“Enhanced Prudential Standards” for Large U.S. Bank Holding Companies and Foreign Banking Organizations: Federal Reserve Approves Final Rule Implementing Certain Provisions of Section 165 of the Dodd-Frank Act Increasing Supervision and Regulation of Large U.S. Bank Holding Companies and Foreign Banking Organizations

Sullivan & Cromwell LLP - February 24, 2014

On February 18, 2014, the Board of Governors of the Federal Reserve System (the “FRB”) approved a final rule (the “Final Rule”) implementing certain of the “enhanced prudential standards” mandated by Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Dodd-Frank”). The Final Rule applies the enhanced prudential standards to (i) U.S. bank holding companies (“U.S. BHCs”) with $50 billion (and in some cases, $10 billion) or more in total consolidated assets and (ii) foreign banking organizations (“FBOs”) with (x) a U.S. banking presence, through branches, agencies or depository institution subsidiaries, and (y) depending on the standard, certain designated amounts of assets worldwide, in the United States or in U.S. non-branch assets. The Final Rule’s provisions are the most significant, detailed and prescriptive for the largest U.S. BHCs and the FBOs with the largest U.S. presence — those with $50 billion or more in total consolidated assets and, in the case of FBOs, particularly (and with increasing stringency) for FBOs with combined U.S. assets of $50 billion or more or U.S. non-branch assets of $50 billion or more.

The Final Rule’s provisions are considerably more noteworthy for FBOs than for U.S. BHCs. In the case of U.S. BHCs, a number of the enhanced prudential standards have previously been finalized and are (or will shortly be) in effect, in particular, the revised U.S. Basel III-based risk-based and leverage capital rules and the capital planning and company-run and supervisory stress testing requirements previously implemented by the FRB. The Final Rule implements, as new requirements for U.S. BHCs, only Section 165’s risk management requirements (including requirements, duties and qualifications for a risk management committee and chief risk officer), liquidity stress testing and buffer requirements, and the potential application of a 15-to-1 debt-to-equity limit for a U.S. BHC deemed by the Financial Stability Oversight Council (the “FSOC”) to pose a grave risk to the financial stability of the U.S. Many, if not most, of these items have already been effectively implemented through supervisory guidance.

For FBOs, the Final Rule incorporates a fundamentally different approach to the regulation of their U.S. operations. Of most significance is the requirement that an FBO having U.S. non-branch assets of $50 billion or more (raised from the $10 billion threshold initially proposed) establish in the United States an intermediate holding company (“IHC”) for its U.S. subsidiaries that must be organized under U.S. law and, with certain limited exceptions, will be subject to the full range of U.S. regulatory requirements applicable to U.S. BHCs of comparable size under Dodd-Frank Section 165 and/or otherwise, including leverage and risk-based capital standards, stress testing, risk management and certain liquidity requirements. In addition, all FBOs with at least $10 billion in worldwide consolidated assets will be subject to a layered and escalating set of capital, stress testing and liquidity and risk management requirements, depending on their respective amount of worldwide consolidated assets and U.S. assets. For example:

  • FBOs with worldwide consolidated assets of $10 billion or more but less than $50 billion must be subject to a home-country capital adequacy stress testing regime that meets certain FRB-defined standards or else face asset maintenance requirements at its U.S. branch;
  • Publicly traded FBOs with total consolidated assets of $10 billion or more and FBOs with total consolidated assets of $50 billion or more, whether or not publicly traded, are also required to maintain a committee of its global board of directors on a stand-alone basis or as part of its enterprise-wide risk committee that oversees risk management policies of its U.S. operations;
  • FBOs with worldwide consolidated assets of $50 billion or more but combined U.S. assets of less than $50 billion must also (i) certify to the FRB that they are subject to and in compliance with risk-based and leverage capital requirements in their respective home jurisdictions that are substantially equivalent to those promulgated by the Basel Committee on Banking Supervision (the “Basel Committee”) or face various restrictions on their U.S. operations if they are unable to do so and (ii) report to the FRB the results of internal liquidity stress tests for either their consolidated operations or the combined U.S. operations or else be subject to limits on the net amount owed by their non-U.S. offices to their U.S. offices; and
  • FBOs with worldwide consolidated assets of $50 billion or more and combined U.S. assets of $50 billion or more that also are required to form an IHC must (i) maintain a U.S. risk committee either at the IHC board level or at the FBO parent board level to approve and oversee the risk management framework and policies of the combined U.S. operations, including as to liquidity risk, (ii) appoint a U.S. chief risk officer having certain defined qualifications, and (iii) be subject to various liquidity stress testing and buffer, contingency funding plan, and cash-flow projection requirements.

As discussed below, a more detailed summary of these escalating requirements and their levels of applicability is set forth in Annex B.

Although the FRB postponed some of the most important implementation deadlines (as described below) for FBOs, the planning and implementation process, especially for FBOs with a larger non-banking presence in the U.S., will be a significant and complex undertaking and likely require a great deal of effort and management attention, even before the effectiveness of specific requirements. It will also be important for any FBO subject to the IHC requirement to recognize the potential tax implications that may arise in interposing an IHC into its organizational structure or otherwise reorganizing the FBO’s organizational structure under an IHC.

The Final Rule does not include final rules establishing single counterparty credit limits (“SCCL”) or the early remediation frameworks that would have been applied to U.S. BHCs and FBOs under the FRB’s previous proposals. The FRB stated that these rules are still under development and will be addressed in future rulemakings. The Final Rule also does not address enhanced prudential standards for non-bank financial companies designated by the FSOC for supervision by the FRB. In the Preamble to the Final Rule (the “Preamble”), the FRB indicated that it will establish enhanced prudential standards for these entities at a later date by either rule or order.

The effective date of the Final Rule is June 1, 2014, although compliance with most of the new requirements will be phased in between 2015 and 2018.