The Federal Reserve’s Dodd-Frank enhanced prudential standards (“EPS”) final rule requires a foreign banking organization with $50 billion or more in U.S. non-branch/agency assets (“Foreign Bank”) to place virtually all of its U.S. subsidiaries underneath a top-tier U.S. intermediate holding company (“IHC”). The IHC will be subject to U.S. Basel III, capital planning, Dodd-Frank stress testing, liquidity, risk management requirements and other U.S. EPS on a consolidated basis.
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The Federal Reserve has issued a final rule adopting a tiered approach for applying Dodd-Frank enhanced prudential standards to foreign banking organizations (“FBOs”). Under the tiered approach the most burdensome requirements (e.g., the requirement to establish a top-tier U.S. intermediate holding company) will only apply to FBOs with large U.S. operations, whereas fewer requirements will apply to FBOs with limited U.S. footprints.
We have summarized below the Dodd-Frank enhanced prudential standards that will apply to the following FBOs with limited U.S. footprints:
Pursuant to Section 165 of the Dodd-Frank Act, the Federal Reserve has issued a final rule to establish enhanced prudential standards for large U.S. bank holding companies (BHCs) and foreign banking organizations (FBOs).
U.S. BHCs: The final rule represents the latest in a series of U.S. regulations that apply heightened standards to large U.S. BHCs. As the graphic below illustrates, under the emerging post-Dodd-Frank prudential regulatory landscape for U.S. BHCs, the number and stringency of prudential standards generally increase with the size of the banking organization.
In January 2014, the Basel Committee on Banking Supervision finalized its revisions to the Basel III leverage ratio. Compared to its June 2013 proposed revisions, the Basel Committee has made several important changes to the denominator of the Basel III leverage ratio, including with respect to the treatment of derivatives, securities financing transactions and certain off-balance sheet items.
On the heels of publishing the U.S. Basel III final rule, the U.S. banking agencies have proposed higher leverage capital requirements for the eight U.S. bank holding companies that have been identified as global systemically important banks (“Covered BHCs”) and their insured depository institution (“IDI”) subsidiaries. The higher leverage capital requirements, which we are calling the American Add-on, build upon the minimum Basel III supplementary leverage ratio in the U.S. Basel III final rule.
The proposed American Add-on would require a Covered BHC’s IDI subsidiaries to maintain a Basel III supplementary leverage ratio of at least 6% to be considered well-capitalized under the prompt corrective action framework. The American Add-on also requires Covered BHCs to maintain a leverage buffer that would function in a similar way to the capital conservation buffer in the U.S. Basel III final rule. A Covered BHC that does not maintain a Basel III supplementary leverage ratio of greater than 5%, i.e., a buffer of more than 2% on top of the 3% minimum, would be subject to increasingly stringent restrictions on its ability to make capital distributions and discretionary bonus payments. The proposed effective date of the American Add-on is January 1, 2018.
The Basel Committee has made significant revisions to the Basel III Liquidity Coverage Ratio (“LCR”). The revised LCR standards allow banks to use a broader range of liquid assets to meet their liquidity buffer and relax some of the run-off assumptions that banks must make in calculating their net cash outflows. The revised standards also clarify that banks may dip below the minimum LCR requirement during periods of stress. The Basel Committee expects national regulators to implement the LCR on a phased-in basis beginning on January 1, 2015. The Basel Committee will also press ahead with its review of the Basel III Net Stable Funding Ratio (“NSFR”).
While the Federal Reserve has expressed its intent to implement some version of the LCR and other Basel III liquidity standards in the United States, the scope, timing and nature of U.S. implementation is currently unclear. This memorandum and the accompanying tables explore key aspects of the revised LCR standards and issues relating to their implementation in the United States.
The Federal Reserve launched the 2013 capital planning and stress testing process for large bank holding companies (“BHCs”) with the publication, on November 9, 2012, of two sets of instructions: one set for the 19 BHCs that participated in the 2011 Comprehensive Capital Analysis and Review (“CCAR”) process (“CCAR BHCs”) and another set for the 11 other U.S.-domiciled, top-tier BHCs with total consolidated assets of $50 billion or more that did not participate in the 2011 CCAR process (“non-CCAR BHCs”). On the same day, the Federal Reserve joined with other U.S. banking agencies to announce that recent proposals to implement Basel III in the United States will not become effective on January 1, 2013.
The Federal Reserve’s instructions for the CCAR BHCs, which reveal how the Dodd-Frank Act’s stress testing requirements will be integrated with the Federal Reserve’s capital planning requirements, are instructive for the non-CCAR BHCs that will become subject to Dodd-Frank stress-testing requirements in the 2014 capital planning cycle. Similarly, nonbank financial companies designated by the Financial Stability Oversight Council (“FSOC”) for supervision by the Federal Reserve will be subject to Dodd-Frank stress-testing requirements and, under a proposal by the Federal Reserve, would also be required to submit annual capital plans to the Federal Reserve.
For the CCAR BHCs, the two most significant changes from the 2012 process are:
The Federal Reserve’s decision this week to confer Comprehensive Consolidated Supervision (“CCS”) status to three state-owned Chinese banks has been long awaited and paves the way for major Chinese banks to enter retail commercial banking in the United States by acquiring U.S. banks. We view the Federal Reserve’s decision, which is the first CCS determination with respect to a major jurisdiction in nearly 10 years, as encouraging for banks from other emerging economies that wish to expand their activities in the United States by acquiring U.S. banks or electing to become financial holding companies (“FHCs”). Since many developed economies have attained CCS status, the key markets that might, over time, indirectly benefit from the China CCS determination include Dubai, India, Malaysia, Saudi Arabia, Singapore and South Africa. Brazilian and Mexican banks already benefit from earlier CCS determinations. There are, however, a few lessons to be learned from the Chinese experience, which we take to mean that CCS determinations will require patience and persistence. These lessons are:
- A willingness on the part of the Chinese government and major Chinese banks to make the CCS determination a policy priority across a range of trade, economic and strategic relationships;
- A willingness to invest in smaller U.S. community and regional banks by Chinese banks with a traditional commercial banking profile;
- A strong, reciprocal desire by U.S. financial institutions to enter or expand their presence in the Chinese market;
- A determined effort on the part of the Chinese government and Chinese regulatory authorities to enhance their overall supervisory framework, as well as their anti-money laundering controls; and
- An appreciation that, in today’s environment, CCS determinations may be incremental and more likely to be made on a bank-by-bank basis (or at least with respect to similar banks in the same country).