Prudential regulationi Regulatory reporting requirements and bank examinations
Regulators have two primary tools to supervise BHCs and banks: regulatory reporting requirements and on-site examinations. BHCs and banks are subject to extensive financial, structural and other periodic reporting requirements. Financial reporting requirements for banks include capital, asset and liability data reported quarterly on call reports, and requirements for BHCs include financial statements for the BHC and certain non-bank subsidiaries. BHCs must also provide annual reports to the Federal Reserve that detail their shareholders and organisational structure. Banking institutions that are experiencing financial difficulties or that are not in compliance with regulatory requirements face more frequent and additional reporting obligations.
Bank regulators also conduct on-site examinations of BHCs and banks. Regulators generally conduct three principal types of formal examinations: safety and soundness, or full scope, which determine the bank's fundamental financial health and generally occur every 12 or 18 months;10 compliance examinations covering consumer compliance and fair lending issues; and speciality examinations covering areas such as trust activities and information technology infrastructure.
Congress expanded bank regulators' authority to examine entities beyond BHCs and banks in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act).11 For instance, the Federal Reserve was granted the authority to examine functionally regulated subsidiaries (i.e., subsidiaries whose activities are regulated by another US regulatory authority, such as the SEC) and all insured depository institutions (IDIs) (including those for which the Federal Reserve is not currently the primary federal banking regulator).12
The Dodd-Frank Act also requires the Federal Reserve to examine the permissible activities of BHCs' non-depository institution subsidiaries that are not functionally regulated or subsidiaries of a depository institution.13 The Federal Reserve must examine these entities subject to the same standards and with the same frequency as would be required if the activities were conducted in the lead IDI. With respect to federal consumer financial law, these expanded examination authorities are shared with the Consumer Financial Protection Bureau (CFPB), as described in more detail in Section IV.iv.
Aside from transactions such as mergers and acquisitions or other matters that require formal approvals,14 bank regulators are also routinely informed or involved on a more informal basis with certain key decisions contemplated by a bank or BHC, including capital-raising activities, dividend policies, and changes in business plans or strategies.ii Deposit insurance requirements
The Dodd-Frank Act permanently increased the Standard Maximum Deposit Insurance Amount (SMDIA) to US$250,000.15 Uninsured foreign branches, whether state or federal, may not engage in domestic deposit-taking activities requiring insurance protection,16 subject to certain exemptions. For example, under the FDIC's rules a foreign bank may establish or operate a state branch without federal deposit insurance if such branch, in addition to meeting other requirements, accepts initial deposits only in an amount equal to the SMDIA or greater.17 The OCC's rules for federal branches of foreign banks only permit the acceptance of initial deposits of less than the SMDIA's standard maximum deposit insurance amount under certain circumstances.18
In addition, the Dodd-Frank Act changed how the FDIC assesses deposit insurance premiums against IDIs. An IDI's quarterly deposit insurance assessment is determined by multiplying its assessment rate by its assessment base.19 An IDI's assessment base was historically its domestic deposits, with some adjustments.20 The Dodd-Frank Act, however, requires the FDIC to redefine the assessment base as average consolidated total assets minus average tangible equity during the assessment period.21 As a result, the distribution of assessments and the cost of federal deposit insurance has been shifted to larger banks, which fund a greater percentage of their balance sheet through non-deposit liabilities.22 The FDIC uses an assessment system for large IDIs and highly complex IDIs23 that combines supervisory ratings and certain financial measures into two scorecards, one for most large IDIs and another for highly complex IDIs, and modifies and introduces new assessment rate adjustments.24iii Management of banks
The two traditional areas of regulatory focus on the management of banks have been the responsibilities and duties of BHCs and bank boards, directors and senior management, and the regulation of insider loans.
Bank and BHC boards of directors are different from corporate boards in that they normally have more competing interests to balance, such as shareholder, depositor, parent holding company (in the case of a bank), creditor and regulatory interests. Bank and BHC boards are generally responsible for overseeing management plans and ensuring that adequate controls and systems are in place to identify and manage risk, while management is responsible for the implementation, integrity and maintenance of risk-management systems. Bank examiners normally review bank and BHC board performance and make recommendations for improvement if they find weaknesses.25 In recent years, the Federal Reserve has devoted additional attention to these issues. Specifically, in early 2021 the Federal Reserve finalised guidance for large financial institutions on board effectiveness.26 It also proposed supervisory expectations for management,27 although the management proposal had not yet been finalised as at 31 December 2021.
The Federal Reserve Act of 1913 (FRA) and implementing regulations also govern extensions of credit by a bank to an executive officer, director or principal shareholder of that bank, of a BHC of which the member bank is a subsidiary or of any other subsidiary of that BHC. In general, a bank may not extend credit to any such insider unless the extension of credit is made on substantially all the same terms, and subject to no less stringent credit underwriting procedures, as those for comparable transactions by the bank with persons who are not insiders and not employed by the bank, and the transaction does not involve more than the normal repayment risk or present other unfavourable features. The Dodd-Frank Act expanded the types of transactions subject to insider lending limits to include derivative transactions, repurchase agreements, and securities lending or borrowing transactions. It also imposed limitations on the sale of assets to, or the purchase of assets from, insiders by requiring that such transactions be on market terms and, in the case of significant transactions, have the approval of the majority of disinterested board members.28iv Enhanced prudential standards
Section 165 of the Dodd-Frank Act, as amended by the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), subjects BHCs with total consolidated assets of US$250 billion or more and systemically important non-bank financial companies to enhanced prudential standards (EPS), including increased capital and liquidity requirements, leverage limits, contingent capital, resolution plans, credit exposure reporting, concentration limits, public disclosures and short-term debt limits, as well as enhanced reporting and disclosure requirements and other requirements. The EGRRCPA also amended Section 165 of the Dodd-Frank Act to (1) provide the Federal Reserve with the authority to apply EPS to any BHC with total consolidated assets of US$100 billion or more29 and (2) require the Federal Reserve to tailor its regulations by 'differentiat[ing] among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including the financial activities of their subsidiaries), size, and any other risk-related factors that [it] deems appropriate'.30 In October 2019, the Federal Reserve finalised the tailoring rules (the Tailoring Rules),31 which implement the EGRRCPA and establish risk-based categories for determining prudential standards for large US banking organisations and foreign banking organisations (FBOs), and apply prudential standards to certain large SLHCs using the same categories.32
Under the Tailoring Rules, BHCs are placed into Category I, II, III or IV, with the most stringent category, Category I, reserved for US global systemically important banks (G-SIBs). Because Category I includes only US G-SIBs, FBOs are placed into Category II, III or IV.33 This section provides a general overview of the EPS implemented, or still to be implemented, by the Federal Reserve under Section 165 of the Dodd-Frank Act. Additional detail on the Tailoring Rules is provided in Section III.v and vi.
BHCs covered by the relevant rules finalised by the Federal Reserve under Section 165 of the Dodd-Frank Act, including the Tailoring Rules, must comply with, and hold capital commensurate with, the requirements of any regulations adopted by the Federal Reserve related to capital plans and stress tests, including the Federal Reserve's capital planning rule, described in greater detail below.
The liquidity provisions of the Tailoring Rules require certain BHCs to maintain a sufficient quantity of highly liquid assets to survive a projected 30-day liquidity stress event, conduct regular liquidity stress tests and implement liquidity risk-management requirements, including periodic reviews of business lines for liquidity risks. A BHC's board of directors is ultimately responsible for liquidity risk management, including periodic review, and a risk committee is responsible for approving a contingency funding plan to address potential liquidity stress events.
BHCs with total consolidated assets of US$50 billion or more must also comply with a range of corporate governance requirements, such as establishing a risk committee of the board of directors, and appointing a chief risk officer with defined responsibilities.
The EPS requirements also include the Federal Reserve's supervisory stress test and company-run stress test requirements for covered companies. The stress tests, which are designed to assess firms' capital adequacy, involve nine-quarter planning horizons under both supervisory and company-designed scenarios. The Federal Reserve publishes public summaries of companies' stress test results, with more detailed information remaining confidential. The stress tests are designed to work in tandem with the capital planning rule, which requires large BHCs34 to submit annual capital plans to the Federal Reserve for supervisory review while demonstrating capital adequacy under baseline and severely adverse scenarios.
The EPS requirements also implement a provision of Section 165 of the Dodd-Frank Act that imposes a 15:1 debt-to-equity limit on any BHC that is determined by the Financial Stability Oversight Council (FSOC) to represent a grave threat to US financial stability.
The EPS requirements also include single-counterparty credit limits (SCCL), which the Federal Reserve implemented by issuing a final rule in 2018 and amended with the Tailoring Rules.35 This requirement limits net credit exposure to any single counterparty to 25 per cent of Tier 1 capital for BHCs with US$250 billion or more in total consolidated assets. A more stringent net credit exposure limit of 15 per cent of Tier 1 capital applies to the US G-SIBs with respect to certain large counterparties, including other G-SIBs and non-bank systemically important financial institutions (SIFIs). The final SCCL rule also requires BHCs to measure net credit exposures on an aggregate basis, aggregating exposures to counterparties that are economically interdependent or in the presence of certain control relationships.v Regulation of FBOsApplication of the US IHC Requirement
An FBO with US$50 billion or more in non-branch assets must create a separately capitalised, top-tier US intermediate holding company (US IHC) to hold substantially all of its ownership interests in its US bank and non-bank subsidiaries.36 For the purposes of identifying subsidiaries, the Tailoring Rules rely on the Bank Holding Company Act of 1956 (the BHC Act) definition of control, including the facts and circumstances-based controlling influence test. With very limited exceptions, an IHC FBO may not retain any ownership interest in a US subsidiary (other than its US IHC) directly or through non-US affiliates. However, the Tailoring Rules do not require an IHC FBO to be the 100 per cent owner of any US subsidiary. In other words, an IHC FBO is not required to buy out other, unaffiliated third-party investors in a US subsidiary. The Federal Reserve has the authority to examine any US IHC and any US IHC subsidiary. Note that US branches and agencies of an IHC FBO's foreign bank are not required to be held beneath the US IHC.
Regardless of whether a US IHC controls a US bank, a US IHC will be subject to US Basel III (subject to limited adjustments),37 capital planning and Dodd-Frank company-run and supervisory stress-testing requirements, qualitative and quantitative liquidity standards, risk-management standards and other EPS, depending on its risk-based categorisation under the Tailoring Rules.Application of the Tailoring Rules to FBOs and their US IHCs
As discussed in Section III.iv, the Tailoring Rules reserve Category I for US G-SIBs and place FBOs into Categories II, III and IV. Under the Tailoring Rules, the thresholds for Categories II, III and IV are the same as the thresholds that apply to domestic BHCs, except that some standards apply based on the size and risk profile of the FBO's combined US operations (CUSO) while others are determined by the size and risk profile of the FBO's US IHC. This necessitates that an FBO determine both its category and the category of its US IHC, if any.
This section discusses the application of SCCL and certain EPS to FBOs with respect to their CUSO and US IHCs under the Tailoring Rules. Additional EPS applicable to these entities related to capital and liquidity are discussed in Section III.vi.
The EPS requirements applicable to FBOs and US IHCs include SCCL, under a rule originally finalised in June 2018,38 and amended by the Tailoring Rules. The final SCCL rule limits net credit exposure to any single counterparty to 25 per cent of Tier 1 capital for the US operations of Category II and III FBOs and FBOs with assets of US$250 billion or more and for all operations of Category II and III US IHCs.39 A more stringent net credit exposure limit of 15 per cent of Tier 1 capital applies to FBOs with the characteristics of G-SIBs (G-SIB FBOs) with respect to certain large counterparties, including other G-SIBs and non-bank SIFIs. The SCCL final rule also requires covered FBOs and US IHCs - those FBOs with total consolidated assets of at least US$250 billion and FBOs and US IHCs identified as Category II or III - to measure net credit exposures on an aggregate basis, aggregating exposures to counterparties that are economically interdependent or in the presence of certain control relationships. Category II and III US IHCs of FBOs were generally required to comply with the SCCL requirements from 1 July 2020, although such US IHCs with less than US$250 billion in assets were afforded an additional transition period, until 1 January 2021, to come into compliance with certain more stringent requirements that were amended by the Tailoring Rules. The SCCL final rule allows an FBO to comply with the SCCL applicable to its CUSO by certifying to the Federal Reserve that the FBO meets, on a consolidated basis, SCCL standards established by the FBO's home-country supervisor that are consistent with Basel Committee standards and providing the home-country report, with an English-language translation to the Federal Reserve.
EPS of more general applicability to FBOs include risk management requirements. FBOs with US$50 billion or more but less than US$100 billion in total consolidated assets, as well as FBOs with total consolidated assets of US$100 billion or more but less than US$50 billion in combined US assets, are required to maintain a US risk committee and make an annual certification to that effect. An FBO subject to this requirement may maintain its US risk committee either as a committee of its global board of directors, on a stand-alone basis or as part of its enterprise-wide risk committee. The US risk committee must oversee the risk management policies of the CUSO of the FBO and must include at least one member with experience in identifying, assessing and managing risk exposures of large, complex firms. Additionally, FBOs with total consolidated assets of US$100 billion or more and combined US assets of US$50 billion or more are required to comply with more detailed risk-committee and risk-management requirements under the EPS rule, including a requirement to employ a US chief risk officer with specified risk management expertise and responsibilities.vi Regulatory capital
Federal Reserve policy and regulations traditionally required a BHC to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to their support. This policy became a statutory requirement pursuant to the Dodd-Frank Act. Section 616(d) of the Dodd-Frank Act, which requires all companies that directly or indirectly control an IDI to serve as a source of strength for the institution.40 US banking agencies were required to issue regulations implementing this requirement not later than 21 July 2012, but had not proposed such regulations as at 31 December 2021.
Under the Dodd-Frank Act, as amended by the EGRRCPA and implemented with the Tailoring Rules, BHCs with consolidated assets of US$100 billion or more (large BHCs) and non-bank SIFIs are subject to biennial or annual (depending on their categorisation under the Tailoring Rules) supervisory and company-run stress tests.41 Supervisory stress tests, along with related capital plans required by Federal Reserve rules, are part of the supervisory process for large BHCs.42 Companies subject to stress test requirements must publish summaries of their company-run stress test results, and the Federal Reserve must publish summaries of its supervisory stress test results. The supervisory stress tests are also used to determine large BHCs' stress capital buffers (SCBs), discussed in further detail below. The Federal Reserve must provide notice of each large BHC's SCB by 30 June of the year of the applicable stress testing cycle.43
The Federal Reserve has integrated capital planning and Dodd-Frank Act stress test requirements into its comprehensive capital analysis and review (CCAR), an annual exercise designed to ensure that large BHCs have robust, forward-looking capital planning processes and sufficient capital to continue operations throughout times of economic and financial stress. Capital plans incorporate projected capital distributions over a planning horizon of at least nine quarters and are submitted to the Federal Reserve. As of the 2021 capital planning and stress testing cycle, the Federal Reserve does not issue objections or non-objections to large BHCs' capital plans, either on qualitative or quantitative grounds.44 Large BHCs must submit their capital plans by 5 April of the year of the applicable capital planning cycle.
In light of the coronavirus shock, the Federal Reserve used its authority under the capital planning rule to take several actions intended to ensure that large BHCs remained resilient in the face of significant economic uncertainty. First, the Federal Reserve supplemented the ordinary course CCAR 2020 exercise, the parameters of which were finalised just before the full onset in the United States of the coronavirus pandemic, with additional sensitivity analyses. The hypothetical scenarios used in the sensitivity analysis included a v-shaped recession and recovery; a slower, u-shaped recession and recovery; and a w-shaped, double-dip recession.45 Second, in June 2020, the Federal Reserve announced that it would require each large BHC to update and resubmit its capital plan in December 2020, effectively conducting a second CCAR exercise.46 Third, by requiring capital plan resubmissions, the Federal Reserve triggered a provision of the capital planning rule that prohibits a BHC that is required to resubmit its capital plan from making any capital distributions unless otherwise approved by the Federal Reserve.47 The Federal Reserve then provided prior approval for only a limited set of capital distributions up to June 2021. Most notably, in the third and fourth quarters of 2020, large BHCs were prohibited from making most share repurchases, and could pay dividends only up to a cap.48 In December 2020, the Federal Reserve announced the results of the second round of stress tests and extended into 2021, with modifications, its limitations on large BHCs' capital distributions. As a result, in the first quarter of 2021 large BHCs were allowed to make share repurchases and pay dividends, subject to limitations based on income over the past year.49US Basel III
US Basel III applies to all national banks, state member and non-member banks, and state and federal savings associations regardless of size. The regulation also applies to all BHCs and covered SLHCs other than certain BHCs and SLHCs with less than US$3 billion in total assets that meet certain requirements.50 However, the bank and thrift subsidiaries of these small BHCs and SLHCs are still subject to US Basel III.
US Basel III implements many aspects of the Basel Committee's Basel III capital standards, including higher minimum risk-based capital ratios, capital buffers, revised eligibility criteria for Common Equity Tier 1, Additional Tier 1 and Tier 2 capital instruments, certain deductions from and adjustments to regulatory capital, and the recognition of minority interests. US Basel III introduces a revised and expanded standardised approach for calculating risk-weighted assets (RWAs), the denominator of the risk-based capital ratios, which replaced the previously applicable Basel I-based rules. In addition to the standardised approach, large and internationally active US banking organisations (redefined by the Tailoring Rules to include only Category I and II banking organisations) must calculate RWAs using the advanced internal ratings-based approach for credit risk and advanced measurement approaches for operational risk (together, advanced approaches). A key difference between the standardised approach and advanced approaches is that the former mandates the use of standardised risk weights and methodologies for calculating RWAs, whereas the latter permit the use of supervisor-approved internal models and methodologies that meet specified qualitative and quantitative requirements, which generally give rise to more risk-sensitive measurements.
US Basel III implements the capital floor requirement of Section 171 of the Dodd-Frank Act (known as the Collins Amendment) by requiring advanced approaches banking organisations to calculate their risk-based capital ratios using both the standardised approach and the advanced approaches. An advanced approaches banking organisation's risk-based capital ratios for regulatory purposes, including for calculating capital buffers, are the lower of each ratio calculated under the standardised approach and advanced approaches.
As of January 2018, advanced approaches banking organisations and Category III banking organisations must also maintain a minimum supplementary leverage ratio of 3 per cent.51 The supplementary leverage ratio is based on the Basel Committee's Basel III leverage ratio. The US banking agencies have established enhanced supplementary leverage ratio standards for the eight BHCs identified by the Financial Stability Board as G-SIBs as well as their IDI subsidiaries.52 Under the enhanced supplementary leverage ratio standards, a US G-SIB's IDI subsidiaries must maintain a supplementary leverage ratio of at least 6 per cent to be considered well-capitalised for regulatory purposes. A US G-SIB, on a global consolidated basis, must maintain a leverage capital buffer that functions in a similar way to US Basel III's risk-based capital buffers - the SCB, the countercyclical buffer and the G-SIB capital surcharge. Specifically, a US G-SIB that does not maintain a supplementary leverage ratio of greater than 5 per cent (i.e., a buffer of more than 2 per cent on top of the 3 per cent minimum) will be subject to increasingly stringent restrictions on its ability to make capital distributions and discretionary bonus payments. The Federal Reserve and OCC have proposed to recalibrate the enhanced supplementary leverage ratio requirement for US G-SIBs and their US IDI subsidiaries,53 but this proposal had not been finalised as at 31 December 2021.
The coronavirus pandemic and actions taken in response to it by the Federal Reserve and other US government actors, resulted in a significant expansion of the balance sheets of many large US banking organisations, including as a result of the acquisition of significant amounts of US Treasury securities. Among other things, this led to a substantial increase in deposits by these large US banking organisations at Federal Reserve Banks. To ease the potential strain caused by this balance sheet expansion and to support market functioning, the Federal Reserve in April 2020 adopted an interim final rule excluding US Treasuries and deposits at Federal Reserve Banks from the denominator of the supplementary leverage ratio (SLR).54 This interim final rule, which applied only to BHCs subject to SLR requirements,55 expired at the end of the first quarter of 2021.56
In addition to the enhanced supplementary leverage ratio requirements, US G-SIBs are also subject to a risk-based capital surcharge buffer under US Basel III, which implements the Basel Committee's G-SIB capital surcharge standard with certain modifications. The G-SIB capital surcharge functions as an extension of the Basel III capital conservation buffer, requiring each G-SIB to hold an additional buffer of Common Equity Tier 1 capital, on top of the capital conservation and countercyclical buffers, to avoid limitations on making capital distributions and discretionary bonus payments. Under the US implementation of the G-SIB capital surcharge, the resulting buffers for the eight US G-SIBs currently range from 1 per cent to 3.5 per cent of RWAs, depending on the size of the G-SIB's systemic footprint.57 The US implementation modifies the measure of each US G-SIB's systemic footprint to include a component linked to the G-SIB's reliance on short-term wholesale funding.58
In July 2019, the US banking agencies released a final rule intended to simplify certain elements of the US Basel III capital rules.59 These simplifications, which apply only to the rules applicable to non-advanced approaches banking organisations, modify the capital treatment of capital deductions and recognition of minority interests and became effective on 1 April 2020. In 2019, the US banking agencies also finalised a rule to implement the standardised approach for measuring counterparty credit risk (known as SA-CCR).60 Pursuant to this rule, advanced approaches banking organisations are required to use SA-CCR to calculate total RWAs under the standardised approach and to determine the exposure amount of derivative contracts when calculating total leverage exposure for purposes of the denominator of the SLR.
In early March 2020, the Federal Reserve finalised a rule changing how stress testing is used to impose capital requirements for large BHCs by incorporating a firm's modelled stress losses directly into the firm's point-in-time capital requirements. The final rule replaces the 2.5 per cent fixed portion of the standardised approach capital conservation buffer with a new SCB (on top of the G-SIB surcharge and any applicable countercyclical capital buffer) based on a firm's peak-to-trough stress losses and four quarters of planned dividends.61 The results of the 2021 supervisory stress tests were used by the Federal Reserve to calculate the SCB applicable to each firm subject to the supervisory stress tests in 2021, with SCBs ranging in size from 2.5 per cent (the floor for the SCB) to 7.8 per cent.62 Unless modified by the Federal Reserve,63 these SCBs will remain in effect until 1 October 2022, at which point firms will become subject to SCBs calculated based on the results of the 2022 supervisory stress tests.
In December 2017, the Basel Committee finalised revisions to the international Basel III standards, marking the finalisation and completion by the Basel Committee of all remaining components of the Basel III framework.64 The primary purpose of this final set of revisions was to reduce excessive variability in RWAs and to restore credibility in the calculation of RWAs by enhancing the robustness and risk sensitivity of the standardised approaches for credit risk and operational risk, constraining the use of internally modelled approaches and complementing the risk-weighted capital ratio with a finalised leverage ratio and a revised capital floor. In January 2019, following its fundamental review of the trading book, the Basel Committee finalised updated minimum capital requirements for market risk. As at 31 December 2021, the US banking agencies had not proposed rules to implement the revisions to the international Basel III standards, including the market risk requirements, in the United States.vii Resolution planning
Section 165(d) under Title I of the Dodd-Frank Act, as revised by the EGRRCPA, and its implementing regulations require the submission of a resolution plan. The scope of the resolution plan and the frequency of its submission depends on the size and complexity of the financial institution required to submit the plan.65 In general, (1) US G-SIBs must file biennially, alternating between full and targeted plans; (2) US firms with total assets, and FBOs with combined US assets, of at least US$250 billion (or exceeding certain other quantitative proxies for complexity under the Tailoring Rules) must file triennially, alternating between full and targeted plans; and (3) FBOs with total global consolidated assets of at least US$250 billion not subject to the previous requirement must file reduced plans triennially.66 The resolution plan is submitted to and evaluated jointly by the Federal Reserve and the FDIC. If the resolution plan were deficient, or deemed not credible, the Federal Reserve and the FDIC could jointly agree to impose increasingly onerous restrictions on the company until the plan is determined to be credible. The Federal Reserve and FDIC issued guidance for resolution plan submissions for US G-SIBs in 2019 and for the largest FBO filers in 2020.67
The FDIC separately requires all US IDIs with assets of US$50 billion or more to also submit and regularly update a resolution plan.68 The FDIC has published an advance notice of proposed rule-making that, although not required by the EGRRCPA, would raise this asset threshold to US$250 billion and would tailor the content and frequency of IDI resolution plan submissions based on institution size, complexity, funding structure and other factors.69 As at 31 December 2021, the FDIC had not adopted a final rule. In November 2018, chairman McWilliams announced that the FDIC was imposing a moratorium on IDI resolution plan submissions;70 on 19 January 2021, the FDIC lifted this moratorium for IDIs with US$100 billion or more in total assets.71 On 25 June 2021, the FDIC provided further details regarding the resumption of resolution plans under a modified approach for IDIs with US$100 billion or more in total assets.72 The modified approach divides filers into two groups (the first consisting of IDIs whose top-tier parent company is not a US G-SIB or a Category II banking organisation and the second consisting of all other IDIs with US$100 billion or more in total assets). The FDIC also extends the submission frequency to a three-year cycle, allows filers to incorporate information by reference from, among other sources, resolution plans submitted pursuant to Section 165(d) under Title I of the Dodd-Frank Act, streamlines content requirements and places enhanced emphasis on engagement with firms.viii Orderly liquidation authority
Title II of the Dodd-Frank Act includes an orderly liquidation authority (OLA), modelled on the US bank resolution authority in the Federal Deposit Insurance Act, which would allow the government, under certain circumstances, to resolve a US financial company outside the bankruptcy process. Specifically, if a determination to place a financial company under this resolution regime were made, the FDIC would step in as receiver of the company, with the authority to sell all or any assets and liabilities to a third party, or establish one or more bridge financial companies to hold the part of the business worth preserving until it could be recapitalised, sold or liquidated in an orderly fashion.
The Dodd-Frank Act provides for an orderly liquidation fund to be used to provide liquidity to the covered financial company or bridge financial company. That fund would not be pre-funded, but rather would be funded initially through borrowing from the US Treasury. Any loss in the fund would be paid back over time, either through a clawback from creditors who received additional benefits or through assessments on eligible financial companies.
On 15 July 2011, the FDIC issued a final rule implementing certain provisions of OLA, including:
- how the preferential transfer and fraudulent transfer provisions of OLA will be harmonised with the Bankruptcy Code;
- the priorities of administrative expenses and unsecured claims;
- the obligations of bridge financial companies with respect to assumed claims and the use of any proceeds realised from the sale or other disposition of the bridge;
- certain details of the FDIC's administrative claims process;
- special rules for secured claims;
- proposals for determining whether senior executives or directors of a covered financial company were substantially responsible for its failure and may therefore be ordered to return up to two years of their remuneration; and
- the treatment of claimants whose set-off rights are destroyed by the FDIC.73
After public statements by the FDIC chair indicating that the FDIC's preferred method for resolving the largest and most complex banking groups under Title II is the single-point-of-entry (SPOE) recapitalisation model,74 the FDIC released a notice providing information about how the FDIC would carry out an SPOE recapitalisation in resolving a US G-SIB under Title II.75 Under the SPOE model, only the parent BHC of a banking group would be put into a resolution proceeding. All the parent's assets, including its ownership interests in operating subsidiaries, would be transferred to a bridge financial company. The transferred business would be recapitalised by leaving behind the failed company's equity capital and a sufficient amount of its unsecured long-term debt in a receivership. The operating subsidiaries would be recapitalised and kept out of insolvency proceedings by converting loans or other extensions of credit from the parent into new equity in the operating subsidiaries or otherwise downstreaming available parent assets to the subsidiaries. If the bridge financial holding company (FHC) or any of its operating subsidiaries were unable to obtain sufficient liquidity from the market, the Federal Reserve's discount window76 or Section 13(3) of the FRA,77 the FDIC could provide such liquidity with an orderly liquidation fund by borrowing from the US Treasury, subject to certain limits.78ix Total loss-absorbing capacity
To facilitate an SPOE recapitalisation, the parent BHC of a banking group must have a sufficient amount of eligible long-term debt or other resources capable of absorbing losses to be left behind in a receivership or bankruptcy proceeding. To that end, the application of a minimum requirement of total loss-absorbing capacity (TLAC) for G-SIBs was discussed by the international regulatory community for several years, resulting in the publication by the Financial Stability Board of a statement of principles and a term sheet for an international TLAC standard.79 On 15 December 2016, the Federal Reserve released a final rule implementing the international TLAC standard for the parent BHCs of US G-SIBs and the US IHCs created pursuant to EPS that are controlled by foreign G-SIBs.80 Under the rule, on 1 January 2019, parent BHCs of US G-SIBs and US IHCs that are controlled by foreign G-SIBs became subject to minimum TLAC requirements, separate minimum long-term debt requirements and clean holding company requirements intended to simplify holding company balance sheets. In addition, the rule requires parent BHCs of US G-SIBs and US IHCs that are controlled by foreign G-SIBs to maintain TLAC buffers above the minimum TLAC requirements to avoid being subject to increasingly stringent restrictions on the ability to make capital distributions and discretionary bonus payments. The BHCs and US IHCs subject to the rule are generally able to satisfy TLAC requirements with a combination of Tier 1 capital instruments and unsecured long-term debt that, unlike short-term debt, would not run off as a G-SIB experiences financial distress. On 23 March 2020, in response to the coronavirus pandemic, the Federal Reserve adopted a technical change to the TLAC buffer requirements, making the imposition of restrictions on firms' ability to make capital distributions and discretionary bonus payments more gradual, to facilitate firms' use of their TLAC buffers to promote lending. Separately, the rule requires parent BHCs of US G-SIBs and US IHCs that are controlled by foreign G-SIBs to hold certain minimum amounts of unsecured long-term debt. The clean holding company requirements prohibit parent BHCs of US G-SIBs and US IHCs that are controlled by foreign G-SIBs from entering into certain transactions that might impede an orderly resolution, such as issuing short-term debt to, or entering into certain types of financial contracts with, third parties, and limit the amount of operational liabilities and liabilities such as structured notes that rank pari passu or junior to TLAC in part to limit the risk of successful legal challenge to losses being imposed on holders of TLAC instruments.x Qualified financial contracts
One potential impediment to an SPOE recapitalisation is the inclusion of cross-default provisions in qualified financial contracts (QFCs) that would not be automatically stayed in a resolution of the parent BHC under ordinary insolvency proceedings. This would mean that a counterparty could terminate a QFC against a subsidiary based on the entry of its parent into resolution proceedings, even if the subsidiary otherwise remains operational and able to perform on its obligations, which could impair the continued viability of the subsidiary. This would defeat the purpose of an SPOE resolution, which is meant to enable subsidiaries of the parent BHC to continue operating without entering into their own bankruptcy or resolution proceedings.
The US banking agencies have issued final rules that require US G-SIBs and the US operations of non-US G-SIBs to remediate certain QFCs to eliminate the ability of a counterparty to exercise any cross-default right against a G-SIB entity based on the top-tier parent's or any other affiliate's entry into insolvency, resolution, or similar proceedings, subject to certain creditor protections, and to eliminate the right of counterparties to object to the transfer of any related credit enhancements provided by an affiliate following the entry into any such proceedings. In addition, US G-SIBs and the US operations of non-US G-SIBs must amend certain QFCs to expressly recognise the FDIC's authority under the Federal Deposit Insurance Act and Title II of the Dodd-Frank Act (the OLA provisions described in Section III.viii) to impose a temporary stay on the ability of counterparties to exercise certain default rights, and to transfer the contracts of the failed institution to a third party or bridge institution. The requirements apply to new and existing QFCs.81
These rules complement the international protocol developed by the International Swaps and Derivatives Association (ISDA) at the request of various financial regulators around the world, including the Federal Reserve and the FDIC (the ISDA Protocol). The ISDA Protocol provides for the contractual recognition of statutory stays under certain special resolution regimes and contractual limitations on early termination rights based on cross-defaults under ISDA master agreements and certain other types of financial contracts. The rules would enable relevant G-SIBs to comply with the requirements through adherence to the ISDA Protocol and its annexes or through a new US Protocol that is substantively similar to the ISDA Protocol, which was published by ISDA on 31 July 2018.82xi Enhanced cyber risk management standards
As a result of recent high-profile cyberattacks on banks and other financial institutions, state and federal regulators83 have proposed cybersecurity regulations to protect financial institutions and consumers to supplement the already expansive web of regulator-issued cybersecurity rules and guidance to which BHCs and banks are subject.84 In late 2021, the US federal banking agencies also issued a final rule that would apply to national banks, savings associations, state-chartered banks and any holding company of these institutions, as well as foreign branches of US organisations and the US operations of foreign banks. The rule will, among other things, require such banking organisations to notify their primary federal regulators within 36 hours of identifying a 'computer-security incident' that rises to the level of a 'notification incident'.85 In addition, the New York Department of Financial Services (NYDFS) issued cybersecurity regulations that apply to banks (including New York branches and agencies of foreign banks) and certain other financial institutions chartered or licensed in New York State.86 The rules require covered entities to, among other things, establish and maintain a cybersecurity programme with a written cybersecurity policy, appoint a chief information security officer, conduct regular penetration testing and vulnerability assessments, create a written incident response plan, encrypt non-public information in transit and at rest, and certify compliance with the rules annually.87xii Fintech charters
On 31 July 2018, the OCC issued a policy statement announcing that it would consider applications from fintech companies to become special purpose national banks.88 In contrast to the regulatory sandbox initiatives by some non-US regulators, the OCC's special-purpose charter, like all national bank charters, comes with a host of regulatory obligations and activity limitations. The special purpose national bank charter is available to qualifying companies engaged in a limited range of banking activities, including paying cheques or lending money, but that do not take deposits. Concurrent with the announcement, the OCC issued a supplement to its licensing manual to provide guidance for evaluating special purpose national bank charters for fintech companies.89 Following the announcement, the NYDFS and the Conference of State Bank Supervisors (CSBS) separately filed suit against the OCC to stop it from granting applications for the special purpose national bank charter, arguing that the agency lacks the legal authority to charter non-depository institutions. The District Court for the Southern District of New York ruled in favour of the NYDFS, finding that the OCC exceeded its statutory authority in granting the charter; however, the district court was reversed on appeal to the Second Circuit Court of Appeals, which ordered that the case be dismissed on procedural grounds, for lack of ripeness and standing. The Second Circuit Court of Appeal's decision did not address the legal issue of whether the OCC has legal authority to charter non-depository institutions, leaving the ultimate issue unresolved. The CSBS lawsuit faced similar procedural obstacles, and the CSBS filed a motion to stay the suit in June 2021, after acting Comptroller Michael Hsu indicated that the OCC would review its chartering framework. As at 31 December 2021, the OCC had not received any applications for the special purpose national bank charter. Nonetheless, fintech companies continue entering the financial market by applying for national bank charters, either in the form of regular national bank charters despite non-traditional business plans or in the form of other national bank charters, such as national trust bank charters.xiii Virtual currencies
As digital assets continue to grow in both popularity and market size, the US Congress and a number of US federal and state agencies, including the SEC, the US Commodity Futures Trading Commission (CFTC) and the CFPB, have examined the operations of digital asset networks, with particular focus on questions of safety and soundness arising from banks engaging in cryptocurrency activities, the classification of digital assets under federal securities laws, regulatory challenges connected to the growth of decentralised finance (DeFi),90 and the use and regulation of stablecoins.91 Many of these state and federal agencies have issued consumer advisories regarding the risks posed to investors in digital assets. In addition, federal and state agencies have issued rules or guidance about the treatment of digital asset transactions or requirements for businesses engaged in digital asset activity.92 As financial institutions have expanded into the digital assets sector, banking regulators continue to evaluate potential prudential concerns; the OCC, for example, issued an interpretive letter confirming that national banks may engage in certain cryptocurrency, distributed ledger, and stablecoin activities, provided the bank can demonstrate 'that it has controls in place to conduct the activity in a safe and sound manner'.93 Regulators' concerns are animated by certain gaps in prudential oversight of the digital assets sector. In 2021, for example, the President's Working Group on Financial Markets, together with the FDIC and OCC, issued an extensive report on the risks associated with stablecoins, which recommended that Congress establish a comprehensive legislative framework governing the issuance and use of stablecoins and that Congress limit the entities permitted to issue stablecoins to IDIs.94
In the absence of new legislation tailored to digital assets, regulators have attempted to fit these new technologies into existing regulatory schemes. The CFTC and SEC have concluded, for example, that DeFi markets for derivatives, and certain individuals issuing and trading assets in the DeFi marketplace, are subject to the registration and other requirements of the Commodities Exchange Act and the Securities Act of 1933, respectively.95 Nevertheless, federal regulators and some lawmakers have acknowledged the opportunities offered by digital assets. The Federal Reserve, for example, is exploring the possibility of issuing central bank money on a blockchain or other digital ledger, echoing discussions among other central banks around the world.96xiv ESG initiatives
ESG issues, particularly those regarding climate-related financial risk, have been receiving increasing attention from US banking regulators and the Biden Administration more broadly. Pursuant to an Executive Order issued in October 2021, the Biden Administration published a report outlining its 'whole-of-government' approach to addressing climate-related financial risk.97 Shortly after, also in October 2021, the FSOC published a report stating that '[c]limate change is an emerging threat to the financial stability of the United States' and proposing 35 recommendations for FSOC's member agencies.98 The report serves as a framework for next steps and a call to action, and includes references to numerous committees and working groups across the FSOC member agencies working on climate-related financial risk.99
US banking regulators have since reiterated their position that they have a role to playing protecting financial institutions from risks, including climate risks, but that they should not engage in dictating banks' lending decisions such as by mandating lending decisions based on the ESG profile of borrowers.100 Instead of dictating lending decisions, US banking regulators have focused on risk management supervisory guidance. In December 2021, the OCC released draft guidance that would establish principles for climate-related financial risk management for large banks.101 The proposed principles would provide 'a high-level framework for the safe and sound management of exposures to climate-related financial risks, consistent with the existing risk management framework [in] OCC rules and guidance'.102 Acting Comptroller Hsu has stated that the principles will be finalised in 2022, followed by the OCC issuing more detailed interagency guidance with the Federal Reserve and FDIC.103 The principles and statements from US banking regulators also indicate that climate scenario analysis - exercises to explore the potential impact of climate-related risks on banks, distinct from capital stress testing - will play an increasingly important role over the medium term.