Friday, January 4, 2013

Fed Departs from Traditional Approach to Foreign Banks in the US

On December 14, 2012, the Board of Governors of the Federal Reserve System (Fed) issued for public  comment a rule proposal that, if adopted, could drastically alter the structure and operations of foreign banking organizations (FBOs) in the U.S.  The Fed's proposal drastically limits the flexibility FBOs have historically had in structuring their U.S. banking and financial operations. The proposed rules would also impose capital, liquidity, stress testing, and other requirements on a FBO’s U.S. operations similar to those imposed on domestic U.S. banks.  The extent to which FBOs with U.S. operations will find themselves burdened with these new regulations will vary based on the size of their global operations and their presence in the U.S.

U.S. Intermediate Holding Companies. FBOs having both global consolidated assets of US$50 billion or greater and U.S. assets of US$10 billion or greater would be required to organize its U.S. subsidiaries (but not its U.S. branches or agencies) into an intermediate holding company (IHC). This IHC would then be subject to the proposal’s enhanced prudential standards and early remediation requirements, including risk-based capital and leverage requirements, and Fed supervision generally similar to that imposed on a U.S. bank holding company. IHCs that independently hold consolidated assets of US$50 billion or more also must comply with the Board’s capital plan rule. All FBOs with global consolidated assets of US$50 billion or more would have to comply with capital standards that are consistent with the Basel Capital Framework. The Fed's proposal, however, stops short of requiring FBOs to separately capitalize their U.S. branches and agencies, and they are not required to move them under the IHC.

Liquidity Buffers. Under the Proposal, liquidity requirements are also focused on FBOs with a significant U.S. presence.  FBOs having aggregate U.S. assets of US$50billion or greater would:

  1. be subject o a new framework for managing liquidity risk, 
  2. required to conduct monthly liquidity stress tests for their IHCs and branch and agency networks, and
  3. required to maintain a liquidity buffer based on liquidity stress test findings. FBOs with less than US$50 billion in U.S. assets, in contrast, would only be required to conduct an annual internal liquidity stress test. 

Single Counterparty Credit Limits. The Fed's proposed rules would also impose single unaffiliated counterparty credit exposure limits in the amount of 25 percent of the capital and surplus of each respective entity. This limit would apply to both IHCs and on the combined U.S. operations of FBOs (IHCs and branches or agencies) with total consolidated assets of US$50billion or more. The also proposes a more stringent limit on the credit exposure of certain very large IHCs and the U.S. operations of very large FBOs with respect to certain very large counterparties.

Debt-to-Equity Limits. The Fed also proposes a debt-to-equity ratio and certain asset maintenance requirements on the U.S. operations of FBOs having US$50 billion or greater in total consolidated assets; however this requirement would only be applied to those designated by the Financial Stability Oversight Council (FSOC) as posing a grave or systematic threat to U.S. financial stability.

Risk Management. Similar to those imposed on domestic financial institutions, the proposal would implement new risk management procedures, including the requirement to establish a U.S. risk committee, and for the largest FBOs to appoint a U.S. chief risk officer.

Stress Tests.  IHCs with total consolidated assets of US$50 billion or more would be subject to semi-annual company-run stress tests and annual supervisory stress tests.  IHCs with total consolidated assets of between US$10 billion and US$50 billion would only be required to conduct annual company-run stress tests, and U.S. branches and agencies would not be subject to stress testing requirements.  FBOs with large U.S. operations would, however, be required to conduct stress tests broadly consistent with U.S. stress testing standards administered by a home country supervisor.

Early Remediation.  The Fed proposes a mandatory early remediation regime for US operations of FBOs with US$50 billion.  This remediation framework proposed by the Fed would set up four levels of early remediation, ranging from heightened supervision to resolution, to be applied based on the severity of stress shown by the relevant FBO’s U.S. operations (as revealed by the stress tests outlined above).

The Fed issued this proposal as part of its responsibilities under the Dodd-Frank Act, particularly sections 165 and 166 regarding foreign banking activities in the US.  These proposed regulations represents a significant departure from Fed’s traditional approach to supervising the US operations of FBOs.  In the past, the Fed has relied upon supervision of FBOs by home-country authorities in accordance with international standards as well as an expectation that FBOs would support their US operations under various conditions.  These proposed regulations take a more hands-on approach to FBOs and demonstrate an effort by the Fed to level the playing field between domestic bank regulation and FBO regulation.

The Fed's proposal is open for comment until March 31, 2013, and the anticipated compliance date for FBOs is July 1, 2015.