Basel III Liquidity Framework: Federal Reserve Approves Final Rule Implementing Basel III Liquidity Coverage Ratio for Large U.S. Banks

Sullivan & Cromwell LLP - September 9, 2014

On Wednesday, September 3, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Office of the Comptroller of the Currency (the “OCC”) and the Federal Deposit Insurance Corporation (the “FDIC” and, together with the Federal Reserve and OCC, the “Agencies”) approved a final rule (the “Final Rule”) implementing a quantitative liquidity coverage ratio (“LCR”) requirement for certain large domestic bank holding companies, savings and loan holding companies and depository institutions (“covered companies”), as well as a modified and less stringent LCR for other banking organizations with $50 billion or more in total consolidated assets.  The LCR is intended to ensure that banking organizations hold sufficient stock of “high quality liquid assets” (“HQLA”) to cover the anticipated net cash flows during an acute 30-day stress scenario.

Although it includes a number of important changes in response to public comment, the Final Rule is largely similar to the rule initially proposed in October 2013 (the “Proposed Rule”).  Notable changes include:

  • Timing of compliance.  The Final Rule retains the January 1, 2015 initial compliance date for covered companies subject to the full LCR.  However, the daily calculation requirement is delayed until July 1, 2015 for the largest banking organizations and July 1, 2016 for all other banking organizations subject to the full LCR.  In the interim, calculation will be required on a monthly basis.
    • The initial compliance date for covered companies subject to the modified LCR is delayed until January 1, 2016.  These covered companies will be subject only to a monthly reporting requirement thereafter. 
  • Peak-day.  Although it continues to address potential maturity mismatches between outflows and inflows, the Final Rule eliminates the assumption that all transactions without a specified maturity date result in an outflow on the first day of each 30-calendar-day measurement period.  The Final Rule, however, includes a new calculation methodology that is designed to capture such potential mismatches but only from specific types of transactions, such as repos and reverse repos with financial sector entities, that the Agencies believe are most likely to expose covered companies to maturity mismatches within the 30-day period.
  • Collateralized deposits. For the calculation of HQLA, covered companies are not required to apply the hypothetical unwind to certain collateralized deposits that are unlikely to be manipulated by a covered company for HQLA purposes.
In light of ongoing analysis, the Agencies left open the possibility that certain municipal securities may be sufficiently liquid to be included as HQLA, which would be the subject of a future proposal for public comment.

The Final Rule does not currently apply to foreign banking organizations or U.S. intermediate holding companies required to be formed under the Federal Reserve’s enhanced prudential standards mandated by Section 165 of Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) that do not otherwise qualify as covered companies.  However, the Federal Reserve reaffirmed its plans to issue additional rulemaking in the future to apply an LCR-based standard to the U.S. operations (possibly including U.S. branches) of some or all foreign banking organizations with $50 billion or more in combined U.S. assets.  In addition, unlike the Proposed Rule, the Final Rule does not apply to nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve.  Instead, enhanced liquidity requirements would be applied to such firms by rule or order.

The Final Rule continues to be more restrictive than the international liquidity standards (the “Basel III LCR”) published by the Basel Committee on Banking Supervision (the “Basel Committee”) in a number of significant respects, including the accelerated implementation schedule and peak-day calculation requirement noted above.  The Final Rule’s accelerated timeframe affirms the Agencies’ willingness to proceed with implementing the LCR notwithstanding the slower pace of European regulators in adopting similar rules.

This memorandum highlights certain key features of the Final Rule, focusing on the more significant changes from the Proposed Rule and areas where the industry sought changes in the Proposed Rule that the Agencies did not include.  For reference, the Appendix hereto provides a brief, high-level introduction and summary of the LCR.