4/12/19 - Promontory Currents: Federal Reserve Announces Proposed Tailoring of Prudential Standards for FBOs
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4/12/19 - Promontory Currents: Federal Reserve Announces Proposed Tailoring of Prudential Standards for FBOs

By Patrick Parkinson, Mark Sexton, Katheryn Van der Celen, and Joseph Medioli

On April 8, 2019, the Federal Reserve Board issued proposed rules to revise the prudential standards applicable to foreign banking organizations and scale the application of those standards to an FBO’s U.S. risk profile.1

The issuance represents the latest release of proposed rules to tailor prudential requirements applicable to large banks, including implementing amendments to provisions of the Dodd-Frank Act made by the Economic Growth, Regulatory Relief, and Consumer Protection Act of May 24, 2018.2 The FBO proposals go beyond what is required by EGRRCPA, with the governors relying on the authority granted in Dodd-Frank permitting tailoring of enhanced prudential standards (EPS) on any risk-related factors deemed appropriate.3

As anticipated, the proposed rules for FBOs would apply a framework similar to the one outlined in proposals issued for large U.S. banking organizations,4 which assigns firms to a category of regulatory stringency based on their size, business model, and risk profile. For FBOs, however, the Federal Reserve adapted the measure of cross-jurisdictional activity to recognize the significance of affiliate transactions. The weighted short-term wholesale funding (wSTWF) measure is particularly impactful, because the U.S. operations of most FBOs have very limited access to retail deposits and instead rely heavily on short-term wholesale funding.

Notably, the Federal Reserve did not propose applying liquidity standards — such as the liquidity coverage ratio — to the U.S. branches and agencies of FBOs. Inclusion of such a proposal was anticipated as a means for the Federal Reserve to address its often-expressed concerns about the potential for regulatory arbitrage, created by the application of the LCR to U.S. financial subsidiaries of FBOs but not to their agencies and branches. Rather, regulators are soliciting input from the industry on whether and how to incorporate the LCR or other standardized liquidity requirements into the final rules.

Proposed FBO Categories*
Category II Category III Category IV FBOs with $50B-$100B in U.S. assets

≥ $700B in U.S. assets
or
 ≥ $75B in cross-jurisdictional activity

≥ $250B in U.S assets
or
     ≥ $75B in nonbank assets, wSTWF, or off-balance sheet exposure

Other firms with $100B to $250B in U.S assets

≥ $100B in global assets
and  
$50B to $100B in U.S. assets

Source: “Presentation Materials for Prudential Standards for Foreign Banking Organizations,” Federal Reserve Board

*For capital standards, the applicable category is based on the U.S. assets and risk profile of the U.S. intermediate holding company (IHC). For risk management standards, liquidity standards, and single-counterparty credit limits, the applicable category is based on the U.S. assets and risk profile of the combined U.S. operations (which includes all U.S. subsidiaries, branches, and agencies).

Key Aspects of the Proposed Tailoring:

IHC Threshold
  • Maintains $50 billion in U.S. non-branch assets as the threshold for requiring establishment of a U.S. IHC
 
Capital and Other Requirements
  • Adds the countercyclical capital buffer and supplemental leverage-ratio requirements to non-advanced-approach category II and III institutions
  • Removes the ability of non-advanced-approach category II institutions to opt out of the accumulated other comprehensive income capital impact
  • Reduces the company-run stress-testing requirement to biannual for IHCs with assets between $250-$700 billion (unless otherwise captured in category II), and supervisory stress testing to biannual for IHCs with assets between $100-$250 billion (unless otherwise captured in category II or III)
  • Eliminates the company-run stress-testing requirement for IHCs with less than $250 billion in assets, and single-counterparty credit limits for FBOs with U.S. assets between $50-$250 billion (unless otherwise captured in category III)
 
Liquidity Requirements
  • Defers the application of liquidity standards to U.S. branches and agencies of FBOs, but leaves open the possibility of a future proposal
  • Focuses on the measure of wSTWF in applying the LCR and net-stable-funding-ratio liquidity standards to IHCs, with thresholds set at $75 billion for full requirements, and $50-$75 billion for reduced requirements
  • Reduces the frequency of internal liquidity stress testing and reduces certain liquidity-risk management requirements for FBOs with U.S. assets between $100-$250 billion
  • Eliminates local liquidity reporting (FR 2052a) and liquidity-risk management requirements for FBOs with U.S. assets between $50-$100 billion
 

What Should FBOs Do?

Unsurprisingly, the proposed rules would introduce a variety of complexities for FBOs, even where legacy requirements may be reduced or otherwise changed. Certainly, firms that fall outside categories II and III are likely to experience significant relief relative to legacy requirements, though certain firms captured by those categories may require substantial compliance uplift.

While the Federal Reserve seeks public comment and continues to develop additional proposals, FBOs can be confident that cross-jurisdictional exposure and wSTWF will attract regulatory scrutiny at branches as well as IHCs. FBOs should actively interact with industry groups and supervisors to comment on key aspects of the proposals, such as the impact of the wSTWF approach to setting IHC liquidity standards, potential approaches to implementing liquidity standards for U.S. branches and agencies, and the alignment of the proposals with home-country requirements, in the spirit of national treatment.

As with the first wave of EPS implementation, the proposed and eventual final rules are likely to necessitate carefully designed and executed implementation plans, particularly for institutions facing new or substantially different requirements. First and foremost, FBOs will need to determine which category they fall under, and they will need to evaluate the impact of potential changes to the proposed categorization criteria.

FBO boards and management teams will be best served by leveraging the benefits of recent investments in risk management processes, data, and other lessons learned from EPS implementation to assess preparedness and plan strategically. In particular, FBOs should:

Monitor Positions
  • Review data requirements and capabilities to determine, substantiate, and monitor applicability of the proposed rules based on the new categorization, and implement needed enhancements
  • Enhance monitoring of U.S. positions to include measures of cross-jurisdictional activity, wSTWF positions, non-banking activity, and off-balance-sheet exposures  
 
Think Strategically
  • Analyze the U.S. business strategy relative to the proposed rules and reassess views of risks and opportunities to optimize operations
  • Consider where the proposed rules increase or decrease alignment with home-country requirements in determining potential opportunities and costs
  • Review the global business model in consideration of the capital and liquidity impacts of the proposed rules along with the intermediate EU-parent undertaking rule (Article 21b of CRD-V)5
  • Consider the long-term business value of, and investment in, processes and systems established during the first wave of EPS implementation
 
Maintain Sound Risk Management Practices
  • Consider the intersection between alleviated requirements and regulatory expectations for sound risk management
  • Carefully evaluate staffing models and program adjustments to balance the quality of talent and delivery with process frequency and execution needs
  • Take advantage of reduced supervisory pressure to identify opportunities for efficiency and leverage lessons learned
 
Assess Preparedness for Implementation
  • Review and update existing capital and liquidity implementation plans
  • Consider opportunities to leverage global processes based on commonalities with home-country regulations and areas requiring adaptation or development to address U.S. requirements
 

Authors

Pat Parkinson is a managing director in Promontory’s Washington office. Mark Sexton is a managing director, Katheryn Van der Celen is a director, and Joseph Medioli is a senior principal, in Promontory’s New York office.


FOOTNOTES

  1. Federal Reserve Board invites public comment on regulatory framework that would more closely match rules for foreign banks with the risks they pose to U.S. financial system,” Federal Reserve Board (April 8, 2019).
  2. Statement regarding the impact of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA),” Federal Reserve (July 6, 2018).
  3. See (a)(2) of “§5365. Enhanced supervision and prudential standards for nonbank financial companies supervised by the Board of Governors and certain bank holding companies,” Office of the Law Revision Counsel (April 10, 2019).
  4.  “Federal Reserve Board invites public comment on framework that would more closely match regulations for large banking organizations with their risk profiles,” Federal Reserve (Oct. 31, 2018).
  5. Directive of the European Parliament and of the Council on the prudential supervision of investment firms and amending Directives 2013/36/EU and 2014/65/EU,” Council of the European Union (March 19, 2019).