Regulatory Tailoring for Foreign Banking Organizations: Federal Bank Regulators Propose Significant Revisions to the Application of Prudential Standards to Foreign Banking Organizations and Seek Comment on Whether to Impose Standardized Liquidity Requirements on their U.S. Branches and Agencies

Sullivan & Cromwell LLP - April 23, 2019
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On April 8, the Federal Reserve Board adopted two proposals that would tailor how certain aspects of the post-crisis bank regulatory framework, including certain capital and liquidity requirements and other prudential standards, apply to foreign banking organizations (“FBOs”) that have significant U.S. operations (the “FBO Proposals”). One of the proposals was also adopted on April 16 by the FDIC and will be issued jointly by the FDIC, Federal Reserve, and OCC. The other was issued solely by the Federal Reserve.
The FBO Proposals follow the federal bank regulators’ analogous proposals for large U.S. banking organizations released in the fourth quarter of 2018 (the “domestic tailoring proposals”). As described in our Memorandum to Clients, dated November 5, 2018, the regulators proposed to assign all domestic bank holding companies (“BHCs”) and certain domestic savings and loan holding companies (“SLHCs”) with $100 billion or more in total consolidated assets to one of four categories of tailored regulatory requirements. One category applies to all U.S. G-SIBs and the other three are based on size and four other “risk-based indicators”.
The FBO Proposals similarly would tailor prudential standards by assigning FBOs with $100 billion or more in combined U.S. assets to categories similar to those proposed for domestic BHCs and SLHCs that are not G-SIBs. The Federal Reserve’s objectives for the proposed tailoring approach for FBOs, as described by Vice Chairman for Supervision Quarles, are to “creat[e] a level playing field between foreign banks operating in the United States and domestic firms of similar size and business models, and giv[e] due regard to the principle of national treatment”. Vice Chairman Quarles added, however, that, due to the “the important differences between domestic firms and foreign banks operating in the United States”, the proposed tailoring for FBOs shares the “same basic framework” with, but is not a “direct transposition of”, the template proposed for U.S. banking organizations.

In the FBO Proposals, the agencies describe risks they believe to be associated with certain funding models employed in connection with the U.S. operations of FBOs, and the tailoring takes these models directly into account. Specifically, the Federal Reserve notes that, during the financial crisis, funding models that “relied on dollar-denominated short-term wholesale funding obtained in the United States to fund . . . global investment activities” presented “unique vulnerabilities”. The agencies also state that “reliance on short-term, generally unsecured funding from more sophisticated counterparties can make . . . operations vulnerable to large-scale funding runs”.

Citing these concerns, the agencies also request comment on whether they should impose standardized liquidity requirements on U.S. branches and agencies of FBOs, as well as possible approaches for doing so. Vice Chairman Quarles acknowledged that these potential requirements are “novel in the realm of international regulation”, but described them as a potential means to create the “optimal balance of certainty for host supervisors and local operations in a time of crisis and freely available liquidity for home supervisors and consolidated firms in good times”. Any such requirements would be subject to a separate notice-and-comment rulemaking.

Notably, the Federal Reserve did not propose any increase in the $50 billion U.S. non-branch asset threshold for application of the U.S. intermediate holding company requirement.
Comments on the FBO Proposals are due by June 21, 2019.