The Federal Deposit Insurance Corporation has issued a proposed regulation intended to address an emerging issue in international banking: how to grant non-US branch deposits equal treatment with US deposits in the event of the bank’s insolvency. Below are both big-picture and technical issues that need to be addressed in order to make the proposal effective.

The proposed regulation would effectively grant deposit status at non-US branches of US insured banks to deposits booked there for purposes of the depositor preference provisions of Federal law. [1] Its purpose is to provide the benefits of depositor preference status to deposits in branches in other countries. Depositor preference simply means that, in the liquidation of the bank, deposits will be paid ahead of non-deposit unsecured creditors, thereby increasing significantly the likelihood of full or almost-full repayment. This issue has been spotlighted by the United Kingdom, which has proposed to require that UK branches of foreign banks be entitled to depositor preference under their home country insolvency rules or provide clear disclosure of its absence to their depositors. This requirement, if implemented, might create an incentive for US banks to take such steps as making their US offices liable for repayment of such deposits; these would be so-called “dual-office” deposits, in which both a US and a non-US office would be liable for repayment.

…continue reading: Preferring Foreign Depositors

This posting, the January 2013 Davis Polk Dodd-Frank Progress Report, is one in a series of Davis Polk presentations that illustrate graphically the progress of the rulemaking work that has been done and is yet to occur under the Dodd-Frank Act. The Progress Report has been prepared using data from the Davis Polk Regulatory Tracker™, an online subscription service offered by Davis Polk to help market participants understand the Dodd-Frank Act and follow regulatory developments on a real-time basis.

In this report:

• As of January 2, 2013, a total of 237 Dodd-Frank rulemaking requirement deadlines have passed. Of these 237 passed deadlines, 142 (59.9%) have been missed and 95 (40.1%) have been met with finalized rules.
• In addition, 136 (34.2%) of the 398 total required rulemakings have been finalized, while 129 (32.4%) rulemaking requirements have not yet been proposed.
• Rulemaking activity this month included an SEC final rule on requirements to search for lost securityholders and notification requirements with respect to unresponsive payees. The Federal Reserve released a proposed rule on enhanced prudential standards and early remediation requirements for foreign banking organizations and foreign nonbank financial companies.

Following closely on the heels of Federal Reserve Governor Daniel K. Tarullo’s November 2012 speech, the Federal Reserve has proposed a tiered approach for applying U.S. capital, liquidity and other Dodd-Frank enhanced prudential standards, including single counterparty credit limits, risk management, stress testing and early remediation requirements, to the U.S. operations of foreign banking organizations with total global consolidated assets of $50 billion or more (“Large FBOs”). Most Large FBOs would have to create a separately capitalized top-tier U.S. intermediate holding company (“IHC”) that would hold all U.S. bank and nonbank subsidiaries. A Large FBO with combined U.S. assets of less than $10 billion, excluding its U.S. branch and agency assets, would not be required to form an IHC.

The IHC would be subject to U.S. capital, liquidity and other enhanced prudential standards on a consolidated basis. In addition, the Federal Reserve would have the authority to examine any IHC and any subsidiary of an IHC. Although the U.S. branches and agencies of a Large FBO’s foreign bank would not be required to be held beneath the IHC, they too would be subject to liquidity, single counterparty credit limits and, in certain circumstances, asset maintenance requirements. Large FBOs not required to form an IHC would also be subject to many of the new enhanced prudential standards.

This memorandum provides an overview of key aspects of the Federal Reserve’s proposal, which would become effective on July 1, 2015. We invite you to also read the accompanying diagrams and tables for a visual representation of these new requirements, available here. The comment period for the proposal ends on March 31, 2013.

…continue reading: Dodd-Frank Enhanced Prudential Standards for Foreign Banking Organizations

Summary

On November 20, 2012, the New York Court of Appeals issued an opinion that is of substantial importance to international banks and financial institutions that maintain and use correspondent banking accounts in New York. In Licci v. Lebanese Canadian Bank, SAL (N.Y. Nov. 20, 2012), the Court of Appeals held that a non-U.S. bank’s maintenance and use of such an account to effect “dozens” of wire transfers, worth millions of dollars, on behalf of a non-U.S. client was sufficient to form the basis for personal jurisdiction under the New York State long-arm statute, N.Y. C.P.L.R. § 302(a)(1). Due to the prevalence of U.S. dollar-denominated financial transactions, many non-U.S. banks maintain and use correspondent accounts in New York. As a result, the Licci decision has the potential to increase plaintiffs’ ability to establish personal jurisdiction over non-U.S. financial intuitions in state and federal courts in New York.

…continue reading: Personal Jurisdiction Over Non-U.S. Financial Institutions

In an unprecedented and provocative speech, Federal Reserve Governor Daniel K. Tarullo foreshadowed a proposal from the Federal Reserve Board that could fundamentally change the way foreign banks are regulated in the United States. As previewed, the proposal would require foreign banks with large operations in the U.S. to create a separately capitalized top-tier U.S. intermediate holding company (“IHC”) that would sit on top of all U.S. bank and nonbank subsidiaries. The IHC would be required independently to meet all U.S. capital and liquidity requirements as well as other enhanced prudential standards required by the Dodd-Frank Act. While the U.S. branches and agencies of a foreign bank would not be part of the IHC, they would be subject to “certain additional measures,” especially regarding liquidity. Governor Tarullo noted that the “all-important details” of the proposal are still under discussion and anticipated the release of a notice of proposed rulemaking “in the coming weeks.”

If the Federal Reserve actually adopts a proposal along the lines outlined in Governor Tarullo’s speech, it could have profound negative implications not only for the operations of foreign banks in the United States, but also for U.S. banking organizations doing business outside the United States. It would likely contribute and add fuel to the growing trend towards regionalization of global banking, thereby complicating and increasing the cost of providing cross-border banking services.

…continue reading: Fed Governor Tarullo Foreshadows Foreign Banks Proposal

How can governments limit excessive and unstable credit growth? Should they raise capital requirements for banks? In our recent NBER working paper, Does Macropru Leak? Evidence from a UK Policy Experiment, we address these questions using evidence from a policy experiment in the UK. The minimum capital ratio requirements that national regulatory authorities impose on banks have two sets of objectives: (i) so-called ‘micro-prudential’ motives, to ensure the safety and soundness of individual banks; and (ii) ‘macro-prudential’ goals, especially to influence the aggregate supply of credit. Micro-prudential regulation has a long pedigree, but the focus on macro-prudential regulation has increased sharply in the wake of the global financial crisis. This sharpened focus underlies recent changes in the international regulatory regime for banks. Basel III, as the new regime is called, establishes a “countercyclical capital buffer”, under which national regulators would vary banks’ required capital-to-risk-weighted assets ratio over time, thereby helping smooth the credit cycle. For variation in minimum capital requirements to be effective in regulating the aggregate supply of credit, three conditions must be satisfied:

…continue reading: Does Macropru Leak? Evidence from a UK Policy Experiment

The first wave filers – the largest and most complex domestic and foreign bank holding companies – have now filed their living wills and the public portions have been posted on the FDIC’s and the Federal Reserve’s websites. Based on our experience advising a number of banking institutions on their resolution plans, and based on the public portions of the plans, we believe there are lessons to be learned for second and third wave filers, even in this early stage of an iterative process. At the same time, these lessons should be drawn carefully in light of the fact that the business models and legal structures of the second wave filers are somewhat different from the first wave filers, and those of the third wave filers are very different. Any lessons learned from the first wave should also be tempered by the fact that the standard format for the living wills that the regulators required in the first wave is likely to change for second and third wave filers. With that in mind, we suggest the following key lessons from the first wave filers based on what is known immediately after their public filings.

…continue reading: Living Wills: Key Lessons from the First Wave

The Volcker Rule, as embodied in the Dodd-Frank Act and reflected in proposed regulations, generally prohibits “banking entities” from engaging in proprietary trading and from investing in or sponsoring private equity and hedge funds. [1] These “banking entities” include foreign banks that maintain branches or agencies in the U.S. or that own U.S. banks or commercial lending companies in the United States. These banks, as well as their parent holding companies, are referred to in U.S. regulations as “foreign banking organizations,” or “FBOs,” and we will use this term throughout this paper. [2] This bulletin evaluates how Volcker, as construed by proposed regulations, impacts the proprietary trading and investment fund-related activities of FBOs outside the United States.

Generally, the Dodd-Frank Act exempts proprietary trading by FBOs that is conducted solely outside the United States, and, provided that no ownership interest in a fund is offered or sold in the United States, investment fund-related activities by FBOs conducted solely outside the United States. The exemptions are available under the Dodd-Frank Act for FBOs (or their affiliates) not controlled by U.S.-based banking entities as long as the activities in question are conducted consistent with the exemption accorded FBOs for activities conducted outside the United States pursuant to Sections 4(c)(9 ) or 4(c)(13) of the Bank Holding Company Act. Accordingly, the exemptions are not available for activities conducted by the U.S. branches or agencies of FBOs, or by U.S. banks or U.S. commercial lending companies owned by FBOs.

…continue reading: The Volcker Rule’s Impact on Foreign Banking Organizations

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).

…continue reading: Federal Reserve’s Chinese Bank Determination Has Broader Implications

Although a branch of a bank is not a separate juridical entity from the bank of which it is a component, U.S. law treats branches as separate from the head office and other branches of a bank when such differentiation is appropriate for various purposes. Branches are a hybrid structure, at the same time both an integral part of the banks of which they are merely offices and separate legal entities for a number of U.S. regulatory and commercial law purposes. This feature of bank branches is a central tenet of federal banking statutes, and the law governing U.S. branches of foreign banks in particular.

At times the status of a U.S. branch of a foreign bank under a particular statutory scheme is explicit. Such is the case with the U.S. law treatment of U.S. branches of foreign banks in insolvency. As discussed below, U.S. law treats those branches virtually as separate entities in insolvency.

In other circumstances, a particular statute does not explicitly address the status of U.S. branches of foreign banks, and the treatment has to be arrived at through an analysis of the purpose of the statutory scheme. For example, as discussed below, after a long series of no-action letters, the Securities and Exchange Commission (“SEC”) issued interpretive guidance providing that securities issued or guaranteed by U.S. branches of a foreign bank (but not its non-U.S. branches) could rely on the exemption from registration afforded to securities issued or guaranteed by a bank under Section 3(a)(2) of the Securities Act of 1933 (“Securities Act”). Thus, U.S. branches can rely on the Section 3(a)(2) exemption while the bank itself is required to register to distribute its securities in the United States.

This paper will review the treatment of U.S. branches of foreign banks under a variety of statutory schemes and explore the rationale for that treatment.

…continue reading: Separate Entity Doctrine for U.S. Branches of Foreign Banks