Enhanced-Supervision-for-U.S.-Operations-of-Foreign-Banking-Organizations

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					BEIJING BRUSSELS CHICAGO DALLAS FRANKFURT GENEVA HONG KONG HOUSTON LONDON LOS ANGELES NEW YORK PALO ALTO SAN FRANCISCO SHANGHAI SINGAPORE SYDNEY TOKYO WASHINGTON, D.C.




                  Enhanced Supervision for U.S. Operations
                 of Foreign Banking Organizations: The FRB
                      Proposal and Its Implications
                                                                    Connie M. Friesen
                                                                         David M. Katz
                                                                       March 13, 2013
    I. Introduction




2
                     Background

• On December 14, 2012, the Federal Reserve Board
  (the “FRB”) released a significant new proposal (the
  “Proposal”) to strengthen oversight of the U.S.
  operations of foreign banking organizations (“FBOs”).

• The Proposal applies to any FBO with total global
  consolidated assets of $50 billion or more, but its
  application to a particular FBO depends on the size
  and composition of the FBO’s U.S. operations.

• If adopted substantially as proposed, the Proposal
  would be the most significant change in U.S.
  regulation of FBOs since the adoption of the
  International Banking Act of 1978.

3
      A Paradigm Shift for Bank Regulation

• The Proposal represents a paradigm shift and
  indicates that the FRB has lost confidence in
  traditional methods of bank supervision and
  regulation.

• The Proposal represents a transition away from the
  old qualitative and judgmental supervisory approach
  to a more quantitative approach and requirements.

• The Proposal also represents a movement away from
  principles of reliance on home country supervision to
  a greater focus on host country supervision and U.S.
  ring-fencing of the U.S. operations of FBOs.


4
        Introduction of the New Approach:
             Governor Tarullo’s Speech
• FRB Governor Daniel Tarullo explained the need for a
  new approach to regulation of foreign banks in the
  United States in an important speech on November
  28, 2012.

• Regulation of foreign banks in the United States has
  changed little over the past decade or two, despite a
  significant and rapid transformation of foreign bank
  operations.

• Foreign banks have moved beyond traditional lending
  functions to engage in substantial, complex trading
  and capital markets activities.


5
    “Lending Branches” and “Funding Branches”

• The traditional model of U.S. branches as “lending
  branches” well-funded by the home country Head Office
  changed dramatically in the period preceding the
  financial crisis.

• Reliance on less stable, short-term wholesale funding
  increased significantly and many foreign banks shifted
  to a “funding branch” model in which U.S. branches of
  foreign banks were borrowing large amounts of U.S.
  dollars to upstream to their home country operations.

• According to Governor Tarullo, assets of such “funding
  branches” grew from 40 percent to 75 percent of foreign
  bank branch assets between the mid-1990s and 2009.


6
    Rapidly Changing Transactions and Objectives

• Short-term U.S. dollar funding raised in the United States was
  used to provide long-term U.S. dollar-denominated project
  and trade finance around the world and to finance non-U.S.
  affiliates’ investments in U.S. dollar-denominated asset-
  backed securities.

• Commercial and industrial lending originated by U.S. branches
  and agencies as a share of third-party liabilities declined
  significantly after 2003.

• U.S. broker-dealer assets of the top ten foreign banks
  increased rapidly during the past 15 years, rising from 13% of
  all foreign bank third-party U.S. assets to 50% in 2011.

• Five of the top ten U.S. broker-dealers are currently owned by
  FBOs.


7
New Structures to Support Supervisory Objectives

• Governor Tarullo suggested that a more uniform structure
  should be required for the U.S. operations of foreign banks.
  FBOs with significant U.S. operations should be required to
  establish a top-tier U.S. intermediate holding company
  (“IHC”) over all U.S. bank and nonbank subsidiaries.

• Capital requirements that apply to U.S. bank holding
  companies should be applied to IHCs.

• While IHCs would be subject to special requirements,
  Governor Tarullo also indicated that there would be
  enhanced supervision of U.S. branches and agencies of
  FBOs.




8
    II. Overview of Proposal




9
Proposal Implements Dodd-Frank Act Provisions
• Sections 165 and 166 of the Dodd-Frank Act direct the FRB to
  impose enhanced prudential standards on FBOs with total global
  consolidated assets of $50 billion or more.

• Section 166 of the Dodd-Frank Act requires the FRB to establish a
  regulatory framework for the early remediation of financial
  weaknesses of FBOs in order to minimize the possibility that they
  will become insolvent.

• The FRB notes in its introduction to the Proposal that its proposal
  for IHCs is a “supplemental enhanced standard”.

• The FRB also cites the so-called Collins Amendment to the Dodd-
  Frank Act, which directs the FRB to strengthen capital standards
  applied to U.S. bank holding company subsidiaries of FBOs .




10
                 Some Important Dates

 • Proposal would be effective on July 1, 2014 and FBOs
   would be required to meet new standards as of
   July 1, 2015.

 • Proposal includes numerous requests for comments or
   responses to questions on specific items. Comment
   period ends April 30, 2013.

 • Proposal requires careful study and pre-planning to
   assess and adapt to its capital and leverage, liquidity,
   risk management, corporate governance, tax,
   accounting, cost allocation and restructuring implications.




11
 Types of Requirements Included in the Proposal

• Enhanced FRB supervision of all U.S. operations of FBOs.
• Imposition of IHC requirement for FBOs with more than
  $10 billion in U.S. non-branch and non-agency assets.
• Risk-based capital and leverage requirements.
• Liquidity requirements.
• Single-counterparty credit limits.
• Risk management requirements.
• Stress testing requirements.
• Debt-to-equity limitations.
• Early remediation requirements.




12
               Tailored Requirements for
           Different Structures and Activities
• Different requirements for:
     – FBOs with total global consolidated assets of greater
       than $10 billion but less than $50 billion.
     – FBOs with total global consolidated assets of $50 billion
       or more but less than $50 billion in combined U.S.
       assets.
     – FBOs with total global consolidated assets of $50 billion
       or more and more than $50 billion in combined U.S.
       assets.
     – Note: The term “combined U.S. assets” is defined in
       the Proposal to mean all U.S. assets (banking and non-
       banking) unless otherwise qualified for certain purposes
       to exclude U.S. branch and agency assets.

13
     Application of the Proposal to U.S. Operations

• The Proposal’s focus on IHCs sometimes seems to
  obscure the fact that it will also apply to U.S.
  branches and agencies and to nonbank operations
  whether or not included in an IHC.
• Some of the Proposal’s requirements are directed
  specifically to IHCs or to U.S. branches and agencies.
• Other requirements are applied to the “combined U.S.
  operations,” a term which generally means (i) any
  IHC and its consolidated subsidiaries; (ii) any U.S.
  branch or agency; and (iii) any other U.S. subsidiary
  of an FBO that is not a section 2(h)(2) company.



14
     III. Specific Provisions of the Proposal




15
                    IHC Requirement
• One of the most controversial aspects of the Proposal is the
  IHC requirement.

• IHC requirement would apply to an FBO that meets the
  asset thresholds and other criteria for establishment of an
  IHC regardless of whether the FBO has a bank subsidiary.

• An IHC would be subject to the same U.S. requirements on
  capital, liquidity and leverage that would apply to a U.S.
  domestic bank holding company.

• Imposition of IHC requirement for FBOs with more than
  $50 billion in total global consolidated assets and more
  than $10 billion in U.S. non-branch and non-agency assets.




16
            IHC Formation Requirements

• An FBO that establishes an IHC would be required to hold
  its interest in any U.S. subsidiary, other than a Section
  2(h)(2) company, through the IHC.
• An FBO that forms an IHC would be required to transfer to
  such IHC any controlling interest in U.S. companies
  acquired pursuant to the merchant banking authority.
• An IHC would be required to have a board of directors.
• There would be an after-the-fact notice procedure for the
  formation of an IHC.
• The FRB may, on a case by case basis, permit an FBO to
  establish multiple IHCs or alternative organizational
  structures if foreign laws or other circumstances warrant
  an exception.

17
              Risk-Based Capital and
          Leverage Requirements for IHCs
• An IHC of an FBO would be subject to the same capital
  adequacy standards, including minimum risk-based capital
  and leverage requirements and restrictions associated with
  applicable capital buffers, that are applicable to U.S. bank
  holding companies.

• The FRB anticipates that the capital adequacy standards for
  U.S. bank holding companies will incorporate Basel III
  standards on the July 1, 2015 effective date.




18
     New Capital Requirements and Broker-Dealers
• The capital requirements for IHCs would seem to present a
  particular challenge for IHCs that do not include a bank
  subsidiary.
• Broker-dealers, investment advisers and other nonbank
  subsidiaries that are currently subject only to capital
  requirements that might be imposed by the SEC or other
  functional regulators would, under the terms of the
  Proposal, be subject to bank capital requirements that
  were not developed or designed for broker-dealers or other
  nonbank subsidiaries.
• SEC Commissioner Dan Gallagher noted in a speech on
  February 22, 2013 that a U.S. broker-dealer subsidiary of
  an FBO could be required to hold more capital than would
  be necessary to satisfy the SEC’s net capital rule to
  maintain the same positions.

19
New Capital Requirements and Broker-Dealers (continued)
  • SEC-registered broker-dealers, as an example of nonbank
     subsidiaries that might be included in an IHC, are already
     subject to separate capital requirements.
  • The SEC has a robust and extensive capital regulatory
     structure for SEC- registered broker-dealers via SEC Rule
     15c3-1.
  • However, the SEC’s capital regime has a fundamentally
     different focus than the FRB’s capital requirements. SEC
     Rule 15c3-1 is a net liquid assets test that is designed to
     require a broker-dealer to maintain sufficient liquid assets
     to meet all of its obligations to customers and
     counterparties, and then have adequate additional
     resources to wind-down its business in an orderly manner
     without the need for a formal proceeding it fails financially
     (that is, via a self-liquidation) and, thus, without the need
     to tap into the SIPC insurance fund established under
  20
     Securities Investor Protection Act of 1970.
New Capital Requirements and Broker-Dealers (continued)
  • U.S. bank capital requirements on the other hand are
    focused on ensuring the safety and soundness of
    bank operations; that is, to ensure that banks
    operate in a manner to minimize risk and avoid
    liquidation. Thus, bank capital requirements are not
    designed to ensure that banks maintain sufficient net
    liquid assets to satisfy all creditors because banks
    have access to federal liquidity facilities that can be
    accessed in the event the bank cannot otherwise
    obtain private funding, but bank capital requirements
    are designed to minimize the need to tap into those
    federal liquidity facilities.



  21
New Capital Requirements and Broker-Dealers (continued)
  • Pursuant thereto, there are four fundamental capital regimes for
    SEC-registered broker-dealers (current and proposed) and all of
    these regimes are quite distinct from bank capital requirements:
       – “Standard” broker-dealers
         i.    SEC Rule 15c3-1(a)(1)(i) sets forth the “basic” standard for computing
               net capital and is often used by smaller broker-dealers. A broker-
               dealer operating under this requirement must maintain minimum net
               capital equal to the greater of some specified amount (which varies
               depending on the type of business in which the broker-dealer is
               engaged) and 6⅔% of “aggregate indebtedness” (“AI”; that is, the
               total money liabilities of a broker-dealer arising in connection with any
               securities transaction whatsoever, subject to certain exceptions).
               Alternatively, the broker-dealer’s aggregate indebtedness cannot
               exceed fifteen times its net capital (where 1/15 equals 6-2/3%).
         ii.   SEC Rule 15c3-1(a)(1)(ii) sets forth an “alternative” standard for
               computing net capital and is generally used by larger broker-dealers.
               A broker-dealer operating under this requirement must maintain net
               capital equal to the greater of $250,000 and 2% of specified aggregate
               “debit” items, subject to certain adjustments.        Broker-dealers
               operating under the alternative standard, however, are not subject to
               any specific AI or debt limits.
  22
New Capital Requirements and Broker-Dealers (continued)

      OTC Derivative Dealers (“OTCDDs”)
        i.    OTCDDs are allowed to engage in dealer activities involving
              certain OTC derivative instruments, such as swaps and OTC
              options, and must maintain minimum net capital of $20 million
              and minimum tentative net capital of $100 million (subject to
              adjustments and deductions).
      – Alternative Net Capital Broker-Dealers (“ANCBDs”)
        i.    ANCBDs are the largest broker-dealers and they have been
              approved by the SEC, on a firm-by-firm basis, to use internal
              value-at-risk (VaR) models to determine market risk charges for
              proprietary securities and derivatives positions and to take a
              credit risk charge in lieu of a 100% charge of unsecured
              receivables related to OTC derivatives transactions. VaR models
              are also available for OTCDDs.
        ii.   ANCBDs are required to maintain minimum net capital of $500
              million and minimum tentative net capital of $1 billion, although
              under an SEC rule proposal an ANCBD would be required to
              maintain minimum net capital of $1 billion and minimum tentative
              net capital of $5 billion.
 23
New Capital Requirements and Broker-Dealers (continued)
      – Proposed Net Capital Rules for Security-Based Swap
        Dealers (“SBSDs”)
        i.   Under an SEC proposal, a non-bank SBSD (stand-alone
             and not otherwise registered as a broker-dealer) without a
             prudential regulator would be required to maintain
             minimum net capital of $20 million if such SBSD does not
             use internal VaR models. SBSDs that use internal VaR
             models would be required, in addition to the $20 million
             requirement, to maintain minimum tentative net capital of
             $100 million.

 • Broker-dealers are also subject to higher “minimum”
   amounts by reason of various SEC “early warning”
   requirements (including a proposal to raise the early
   warning amount to $6 billion for ANCBDs).


 24
New Capital Requirements and Broker-Dealers (continued)
 • In addition, FINRA can impose additional capital
   requirements on certain member firms. Pursuant to
   Section 15(i)(1) of the Securities Exchange Act of
   1934 (the “Exchange Act”), the States are
   preeempted from imposing, among other things,
   capital requirements that differ from or are in addition
   to the capital requirements under the Exchange Act,
   although such preemption does not, technically,
   prohibit the States from imposing capital
   requirements on stand-alone SBSDs.




 25
New Capital Requirements and Broker-Dealers (continued)

      – Proposed Net Capital Rules for Security-Based Swap
        Dealers (“SBSDs”)
        i.   Under an SEC proposal, a non-bank SBSD (stand-alone
             and not otherwise registered as a broker-dealer) without a
             prudential regulator would be required to maintain
             minimum net capital of $20 million if such SBSD does not
             use internal VaR models. SBSDs that use internal VaR
             models would be required, in addition to the $20 million
             requirement, to maintain minimum tentative net capital of
             $100 million.

 • Broker-dealers are also subject to higher “minimum”
   amounts by reason of various SEC “early warning”
   requirements (including a proposal to raise the early
   warning amount to $6 billion for ANCBDs).


 26
New Capital Requirements and Broker-Dealers (continued)

 • In addition, FINRA can impose additional capital requirements on
   certain member firms. Pursuant to Section 15(i)(1) of the
   Securities Exchange Act of 1934 (the “Exchange Act”), the States
   are preeempted from imposing, among other things, capital
   requirements that differ from or are in addition to the capital
   requirements under the Exchange Act, although such preemption
   does not, technically, prohibit the States from imposing capital
   requirements on stand-alone SBSDs.
 • Also, registered broker-dealers are permitted to finance
   themselves using satisfactory subordinated debt under Appendix
   D to SEC Rule 15c3-1. Generally, a broker-dealer may borrow
   funds on a subordinated basis and treat the borrowing as “good
   capital” for the purposes of SEC Rule 15c3-1 (an addition to
   assets and an exclusion from liabilities in the computation of net
   capital), although in most cases, a broker-dealer is limited in the
   amount of subordinated debt financing that it may incur
   (generally, not more than 70% of its debt-equity total).

 27
New Capital Requirements and Broker-Dealers (continued)

 • To require a broker-dealer to adhere to a capital
   framework for banks may be unworkable;
   nonetheless, to date, the FRB seems committed to
   imposing bank capital requirements on IHCs.
 • FRB states in the Proposal that it will consult with the
   SEC and other relevant regulators before it adopts a
   final rule, but the Proposal seems quite prescriptive in
   its approach.
 • FBOs with significant broker-dealer or other nonbank
   subsidiaries might want to take advantage of the
   opportunity to comment on or respond to the FRB’s
   questions included in the Proposal before the April 30
   deadline.

 28
 Capital and Leverage Requirements for FBOs with Total
   Global Consolidated Assets of $50 Billion or More

• FBOs with total global consolidated assets of $50 billion or more
  must certify to FRB that they meet, at the consolidated level,
  capital adequacy standards established by home country
  supervisor that are consistent with the Basel Capital Framework
  (Basel III) or are otherwise consistent with Basel III.

• The Proposal would not apply the U.S. minimum leverage ratio to
  an FBO. However, when the Basel III leverage ratio is
  implemented internationally in 2018, FBOs with total global
  consolidated assets of $50 billion or more would need to
  demonstrate compliance with the international leverage ratio.




29
              Liquidity Requirements

• Generally, the Proposal imposes detailed and complex
  liquidity requirements on FBOs with combined U.S.
  assets of $50 billion or more.
• Such requirements are broadly consistent with those
  set forth in the FRB’s December 2011 Proposal for
  large U.S. bank holding companies and are based on
  standards set forth in the Interagency Liquidity Risk
  Policy Statement (March 2010).
• FBOs with combined U.S. assets of less than $50
  billion would be subject to a more limited set of
  requirements.



30
       Liquidity Requirements for FBOs with
     Combined U.S. Assets of Less than $50 Billion
• An FBO with combined U.S. assets of less than $50 billion
  would be required to:
     – Report to the FRB the results of an internal liquidity stress test
       (either on a consolidated basis or for its combined U.S.
       operations) on an annual basis.
     – Internal stress test would need to be consistent with Basel
       Committee principles for liquidity risk management and
       incorporate 30-day, 90-day and one-year stress test horizons.
     – An FBO that does not comply with this requirement must limit the
       net aggregate amount owed by the FBO’s head office and non-
       U.S. affiliates to its combined U.S. operations to 25% or less of
       the 3rd party liabilities of its combined U.S. operations, on a daily
       basis.




31
       Liquidity Requirements for FBOs with
     Combined U.S. Assets of $50 Billion or More
• More burdensome liquidity requirements for FBOs
  with larger U.S. operations:
     – U.S. risk committee and U.S. risk officer
     – Independent review
     – Cash flow projections
     – Liquidity stress tests
     – Liquidity buffers
     – Contingency funding plan
     – Specific limits
     – Monitoring


32
       Liquidity Requirements for FBOs with
     Combined U.S. Assets of $50 Billion or More
• Requirements include:
A. U.S. Risk Committee and U.S. Risk Officer Responsibilities.
• U.S. Risk Committee would review and approve the liquidity risk
  tolerance for the FBO’s combined U.S. operations at least
  annually.
• U.S. Risk Officer would be responsible for:
       -   Reviewing and pre-approving the liquidity costs,
           benefits and risks of each significant new U.S. business
           line and each significant new product offered.
       -   Reviewing approved significant business lines and
           products for compliance with established liquidity risk
           tolerance for combined U.S. operations at least
           annually.
       -   Many other review, reporting and approval
           responsibilities.

33
Liquidity Requirements for FBOs with Combined
  U.S. Assets of $50 Billion or More (continued)
     B. Independent Review

      ● FBO would be required to maintain an independent review
        function to evaluate the liquidity risk management of
        combined U.S. operations.

     C. Cash Flow Projections

      ● FBO would be required to provide cash flow projections for
        combined U.S. operations that project cash flows arising
        from assets, liabilities and off-balance sheet exposures over
        short-term and long term time horizons.




34
Liquidity Requirements for FBOs with Combined
  U.S. Assets of $50 Billion or More (continued)
D. Liquidity Stress Tests
•    FBO would be required to conduct monthly liquidity stress
     tests of its cash flow projections separately for its IHC and
     its U.S. branch and agency network.

•    FBO must establish and maintain policies and procedures
     outlining its liquidity stress testing practices,
     methodologies and assumptions.

•    FBO must maintain an effective system of controls and
     oversight over stress test function.




35
Liquidity Requirements for FBOs with Combined
  U.S. Assets of $50 Billion or More (continued)
E. Liquidity Buffers
 ●    FBO must maintain separate liquidity buffers for its U.S.
      branch and agency network and its IHC, comprised of
      highly liquid assets that are sufficient to meet net
      stressed cash flow needs over a 30-day stressed horizon.

 i.   U.S. branch and agency network would be required to
      maintain the first 14 days of its 30-day buffer in the
      United States. The remainder of the buffer could be
      maintained at the parent consolidated level.

 ii. IHC would be required to maintain the full 30-day buffer
     in the United States.



36
Liquidity Requirements for FBOs with Combined
  U.S. Assets of $50 Billion or More (continued)
F. Contingency Funding Plan

•    The FBO must maintain and update (at least
     annually) a contingency funding plan for its
     combined U.S. operations that describes strategies
     for addressing liquidity needs during liquidity stress
     events.




37
 Liquidity Requirements for FBOs with Combined
   U.S. Assets of $50 Billion or More (continued)
G. Specific Limits
     The FBO must establish limits on potential sources of
     liquidity risk, including:
i.   Concentrations of funding sources, by instrument type,
     counterparty type, etc;

ii. The amount of specified liabilities that mature within
    various time horizons; and

iii. Off-balance sheet exposures and other exposures that
     could create funding needs during liquidity stress events.




38
Liquidity Requirements for FBOs with Combined
  U.S. Assets of $50 Billion or More (continued)
H. Monitoring
     FBO must have procedures for:
i. Monitoring assets pledged or available to be pledged
   as collateral;

ii. Monitoring liquidity risk and funding needs within
    and across significant legal entities, business lines
    and currencies;

iii. Monitoring intraday liquidity risk exposure; and

iv. Monitoring specific limits on potential sources of
    liquidity risk.

39
            Single-Counterparty Credit Limits

• The Proposal would establish a 25 percent net credit
  exposure limit between an IHC or the combined U.S.
  operations of an FBO with total global consolidated
  assets of $50 billion or more and a single unaffiliated
  counterparty.*
     – The IHC would be prohibited from having aggregate net
       exposure to any single unaffiliated counterparty in
       excess of 25 percent of the IHC’s capital stock and
       surplus.
     – Combined U.S. operations of an FBO would be
       prohibited from having aggregate net credit exposure to
       any single unaffiliated counterparty in excess of 25
       percent of the consolidated capital stock and surplus of
       the FBO.

40    (* Includes subsidiaries)
     Single-Counterparty Credit Limits (continued)

• Compliance
     – An FBO must submit a monthly compliance report
       demonstrating its daily compliance with the single-
       counterparty credit limits.
     – Noncompliance by either the IHC or the combined U.S.
       operations could result in the IHC and/or the combined
       U.S. operations being prohibited from engaging in any
       additional credit transactions with the particular
       counterparty.




41
                  Risk Management and
              Risk Committee Requirements
• FBOs that are publicly-traded with global consolidated
  assets of $10 billion or more and all FBOs with total
  global consolidated assets of $50 billion or more would
  be required to certify annually to the FRB that they
  maintain a U.S. risk committee to oversee risk
  management practices of the U.S. operations.
     – Risk committee must have at least one member with
       appropriate risk management expertise.

     – An FBO’s enterprise-wide risk committee may serve as the
       U.S. risk committee. However, if the FBO has combined
       U.S. assets of $50 billion or more and operates in the U.S.
       solely through an IHC, it must maintain the risk committee
       at the IHC.

42
      Risk Management and Risk Committee
            Requirements (continued)
• FBOs with combined U.S. assets of $50 billion or
  more are subject to additional risk committee
  requirements.
– U.S. risk committee would be responsible for reviewing and
  approving the risk management practices of the combined
  U.S. operations and for overseeing the operations of an
  appropriate risk management framework.

– At least one member of the U.S. risk committee must be
  independent.

– Risk management framework must be comprehensive and
  consistent with the FBO’s enterprise-wide risk management
  framework.

43
       Risk Management and Risk Committee
             Requirements (continued)
• U.S. Chief Risk Officer
– FBOs with combined U.S. assets of $50 billion or more or
  its IHC must appoint a U.S. chief risk officer to be in charge
  of the risk management framework and practices for the
  FBO’s combined U.S. operations.
– U.S. chief risk officer would report directly to the U.S. risk
  committee and the FBO’s chief risk officer and must be
  employed by a U.S. branch or agency, an IHC or another
  U.S. subsidiary.
– U.S. chief risk officer would have direct oversight
  responsibilities for implementation of and ongoing
  compliance with appropriate policies and procedures.




44
            Stress Test Requirements

• Stress tests requirements would vary depending on
  the size of the FBO and the scope of its U.S.
  operations.
• Smaller FBOs with total global consolidated assets of
  more than $10 billion, but combined U.S. assets of
  less than $50 billion, must be subject to a home
  country stress testing regime that meets certain
  standards. Otherwise, it must meet certain U.S.
  requirements, including a 105% asset maintenance
  requirement for the FBO’s U.S. branch and agency
  network and annual stress tests for U.S. subsidiaries
  not held under an IHC.


45
             Stress Test Requirements (continued)
• FBOs with combined U.S. assets of $50 billion or
  more that have a U.S. branch and agency network
  must meet certain stress test requirements or be
  subject to additional standards imposed by the FRB:
     – The FBO must be subject to and meet the minimum
       standards of a consolidated home country capital stress
       testing regime that is broadly consistent with U.S.
       standards and includes:
        i.   either an annual supervisory capital stress test conducted by the
             home country supervisor or an annual review by the home
             country supervisor of an internal capital adequacy stress test
             conducted by the FBO; and
        ii. requirements for governance and controls of the stress testing
            practices by relevant FBO management and the board of directors.



46
     Stress Test Requirements (continued)
     – FBOs that meet the above requirements would submit to
       the FRB summary information regarding the home country
       stress test activities and results.
     i. If the FBO’s U.S. branch and agency network provides, on
        a net basis, funding to its parent or non-U.S. affiliates,
        FBO must provide additional information regarding annual
        stress test results.
     – FBOs that do not meet these requirements must comply
       with the following additional standards imposed by the
       FRB:
     i. Asset maintenance requirement for U.S. branches and
        agencies of not less than 108% of the preceding quarter’s
        average value of third party liabilities.
     ii. Separate internal stress tests for any U.S. subsidiary not
         held under an IHC.
     iii. Intragroup funding restrictions as determined by the FRB.

47
                   Debt-to-Equity Limits

• If the Financial Stability Oversight Council (the
  “FSOC”) has determined that an FBO (with total
  global consolidated assets of $50 billion or more)
  poses a grave threat to U.S. financial stability and
  determines that a debt-to-equity limit is necessary to
  mitigate that risk, the Proposal would require such an
  FBO to maintain:
     – a debt-to-equity ratio of not more than 15-to-1 for its
       IHC and any U.S. subsidiary not organized under an
       IHC; and
     – a 108% asset maintenance requirement for its U.S.
       branch and agency network.


48
                  Early Remediation
• The Proposal would establish a regime for the early
  remediation of the combined U.S. operations of an
  FBO with total global consolidated assets of $50
  billion or more, in a manner generally consistent with
  the December 2011 Proposal for U.S. bank holding
  companies.
• The regime is divided into four levels of remediation
  that increase in stringency with respect to
  remediation requirements.
• Early remediation triggers for each level are based on
  one or more of the following: risk-based capital and
  leverage ratios, stress test results, liquidity risk and
  risk management deficiencies and market indicators.

49
     IV. Implications of the Proposal




50
                   Major Implications
• Like the International Banking Act, the Foreign Bank
  Supervision Enhancement Act and the Gramm-Leach-Bliley
  Act, the Proposal would likely result in fundamental
  changes in the U.S. operations of many FBOs.

• The Proposal would require enhanced attention to
  compliance, risk management and corporate governance.

• The Proposal would require many FBOs to dedicate more
  capital to U.S. operations and would subject FBOs to new
  liquidity and leverage requirements.

• New activities of FBOs would be subject to greater
  supervisory scrutiny.

• U.S. nonbank operations of FBOs would be subject to
  greater scrutiny by the FRB.
51
         Effects on Funding Arrangements

• Many international banks issue commercial paper,
  certificates of deposit and medium-term notes in the
  United States and then send some of the proceeds
  back to the home country to fund operations there.

• The Proposal aims to limit such transfers; FBOs will
  need to assess the effects of potential limitations and
  adjust their funding programs accordingly.




52
      Special Implications for Broker-Dealers
• Capital requirements for IHCs are to be calculated
  with reference to requirements typically applied to
  domestic U.S. bank holding companies. As noted
  earlier, the FRB’s “safety and soundness” approach to
  bank regulation is fundamentally different from the
  SEC’s financial responsibility regulation of broker-
  dealers (where the latter focuses on customer
  protection and orderly liquidation).
• Such calculations may present significant issues for
  IHCs where the primary subsidiary is a broker-dealer.
  As noted above, broker-dealers are subject to capital
  requirements established by the SEC, which rule
  establishes a liquid assets test or approach.


53
      Special Implications for Broker-Dealers
• It is unclear how the differing capital requirements of
  the SEC and FRB might be coordinated or how capital
  required by the SEC will be counted towards IHC
  capital requirements. It is possible that such SEC and
  FRB requirements may conflict in certain respects.
• As noted earlier, for larger broker-dealers, there are
  no specific debt limits/ratios under the SEC’s capital
  requirements, although there are for smaller broker-
  dealers that are subject to AI requirements.




54
     Special Implications for Broker-Dealers
• Broker-dealers are already subject to oversight by
  multiple regulators, including the SEC and at least
  one self-regulatory organization (SRO) that is the
  designated examining authority for the broker-dealer.
  SEC Rule 17d-1 requires coordination among such
  multiple SRO regulators.
• Adding the FRB to the mix of regulators runs the risk
  of having too many “cooks in the kitchen” that can
  result in duplicative or contradictory regulatory
  regimes absent careful coordination between the FRB
  and the SEC.




55
     Special Implications for Broker-Dealers
• Proposed U.S. Risk Officer Requirement: might
  subject to such person to FINRA registration as a
  FINOP (Financial and Operations Principal), if such
  person can approve/manage financial funding for a
  broker-dealer or review and approve contingency
  plans or conduct quarterly reviews of liquidity stress
  test results, cash flow projections, and size and
  composition of its liquidity buffer as well as review
  strategies, policies and procedures for managing
  liquidity risk – all least for a broker-dealer which is a
  significant subsidiary.
• U.S. Risk Committee responsible for overall risk
  monitoring: should not necessarily trigger principal
  registration with FINRA under NASD Notice to
  Members 99-49.
56
     Special Implications for Broker-Dealers
• The SEC requires that broker-dealers be subject to the
  SEC’s capital requirements on a “moment to moment”
  basis. FINRA also imposes capital requirements on
  broker-dealers, requires that a broker-dealer appoint a
  chief financial officer/FINOP and that such FINOP be
  responsible for preparing detailed monthly or quarterly
  unaudited financial reports.
• Subjecting broker-dealers to a different capital regime
  with a fundamentally different policy/purpose could
  require broker-dealers to hire additional/multiple
  financial principals who are responsible for potential
  conflicting requirements, and could subject broker-
  dealers to substantial/additional capital compliance
  costs, including the need to build-out of new compliance
  procedures and financial control systems.
57
Special Implications for Broker-Dealers (continued)
• One principle affirmed in 1994 by the Gramm-Leach-Bliley
  Act and generally respected by federal banking and
  securities regulators has been the principle of “functional”
  regulation which requires federal banking regulators to
  respect the primary supervisory authority of the functional
  regulator, i.e., the SEC in the case of a broker-dealer.
• The Proposal assigns supervisory responsibility for IHC
  capital, liquidity and leverage requirements to the FRB and
  it is not clear whether the FRB would also be allowed to
  inspect the books and records, generally examine or
  initiate supervisory actions directly against a broker-dealer
  subsidiary of an IHC.
• The Proposal notes that the FRB intends to consult with
  each primary or functional regulator of a bank or non-bank
  subsidiary before imposing specific prudential standards.
58
     Special Implications for Broker-Dealers
• The imposition of an IHC could trigger FINRA and
  other SRO approvals. For example, NASD Rule
  1017(a)(4), (b) and (c) requires the filing of a formal
  application with, and approval by, FINRA in respect of
  any change in the equity ownership or partnership
  capital of a FINRA member (broker-dealer) that
  results in one person or entity directly or indirectly
  owning or controlling 25% or more of the equity or
  partnership capital thereof. FINRA takes the position
  that NASD Rule 1017(a)(4) applies to the imposition
  of a new intermediate holding company for a FINRA
  member, even if the foregoing does not result in a
  change in the beneficial ownership or control of the
  broker-dealer. Other SROs have similar filing and
  approval requirements.
59
     Special Implications for Broker-Dealers

• Pursuant to FINRA Rule 8210, FINRA may have
  jurisdiction to examine the books and records of an
  IHC.




60
               Regulation of Other
           Non-Bank Subsidiaries of IHC
• The FRB notes in its explanation of the Proposal that
  an IHC would provide a more uniform platform for
  oversight of the U.S. operations of FBOs.

• It is unclear how the Proposal would affect the
  traditional application of Regulation Y and Regulation
  K to non-banking subsidiaries of FBOs.




61
     V.   Actions to be Taken




62
     Assessing Impact of Proposal’s Requirements

• An FBO will need to identify all of the specific
  provisions of the Proposal that might be applicable to
  its U.S. operations.
• An FBO will need to conduct a “gap analysis” by
  assessing its current capital and leverage, liquidity,
  risk management, counterparty credit limit positions
  against the new requirements of the Proposal.
• Comparison of capital requirements on a cross-border
  basis and including Basel III requirements as well
  may prove to be a challenging but necessary
  exercise.



63
                  Rethinking U.S. Strategy
● In addition to the specific gap analysis noted above, every FBO
  should be conducting an analysis of the Proposal’s effects on its
  U.S. strategy and structure.

● Questions to be considered would include:
     – How will enhanced supervision affect U.S. operations
       generally?
     – What changes in business model will be needed as a result of
       the Proposal?
     – What new compliance, risk management and corporate
       governance policies and procedures will be needed if the
       Proposal is adopted as issued?
     ● While the Proposal has not yet been adopted, the changes it
       will introduce are significant and an FBO should begin now to
       consider how it will meet the challenges of the new regulatory
       regime contemplated by the Proposal.

64
                                  Contact Information


                                          Connie M. Friesen
                                            (212) 839-5507
                                         cfriesen@sidley.com

                                             David M. Katz
                                            (212) 839-7386
                                           dkatz@sidley.com




    This presentation has been prepared by Sidley Austin LLP for informational purposes only and does not constitute
    legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client
    relationship. Readers should not act upon this without seeking advice from professional advisers.


    65
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     World Offices




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