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From Banking and Finance Law Daily, February 18, 2014

Fed adopts final rule on enhanced prudential standards for large banking organizations

By Richard A. Roth, J.D.

The Federal Reserve Board has adopted amendments to Reg. YY—Enhanced Prudential Standards (12 CFR Part 252) to carry out the Dodd-Frank Act mandate of enhanced prudential standards for the largest U.S. bank holding companies and foreign banking organizations with substantial U.S. operations (see 12 U.S.C. §5365). The amendments impose liquidity, risk management, capital, and corporate governance requirements on the covered companies. According to the Fed, the set of requirements imposed on a covered company “increases in stringency based on the nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company.”

Most provisions of the rule apply to U.S. bank holding companies (BHCs) and foreign banking organizations (FBOs) with total consolidated assets of $50 billion or more, but some have a $10-billion threshold. The rule is effective June 1, 2014, but compliance is delayed until Jan. 1, 2015, for U.S. holding companies and July 1, 2016 (or later), for some requirements that are imposed on foreign banking organizations.

The Fed noted that the rule does not include a number of provisions that are under consideration. It does not apply to nonbank financial companies the Financial Stability Oversight Council has designated for Fed supervision. It also omits single-counterparty credit limits and early remediation requirements the Fed says require further study.

BHC capital. The Fed says the rule includes, as an enhanced prudential standard, the previously-adopted capital planning and stress test requirements. Stress test rules apply to banks with more than $10 billion but less than $50 billion in total consolidated assets as well as those that pass the $50 billion threshold.

BHC risk management. A publicly traded company with more than $10 billion in assets will be required to establish a risk management committee. The committee will be responsible for periodically reviewing and approving the company’s enterprise-wide risk management policies and framework. The framework must be appropriate for the company’s “structure, risk profile, complexity, activities, and size,” and it is to set the policies and procedures for the company’s risk-management governance, practices, and infrastructure. The framework is to cover the company’s global operations, the Fed says.

The risk management committee is to be chaired by an independent director. It must have at least one member with risk-management expertise—more, if the company’s activities merit the increase. The committee also must have a written charter from the company’s board of directors.

Additional risk-management duties apply to institutions with assets of $50 billion or more. For these larger institutions, the risk management committee must be separate from any other committee and must report directly to the board. The company also must designate a chief risk officer with prior risk management experience.

BHC liquidity. The rule requires BHCs that exceed the $50 billion threshold to carry out liquidity stress tests at least monthly. Each company’s board is to establish the company’s liquidity risk tolerance at least annually. The company’s required contingency funding plan is to be reviewed at least annually by the risk management committee. Liquidity management also must be subject to an annual independent review.

The rule requires BHCs to set limits on potential sources of risk, including:

  • concentrations of funding by instrument type, single counterparty, counterparty type, secured and unsecured funding, and other identifiers;

  • the amount of liabilities that mature within various time horizons; and

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

Intraday liquidity monitoring is required.

Additionally, these largest BHCs must hold a liquidity buffer comprising unencumbered highly liquid assets adequate to meet projected funding needs for 30 days over the range of liquidity stress scenarios used in the liquidity stress test.

BHC debt-to-equity limits. A BHC deemed by the FSOC to pose a “grave threat” to U.S. financial stability cannot have a debt-to-equity limit that exceeds 15-to-1, if the FSOC determines that limit is needed. If the limit is imposed, the company generally must come into compliance within 180 days.

FBO intermediate holding companies. A FBO that meets the $50 billion threshold and that has U.S. non-branch assets of at least $10 billion must place all of its U.S. subsidiaries into an intermediate U.S. holding company. This is intended to facilitate supervision of the FBO’s U.S. operations. Compliance with this requirement is delayed until at least July 1, 2016, and for an additional year in some cases. The Fed noted that the requirement applies even if the FBO does not have a U.S. depository institution subsidiary.

FBO capital. Intermediate holding companies are required generally to comply with the risk-based capital and leverage capital requirements that apply to U.S. BHCs. This will subject the intermediate holding companies to the disclosure rules included in the Fed’s regulatory capital rules; however, those rules include an exception for foreign organizations that are subject to disclosure requirements in their home countries that usually will apply, the Fed points out.

Intermediate holding companies will need to comply with the Fed’s capital plan rule as well. This will put them on equal footing with U.S. BHCs, the Fed says.

FBO risk management. Risk management committee and chief risk officer appointment obligations generally will apply to FBOs in order to account for the risk of their U.S. operations. However, the rule does allow consideration for home-country risk management standards.

FBO liquidity. An FBO that meets the $50 billion threshold will be required to: establish a liquidity risk management framework; carry out independent reviews and cash-flow projections; create a contingency funding plan; engage in stress tests of its combined U.S. operations, intermediate holding company and U.S. branches and agencies; and hold liquidity buffers. These requirements are comparable, but not identical, to those imposed on U.S. BHCs.

FBO stress tests. Intermediate holding companies generally are subject to stress test requirements comparable to the requirements that apply to U.S. BHCs of the same size. In addition, the foreign parent is to be subject to a stress test regime in its home country and is to report the results of those tests to the Fed.

If the FBO does not comply with the stress test requirement, the Fed has the ability to require the FBO’s U.S. branches and agencies to maintain eligible assets that equal at least 108 percent of third-party liabilities. Funding and liquidity restrictions can be imposed as well.

FBO debt-to-equity limits. The same 15-to-1 debt-to-equity limit can be imposed on a FBO that poses a grave threat to U.S. financial stability that can be imposed on a U.S. BHC. In such a situation, the 108-percent asset maintenance requirement could be imposed on the FBO’s U.S. branches and agencies as well.

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