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In February 2014, the Federal Reserve (the Fed) approved a final rule strengthening the
supervision and regulation of large U.S. bank holding companies and foreign banking organizations (FBOs) under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) Section 165. Enhanced prudential standards (EPS) provide a framework for supervising and regulating large domestic and foreign financial institutions. In the big picture, EPS is intended to help banks anticipate and lessen risks, while bolstering the resiliency of bank operations.
Expectations for FBOs
U.S.-based global financial institutions have spent a significant amount of their time and resources meeting compliance requirements in recent years. For FBOs, EPS represents the most significant development since the International Banking Act of 1978, which introduced the principle of national treatment for international banking organizations.
The Fed has adopted a tiered approach for applying Dodd-Frank EPS to FBOs wherein the most onerous requirements, including the U.S. Intermediate Holding Company (IHC) requirement, will only apply to FBOs with U.S. operations of more than $50 billion in total global consolidated assets and more than $50 billion in combined U.S. (nonbranch) assets. Fewer requirements will apply to FBOs with limited U.S. footprints. Thresholds for both global and combined U.S. assets are determined by the average of the four most recent consecutive quarters as reported by the FBO on Form FR Y-7Q.
Meeting final rule requirements
As a first step toward meeting the final rule requirements, mid-size and small FBOs must plan and assess possible impacts of EPS on their operating models, along with associated impacts like governance, infrastructure and their broader U.S. operations strategies. Mid-size and small FBOs can begin the process for meeting the following requirements, as defined by the final rule:
- Risk management. If publicly traded, both mid-size and small FBOs need to either certify or establish a U.S. risk committee comprised of members of its global board of directors. This committee (i) oversees the risk management policies of the U.S. operations and, (ii) includes at least one member with experience in identifying, assessing and managing risk exposures of large, complex organizations. This requirement may lead to changes in the identification, assessment, monitoring and reporting of risks across the institution, thereby forcing the enhancement of the holistic risk management framework including stress testing, capital and liquidity management.
- Capital. Both mid-size and small FBOs must certify to the regulators annually that they meet capital adequacy standards on a consolidated basis. These standards are established by their home country supervisors and are consistent with the Basel capital framework. Specifically, the minimum capital ratios, leverage ratios and capital buffers must be consistent with those established in the Basel III framework. There has been a clear upward trend among the regulators with respect to the demands on the amount and quality of capital an institution holds. Complying with these capital rules will bring a variety of management challenges including the consideration of the impact a business decision has on the amount of capital that may be required.
- Stress testing. Regardless of whether small and mid-size FBOs are publicly traded, they are subject on a consolidated basis to capital stress testing regimes established by their home country supervisor. This home country stress test must be conducted on an annual basis and dictate specific requirements around the governance and internal controls of the stress testing process. In addition, the FBOs must meet any minimum standards set by their home country supervisors with regards to stress tests. Like many peers, FBOs will need to assess the data, modeling and governance implications of the new rules to ensure that the requirements are met. While analyzing this data, FBOs should keep in mind that stress testing should be considered hand-in-hand with recovery and resolution planning.
- Liquidity. Mid-size FBOs must report to the regulators the results of an internal liquidity stress for either its global or U.S. operations on an annual basis. This stress test must also be conducted consistently with the Basel Committee’s principles of liquidity risk management and incorporate 30-day, 90-day and one-year stress test horizons. The quantitative requirements of the final rule complement the liquidity coverage ratio (LCR) requirements, which require banks to hold an amount of high-quality liquid assets equal to or greater than their net cash over a 30-day period (having at least 100% coverage). FBOs need to focus on building the U.S. processes to meet these requirements which may involve a significant effort on the part of infrastructure to ensure delivered downward stream data is timely and accurate.
- Debt-to-equity limits. If an FBO’s debt-to-equity ratios pose a grave threat to U.S. financial stability, as determined by the Financial Stability Oversight Council (or from the FRB on behalf of the Council), then a specific requirement may be imposed. In that case, the IHC (or in absence of an IHC, certain of the FBO’s U.S. subsidiaries) must achieve and maintain debt-to-equity ratios of no more than 15–1. In addition, the FBO’s U.S. branches and agency will be subject to an asset maintenance requirement.
The timeline to execute structural reorganization and fully comply with the regulations remains challenging. FBOs need to quickly switch gears from theoretical plans and press forward with implementation.
Tariq A. Mirza
National Managing Director, Bank Advisory and Regulatory Services
T +1 202 251 8677
National Managing Partner, Financial Services Industry Group; Financial Services Global Leader
T +1 212 542 9660
The authors wish to acknowledge the contributions of Michelle Berman to the research underlying this article.
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