Single Counterparty Credit Limits: Federal Reserve Board Proposes Revised Rules to Establish Single Counterparty Credit Limits

Sullivan & Cromwell LLP - March 8, 2016

On March 4, the Federal Reserve issued a proposed rulemaking (“SCCL Reproposal”) that would impose single counterparty credit limits (“SCCL”), pursuant to Section 165(e) of the Dodd-Frank Act, on:

  • U.S. bank holding companies (“BHCs”) with $50 billion or more in total consolidated assets;
  • Foreign banking organizations (“FBOs”) with $50 billion or more in total consolidated assets, but with single counterparty credit limits applying only to the exposures of their combined U.S. operations; and
  • U.S. intermediate holding company subsidiaries (“IHCs”) of FBOs with $50 billion or more in total consolidated assets (together with the U.S. BHCs and FBOs described above, “Covered Companies”). 

Section 165(e) requires the Federal Reserve to promulgate regulations prohibiting a BHC or FBO with $50 billion or more in total consolidated assets from having credit exposure to any unaffiliated company in excess of 25 percent of the company’s capital stock and surplus, with discretion to impose a lower limit if “necessary to mitigate risks to the financial stability of the United States.” 

In December 2011 (for U.S. BHCs) and December 2012 (for FBOs and IHCs), the Federal Reserve initially proposed single counterparty credit limit rules (the “Original SCCL Proposal”), along with other enhanced prudential standards for Covered Companies, but the Original SCCL Proposal was not included in the final package of enhanced prudential standards issued by the Federal Reserve in 2014.  The Original SCCL Proposal met with significant criticism due in large part to measurement methodologies that would have produced significant overstatements of realistic economic exposure, which would likely have required Covered Companies to unwind existing transactions on a large scale. 

The SCCL Reproposal makes important changes to the Original SCCL Proposal that should reduce both the number of counterparties with exposures that would be at or above the applicable limit and the aggregate amount of exposures that exceed the limit, although the full impact will not be known until the Federal Reserve makes a final determination of how credit exposure from derivative transactions will be measured.  The Federal Reserve estimates that, under the SCCL Reproposal, the total amount of excess credit exposure of U.S. BHCs would be less than $100 billion.  By contrast, an industry data study of the Original SCCL Proposal estimated that there would have been, in the aggregate, 100 incidents of counterparty exposures in excess of the proposed limits totaling nearly $1.3 trillion.  Nonetheless, the SCCL Reproposal remains conservative and introduces new concepts that would increase the complexity of, and burden associated with, compliance.  We have summarized below key elements of the SCCL Reproposal. 

The Federal Reserve has asked that comments on the SCCL Reproposal be submitted by June 3, 2016.