAs. To disincentivize G-SIBs from increasing materially their global systemic importance, the Basel G-SIB Framework includes an empty bucket with a surcharge of 3.5%. If the empty bucket becomes populated, a new vacant bucket (with an incremental 1% surcharge) will be added to maintain the incentive for banks to avoid becoming even more systemically important. The table below summarizes the surcharge buckets under the Basel Framework.-14- Bank Capital Requirements December 14, 2014 Systemic Indicator Score Buckets Basel G-SIB Framework Surcharge Less than 130 0.0 percent 130-229 1.0 percent 230-329 1.5 percent 330-429 2.0 percent 430-529 2.5 percent 530-629 3.5 percent 630 or greater 4.5 percent (from this point, continue to increase 1.0 percentage point for every 100 basis point increase in score over the 530-629 bucket) The Basel G-SIB Framework’s surcharge requirement will be phased in beginning on January 1, 2016, to become fully effective on January 1, 2019. The updated list of G-SIBs that will be subject to a G-SIB surcharge starting on January 1, 2016 was published on November 6, 2014.