Introduction

On January 23 2018 the Board of Governors of the Federal Reserve System announced revisions to the Annual Report of Foreign Banking Organisations (FR Y-7) that will enable foreign banking organisations (FBOs) to certify their compliance with US risk committee and home country capital stress testing requirements under Regulation YY's enhanced prudential standards. The FR Y-7 is an annual report submitted by qualifying FBOs to provide financial, organisational, shareholder and managerial information to the board. The FR Y-7 must be filed within four months of the end of an FBO's fiscal year.

The revisions to the FR Y-7 were originally proposed in December 2015(1) and have been generally adopted as proposed. The revisions will 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 regarding 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 Board of Governors of the Federal Reserve System to establish enhanced prudential standards for bank holding companies and FBOs with total consolidated assets of $50 billion or more and certain designated non-bank 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 board adopted enhanced prudential standards for FBOs, including risk committee and capital stress testing requirements, which are set forth in Regulation YY (12 CFR Part 252).

The revised FR Y-7 and its instructions(2) add the new Report Item 5 which comprises five subsections that require an FBO to indicate whether it has satisfied the Regulation YY risk committee and capital stress testing standards.

Capital stress testing certification The subsections relevant for capital stress testing certification are as follows:

  • Report Item 5(a) – capital stress testing standards for FBOs and foreign savings and loan holding companies with total consolidated assets of more than $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 US 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 US assets of $50 billion or more.

These report items require that the FBO indicate whether it satisfies the following standards:

  • The FBO is subject, on a consolidated basis, to a capital stress testing regime by its home country supervisor that includes:
    • 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
    • requirements for governance and controls of stress testing practices by relevant management and the board of directors (or equivalent thereof).
  • 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 The subsections relevant for risk committee certification are as follows:

  • 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 US 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), on a standalone basis or as part of its enterprise-wide risk committee (or equivalent), that:

  • oversees the risk management policies of the combined US operations of the FBO; and
  • includes at least one member with experience in identifying, assessing and managing risk exposures of large, complex firms.

Discussion of public comments

The Board of Governors of the Federal Reserve System's release also discusses comments received on the FR Y-7 proposal. Some of the key questions and responses are summarised below.

US risk committee configuration and design One commenter asked whether the US risk committee must be composed entirely of members of the FBO's global board, or whether it may be configured in other ways which take into account the size, scale and complexity of an FBO's combined US operations and therefore more effectively utilise the expertise of personnel familiar with the risk of these operations.

The board responded that the FBO is not required to form a special US risk committee composed of members of its board of directors. However, the board of directors or a committee comprised of members of the board of directors must have primary responsibility for overseeing the risks of the combined US operations. The US risk committee subject to Regulation YY may, but is not required to, directly administer the FBO's US risk management policies. The FBO may designate specific senior management officials from its US operations to be responsible for administering the US risk management policies and for providing regular reports directly to its board of directors or risk committee.

The FBO has flexibility when establishing and designing its oversight function, provided that its board of directors is informed about the risks of its combined US 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 US operations are implemented and that the risk committee receives sufficient information on the combined US operations to allow it to carry out its responsibilities.

Two-tiered board structures A commenter requested clarification regarding how the US risk committee requirement would apply to an FBO with a two-tier board structure, which is a common feature of FBOs in European countries. The two-tier structure generally consists of:

  • a supervisory board independent from management which sets the direction of the company and oversees the company's senior management; and
  • a management or executive board which implements the company's strategies and risk management.

The board 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 US 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 or executive board (or a combination thereof) could be considered a committee of the FBO's board of directors for the purposes of the US risk committee requirement. Both tiers 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 board 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 board 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 Organisations). 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 board 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, it 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 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 its combined US operations, which incorporate three specified planning horizons (30 days, 60 days and one year). A commenter requested guidance on how an FBO should report if its home country uses fewer or different planning horizons.

The board 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 the combined US operations only. If an FBO does not comply with Regulation YY's internal liquidity stress testing reporting requirements, it must limit the net aggregate amount owed by the parent or other non-US affiliates to the US operations to 25% or less of the third-party liabilities of the combined US operations.

In addition, the commenter requested clarification on the results of the internal liquidity stress tests that must be reported annually. The board stated that Regulation YY does not prescribe the information that must be reported to the board regarding the internal liquidity stress tests. However, FBOs are expected to provide sufficient information to enable the board to assess its liquidity position.

For further information on this topic please contact Connie M Friesen at Sidley Austin by telephone (+1 212 839 5300) or email (cfriesen@sidley.com). The Sidley Austin website can be accessed at www.sidley.com.

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Endnotes

(1) See 80 Fed Reg 75457 (December 2 2015).

(2) The proposed revisions to the FR Y-7 and its instructions are available at https://www.federalreserve.gov/reportforms/formsreview/FR%20Y-7_Draft%20Form_01032018.pdf and https://www.federalreserve.gov/reportforms/formsreview/FR%20Y-7_Draft%20Instructions_01032018.pdf.