[Federal Register Volume 77, Number 3 (Thursday, January 5, 2012)]
[Proposed Rules]
[Pages 594-663]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-33364]
[[Page 593]]
Vol. 77
Thursday,
No. 3
January 5, 2012
Part III
Federal Reserve System
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12 CFR Part 252
Enhanced Prudential Standards and Early Remediation Requirements for
Covered Companies; Proposed Rule
Federal Register / Vol. 77 , No. 3 / Thursday, January 5, 2012 /
Proposed Rules
[[Page 594]]
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FEDERAL RESERVE SYSTEM
12 CFR Part 252
[Regulation YY; Docket No. 1438]
RIN 7100-AD-86
Enhanced Prudential Standards and Early Remediation Requirements
for Covered Companies
AGENCY: Board of Governors of the Federal Reserve System (Board).
ACTION: Proposed rule; request for public comment.
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SUMMARY: The Board is requesting comment on proposed rules that would
implement the enhanced Prudential standards required to be established
under section 165 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act or Act) and the early remediation
requirements established under section 166 of the Act. The enhanced
standards include risk-based capital and leverage requirements,
liquidity standards, requirements for overall risk management
(including establishing a risk committee), single-counterparty credit
limits, stress test requirements, and a debt-to-equity limit for
companies that the Financial Stability Oversight Council has determined
pose a grave threat to financial stability.
DATES: Comments: Comments should be received on or before March 31,
2012.
ADDRESSES: You may submit comments, identified by Docket No. 1438 and
RIN 7100-AD-86 by any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Email: [email protected]. Include docket
and RIN numbers in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue NW.,
Washington, DC 20551.
All public comments are available from the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information. Public comments may also be viewed electronically or in
paper form in Room MP-500 of the Board's Martin Building (20th and C
Streets NW.) between 9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Mark Van Der Weide, Senior Associate
Director, (202) 452-2263, or Molly E. Mahar, Senior Supervisory
Financial Analyst, (202) 973-7360, Division of Banking Supervision and
Regulation; or Laurie Schaffer, Associate General Counsel, (202) 452-
2272, or Dominic A. Labitzky, Senior Attorney, (202) 452-3428, Legal
Division.
Risk-Based Capital Requirements and Leverage Limits: Anna Lee
Hewko, Assistant Director, (202) 530-6260, or Meg Donovan, Supervisory
Financial Analyst, (202) 872-7542, Division of Banking Supervision and
Regulation; or April C. Snyder, Senior Counsel, (202) 452-3099, or
Benjamin W. McDonough, Senior Counsel, (202) 452-2036, Legal Division.
Liquidity Requirements: Mary Aiken, Manager, (202) 721-4534, or
Chris Powell, Financial Analyst, (202) 921-4353, Division of Banking
Supervision and Regulation; or April C. Snyder, Senior Counsel, (202)
452-3099, Legal Division.
Single-Counterparty Credit Limits: Mark Van Der Weide, Senior
Associate Director, (202) 452-2263, or Molly E. Mahar, Senior
Supervisory Financial Analyst, (202) 973-7360, Division of Banking
Supervision and Regulation; or Pamela G. Nardolilli, Senior Counsel,
(202) 452-3289, Patricia P. Yeh, Counsel, (202) 912-4304, or Anna M.
Harrington, Attorney, (202) 452-6406, Legal Division.
Risk Management and Risk Committee Requirements: Pamela A. Martin,
Senior Supervisory Financial Analyst, (202) 452-3442, Division of
Banking Supervision and Regulation; or Jonathan D. Stoloff, Senior
Counsel, (202) 452-3269, or Jeremy C. Kress, Attorney, (202) 872-7589,
Legal Division.
Stress Test Requirements: Tim Clark, Senior Adviser, (202) 452-
5264, Lisa Ryu, Assistant Director, (202) 263-4833, Constance Horsley,
Manager, (202) 452-5239 or David Palmer, Senior Supervisory Financial
Analyst, (202) 452-2904, Division of Banking Supervision and
Regulation; Dominic A. Labitzky, Senior Attorney, (202) 452-3428, or
Christine E. Graham, Senior Attorney, (202) 452-3005, Legal Division.
Debt-to-Equity Limits for Certain Covered Companies: Robert Motyka,
Senior Project Manager, (202) 452-5231, Division of Banking Supervision
and Regulation; or April C. Snyder, Senior Counsel, (202) 452-3099, or
Benjamin W. McDonough, Senior Counsel, (202) 452-2036, Legal Division.
Early Remediation Framework: Barbara J. Bouchard, Senior Associate
Director, (202) 452-3072, or Molly E. Mahar, Senior Supervisory
Financial Analyst, (202) 973-7360, Division of Banking Supervision and
Regulation; or Paul F. Hannah, Counsel, (202) 452-2810, or Jay R.
Schwarz, Counsel, (202) 452-2970, Legal Division.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Overview of the Proposal
A. Scope of Application
B. Risk-Based Capital Requirements and Leverage Limits
C. Liquidity Requirements
D. Single-Counterparty Credit Limits
E. Risk Management and Risk Committee Requirements
F. Stress Testing Requirements
G. Debt-to-Equity Limits for Certain Covered Companies
H. Early Remediation Framework
I. Transition Arrangements and Ongoing Compliance
J. Reservation of Authority
K. Common Definitions
III. Risk-Based Capital Requirements and Leverage Limits
A. Background
B. Overview of the Proposed Rule
1. Capital Planning and Minimum Capital Requirements
2. Quantitative Risk-Based Capital Surcharge
IV. Liquidity Requirements
A. Background
B. Overview of the Proposed Rule
1. Key Definitions
2. Corporate Governance Provisions
3. Liquidity Requirements
V. Single Counterparty Exposure Limits
A. Background
B. Overview of the Proposed Rule
VI. Risk Management and Risk Committee Requirements
A. Background
B. Overview of the Proposed Rule
1. Risk Committee Requirements
2. Additional Enhanced Risk Management Standards for Covered
Companies
VII. Stress Test Requirements
A. Background
B. Overview of the Proposed Rule
1. Annual Supervisory Stress Tests Conducted by the Board
2. Annual and Additional Stress Tests Conducted by the Companies
C. Request for Comments
VIII. Debt-to-Equity Limit for Certain Covered Companies
A. Background
B. Overview of the Proposed Rule
IX. Early Remediation
A. Background
B. Overview of the Proposed Rule
1. Early Remediation Requirements
2. Early Remediation Triggering Events
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X. Administrative Law Matters
A. Solicitation of Comments and Use of Plain Language
B. Paperwork Reduction Act Analysis
C. Regulatory Flexibility Act Analysis
I. Introduction
The recent financial crisis showed that some financial companies
had grown so large, leveraged, and interconnected that their failure
could pose a threat to overall financial stability. The sudden
collapses or near-collapses of major financial companies were among the
most destabilizing events of the crisis. The crisis also demonstrated
weaknesses in the existing framework for supervising, regulating and
otherwise constraining the risks of major financial companies, as well
as deficiencies in the government's toolkit for managing their failure.
As a result of the imprudent risk taking of major financial
companies and the severe consequences to the financial system and the
economy associated with the disorderly failure of these interconnected
companies, the U.S. government (and many foreign governments in their
home countries) intervened on an unprecedented scale to reduce the
impact of, or prevent, the failure of these companies and the attendant
consequences for the broader financial system. Market participants
before the crisis had assumed some probability that major financial
companies would receive government assistance if they became troubled.
But the actions taken by the government in response to the crisis,
although necessary, have solidified that market view.
The market perception that some companies are ``too big to fail''
poses threats to the financial system. First, it reduces the incentives
of shareholders, creditors and counterparties of these companies to
discipline excessive risk-taking. Second, it produces competitive
distortions because companies perceived as ``too big to fail'' can
often fund themselves at a lower cost than other companies. This
distortion is unfair to smaller companies, damaging to competition, and
tends to artificially encourage further consolidation and concentration
in the financial system.
A major thrust of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (Dodd-Frank Act or Act) \1\ is mitigating the
threat to financial stability posed by systemically important financial
companies. The Dodd-Frank Act addresses this problem with a multi-
pronged approach: a new orderly liquidation authority for financial
companies (other than banks and insurance companies); the establishment
of the Financial Stability Oversight Council (Council) empowered with
the authority to designate nonbank financial companies for Board
oversight; stronger regulation of major bank holding companies and
nonbank financial companies designated for Board oversight; and
enhanced regulation of over-the-counter (OTC) derivatives, other core
financial markets, and financial market utilities.
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\1\ Public Law 111-203, 124 Stat. 1376 (2010).
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Overview of Statutory Requirements
The focus of this proposal is stronger regulation of major bank
holding companies and nonbank financial companies designated by the
Council for Board supervision. In particular, sections 165 and 166 of
the Dodd-Frank Act require the Board to impose a package of enhanced
prudential standards on bank holding companies with total consolidated
assets of $50 billion or more \2\ and nonbank financial companies the
Council has designated, pursuant to section 113 of the Dodd-Frank
Act,\3\ for supervision by the Board (together, covered companies and
each a covered company). By their terms, sections 165 and 166 of the
Act apply to any foreign nonbank financial company designated by the
Council for supervision by the Board \4\ and any foreign banking
organization with total consolidated assets of $50 billion or more that
is or is treated as a bank holding company for purposes of the Bank
Holding Company Act of 1956 pursuant to section 8(a) of the
International Banking Act of 1978.\5\ However, as explained in greater
detail below, this proposal does not apply to foreign banking
organizations, and the Board expects to issue a separate proposal
shortly that would apply the enhanced standards of sections 165 and 166
of the Act to foreign banking organizations. The definition of
``covered company'' for purposes of the proposal would nonetheless
include a foreign banking organization's U.S.-based bank holding
company subsidiary that on its own has total consolidated assets of $50
billion or more.\6\ This proposal would not extend to the U.S.
operations of a foreign banking organization that are conducted outside
of a U.S.-based bank holding company subsidiary.
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\2\ The Board, pursuant to a Council recommendation, may raise
the $50 billion asset threshold for bank holding companies with
respect to the application of certain enhanced standards. See 12
U.S.C. 5365(a)(2)(B).
\3\ See 12 U.S.C. 5323. The Council proposed rules to implement
its authority under section 113 in January 2011 and October 2011.
See 76 FR 4555 (January 26, 2011) and 76 FR 64264 (October 18,
2011).
\4\ See 12 U.S.C. 5323(b). Section 102(c) limits the application
of section 165 to only the U.S. activities and subsidiaries of a
foreign nonbank financial company. 12 U.S.C. 5311(c).
\5\ See 12 U.S.C. 5311(a)(1) (defining the term ``bank holding
company'' for purposes of Title I of the Dodd-Frank Act). A foreign
banking organization is treated as a bank holding company pursuant
to section 8(a) of the International Banking Act if the foreign
banking organization operates a branch, agency or commercial lending
company in the United States.
\6\ With the exception of the proposed liquidity and enterprise-
wide risk management requirements and the debt-to-equity limit for
covered companies that the Council has determined pose a grave
threat, the proposed rule would not apply to any bank holding
company subsidiary of a foreign banking organization that has relied
on Supervision and Regulation Letter SR 01-01 issued by the Board of
Governors (as in effect on May 19, 2010) until July 21, 2015. This
is consistent with the phase-in period for the imposition of minimum
risk-based and leverage capital requirements established in section
171 of the Dodd-Frank Act.
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The prudential standards for covered companies required under
section 165 of the Dodd-Frank Act must include enhanced risk-based
capital and leverage requirements, enhanced liquidity requirements,
enhanced risk management and risk committee requirements, a requirement
to submit a resolution plan, single-counterparty credit limits, stress
tests, and a debt-to-equity limit for covered companies that the
Council has determined pose a grave threat to financial stability. In
general, the Act directs the Board to implement enhanced prudential
standards that strengthen existing micro-prudential supervision \7\ and
regulation of individual companies and incorporate macro-prudential
considerations so as to reduce threats posed by covered companies to
the stability of the financial system as a whole. Section 166 of the
Act requires the Board to establish a regulatory framework for the
early remediation of financial weaknesses of covered companies in order
to minimize the probability that such companies will become insolvent
and the potential harm of such insolvencies to the financial stability
of the United States.\8\
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\7\ Micro-prudential supervision focuses on surveillance of the
safety and soundness of individual companies, whereas macro-
prudential supervision focuses on the surveillance of systemic risk
posed by individual companies and systemic risks posed by
interconnectedness among companies.
\8\ See 12 U.S.C. 5366(b).
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In addition to the required standards, the Act authorizes but does
not require the Board to establish additional enhanced standards for
covered companies relating to (i) contingent capital; (ii) public
disclosures; (iii) short-term debt limits; and (iv) such other
prudential standards as the Board
[[Page 596]]
determines appropriate.\9\ The Board is not proposing any of these
supplemental standards at this time but continues to consider whether
adopting any of these standards would be appropriate.
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\9\ See 12 U.S.C. 5365(b)(1)(B).
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The Act requires the enhanced standards established by the Board
for covered companies under section 165 to be more stringent than those
standards applicable to other bank holding companies and nonbank
financial companies that do not present similar risks to U.S. financial
stability.\10\ Section 165 also requires that the enhanced standards
established pursuant to that section increase in stringency based on
the systemic footprint and risk characteristics of individual covered
companies.\11\
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\10\ See 12 U.S.C. 5365(a)(1)(A).
\11\ See 12 U.S.C. 5365(a)(1)(B). Under section 165(a)(1)(B),
the enhanced standards must increase in stringency, based on the
considerations listed in section 165(b)(3). These considerations are
summarized in note 13, infra.
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In prescribing prudential standards under section 165(b)(1) \12\ to
covered companies, the Board is required to take into account
differences among bank holding companies covered by the rule and
nonbank financial companies supervised by the Board, based on certain
considerations.\13\ The Board also has authority under section 165 to
tailor the application of the standards, including differentiating
among covered companies on an individual basis or by category.\14\ When
differentiating among companies for purposes of applying the standards
established under section 165, the Board may consider the companies'
size, capital structure, riskiness, complexity, financial activities,
and any other risk-related factor the Board deems appropriate.
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\12\ 12 U.S.C. 5365(b)(1). The Board is separately required to
issue regulations to implement the risk committee and stress test
enhanced standards pursuant to sections 165(h) and 165(i),
respectively.
\13\ See 12 U.S.C. 5365(b)(3). The factors the Board must
consider include--(i) The factors described in sections 113(a) and
(b) of the Dodd-Frank Act (12 U.S.C. 5313(a) and (b)); (ii) whether
the company owns an insured depository institution; (iii)
nonfinancial activities and affiliations of the company; and (iv)
any other risk-related factors that the Board determines
appropriate. 12 U.S.C. 5365(b)(3)(A). The Board must, as
appropriate, adapt the required standards in light of any
predominant line business of a nonbank financial company for which
particular standards may not be appropriate. 12 U.S.C.
5365(b)(3)(D). Section 165(b)(3) also requires the Board, to the
extent possible, to ensure that small changes in the factors listed
in sections 113(a) and 113(b) of the Dodd-Frank Act would not result
in sharp, discontinuous changes in the prudential standards
established by the Board under section 165(b)(1). 12 U.S.C.
5365(b)(3)(B). The statute also directs the Board to take into
account any recommendations made by the Council pursuant to its
authority under section 115 of the Dodd-Frank Act. 12 U.S.C.
5365(b)(3)(C).
\14\ See 12 U.S.C. 5365(a)(2)(A).
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II. Overview of the Proposal
The Board is requesting comment on proposed rules to implement
certain requirements of sections 165 and 166 of the Dodd-Frank Act.\15\
The Board consulted with the Council, including by providing periodic
updates to members of the Council and their staff on the development of
the proposed enhanced standards. The proposal reflects comments
provided to the Board as a part of this consultation process. The Board
also intends, before imposing prudential standards or any other
requirements pursuant to section 165 that are likely to have a
significant impact on a functionally regulated subsidiary or depository
institution subsidiary of a covered company, to consult with each
Council member that primarily supervises any such subsidiary.\16\
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\15\ 12 U.S.C. 5365 and 5366.
\16\ See 12 U.S.C. 5365(b)(4).
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This proposal includes rules to implement the requirements under
section 165 related to (i) risk-based capital and leverage; (ii)
liquidity; (iii) single-counterparty credit limits; (iv) overall risk
management and risk committees; (v) stress tests; and (vi) a debt-to-
equity limit for covered companies that the Council has determined pose
a grave threat to financial stability. The proposal also includes rules
to implement the early remediation requirements in section 166 of the
Act related to establishing measures of financial condition and
remediation requirements that increase in stringency as the financial
condition of a covered company declines.
Section 165(d) of the Act also establishes requirements that each
covered company submit periodically to the Board and Federal Deposit
Insurance Corporation (FDIC) a plan for rapid and orderly resolution
under the Bankruptcy Code in the event of its material financial
distress or failure, as well as a periodic report regarding credit
exposures between each covered company and other significant financial
companies. The Board and FDIC jointly issued a final rule to implement
the resolution plan requirement that became effective on November 30,
2011 and expect to implement periodic reporting of credit exposures at
a later date.\17\
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\17\ See 76 FR 67323 (November 1, 2011). In response to
significant concerns expressed by commenters about the clarity of
key definitions and the scope of the reporting requirement of the
proposed credit exposure reporting requirement, the Board and FDIC
postponed finalizing the credit exposure reporting requirement. The
Board believes that robust reporting of a covered company's credit
exposures to other significant bank holding companies and financial
companies is critical to ongoing risk management by covered
companies, as well as to the Board's ongoing supervision of covered
companies and financial stability responsibilities, and the FDIC's
responsibility to resolve failed covered companies. However, the
agencies also recognize that these reports would be most useful and
complete if developed in conjunction with the Dodd-Frank Act's
single counterparty credit exposure limits. See 12 U.S.C. 5365(e).
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By setting forth comprehensive enhanced prudential standards and an
early remediation framework for covered companies, the proposal would
create an integrated set of requirements that seeks to meaningfully
reduce the probability of failure of systemically important companies
and minimize damage to the financial system and the broader economy in
the event such a company fails. The proposed rules, which increase in
stringency with the level of systemic risk posed by and the risk
characteristics of the covered company, would provide incentives for
covered companies to reduce their systemic footprint and encourage
covered companies to consider the external costs that their failure or
distress would impose on the broader financial system, thus helping to
offset any implicit subsidy they may have enjoyed as a result of market
perceptions of implicit government support.
This proposal provides a core set of concrete rules to complement
the Federal Reserve's existing efforts to enhance the supervisory
framework for covered companies. The Federal Reserve, since before the
passage of the Dodd-Frank Act, has been taking steps to strengthen its
supervision of the largest, most complex banking companies. For
example, the Federal Reserve created a centralized multidisciplinary
body called the Large Institution Supervision Coordinating Committee
(LISCC) to oversee the supervision of these companies. This committee
uses horizontal, or cross-company, evaluations to monitor
interconnectedness and common practices among companies that could lead
to greater systemic risk. The committee also uses additional and
improved quantitative methods for evaluating the financial condition of
companies and the risks they might pose to each other and to the
broader financial system.
A. Scope of Application
The Dodd-Frank Act requires the Board to apply enhanced standards
established under section 165(b)(1) and early remediation requirements
under
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section 166 of the Dodd-Frank Act to covered companies. As noted above,
covered companies are described in the Act as bank holding companies
with total consolidated assets of $50 billion or more (which would
include any foreign banking organization that has banking operations in
the United States and that has global consolidated assets of $50
billion or more) and nonbank financial companies the Council has
designated for supervision by the Board. The proposal incorporates this
definition but, for reasons described below, at this time only covers
U.S. bank holding companies and nonbank financial companies the Council
has designated.
Under section 165(i)(2), the requirements to conduct annual stress
tests apply to any financial company with more than $10 billion in
total consolidated assets and that is regulated by a primary federal
financial regulatory agency.\18\ The Board, as the primary Federal
financial regulatory agency for bank holding companies, savings and
loan holding companies, and state member banks, proposes to apply the
annual company-run stress test requirements to any bank holding
company, savings and loan holding company,\19\ and state member bank
with more than $10 billion in total consolidated assets. Moreover, the
requirement to establish a risk committee under section 165(h) of the
Act applies to any publicly traded bank holding company with $10
billion or more in total consolidated assets.\20\
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\18\ 12 U.S.C. 5365(i)(2). The Dodd-Frank Act defines primary
financial regulatory agency in section 2 of the Act. See 12 U.S.C.
5301(12). The Board, Office of the Comptroller of the Currency, and
Federal Deposit Insurance Corporation have consulted on rules
implementing section 165(i)(2).
\19\ As discussed below, the Board proposes to delay the
effective date of the portion of the proposal implementing section
165(i)(2) for savings and loan holding companies until such time as
the Board has implemented consolidated capital rules for savings and
loan holding companies.
\20\ 12 U.S.C. 5365(h).
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For purposes of the definition of a covered company, a bank holding
company is deemed to have met the $50 billion asset criterion based on
the average of the company's total consolidated assets as reported on
its four most recent quarterly reports to the Board, i.e., the
Consolidated Financial Statements for Bank Holding Companies (Federal
Reserve Form FR Y-9C).\21\ This calculation will be effective as of the
due date of the bank holding company's most recent FR Y-9C.\22\ Under
the proposal, a bank holding company that becomes a covered company
would remain a covered company until its total consolidated assets, as
reported to the Board on a quarterly basis on the FR Y-9C, fall and
remain below $50 billion for four consecutive quarters.
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\21\ With respect to a company that has been a bank holding
company for less than four quarters, the Board would refer to the
company's financial statements from quarters preceding the time that
it began reporting on the FR Y-9C. For example, if a bank holding
company had been reporting on the FR Y-9C for only one quarter, the
Board would refer to its GAAP financial statements for the prior
three quarters for purposes of calculating its average total
consolidated assets.
\22\ For purposes of subpart E of the proposed rule, the same
calculation approach would be applied to any bank holding company in
determining when it becomes an over $10 billion bank holding
company. For purposes of subpart G of the proposed rule, the same
calculation approach would be applied to any bank holding company,
savings and loan holding company, or state member bank in
determining when it becomes an over $10 billion company.
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This proposal would apply the same set of enhanced prudential
standards to covered companies that are bank holding companies and
covered companies that are nonbank financial companies. As noted above,
however, in applying the enhanced prudential standards to covered
companies, the Board may determine, on its own or in response to a
recommendation by the Council, to tailor the application of the
enhanced standards to different companies on an individual basis or by
category, taking into consideration their capital structure, riskiness,
complexity, financial activities, size, and any other risk-related
factors that the Board deems appropriate.\23\
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\23\ 12 U.S.C. 5365(a)(2).
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The Board notes that this authority will be particularly important
in applying the enhanced standards to specific nonbank financial
companies designated by the Council that are organized and operated
differently from banking organizations.\24\ Under the Act,\25\ the
Council generally may determine that a nonbank financial company, i.e.,
a company predominantly engaged in financial activities, should be
subject to supervision by the Board and the enhanced standards
established pursuant to section 165 and the early remediation
requirements established pursuant to section 166, if material financial
distress at such company, or the nature, scope, size, scale,
concentration, interconnectedness, or mix of the activities of the
nonbank financial company, could pose a threat to the financial
stability of the United States. As such, the types of business models,
capital structures, and risk profiles of companies that would be
subject to designation by the Council could vary significantly.
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\24\ To date, the Council has not designated any nonbank
financial company for supervision by the Board.
\25\ See 12 U.S.C. 5315. See also 76 FR 64264 (Oct. 18, 2011)
(proposing to implement the Council's authority under section 113 of
the Dodd-Frank).
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While this proposal was largely developed with large, complex bank
holding companies in mind, some of the standards nonetheless provide
sufficient flexibility to be readily implemented by covered companies
that are not bank holding companies. In prescribing prudential
standards under section 165(b)(1), the Board would to take into account
differences among bank holding companies and nonbank financial
companies supervised by the Board.\26\ Following designation of a
nonbank financial company by the Council, the Board would thoroughly
assess the business model, capital structure, and risk profile of the
designated company to determine how the proposed enhanced prudential
standards and early remediation requirements should apply. The Board
may, by order or regulation, tailor the application of the enhanced
standards to designated nonbank financial companies on an individual
basis or by category, as appropriate.\27\
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\26\ See 12 U.S.C. 5365(b)(3). The factors the Board must take
into consideration in prescribing the enhanced standards under
section 165(b)(1) are described above. See supra note 13. Under
section 171 of the Dodd-Frank Act, the Board is required to impose
the same minimum risk-based and leverage capital requirements on
bank holding companies and nonbank covered company as it imposes on
insured depository institutions. 12 U.S.C. 5371.
\27\ Following designation of nonbank financial companies by the
FSOC, the Board also would consider the appropriate risk-based
capital treatment of asset types with no explicit treatment under
the current risk-based capital rules. See generally 76 FR 37620
(June 28, 2011).
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The Board solicits comment on alternative approaches for applying
the enhanced prudential standards and the early remediation
requirements the Dodd-Frank Act requires to nonbank covered companies.
Question 1: What additional characteristics of a nonbank covered
company--in addition to its business model, capital structure, and risk
profile--should the Board consider when determining how to apply the
enhanced standards and the early remediation requirements to such a
company?
Question 2: What are the potential unintended consequences and
burdens associated with subjecting a nonbank covered company to the
enhanced prudential standards and the early remediation requirements?
The current proposal would apply only to U.S.-based bank holding
companies that are covered companies and to nonbank covered companies,
and would not apply to foreign banking
[[Page 598]]
organizations. As discussed above, however, foreign banking
organizations that have U.S. banking operations (whether a U.S. branch,
a U.S. agency, or a U.S. subsidiary bank holding company or bank) and
have global total consolidated assets \28\ of $50 billion or more are
subject to sections 165 and 166 of the Dodd-Frank Act. Section 165
instructs the Board, in applying the enhanced prudential standards of
section 165 to foreign financial companies, to give due regard to the
principle of national treatment and equality of competitive
opportunity, and to take into account the extent to which the foreign
company is subject, on a consolidated basis, to home country standards
that are comparable to those applied to financial companies in the
United States.
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\28\ For a foreign banking organization subject to section 165
of the Dodd-Frank Act, total consolidated assets would be based on
the foreign banking organization's Capital and Asset Reports for
Foreign Banking Organizations (Federal Reserve Form FR Y-7Q).
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Determining how to apply the enhanced prudential standards and
early remediation framework established by the Dodd-Frank Act to
foreign banking organizations in a manner consistent with the purposes
of the statute and the Board's existing framework of supervising
foreign banking organizations is difficult. The scope of enhanced
prudential standards required under sections 165 and 166 extends beyond
the set of prudential standards that are part of existing international
agreements, and foreign banking organizations are subject to home
country regulatory and supervisory regimes that employ a wide variety
of approaches to prudential regulation. Further, foreign banking
organizations operate in the United States through diverse structures,
complicating the consistent application of the enhanced standards to
the U.S. operations of a foreign banking organization. Finally, the
risk posed to U.S. financial stability by foreign banking organizations
that are subject to sections 165 and 166 varies widely. The Board is
actively developing a proposed framework for applying the Act's
enhanced prudential standards and early remediation requirement to
foreign banking organizations, and expects to issue this framework for
public comment shortly.
While sections 165 and 166 generally do not apply to savings and
loan holding companies, section 165(i)(2) requires the Board to issue
regulations pursuant to which any financial company for which the Board
is the primary federal financial regulatory agency and that has more
than $10 billion in total consolidated assets must conduct an annual
stress test.\29\ Thus, the proposal would apply annual company-run
stress test requirements to any savings and loan holding company with
more than $10 billion in consolidated assets. However, because the
annual stress test requirement, as proposed, is predicated on a company
being subject to consolidated capital requirements, this proposal would
delay the effective date of the company-run stress test requirements
for savings and loan holding companies until the Board has established
risk-based capital requirements for savings and loan holding companies.
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\29\ Among entities covered by this part of the Dodd-Frank are
state member banks, bank holding companies, and savings and loan
holding companies with total consolidated assets of $10 billion or
more.
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While the remaining parts of section 165 and section 166 do not
specifically apply to savings and loan holding companies, the Board, as
the primary supervisor of savings and loan holding companies, has the
authority under the Home Owners' Loan Act to apply the enhanced
standards to savings and loan holding companies to ensure their safety
and soundness.\30\ The Board intends to issue a separate proposal for
notice and comment to initially apply the enhanced standards and early
remediation requirements to all savings and loan holding companies with
substantial banking activities--i.e., any savings and loan holding
company that (i) has total consolidated assets of $50 billion or more;
and (ii)(A) has savings association subsidiaries which comprise 25
percent or more of such savings and loan holding company's total
consolidated assets, or (B) controls one or more savings associations
with total consolidated assets of $50 billion or more. The Board
believes that applying the enhanced prudential standards of this
proposal to savings and loan holding companies that satisfy these
criteria is an important aspect of ensuring their safety and soundness.
The Board also may determine to apply the enhanced standards to any
savings and loan holding company, if appropriate to ensure the safety
and soundness of such company, on a case-by-case basis.
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\30\ See 12 U.S.C. 1467a(g) (authorizing the Board to issue such
regulations and orders as the Board deems necessary or appropriate
to administer and carry out the purposes of section 10 of the Home
Owners' Loan Act).
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As is the case with stress testing, many of the other enhanced
standards are predicated on a covered company being subject to
consolidated capital requirements. Therefore, similar to the approach
with respect to applying the annual company-run stress test requirement
to savings and loan holding companies, the Board intends to impose
enhanced prudential standards and early remediation requirements on
savings and loan holding companies with substantial banking activities
once the Board has established risk-based capital requirements for
savings and loan holding companies.
Question 3: The Board seeks comment on its proposed approach to the
application of the company-run stress test requirements, including the
delayed effective date, to savings and loan holding companies. Also,
what additional or alternative criteria should the Board consider for
determining which savings and loan holding companies initially would be
subject to the enhanced prudential standards and early remediation
requirements?
B. Risk-Based Capital Requirements and Leverage Limits
The recent financial crisis exposed significant weaknesses in the
regulatory capital requirements for large banking companies. The amount
of capital held by many large, complex banking companies proved to be
inadequate to cover the risks that had accumulated in the companies.
For certain exposure types, such as trading positions, OTC derivatives,
and securitization and re-securitization exposures, it became evident
that capital requirements did not adequately cover the risk of loss
from those activities. In addition, it became apparent that some of the
instruments that qualified as tier 1 capital for banking companies, the
core measure of capital adequacy, were not truly loss absorbing.
Section 165(b)(1)(A)(i) of the Act directs the Board to establish
enhanced risk-based capital and leverage standards for covered
companies to address these weaknesses. The Board plans to meet this
statutory requirement with a two-part effort. Under this proposal, the
Board would subject all covered companies to the Board's capital plan
rule, which currently requires all bank holding companies with $50
billion or more in consolidated assets to submit an annual capital plan
to the Board for review (capital plan rule).\31\ Under the capital plan
rule, covered companies would have to demonstrate to the Board that
they have robust, forward-looking capital planning processes that
account for their unique risks and that permit continued operations
during times of economic
[[Page 599]]
and financial stress. The supervisory and company-run stress tests that
are part of this proposal and discussed in detail below are important
aspects of this forward-looking process.\32\ The Board expects that a
covered company will integrate into its capital plan, as one part of
the underlying analysis, the results of the company-run stress tests
conducted in accordance with section 165(i)(2) of the Dodd-Frank Act
and the Board's proposed implementing rules. The results of those
stress tests, as well as the annual supervisory stress test conducted
by the Board under section 165(i)(1) of the Dodd-Frank, will be
considered in the evaluation of a covered company's capital plan.
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\31\ 12 CFR 225.8.
\32\ In June 2011, the Board, along with the OCC and FDIC,
issued for comment proposed supervisory guidance on stress testing
for banking organizations with more than $10 billion in total
assets. 76 FR 35072 (June 15, 2011). That proposed guidance contains
principles for an effective stress testing framework that would
cover an organization's various stress testing activities, including
capital and liquidity stress testing. The agencies issued the
proposed guidance for comment separately from this proposal because
the proposed guidance is intended to apply broadly to organizations'
use of stress testing in overall risk management, not just to
capital and liquidity stress testing, as is the case for the
requirements of this proposed rule. The agencies are considering
comments on the proposed guidance and expect to issue a final
version shortly. The Board expects that companies would follow the
principles set forth in the final stress testing guidance--as well
as with other relevant supervisory guidance--when conducting capital
and liquidity stress testing in accordance with requirements in this
proposed rule.
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Under the capital plan rule, covered companies would be required to
demonstrate to the Board their ability to maintain capital above
existing minimum regulatory capital ratios and above a tier 1 common
ratio of 5 percent under both expected and stressed conditions over a
minimum nine-quarter planning horizon.\33\ Covered companies with
unsatisfactory capital plans would face limits on their ability to make
capital distributions.
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\33\ Under the capital plan rule, tier 1 common is defined as
tier 1 capital less non-common elements in tier 1 capital, including
perpetual preferred stock and related surplus, minority interest in
subsidiaries, trust preferred securities and mandatory convertible
preferred securities. Specifically, non-common elements include the
following items captured in the FR Y-9C reporting form: Schedule HC,
line item 23 net of Schedule HC-R, line item 5; and Schedule HC-R,
line items 6a, 6b, and 6c.
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The Board intends to supplement the enhanced risk-based capital and
leverage requirements included in this proposal with a subsequent
proposal to implement a quantitative risk-based capital surcharge for
covered companies or a subset of covered companies. Over the past few
years, the Federal Reserve and other U.S. federal banking agencies have
worked together with other members of the Basel Committee on Banking
Supervision (BCBS) to strengthen the regulatory capital regime for
internationally active banks and develop a framework for a risk-based
capital surcharge for the world's largest, most interconnected banking
companies. The new regime for internationally active banks, known as
Basel III,\34\ materially improves the quality of regulatory capital
and introduces a new minimum common equity requirement. Basel III also
raises the numerical minimum capital requirements and introduces
capital conservation and countercyclical buffers to induce banking
organizations to hold capital in excess of regulatory minimums. In
addition, Basel III establishes for the first time an international
leverage standard for internationally active banks. The Board is
working with the other U.S. banking regulators to implement the Basel
III capital reforms in the United States.
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\34\ See Basel Committee on Banking Supervision, Basel III: A
global regulatory framework for more resilient banks and banking
systems (revised June 2011), available at http://www.bis.org/publ/bcbs189.htm (hereinafter Basel III framework). See also Basel
Committee on Banking Supervision, Basel III: International framework
for liquidity risk measurement, standards and monitoring (December
2010), available at www.bis.org/publ/bcbs188.htm (hereinafter Basel
III liquidity framework); Enhancements to the Basel II framework
(July 2009), available at www.bis.org/publ/bcbs157.htm; and
Revisions to the Basel II market risk framework (July 2009),
available at www.bis.org/publ/bcbs158.htm.
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Building on the Basel III reforms, the BCBS published a document in
November 2011 entitled Global systemically important banks: Assessment
methodology and the additional loss absorbency requirement (BCBS
framework), which set forth an additional capital requirement for
global systemically important banks (G-SIBs).\35\
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\35\ See Basel Committee on Banking Supervision, Global
systemically important banks: Assessment methodology and the
additional loss absorbency requirement (November 2011), available at
http://www.bis.org/publ/bcbs207.htm (hereinafter BCBS capital
surcharge framework).
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The Basel III and BCBS frameworks, once implemented in the United
States, are expected to significantly enhance risk-based capital and
constrain the leverage of covered companies and will be a key part of
the Board's overall approach to enhancing the risk-based capital and
leverage standards applicable to these companies in accordance with
section 165 of the Dodd-Frank Act. The Board intends to propose a
quantitative risk-based capital surcharge in the United States based on
the BCBS approach consistent with the BCBS's implementation timeframe.
The forthcoming proposal would contemplate adopting implementing rules
in 2014, and requiring G-SIBs to meet the capital surcharges on a
phased-in basis from 2016-2019.
C. Liquidity Requirements
The financial crisis revealed significant weaknesses in liquidity
buffers and liquidity risk management practices throughout the
financial system that directly contributed to the failure or near
failure of many companies and exacerbated the crisis. Section
165(b)(1)(A)(ii) addresses inadequacies in the existing regulatory
liquidity requirements by directing the Board to establish liquidity
standards for covered companies. Similar to enhanced risk-based capital
and leverage requirements, the Federal Reserve intends to implement
this statutory requirement through a multi-stage approach.
This proposal would subject covered companies to a set of enhanced
liquidity risk management standards, including liquidity stress
testing.\36\ The proposal builds on guidance previously adopted by the
Board and other U.S. federal banking agencies and proposes higher
liquidity risk management standards for covered companies.\37\
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\36\ See supra note 32.
\37\ Supervision and Regulation Letter SR 10-6, Interagency
Policy Statement on Funding and Liquidity Risk Management (March 17,
2010), available at http://www.federalreserve.gov/boarddocs/srletters/2010/sr1006.pdf; 75 FR 13656 (March 22, 2010). The Board,
the Office of the Comptroller of the Currency (OCC), the FDIC, the
Office of Thrift Supervision, the National Credit Union
Administration, and the Conference of State Bank Supervisors jointly
issued the Interagency Liquidity Risk Policy Statement. The
Interagency Liquidity Risk Policy Statement incorporates principles
of sound liquidity risk management that the agencies have issued in
the past, and supplements them with the principles of sound
liquidity risk management established by the Basel Committee on Bank
Supervision (Basel Committee) in its document entitled ``Principles
for Sound Liquidity Management and Supervision.'' Principles for
Sound Liquidity Risk Management and Supervision (September 2008),
available at https://ww.bis.org/publ/bcbs144.htm.
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The proposal would require covered companies to conduct internal
stress tests at least monthly to measure their liquidity needs at 30-
day, 90-day and one-year intervals during times of instability in the
financial markets and to hold liquid assets that would be sufficient to
cover 30-day stressed net cash outflows under their internal stress
scenarios. Covered companies also would be required to meet specified
corporate governance requirements around liquidity risk management, to
project cash flow needs over various time horizons, to establish
internal limits on certain liquidity metrics, and
[[Page 600]]
to maintain a contingency funding plan (CFP) that identifies potential
sources of liquidity strain and alternative sources of funding when
usual sources of liquidity are unavailable.
In addition to the enhanced liquidity risk management standards
included in this proposal, the Federal Reserve and other U.S. federal
banking agencies have been working with the BCBS over the past few
years to develop quantitative liquidity requirements to increase the
capacity of internationally active banking firms to absorb shocks to
funding relative to the liquidity risks they face. The BCBS approved
two new liquidity rules as part of the Basel III reforms in December
2010. The first rule is a Liquidity Coverage Ratio (LCR), which would
require banks to hold an amount of high-quality liquid assets
sufficient to meet expected net cash outflows over a 30-day time
horizon under a supervisory stress scenario. The second rule is the Net
Stable Funding Ratio (NSFR), which would require banks to enhance their
liquidity risk resiliency out to one year. Under the terms of Basel
III, global banks are required to comply with the LCR by 2015 and with
the NSFR by 2018.
The Basel III liquidity rules are currently in an international
observation period as the U.S. federal banking agencies and other BCBS
members assess the potential impact of the rules on banks and various
financial markets. The Board intends, in conjunction with other federal
banking agencies, to implement these standards in the United States
through one or more separate rulemakings. Through implementation of
these standards in the United States, the Board anticipates that the
Basel III liquidity rules would then become a central component of the
enhanced liquidity requirements for covered companies, or a subset of
covered companies, under section 165 of the Dodd-Frank Act.
D. Single-Counterparty Credit Limits
As demonstrated in the crisis, interconnectivity among major
financial companies poses risks to financial stability. The effects of
one large financial company's failure or near collapse may be
transmitted and amplified by the bilateral credit exposures between
large, systemically important companies. The financial crisis also
revealed inadequacies in the structure of the U.S. regulatory framework
for single-counterparty credit limits. Although banks were subject to
single-borrower lending and investment limits, these limits did not
apply to bank holding companies on a consolidated basis and did not
adequately cover credit exposures generated by derivatives and some
securities financing transactions.\38\
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\38\ Section 610 of the Dodd-Frank Act amends the term ``loans
and extensions of credit'' for purposes of the lending limits
applicable to national banks to include any credit exposure arising
from a derivative transaction, repurchase agreement, reverse
repurchase agreement, securities lending transaction, or securities
borrowing transaction. See Dodd-Frank Act, Public Law 111-203, Sec.
610, 124 Stat. 1376, 1611 (2010). As discussed in more detail below,
these types of transactions are also all made subject to the single
counterparty credit limits of section 165(e). 12 U.S.C. 5365(e)(3).
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In an effort to address concentration risk among large financial
institutions, section 165(e) of the Dodd-Frank Act directs the Board to
establish single-counterparty credit limits for covered companies in
order to limit the risks that the failure of any individual company
could pose to a covered company.\39\ This section directs the Board to
prescribe regulations that prohibit covered companies from having
credit exposure to any unaffiliated company that exceeds 25 percent of
the capital stock and surplus of the covered company.\40\ This section
also authorizes the Board to lower the 25 percent threshold if
necessary to mitigate risks to the financial stability of the United
States.\41\
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\39\ See 12 U.S.C. 5365(e)(1).
\40\ 12 U.S.C. 5365(e)(2).
\41\ See id.
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Credit exposure to a company is defined broadly in section 165(e)
of the Act to cover all extensions of credit to the company; all
repurchase and reverse repurchase agreements, and securities borrowing
and lending transactions, with the company; all guarantees and letters
of credit issued on behalf of the company; all investments in
securities issued by the company; counterparty credit exposure to the
company in connection with derivative transactions; and any other
similar transaction that the Board determines to be a credit exposure
for purposes of section 165(e).\42\ Section 165(e) also grants
authority to the Board to exempt transactions from the definition of
the term ``credit exposure'' if the Board finds that the exemption is
in the public interest and consistent with the purposes of the
subsection.\43\
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\42\ See 12 U.S.C. 5365(e)(3).
\43\ See 12 U.S.C. 5365(e)(5)-(6).
---------------------------------------------------------------------------
The proposal implements these statutory provisions by defining key
terms, such as covered company, unaffiliated counterparty, and capital
stock and surplus. The proposal also targets the mutual
interconnectedness of the largest financial companies by setting a
stricter 10 percent limit for credit exposure between a covered company
and a counterparty that each either have more than $500 billion in
total consolidated assets or are a nonbank covered company. In
addition, the proposal provides rules for measuring the amount of
credit exposure generated by the various types of credit transactions.
Notably, the proposal would allow covered companies to reduce their
credit exposure to a counterparty for purposes of the limit by
obtaining credit risk mitigants such as collateral, guarantees, and
credit derivative hedges. The proposal describes the types of
collateral, guarantees and derivative hedges that are eligible under
the rule and provides valuation rules for reflecting such credit risk
mitigants.
E. Risk Management and Risk Committee Requirements
Sound, enterprise-wide risk management by covered companies reduces
the likelihood of their material distress or failure and thus promotes
financial stability. In addition to adopting enhanced risk management
standards for covered companies, the Board is directed by section
165(h) to require publicly traded covered companies and publicly traded
bank holding companies with $10 billion or more in total consolidated
assets to establish a risk committee of the board of directors that is
responsible for oversight of enterprise-wide risk management, is
comprised of an appropriate number of independent directors, and
includes at least one risk management expert.
The proposal would require all covered companies to implement
robust enterprise-wide risk management practices that are overseen by a
risk committee of the board of directors and chief risk officer with
appropriate levels of independence, expertise and stature. The proposal
also would require any publicly traded bank holding company with $10
billion or more in total consolidated assets and that is not a covered
company to establish a risk committee.
F. Stress Testing Requirements
The crisis also revealed weaknesses in the stress testing practices
of large banking organizations, as well as gaps in the regulatory
community's approach to assessing capital adequacy. During the height
of the crisis, the Federal Reserve began stress testing the capital
adequacy of large, complex bank holding companies as a forward-looking
exercise designed to estimate losses, revenues, regulatory capital
ratios, and reserve needs under various macroeconomic
[[Page 601]]
scenarios.\44\ By looking at the broad needs of the financial system
and the specific needs of individual companies, these stress tests
provided valuable information to market participants and had an overall
stabilizing effect.
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\44\ In early 2009, the Federal Reserve led the Supervisory
Capital Assessment Program (SCAP) as a key element of the plan to
stabilize the U.S. financial system. Building on SCAP and other
supervisory work coming out of the crisis, the Federal Reserve
initiated the Comprehensive Capital Analysis and Review (CCAR) in
late 2010 to evaluate the internal capital planning processes of
large, complex bank holding companies. The CCAR represented a
substantial strengthening of previous approaches to ensuring that
large firms have thorough and robust processes for managing and
allocating their capital resources. The CCAR also focused on the
risk measurement and management practices supporting firms' capital
adequacy assessments, including their ability to deliver credible
inputs to their loss estimation techniques.
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Section 165(i)(1) directs the Board to implement rules requiring
the Federal Reserve, in coordination with the appropriate primary
Federal regulatory agencies and the Federal Insurance Office, to
conduct an annual evaluation of whether each covered company has
sufficient capital to absorb losses as a result of adverse economic
conditions (supervisory stress tests). The Board is also required to
publish a summary of the results of the supervisory stress tests. In
addition, section 165(i)(2) directs the Board to implement rules
requiring each covered company to conduct its own semi-annual stress
tests and any state member bank, bank holding company or savings and
loan holding company with more than $10 billion in total consolidated
assets (that is not a covered company) to conduct its own annual stress
tests (company-run stress tests). Companies must also publish a summary
of the results of the company-run stress tests.
The proposal would implement these statutory provisions by
requiring the Federal Reserve to conduct annual supervisory stress
tests of covered companies under baseline, adverse, and severely
adverse scenarios and by requiring companies that are subject to
company-run stress test requirements to conduct their own capital
adequacy stress tests on an annual or semi-annual basis, as applicable.
Under the proposal, the Board would publicly disclose information on
the company-specific results of the supervisory stress tests.
G. Debt-to-Equity Limits for Certain Covered Companies
Section 165(j) of the Dodd-Frank Act provides that the Board must
require a covered company to maintain a debt-to-equity ratio of no more
than 15-to-1, upon a determination by the Council that (i) such company
poses a grave threat to the financial stability of the United States
and (ii) the imposition of such a requirement is necessary to mitigate
the risk that the company poses to U.S. financial stability. The
proposal establishes procedures to notify a covered company that the
Council has made a determination under section 165(j) that the company
must comply with the 15-to-1 debt-to-equity ratio requirement, defines
``debt'' and ``equity'' for purposes of calculating compliance with the
ratio, and provides an affected company with a transition period to
come into compliance with the ratio.
H. Early Remediation Framework
The financial crisis revealed that the condition of large banking
organizations can deteriorate rapidly even during periods when their
reported regulatory capital ratios are well above minimum requirements.
The crisis also revealed that financial companies that addressed
incipient financial problems swiftly and decisively performed much
better than companies that delayed remediation work.
Section 166 of the Dodd-Frank Act directs the Board to prescribe
regulations to provide for the early remediation of financial distress
at covered companies so as to minimize the probability that the company
will become insolvent and to reduce the potential harm of the
insolvency of a covered company to the financial stability of the
United States. The regulation must use measures of the financial
condition of a covered company, including regulatory capital ratios,
liquidity measures, and other forward-looking indicators as triggers
for remediation actions. Remediation requirements must increase in
stringency as the financial condition of a covered company
deteriorates. Remedies must include, in the initial stages of financial
decline of the covered company, limits on capital distributions,
acquisitions, and asset growth. Remedies in the later stages of
financial decline of the covered company must include a capital
restoration plan and capital-raising requirements, limits on
transactions with affiliates, management changes, and asset sales.
The proposed rule implementing section 166 establishes a regime for
the early remediation of financial distress at covered companies that
includes several forward-looking triggers designed to identify emerging
or potential issues before they develop into larger problems. In
addition to regulatory capital triggers, the proposed rule includes
triggers based on supervisory stress test results, market indicators
and weaknesses in enterprise-wide and liquidity risk management. The
proposed rule also describes the regulatory restrictions that a covered
company must comply with in each remedial stage.
I. Transition Arrangements and Ongoing Compliance
Another important aspect of the proposal is the timing of initial
compliance and ongoing reporting to the Board in conjunction with the
proposed enhanced standards. In order to reduce the burden on covered
companies of coming into initial compliance with the standards, the
Board is proposing to provide meaningful phase-in periods. In general,
a company that is a covered company on the effective date of the final
rule would be subject to the enhanced prudential standards beginning on
the first day of the fifth quarter following the effective date of the
final rule. A company that becomes a covered company after the
effective date of the final rule generally would become subject to the
enhanced standards beginning on the first day of the fifth quarter
following the date that it became a covered company. For a variety of
reasons, the proposed rule provides different transition arrangements
for enhanced risk-based capital and leverage requirements, single-
counterparty credit limits and stress testing requirements. Transition
arrangements for these standards are discussed in the relevant sections
of the preamble below.
To reduce the burden of ongoing compliance with the enhanced
standards, the Board is also proposing to sequence the timing of
required submissions. For example, the requirement that covered
companies conduct stress tests is specifically timed to coordinate with
the reporting requirements associated with the capital plan, and the
capital plan and stress test requirements are specifically timed to
minimize overlap with resolution plan update requirements.\45\
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\45\ See 12 CFR 243.3.
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Question 4: Are there alternative approaches the Board should
consider to phase in the proposed enhanced prudential standards for
either bank holding companies or nonbank financial companies?
J. Reservation of Authority
To address situations where compliance with the requirements of the
proposed rule would not sufficiently mitigate the risks to U.S.
financial
[[Page 602]]
stability posed by the failure or material financial distress of a
covered company, the proposed rule includes a reservation of authority
provision. This reservation of authority would permit the Board to
implement additional or further enhanced prudential standards for a
covered company, including, but not limited to, additional capital or
liquidity requirements, corporate governance standards, concentration
limits, stress testing requirements, activity limits, or other
requirements or restrictions that the Board may deem necessary to carry
out the purposes of the proposal or section 165 of the Dodd-Frank
Act.\46\ The proposed rule also specifies that the Board may determine
that a bank holding company that is not a covered company shall be
subject to one or more of the standards established under the proposed
rule if the Board determines that doing so is necessary or appropriate
to protect the safety and soundness of the company or to promote
financial stability.
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\46\ 12 U.S.C. 5365(b)(1)(B)(iv).
---------------------------------------------------------------------------
In addition, the proposed rule would specifically state that
nothing in the rule would limit the authority of the Board under any
other provision of law or regulation to take supervisory or enforcement
action, including action to address unsafe and unsound practices or
conditions, deficient capital or liquidity levels, or violations of
law.
K. Common Definitions
A number of terms are used throughout the proposed rule. Some of
these terms are generally given the same meaning as their definitions
under other regulations issued by the Board. For example, under the
proposal, the term ``company'' would be defined as a corporation,
partnership, limited liability company, depository institution,
business trust, special purpose entity, association, or similar
organization. The term ``bank holding company'' generally would have
the same meaning as in section 2 of the Bank Holding Company Act, as
amended (12 U.S.C. 1841), and the Board's Regulation Y (12 CFR part
225).\47\ Additional common definitions are detailed in the proposed
rule.
---------------------------------------------------------------------------
\47\ Control would have a different meaning under the proposed
rules concerning single-counterparty credit limits.
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The Board solicits comment on these proposed definitions.
III. Risk-Based Capital Requirements and Leverage Limits
A. Background
Section 165 of the Dodd-Frank Act directs the Board to establish
risk-based capital and leverage standards for covered companies that
are more stringent than the risk-based capital and leverage standards
applicable to nonbank financial companies and bank holding companies
that do not present similar risks to the financial stability of the
United States and increase in stringency based on the systemic
footprint of the company.
As discussed above, in addition to implementing the broader Basel
III capital reforms, the Board seeks to implement enhanced risk-based
capital and leverage standards for covered companies in a two-stage
process: (i) In this proposal, the application of the Board's capital
plan rule to covered companies, including the requirement for covered
companies to maintain capital above 5 percent tier 1 common risk-based
capital ratio under both expected and stressed conditions; and (ii) in
a separate future proposal, the introduction of a quantitative risk-
based capital surcharge for covered companies or a subset of covered
companies based on the BCBS capital surcharge framework for G-SIBs.
B. Overview of the Proposed Rule
1. Capital Planning and Minimum Capital Requirements
Under the proposal, all covered companies would be required to
comply with, and hold capital commensurate with, the requirements of
any regulations adopted by the Board relating to capital plans and
stress tests. Thus, in addition to the stress testing requirements that
are part of this proposal, this subpart would require all covered
companies to comply with the capital plan rule recently adopted by the
Board.\48\ In addition, the Board is proposing that nonbank covered
companies be subject to the same minimum risk-based and leverage
capital requirements that apply to covered companies that are bank
holding companies.
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\48\ 12 CFR 225.8. See 76 FR 74631 (December 1, 2011). The
capital plan rule currently applies to all U.S. bank holding
companies with $50 billion or more in total consolidated assets
(large bank holding companies).
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As discussed further below, the capital plan rule would enhance
minimum capital standards for covered companies in several dimensions,
including requiring firms to demonstrate capital adequacy over a
minimum nine-quarter planning horizon under both expected and stressed
conditions.\49\ The Board believes that the safety and soundness
rationale that underlies the capital plan rule's enhanced risk-based
capital and leverage standards for bank holding companies is also
applicable to nonbank covered companies, and that compliance with this
rule by such companies would help to promote their ongoing financial
stability. By requiring covered companies to have robust capital plans
and to hold capital commensurate with the risks they would face under
stressful financial conditions, and by limiting capital distributions
under certain circumstances, the proposed rule would reduce the
probability of the failure of a covered company.
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\49\ At present, the Board's rules for calculating minimum
capital requirements are found at 12 CFR part 225, appendix A
(general risk-based capital rule), 12 CFR part 225, appendix D
(leverage rule), 12 CFR part 225, appendix E (market risk rule), and
12 CFR part 225, appendix G (advanced approaches risk-based capital
rule). A firm that met the applicability thresholds under the market
risk rule or the advanced approaches risk-based capital rule would
be required to use those rules to calculate its minimum risk-based
capital requirements in addition to the general risk-based capital
requirements and the leverage rule.
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The current capital plan rule imposes enhanced risk-based and
leverage requirements on large bank holding companies in several ways.
The rule requires such companies to submit board-approved annual
capital plans to the Federal Reserve in which they demonstrate their
ability to maintain capital above the Board's minimum risk-based
capital ratios (total capital ratio of 8 percent, tier 1 capital ratio
of 4 percent) and tier 1 leverage ratio (4 percent) under both baseline
and stressed conditions over a minimum nine-quarter, forward-looking
planning horizon. Each such plan must include a discussion of the bank
holding company's sources and uses of capital reflecting the risk
profile of the firm over the planning horizon. In addition, these bank
holding companies must demonstrate the ability to maintain a minimum
tier 1 common risk-based capital ratio of 5 percent over the same
planning horizon (under both baseline and stressed conditions).\50\ The
stressed scenarios must include any scenarios provided by the Federal
Reserve (such as those discussed in section VII of this preamble) as
well as at least one stressed scenario developed by the bank holding
company appropriate to its business model. A capital plan must
[[Page 603]]
also include a description of all planned capital actions over the
planning horizon.
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\50\ Under the capital plan rule, tier 1 common is defined as
tier 1 capital less non-common elements in tier 1 capital, including
perpetual preferred stock and related surplus, minority interest in
subsidiaries, trust preferred securities and mandatory convertible
preferred securities. Specifically, non-common elements include the
following items captured in the FR Y-9C reporting form: Schedule HC,
line item 23 net of Schedule HC-R, line item 5; and Schedule HC-R,
line items 6a, 6b, and 6c.
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In its capital plan, a large bank holding company must provide a
detailed description of its process for assessing capital adequacy,
including a description of how it will, under stressful conditions,
maintain capital commensurate with its risks and continue its
operations by maintaining ready access to funding, meeting its
obligations to creditors and other counterparties, and continuing to
serve as a credit intermediary. A large bank holding company that is
unable to satisfy these requirements generally may not make any capital
distributions until it provides a satisfactory capital plan to the
Federal Reserve.\51\
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\51\ See section VII supra on the enhanced prudential
requirement that a covered company conduct certain stress tests for
explanation of the relation between this enhanced prudential capital
requirement and the stress test requirement under section 165.
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In addition, a large bank holding company must obtain prior
approval from the Federal Reserve before making a capital distribution
in certain circumstances where the Federal Reserve had provided a non-
objection to the large bank holding company's capital plan. The bank
holding company would be required to include certain information in the
request, which may include, among other things, an assessment of the
bank holding company's capital adequacy under a revised stress scenario
provided by the Federal Reserve, a revised capital plan, and supporting
data.
As stated above, a nonbank covered company would be subject to the
capital plan rule under this proposal. While a bank holding company
that becomes a covered company over time is subject to the requirements
of the capital plan rule as provided for in that rule,\52\ a nonbank
covered company would become subject to the requirements of the capital
plan rule in the calendar year that it was designated by the Council,
if the nonbank covered company was designated by the Council more than
180 days before September 30 of that calendar year.
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\52\ See generally 12 CFR 225.8(b). The final capital plan rule
provides that a bank holding company that becomes subject to the
final rule by operation of the asset threshold after the 5th of
January of a calendar year will not be subject until January 1 of
the next calendar year to the final rule's requirement to file a
capital plan with the Federal Reserve, resubmit a capital plan under
certain circumstances, or to obtain prior approval of capital
distributions in excess of those described in the firm's capital
plan. A bank holding company would be subject to all other
requirements under the capital plan rule immediately upon becoming
subject to that rule.
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In addition, 180 days following its designation by the Council, a
nonbank covered company would be subject to minimum risk-based capital
and leverage requirements. A nonbank covered company would be required
to calculate its minimum risk-based and leverage capital requirements
as if it were a bank holding company in accordance with any minimum
capital requirements established by the Board for bank holding
companies.\53\ Accordingly, the nonbank covered company would be
required to hold capital sufficient to meet (i) a tier 1 risk based
capital ratio of 4 percent and a total risk-based capital ratio of 8
percent, as calculated according to the Board's risk-based capital
rules,\54\ and (ii) a tier 1 leverage ratio of 4 percent as calculated
under the leverage rule.\55\ Finally, each nonbank covered company
would be required to report to the Board on a quarterly basis its risk-
based capital and leverage ratios. Upon ascertaining that it had failed
to meet any of its minimum risk-based or leverage requirements, a
nonbank covered company would be required to notify the Board
immediately.\56\
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\53\ See supra note 49.
\54\ 12 CFR part 225, appendix A and G.
\55\ 12 CFR part 225, appendix D, section II.
\56\ Under section 171 of the Dodd-Frank Act, the Board is
required to impose minimum risk-based and leverage capital
requirements on bank holding companies and nonbank covered companies
that are not less than the generally applicable capital requirements
it imposes on insured depository institutions. 12 U.S.C. 5371. The
Board recognizes that some aspects of its capital requirements may
not take into account the characteristics of activities and assets
of nonbank covered companies that are impermissible for banks and
bank holding companies. When a nonbank covered company is designated
by the Council, the Board may consider whether any adjustments to
the minimum capital requirements applicable to the nonbank covered
company may be appropriate, within the limits of section 171 of the
Dodd-Frank Act.
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Under the proposed rules' reservation of authority, the Board may
require any covered company to hold additional capital or be subject to
other requirements or restrictions if it determines that compliance
with the requirements of the proposal does not sufficiently mitigate
risks to U.S. financial stability posted by the failure or material
financial distress of the covered company.
The Board seeks comment on all aspects of the proposed enhanced
risk-based capital and leverage requirements.
In particular, the Board seeks comment on the appropriateness of
requiring nonbank covered companies to have the same capital planning
and stress testing, and regulatory capital requirements as bank holding
companies.
Question 5: What factors should the Board consider in deciding
whether to impose different capital planning or stress testing
requirements on nonbank covered companies?
Question 6: What alternative enhanced capital requirements for
nonbank covered companies should the Board consider? Should the Board
consider a longer or shorter phase-in period for capital requirements
for nonbank covered companies?
Conforming Amendment to Section 225.8 of Regulation Y
To make the applicability of the Board's capital plan rule
consistent with the applicability of the proposed enhanced capital
standards under this proposed rule, the Board is considering whether to
amend the capital plan rule to provide that a bank holding company
subject to that rule would remain subject to that rule until its total
consolidated assets fall below $50 billion for four consecutive
calendar quarters.
2. Quantitative Risk-Based Capital Surcharge
In November 2011, the BCBS agreed to require G-SIBs to hold an
additional amount of common equity above the regulatory minimums to
enhance their resiliency and ability to absorb losses under difficult
economic conditions. The recently finalized BCBS framework establishes
five capital surcharge categories, ranging from 100 to 350 basis
points,\57\ and allocates G-SIBs to a specific surcharge category based
on a twelve-factor formula. The formula includes measures of size,
interconnectedness, complexity, lack of substitutes and cross-border
activity. The capital surcharge must be met with common equity only and
would operate to expand the Basel III capital conservation buffer. The
BCBS framework would phase-in the G-SIB surcharge requirement in equal
increments from 2016 to 2019, in parallel with the capital conservation
buffer.
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\57\ Initially, G-SIBs would be placed in 1 of 4 categories,
with surcharges ranging from 100 to 250 basis points and the fifth
category, with an associated surcharge of 350 basis points, would be
left empty in order to leave room to apply higher surcharges to G-
SIBs that increase their systemic footprint further over time.
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Approximately 30 global banks would be subject initially to the G-
SIB surcharge under the BCBS framework. The BCBS has noted that the
number of banks subject to the framework, and the surcharge category
associated with different banks, would evolve over time as the systemic
risk profiles of different
[[Page 604]]
banks change. The BCBS expects to refine and update the framework in
the coming years as additional analysis is performed.
The Board and other U.S. federal banking agencies worked closely
with other members of the BCBS to develop the BCBS framework and the
Board believes that it is consistent with the financial stability
objectives of section 165 of the Dodd-Frank Act, including minimizing
the threat to U.S. financial stability posed by systemically important
financial companies. The Board believes that a U.S. capital surcharge
framework based on the BCBS framework would meaningfully reduce the
probability of failure of the largest, most complex financial companies
and would minimize losses to the U.S. financial system and the economy
if such a company should fail. A capital surcharge would help require
that these companies account for the costs they impose on the broader
financial system and would reduce the implicit subsidy they enjoy due
to market perceptions of their systemic importance. The Board intends
to issue a concrete proposal for implementation of a quantitative risk-
based capital surcharge for covered companies, or a subset thereof,
based on the BCBS approach consistent with the BCBS's implementation
timeframe. The forthcoming proposal would contemplate adopting
implementing rules in 2014, and requiring G-SIBs to meet the capital
surcharges on a phased-in basis from 2016-2019.
Question 7: How should the Board implement the BCBS framework
discussed above, or are there alternatives to the BCBS framework the
Board should consider?
Question 8: What is the appropriate scope of application of a
quantitative capital surcharge in the United States in light of section
165 of the Dodd-Frank Act? What adaptations to the BCBS framework, or
alternative surcharge assessment methodologies, would be appropriate
for determining a quantitative capital surcharge for covered companies
that are not identified as global systemically important banks in the
BCBS framework?
Question 9: If the BCBS framework were to be applied to nonbank
covered companies, how should the framework be modified to capture the
systemic footprint of those companies?
IV. Liquidity Requirements
A. Background
During the financial crisis that began in 2007, many solvent
financial companies experienced significant financial stress because
they did not manage their liquidity in a prudent manner. In some cases,
these companies had difficulty in meeting their obligations as they
became due because sources of funding became severely restricted. These
events followed several years of ample liquidity in the financial
system, during which liquidity risk management did not receive the same
level of priority and scrutiny as management of other sources of risk.
The rapid reversal in market conditions and availability of liquidity
during the crisis illustrated how quickly liquidity can evaporate, and
that illiquidity can last for an extended period, leading to a
company's insolvency before its assets experience significant
deterioration in value.
Many of the liquidity-related difficulties experienced by financial
companies were due to lapses in basic principles of liquidity risk
management. This problem was evident from the horizontal reviews of
financial companies conducted by the Senior Supervisors Group
(``SSG''), which comprises senior financial supervisors from seven
countries.\58\ The SSG found that failure of liquidity risk management
practices contributed significantly to the financial crisis. In
particular, the SSG noted that firms' inappropriate reliance on short-
term sources of funding and in some cases, the repo market, as well as
inaccurate measurements of funding needs and lack of effective
contingency funding were key factors in the liquidity crises many firms
faced.\59\
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\58\ See Senior Supervisors Group, Observations on Risk
Management Practices During the Recent Market Turbulence (March
2008), available at http://www.newyorkfed.org/newsevents/news/banking/2008/SSG_Risk_Mgt_doc_final.pdf (hereinafter 2008 SSG
Report).
\59\ See Senior Supervisors Group, Risk Management Lessons from
the Global Banking Crisis of 2008 (October 2009), available at
http://www.newyorkfed.org/newsevents/news_archive/banking/2009/SSG_report.pdf (hereinafter 2009 SSG Report).
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Given the direct link between liquidity risk management failures
and the many strains on firms and the financial system experienced
during the recent crisis, the Board believes that strong liquidity risk
management is crucial to ensuring a company's resiliency during periods
of financial market stress and that covered companies should be held to
the highest liquidity standards, as well as capital standards.
The Board also believes establishing minimum quantitative liquidity
standards will improve the capacity of firms to remain viable during a
liquidity stress. The Basel III Liquidity Framework establishes minimum
requirements for funding liquidity that are designed to promote the
resilience of a banking organization's liquidity risk profile.\60\
These minimum requirements are imposed through two ratios:
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\60\ Basel Committee on Bank Supervision, Basel III:
International Framework for Liquidity Risk Measurement, Standards,
and Monitoring (December 20, 2010), available at www.bis.org/publ/bcbs188.htm.
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A liquidity coverage ratio (LCR), which is designed to
promote the short-term resiliency of a banking organization's liquidity
risk profile by ensuring that it has sufficient high quality liquid
resources to survive an acute stress scenario lasting for one month;
and
A net stable funding ratio (NSFR), which is designed to
promote liquidity risk resilience over a longer time period and to
create incentives for a banking organization to fund its activities
with medium- and longer-term funding sources. The NSFR has a time
horizon of one year, and is designed to provide a sustainable maturity
structure of assets and liabilities.
Under the terms of Basel III, the LCR and NSFR are to be
implemented by Basel Committee member countries by 2015 and 2018,
respectively.
The Board intends to institute a liquidity regime for covered
companies through a multi-stage process that would include a regulatory
framework for strong liquidity risk management and quantitative
liquidity requirements based on the Basel III liquidity ratios. In the
first stage, covered companies would be subject to enhanced liquidity
risk management standards under this proposal. The proposal builds on
the core provisions of the Board's Supervision and Regulation (SR)
letter 10-6, Interagency Policy Statement on Funding and Liquidity Risk
Management issued in March 2010 (Interagency Liquidity Risk Policy
Statement).\61\ As discussed in detail below, the proposed rules would
require a covered company to take a number of prudential steps to
manage liquidity risk. Significantly, the proposed rules introduce
liquidity stress test requirements for covered companies and require
them to maintain liquid assets sufficient to meet projected net cash
flows under the stress tests. The proposed rules would also require a
covered company to generate comprehensive cash flow projections, to
establish and monitor its liquidity risk tolerance, and maintain
contingency plans for funding where normal sources of funding may not
be available.
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\61\ See supra note 37.
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The Board believes liquidity requirements are vitally important to
the
[[Page 605]]
overall goals of section 165 of the Dodd-Frank Act, to prevent or
mitigate risks to the financial stability of the United States that
could arise from the material financial distress or failure, or ongoing
activities, of large, interconnected financial companies. The liquidity
requirements in this proposal are also more stringent than liquidity
standards applied to nonbank financial companies and bank holding
companies that do not present similar risks to financial stability.
Currently, the Board oversees liquidity risk management at bank holding
companies primarily through supervisory guidance, and generally does
not impose specific regulatory liquidity requirements on bank holding
companies. The proposed rules would require covered companies to
implement liquidity risk management practices that are encouraged, but
not required, for non-covered companies.
The requirements of the proposed rule are also designed to increase
in stringency based on the systemic footprint of a company. For
example, a covered company's capital structure, risk profile,
complexity, activities, size, and other appropriate risk related
factors would be considered in: (i) Setting the liquidity risk
tolerance of the covered company; (ii) determining the amount of detail
provided in cash flow projections; (iii) tailoring liquidity stress
testing to the covered company; (iv) setting the size of the liquidity
buffer; (v) formulating the contingency funding plan; and (vi) setting
the size of the specific limits on potential sources of liquidity risk.
In addition, the Board would reserve its authority to require a covered
company to be subject to additional or further enhanced prudential
standards if it determines that compliance with the rule does not
sufficiently mitigate the risks to U.S. financial stability posed by
the failure or material financial distress of the covered company.
In addition to the enhanced liquidity risk management requirements
of this proposal, the Board intends to implement the second stage of
establishing a regulatory liquidity framework for covered companies
through one or more future proposals that would require covered
companies (or a subset of covered companies) to satisfy specific
quantitative liquidity requirements that are derived from, or
consistent with, the international liquidity standards incorporated
into Basel III. The Board believes that the eventual introduction of
the Basel III liquidity standards will be important to establish a
rigorous liquidity framework and should further the important goal of
buttressing systemically important companies from the possibility of
failure due to liquidity shortfalls. These metrics are currently
undergoing observation by the BCBS and may be modified depending on the
results of that observation. The Board and other federal banking
agencies have been working with banking organizations and other members
of the BCBS to gather data and study the impact of the proposed
standards on the banking system. The Board is carefully considering
what changes to the standards it may recommend to the BCBS based on the
results of this observation. The Board also is currently considering,
along with the Office of the Comptroller of the Currency and the
Federal Deposit Insurance Corporation, one or more joint rulemakings
that would implement the Basel Liquidity Framework in the United
States.
Question 10: Is the Board's approach to enhanced liquidity
standards for covered companies appropriate? Why or why not?
Question 11: Are there other approaches that would effectively
enhance liquidity standards for covered companies? If so, provide
detailed examples and explanations.
Question 12: The Dodd-Frank Act contemplates additional enhanced
prudential standards, including a limit on short-term debt. Should the
Board adopt a short-term debt limit in addition to or in place of the
LCR and NSFR? Discuss why or why not?
B. Overview of the Proposed Rule
1. Key Definitions
Under the proposed rule, liquidity is defined as a covered
company's capacity to efficiently meet its expected and unexpected cash
flows and collateral needs at a reasonable cost without adversely
affecting the daily operations or the financial condition of the
covered company. Liquidity risk is defined as the risk that a covered
company's financial condition or safety and soundness will be adversely
affected by its inability or perceived inability to meet its cash and
collateral obligations.
2. Corporate Governance Provisions
A critical element of sound liquidity risk management is effective
corporate governance, consisting of oversight of the covered company's
liquidity risk management by its board of directors, as well as senior
management, and an independent review function. The proposed rule
includes provisions addressing these aspects of a covered company's
corporate governance with respect liquidity risk management.
a. Board of Directors and Risk Committee Responsibilities (Sec.
252.52)
A covered company's board of directors is ultimately responsible
for the liquidity risk assumed by the covered company. Accordingly, the
proposed rule at Sec. 252.52(a) would require that the board of
directors (or the risk committee) \62\ must oversee the covered
company's liquidity risk management processes, and must review and
approve the liquidity risk management strategies, policies, and
procedures established by senior management.
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\62\ The risk committee would be defined as the enterprise-wide
committee established by a covered company's board of directors
under proposed section 252.126 of the risk management rules subpart
of this proposal.
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The proposed rule would impose several specific duties on the board
of directors. First, the board of directors would be required to
establish the covered company's liquidity risk tolerance at least
annually. The proposed rule would define liquidity risk tolerance as
the acceptable level of liquidity risk the covered company may assume
in connection with its operating strategies. In determining the
liquidity risk tolerance, the board of directors would be required to
consider the covered company's capital structure, risk profile,
complexity, activities, size, and other appropriate risk related
factors. These considerations should help to ensure that the
established liquidity risk tolerance will be appropriate for the
business strategy of the covered company and its role in the financial
system, and will reflect the covered company's financial condition and
funding capacity on an ongoing basis.
The liquidity risk tolerance should reflect the board of directors'
assessment of tradeoffs between the costs and benefits of liquidity.
That is, inadequate liquidity can expose the covered company to
significant financial stress and endanger its ability to meet
contractual obligations. Conversely, too much liquidity can entail
substantial opportunity costs and have a negative impact on the covered
company's profitability. In establishing the covered company's
liquidity risk tolerance, the Board would expect a covered company's
board of directors to articulate the liquidity risk tolerance in such a
way that all levels of management clearly would: (i) Understand the
board of director's policy for managing the trade-offs between the risk
of insufficient liquidity and generating profit; and (ii) properly
apply this approach to all aspects of
[[Page 606]]
liquidity risk management throughout the organization.\63\ To ensure
that a covered company is managed in accordance with the liquidity risk
tolerance, the proposed rule would require the board of directors to
review information provided by senior management at least semi-annually
to determine whether the covered company is managed in accordance with
the established liquidity risk tolerance.
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\63\ Under the proposed rule, the established liquidity risk
tolerance would be considered in assessing new business strategies
and products (proposed Sec. 252.52(b)(2)), in setting the size of
the liquidity buffer (proposed Sec. 252.57(b)), in developing the
CFP (proposed Sec. 252.58(a)), and in setting the specific limits
on sources of liquidity (proposed Sec. 252.59(b)).
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Second, the risk committee or a designated subcommittee of the risk
committee would be required to review and approve the liquidity costs,
benefits, and risk of each significant new business line and each
significant new product before the covered company may implement the
line or offer the product. In connection with this review, the risk
committee or a designated subcommittee would be required to consider
whether the liquidity risk of the new strategy or product under current
conditions and under a liquidity stress is within the established
liquidity risk tolerance. At least annually, the risk committee or a
designated subcommittee would be required to review approved
significant business lines and products to determine whether each line
or product has created any unanticipated liquidity risk, and to
determine whether the liquidity risk of each line or product continues
to be within the established liquidity risk tolerance.
Third, the proposed rule would require the board of directors to
review and approve the covered company's CFP at least annually and
whenever the covered company materially revises the plan. As discussed
below, the CFP is the covered company's compilation of policies,
procedures, and action plans for managing liquidity stress events.
Fourth, the risk committee or a designated subcommittee would be
required to conduct the following reviews and approvals at least
quarterly:
(i) A review of cash flow projections produced under section 252.55
of the proposed rule that use time periods in excess of 30 days to
ensure that the covered company's liquidity risk is within the covered
company's established liquidity risk tolerance;
(ii) A review and approval of the liquidity stress testing
described in section 252.56 of the proposed rule, including the covered
company's stress testing practices, methodologies, and assumptions. The
risk committee or a designated subcommittee would also be required to
conduct this review and approval whenever the covered company
materially revises its liquidity stress testing;
(iii) A review of the liquidity stress testing results produced
under section 252.56 of the proposed rule;
(iv) Approval of the size and composition of the liquidity buffer
established under section 252.57 of the proposed rule;
(v) A review and approval of the specific limits on potential
sources of liquidity risk established under section 252.59 of the
proposed rule, and a review of the covered company's compliance with
those limits; and
(iv) A review of liquidity risk management information necessary to
identify, measure, monitor, and control liquidity risk and to comply
with the new liquidity rules.
In addition, the risk committee or a designated subcommittee would
be required to periodically review the independent validation of the
stress tests produced under section 252.56(c)(2)(ii) of the proposed
rule.
The proposed rule establishes minimum requirements governing the
frequency of certain reviews and approvals. It also would require the
board of directors (or the risk committee) to conduct more frequent
reviews and approvals as market and idiosyncratic conditions
warrant.\64\ The risk committee or a designated subcommittee would also
be required to establish procedures governing the content of senior
management reports on the liquidity risk profile of the covered company
and other information described in the senior management
responsibilities section below.
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\64\ As used in this preamble, idiosyncratic conditions or
events refer to conditions or events that are unique to the covered
company. Market conditions or events refer to conditions or events
that are market-wide.
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b. Senior Management Responsibilities (Sec. 252.53)
Under the proposed rule, senior management of a covered company
would be required to establish and implement liquidity risk management
strategies, policies and procedures. This would include overseeing the
development and implementation of liquidity risk measurement and
reporting systems, the cash flow projections, the liquidity stress
testing, the liquidity buffer, the CFP, the specific limits, and the
monitoring procedures required under the proposed rule.
Senior management would also be required to report regularly to the
risk committee or designated subcommittee thereof on the liquidity risk
profile of the covered company, and to provide other relevant and
necessary information to the board of directors (or risk committee) to
facilitate its oversight of the liquidity risk management process. As
noted above, the proposed rule would require the risk committee or a
designated subcommittee to establish procedures governing the content
of management reports on the liquidity risk profile of the covered
company and other information regarding compliance with the proposed
rule. The Board expects that management would be required under these
procedures to report as frequently as conditions warrant, but no less
frequently than quarterly.
c. Independent Review (Sec. 252.54)
Under the proposed rule, a covered company would be required to
establish and maintain an independent review function to evaluate its
liquidity risk management. Under the proposal, this review function
must be independent of management functions that execute funding (the
treasury function). The independent review function would be required
to review and evaluate the adequacy and effectiveness of the covered
company's liquidity risk management processes regularly, but no less
frequently than annually. It would also be required to assess whether
the covered company's liquidity risk management complies with
applicable laws, regulations, supervisory guidance, and sound business
practices, and to report statutory and regulatory noncompliance and
other material liquidity risk management issues to the board of
directors (or the risk committee) in writing for corrective action.
An appropriate internal review conducted by the independent review
function should address all relevant elements of a covered company's
risk management process, including adherence to its own policies and
procedures, and the adequacy of its risk identification, measurement,
and reporting processes. Personnel conducting these reviews should seek
to understand, test, document, and evaluate the risk management
processes, and recommend solutions to any identified weaknesses.
[[Page 607]]
3. Liquidity Requirements
a. Cash Flow Projections (Sec. 252.55)
Comprehensive projections of a covered company's cash flows from
the company's various operations are a critical tool for managing
liquidity risk. To ensure that a covered company has a sound process
for identifying and measuring liquidity risk, the proposed rule would
require a covered company to produce comprehensive projections that
forecast cash flows arising from assets, liabilities, and off-balance
sheet exposures over appropriate time periods, and to identify and
quantify discrete and cumulative cash flow mismatches over these time
periods. The proposed rule would specifically require the covered
company to provide cash flow projections over the short-term and long-
term time horizons that are appropriate to the covered company's
capital structure, risk profile, complexity, activities, size and other
risk-related factors.\65\
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\65\ A covered company would be required to update short-term
cash flow projections daily, and update long-term cash flow
projections at least monthly.
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To make sure that the cash flow projections will analyze liquidity
risk exposure to contingent events, the proposed rule would require
that projections must include cash flows arising from contractual
maturities, as well as cash flows from new business, funding renewals,
customer options, and other potential events that may impact liquidity.
Static projections based on the contractual cash flows of assets,
liabilities, and off-balance sheet items are helpful in identifying
liquidity gaps. However, such static projections may inadequately
quantify important aspects of potential liquidity risk because these
projections ignore new business, funding renewals, customer options,
and other contingent events that have a significant impact on a covered
company's liquidity risk profile. A dynamic analysis that incorporates
management's reasoned assumptions regarding the future behavior of
assets, liabilities, and off-balance sheet items in projected cash
flows is far more useful than a static projection in identifying
potential liquidity risk exposure.
Under the proposed rule, a covered company would be required to
develop cash flow projections that provide sufficient detail to reflect
its capital structure, risk profile, complexity, activities, size, and
other appropriate risk related factors. Such detail may include
projections broken down by business line, legal entity, or
jurisdiction, and cash flow projections that use more time periods than
the two minimum time periods that would be required under the rule.
The proposed rule states that a covered company must establish a
robust methodology for making its cash flow projections,\66\ and must
use reasonable assumptions regarding the future behavior of assets,
liabilities, and off-balance sheet exposures in the projections. Given
the critical importance that the methodology and underlying assumptions
play in liquidity risk measurement, the covered company would also be
required to adequately document the methodology and assumptions.\67\ In
addition, the Board expects senior management to periodically review
and approve the assumptions used in the cash flow projections to make
sure that they are reasonable and appropriate.
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\66\ In its most basic form, a cash-flow-projection may be a
worksheet-table with columns denoting the selected time periods or
buckets for which cash flows are to be projected. The rows of this
table may consist of various types of assets, liabilities, and off-
balance sheet items, often grouped by their cash-flow
characteristics. Different groupings may be used to achieve
different objectives of the cash-flow projection. For each row, net
cash flows arising from the particular asset, liability, or off-
balance sheet activity may be projected across the time buckets. The
detail and granularity of the rows, and thus the projections, should
depend on the sophistication and complexity of the institution.
Complex companies generally provide more detail, while less complex
companies use higher levels of aggregation.
\67\ See section 252.61 of the proposed rule, which states that
a covered company must document all material aspects of its
liquidity risk management process and its compliance with the
requirements in the rule.
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b. Liquidity Stress Testing (Sec. 252.56)
While financial companies typically manage their liquidity under
normal circumstances with regular sources of liquidity readily
available, they should also be prepared to manage liquidity under
adverse conditions in which liquidity sources may be limited or
nonexistent. Insufficient consideration of liquidity management under
the conditions that arose during the financial crisis was a major
contributor to the severe liquidity problems many financial companies
faced at the time. Accordingly, rigorous and regular stress testing and
scenario analysis, combined with comprehensive information about an
institution's funding position, is an important tool for effective
liquidity risk management that should reduce the risk of a firm's
failure due to adverse liquidity conditions.
To promote preparedness for adverse liquidity conditions, the
proposed rule would require the covered company to regularly stress
test its cash flow projections by identifying liquidity stress
scenarios and assessing the effects of these scenarios on the covered
company's cash flow and liquidity. By considering how adverse events,
conditions, and outcomes, including extremes, affect the covered
company's exposure to liquidity risk, a covered company can identify
vulnerabilities, quantify the depth, source, and degree of potential
liquidity strain, and analyze the possible impacts. Under the proposed
rule, the covered company would use the results of the stress testing
to determine the size of its liquidity buffer, and would incorporate
information generated by stress testing in the quantitative component
of the CFP.
The proposed rule would require that liquidity stress testing
comprehensively address a covered company's activities, exposures, and
risks, including off-balance sheet exposures. To satisfy this
requirement, stress testing would have to address the covered company's
full set of activities, exposures and risks, both on- and off-balance
sheet, and address non-contractual sources of risks, such as
reputational risks. For example, stress testing should address
potential liquidity issues arising from the covered company's use of
sponsored vehicles that issue debt instruments periodically to the
markets, such as asset-backed commercial paper and similar conduits.
Under stress scenarios, the covered company may be contractually
required, or compelled in the interest of mitigating reputational risk,
to provide liquidity support to such a vehicle.
The proposed rule would require a covered company to conduct the
liquidity stress testing at least monthly. In addition to monthly
stress testing, a covered company should have the flexibility to
conduct ``ad hoc'' stress testing to address rapidly emerging risks or
consider the impact of sudden events. Accordingly, the proposed rule
specifies that the covered company must have the ability to perform
stress testing more frequently than monthly, and the ability to vary
underlying assumptions as conditions change. To facilitate effective
supervision of the sufficiency of a covered company's liquidity
management, under the proposed rule, a covered company may be required
by the Federal Reserve to perform additional stress testing as
conditions relating to the institution or the markets generally may
warrant, or to address other supervisory concerns. The Federal Reserve
may, for example, require a covered company to perform additional
stress testing where there has been a significant deterioration in the
covered company's earnings, asset quality, or overall financial
condition; are negative
[[Page 608]]
trends or heighten risk associated with a particular product line; or
are increased concerns over the covered company's funding of off-
balance sheet exposures.
Effective stress testing should include scenario analysis that uses
historical and hypothetical scenarios to assess the impact on liquidity
of various events and circumstances, including extremes. Effective
liquidity stress testing should also employ a range of stress scenarios
involving macroeconomic, market-wide, and idiosyncratic events, and
consider interactions and feedback effects. Accordingly, the proposed
rule states that a covered company's stress testing must incorporate a
range of stress scenarios that may significantly affect the covered
company's liquidity, taking into consideration its on- and off-balance
sheet exposures, business lines, organizational structure, and other
characteristics. At a minimum, the proposed rule would require a
covered company to incorporate stress scenarios to account for market
stress, idiosyncratic stress, and combined market and idiosyncratic
stresses. Additional scenarios should be used as needed to ensure that
all of the significant aspects of liquidity risks to the covered
company have been modeled. The proposed rule would also require that
the stress scenarios address the potential impact of market disruptions
on the covered company, and the potential actions of market
participants experiencing liquidity stresses under the same market
disruption.
Under the proposed rule, a covered company's liquidity stress
scenarios must be forward-looking and incorporate a range of potential
changes to a covered company's exposures, activities, and risks as well
as changes to the broader economic and financial environment. To meet
this standard, the stress tests would need to be sufficiently dynamic
to incorporate changes in the covered company's on- and off-balance
sheet activities, portfolio composition, asset quality, operating
environment, business strategy, and other risks that may arise over
time from idiosyncratic events, macroeconomic and financial market
developments, or some combination of thereof. The stress tests should
look beyond assumptions based only on historical data, and incorporate
new events and challenge conventional assumptions.
Effective liquidity stress testing should be conducted over a
variety of different time horizons to adequately capture rapidly
developing events, and other conditions and outcomes that may
materialize in the near or long term. To make sure that a covered
company's stress testing captures such events, condition, and outcomes,
the proposed rule would require that the covered company's stress
scenarios use a minimum of four time horizons including an overnight, a
30-day, a 90-day, and a one-year time horizon. A covered company may be
required to use more time horizons where necessary to reflect the
covered company's capital structure, risk profile, complexity,
activities, size, and other appropriate risk-related factors.
The proposed rule further provides that liquidity stress testing
must be tailored to, and provide sufficient detail to reflect a covered
company's capital structure, risk profile, complexity, activities,
size, and other appropriate risk-related factors. This requirement is
intended to ensure that stress testing will be tied directly to the
covered company's business profile and the regulatory environment in
which the covered company operates,\68\ and will address relevant risk
areas, provide for the appropriate level of aggregation, and capture
all appropriate risk drivers, internal and external influences, and
other key considerations that may affect the covered company's
liquidity position. This may require analyses by business line, legal
entity, or jurisdiction, or stress scenarios that use time horizons in
addition to the minimum number described above.
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\68\ For example, applicable statutory and regulatory
restrictions on covered companies, including restrictions on the
transferability of assets between legal entities, would need to be
incorporated. For bank holding companies these restrictions include
sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c and
371c-1) and Regulation W (12 CFR part 223), which govern covered
transactions between banks and their affiliates.
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The proposed rule would require a covered company to incorporate
certain assumptions designed to ensure that stress testing will provide
relevant information to support the establishment of the liquidity
buffer (see section 252.56(b)(4) of the proposed rule). As discussed
below, the liquidity buffer is composed of highly liquid assets that
are unencumbered, and is designed to meet projected net cash outflows
and the projected loss or impairment of existing funding sources for 30
days during a range of liquidity stress scenarios. To reflect this
design, the proposed rule would require that the covered company must
assume that, for the first 30 days of a liquidity stress scenario, only
highly liquid assets that are unencumbered may be used as cash flow
sources to meet projected funding needs. For time periods beyond the
first 30 days of a liquidity stress scenario, highly liquid assets that
are unencumbered and other appropriate funding sources may be used.\69\
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\69\ The liquidity buffer is discussed more fully below, as are
the definitions of ``unencumbered'' and ``highly liquid asset.''
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A covered company's liquidity stress testing should account for
deteriorations in asset valuations when there is market stress.
Accordingly, the proposed rule would require the covered company to
impose a discount to the fair market value of an asset that is used as
a cash flow source to offset projected funding needs in order to
reflect any credit risk and market volatility of the asset. The
proposed rule would also require that sources of funding used to
generate cash to offset projected funding needs be sufficiently
diversified throughout each stress test time horizon. Thus, if a
covered company holds high quality assets other than cash and
securities issued by the U.S. government, a U.S. government agency,\70\
or a U.S. government-sponsored entity,\71\ the assets should be
diversified by collateral, counterparty, or borrowing capacity, and
other liquidity risk identifiers.
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\70\ A U.S. government agency is defined in the proposed rule as
an agency or instrumentality of the U.S. government whose
obligations are fully and explicitly guaranteed as to the timely
payment of principal and interest by the full faith and credit of
the U.S. government.
\71\ A U.S. government-sponsored entity is defined in the
proposed rule as an entity originally established or chartered by
the U.S. government to serve public purposes specified by the U.S.
Congress, but whose obligations are not explicitly guaranteed by the
full faith and credit of the U.S. government.
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The proposed rule would impose various process and system
requirements for stress testing. Specifically, a covered company would
be required to establish and maintain policies and procedures that
outline its liquidity stress testing practices, methodologies, and
assumptions; detail the use of each stress test employed; and provide
for the enhancement of stress testing as risks change and techniques
evolve. The proposed rule also states that a covered company must have
an effective system of control and oversight over the stress test
function to ensure that each stress test is designed in accordance with
the rule, and the stress process and assumptions are validated. The
validation function must be independent of functions that develop or
design the liquidity stress testing, and independent of management
functions that execute funding (e.g., the treasury function).
In addition, the proposed rule would require a covered company to
rely on reasonably high-quality data and information to produce
creditable
[[Page 609]]
outcomes. Specifically, the proposed rule would require that the
covered company must maintain management information systems and data
processes sufficient to enable it to effectively and reliably collect,
sort, and aggregate data and other information related to liquidity
stress testing.
Question 13: What challenges will covered companies face in
formulating and implementing liquidity stress testing described in the
proposed rule? What changes, if any, should be made to the proposed
liquidity stress testing requirements (including the stress scenario
requirements and required assumptions) to ensure that analyses of the
stress testing will provide useful information for the management of a
covered company's liquidity risk? What alternatives to the proposed
liquidity stress testing requirements, including the stress scenario
requirements and required assumptions, should the Board consider? What
additional parameters for the liquidity stress tests should the Board
consider defining?
c. Liquidity Buffer (Sec. 252.57)
To withstand liquidity stress under adverse conditions, a company
generally needs a sufficient supply of liquid assets that can be sold
or pledged to obtain funds. During the financial crisis, financial
companies that experienced severe liquidity difficulties often held
insufficient liquid assets to meet their liquidity needs as market
sources of funding were severely curtailed. The BCBS's LCR standard was
developed to promote short-term resilience of a bank's liquidity risk
profile by ensuring that it has sufficient high-quality liquid assets
to survive an adverse stress scenario lasting for one month, providing
time for appropriate corrective actions to be taken by management or
supervisors, or to allow the institution to be resolved in an orderly
way.\72\
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\72\ See Basel III liquidity framework at paragraphs 4 and 15.
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Consistent with the effort towards developing a comprehensive
liquidity framework that would eventually incorporate the LCR standard,
the proposed rule, in addition to requiring stress tests as described
above, would require a covered company to continuously maintain a
liquidity buffer of unencumbered highly liquid assets sufficient to
meet projected net cash outflows and the projected loss or impairment
of existing funding sources for 30 days over a range of liquidity
stress scenarios.
In addition to using the results of the liquidity stress testing to
size a covered company's liquidity buffer, the proposed rule would
require that the liquidity buffer would also be aligned to reflect the
covered company's capital structure, risk profile, complexity,
activities, size, and other appropriate risk related factors, as well
as the covered company's established liquidity risk tolerance. These
factors, however, could not justify reducing the buffer to a point
where it would be insufficient to meet projected net cash outflows and
the projected impairment of existing funding sources for 30 days under
the range of liquidity stress scenarios incorporated into its stress
testing. As explained above, under the proposal, the risk committee or
a designated subcommittee of the risk committee would be required to
approve the size and composition of the liquidity buffer at least
quarterly.
The proposed rule limits the type of assets that may be included in
the buffer to highly liquid assets that are unencumbered. The
definition of highly liquid assets would ensure that the assets in the
liquidity buffer can easily and immediately be converted to cash with
little or no loss of value. Thus, cash or securities issued or
guaranteed by the U.S. government, a U.S. government agency, or a U.S.
government-sponsored entity are included in the proposed definition of
highly liquid assets. In addition, the proposed rule includes criteria
that may be used to identify other assets that could be included in the
buffer as highly liquid assets. Specifically, the proposed definition
of highly liquid assets includes any other asset that a covered company
demonstrates to the satisfaction of the Federal Reserve:
(i) Has low credit risk (low risk of default) and low market risk
(little or no price volatility); \73\
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\73\ Generally, market risk is the risk of loss that could
result from broad market movements, such as changes in the general
level of interest rates, credit spreads, equity prices, foreign
exchange rates, or commodity prices.
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(ii) Is traded in an active secondary two-way market \74\ that has
observable market prices, committed market makers, a large number of
market participants, and a high trading volume; and
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\74\ A two-way market would be defined as a market with
independent bona fide offers to buy and sell so that a price
reasonably related to the last sales price or current bona fide
competitive bid and offer quotations can be determined within one
day and settled at that price within a reasonable time period
conforming to trade custom. This definition is consistent with the
definition of ``two-way market'' contained in the interagency
proposed rule on Risk-Based Capital Guidelines; Market Risk, 76 FR
1890 (January 11, 2011) (Market Risk NPR).
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(iii) Is a type of asset that investors historically have purchased
in periods of financial market distress during which liquidity is
impaired (flight to quality). For example, certain ``plain vanilla''
corporate bonds (that is, bonds that are neither structured products
nor subordinated debt) issued by a non-financial company with a strong
financial profile have been reliable sources of liquidity in the
repurchase and sale market during past stressed conditions. Assets with
the above characteristics could, as proposed, meet the definition of a
highly liquid asset.
The highly liquid assets in the liquidity buffer should be readily
available at all times to meet a covered company's liquidity needs.
Accordingly, the assets must be unencumbered. Under the proposed rule,
unencumbered would be defined to mean, with respect to an asset, that:
(i) The asset is not pledged, does not secure, collateralize or provide
credit enhancement to any transaction, and is not subject to any lien;
(ii) the asset is not designated as a hedge on a trading position; \75\
and (iii) there are no legal or contractual restrictions on the ability
of the covered company to promptly liquidate, sell, transfer, or assign
the asset.
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\75\ A trading position would be defined as a position that is
held by a covered company for the purpose of short-term resale or
with the intent of benefiting from actual or expected short-term
price movements, or to lock-in arbitrage profits. This definition is
based on the definition of trading position in the Market Risk NPR.
---------------------------------------------------------------------------
Generally, an asset would be designated as a hedge on a trading
position if the asset is held by a covered company directly to offset
the market risk of another trading asset or group of trading assets
held by the covered company. For example, if a covered company holds a
position in a corporate bond index in its trading account, corporate
bonds that hedge that index position may not be included in the
liquidity buffer.
To account for deteriorations in asset valuations when there is
market stress, the proposed rule also would require a covered company
to impose a discount to the fair market value of an asset included in
the liquidity buffer to reflect the credit risk and market volatility
of the asset. In addition, to ensure that the liquidity buffer is not
concentrated in a particular type of highly liquid assets, the proposed
rule requires that the pool of assets included in the liquidity buffer
must be sufficiently diversified, as discussed above. Thus, these
highly liquid assets should be diversified by instrument type,
counterparties, geographic market, and other liquidity risk
identifiers.
[[Page 610]]
Question 14: The Board requests comment on all aspects of the
proposed definitions of ``highly liquid assets'' and ``unencumbered.''
What, if any, other assets should be specifically listed in the
definition of highly liquid assets? Why should these other assets be
included (that is, describe how the asset is easily and immediately
convertible into cash with little or no loss in value during liquidity
stress events)? Are the criteria for identifying additional assets for
inclusion in the definition of highly liquid assets appropriate? If
not, how and why should the Board revise the criteria?
Question 15: What changes, if any, should the Board make to the
proposed definition of unencumbered to make sure that assets in the
buffer will be readily available at all times to meet a covered
company's liquidity needs? The rule would require a covered company to
discount the fair market value of assets that are included in the
liquidity buffer. Please describe the process that covered company will
use to determine the amount of the discount.
d. Contingency Funding Plan (Sec. 252.58)
The proposed rule would require a covered company to establish and
maintain a CFP. A CFP is a compilation of policies, procedures, and
action plans for managing liquidity stress events. The objectives of
the CFP are to provide a plan for responding to a liquidity crisis, to
identify alternate liquidity sources that a covered company can access
during liquidity stress events, and to describe steps that should be
taken to ensure that the covered company's sources of liquidity are
sufficient to fund its operating costs and meet its commitments while
minimizing additional costs and disruption.
The proposed rule states that a covered company must establish and
maintain a CFP that sets out the covered company's strategies for
addressing liquidity needs during liquidity stress events. Under the
proposed rule, the CFP would be required to be commensurate with the
covered company's capital structure, risk profile, complexity,
activities, size, and other appropriate risk related factors, and
established liquidity risk tolerance. A covered company would be
required to update the CFP at least annually or whenever changes to
market and idiosyncratic conditions warrant an update.
Under the proposed rule, the CFP includes four components: a
quantitative assessment, an event management process, monitoring
requirements, and testing requirements. These components are discussed
in detail below.
a. Quantitative Assessment
The first component of the CFP is the quantitative assessment of
liquidity needs and funding sources. A covered company would be
required to incorporate information generated by liquidity stress
testing into this component of the CFP. The proposed rule would provide
that the stress tests are used to: (i) Identify liquidity stress events
that have a significant impact on the covered company's liquidity; (ii)
assess the level and nature of impact on the covered company's
liquidity that may occur during identified liquidity events; (iii)
assess available funding sources and needs during the identified
liquidity stress events; and (iv) identify alternative funding sources
that may be used during the liquidity stress events.
i. Identification of stress events. A covered company would be
required to identify stress events that have a significant impact on
the covered company's liquidity. Possible stress events may include
deterioration in asset quality, ratings downgrades, widening of credit
default swap spreads, operating losses, declining financial institution
equity prices, negative press coverage, or other events that call into
question the covered company's ability to meet its obligations.
ii. Assessing the level and nature of impact. Once the liquidity
stress events are identified, a covered company's CFP would incorporate
an assessment of the level and nature of impact on the covered
company's liquidity that may occur during the identified liquidity
stress event. The CFP would delineate the various levels of stress
severity that can occur during the stress event, and identify the
various stages for each type of event. The events, stages, and severity
levels should include temporary disruptions, as well as those that
might be intermediate or longer term. The covered company may use the
different levels of severity to design early warning indicators, to
assess potential funding needs at various points in a developing
crisis, and to specify comprehensive action plans.
iii. Assessing available funding sources and needs. To meet the
requirement of the proposal, the CFP must assess available funding
sources and needs during identified liquidity stress events. This would
require an analysis of the potential erosion of available funding at
alternative stages or severity levels of each stress event, as well as
the identification of potential cash flow mismatches that may occur
during the various stress levels. A covered company is expected to base
its analysis on realistic assessments of the behavior of funds
providers during the event, and should incorporate alternative funding
sources. The analysis should include all material on- and off-balance
sheet cash flows and their related effects. The result should be a
realistic analysis of the covered company's cash inflows, outflows, and
funds availability at different time intervals during the identified
liquidity stress event, which should permit the covered company to
measure its ability to fund operations.
iv. Identifying alternative funding sources. Liquidity pressures
are likely to spread from one funding source to another during
significant liquidity stress events. Accordingly, the proposed rule
would require a covered company to identify alternative funding sources
that may be accessed during identified liquidity stress events. Since
some of these alternative funding sources will rarely be used in the
normal course of business, a covered company should conduct advance
planning and periodic testing (see discussion below) to make sure that
the funding sources are available when needed. Administrative
procedures and agreements are expected to also be in place before the
covered company needs to access the alternative funding sources.
Discount window credit may be incorporated into CFPs as a potential
source of funds in a manner consistent with the terms provided by the
Federal Reserve Banks. For example, primary credit is currently
available on a collateralized basis for financially sound depository
institutions as a backup source of funds for short-term funding needs.
CFPs that incorporate borrowing from the discount window should specify
the actions that the covered company will take to replace discount
window borrowing with more permanent funding, including the proposed
time frame for these actions.
b. Event Management Process
Under the proposed rule, the CFP must also include an event
management process that sets out its procedures for managing liquidity
during identified liquidity stress events. This process must include an
action plan that clearly describes the strategies the covered company
would use to respond to liquidity shortfalls for identified liquidity
stress events, including the methods that the covered company would use
to access the alternative funding sources identified in the
quantitative assessment.
Under the proposed rule, the event management process must also
identify
[[Page 611]]
a liquidity stress event management team and specify the process,
responsibilities, and triggers for invoking the CFP, escalating the
responses described in the action plan, decision-making during the
identified liquidity stress events, and executing contingency measures
identified in the action plan.
In addition, to promote the flow of necessary information during a
liquidity stress, the proposed rule would require the event management
process to include a mechanism that ensures effective reporting and
communication within the covered company and with outside parties,
including the Federal Reserve and other relevant supervisors,
counterparties, and other stakeholders.
c. Monitoring
The proposal would also impose monitoring requirements on covered
companies so that they are able to proactively position themselves into
progressive states of readiness as liquidity stress events evolve.
Specifically, the proposed rule would require the CFP to include
procedures for monitoring emerging liquidity stress events, and for
identifying early warning indicators of emerging liquidity stress
events that are tailored to a covered company's capital structure, risk
profile, complexity, activities, size, and other appropriate risk-
related factors. Such early warning indicators may include, but are not
limited to, negative publicity concerning an asset class owned by
covered company, potential deterioration in the covered company's
financial condition, widening debt or credit default swap spreads, and
increased concerns over the funding of off-balance-sheet items.
d. Testing
The proposed rule would require a covered company to periodically
test the components of the CFP to assess its reliability during
liquidity stress events. Such testing would include trial runs of the
operational elements of the CFP to ensure that they work as intended
during a liquidity stress event. These tests would include operational
simulations to test communications, coordination, and decision making
involving relevant managers, including managers at relevant legal
entities within the corporate structure.
A covered company would also be required to periodically test the
methods it will use to access alternate funding to determine whether
these sources of funding will be readily available when needed. For
example, the Board expects that a covered company would test the
operational elements of a CFP that are associated with lines of credit,
the Federal Reserve discount window, or other secured borrowings, since
efficient collateral processing during a liquidity stress event is
especially important for such funding sources.
Question 16: Are the proposed CFP requirements appropriate for all
covered companies? What alternative approaches to the CFP requirements
outlined above should the Board consider? If not, how should the Board
amend the requirements to make them appropriate for any covered
company? Are there additional modifications the Board should make to
the proposed rule to enhance the ability of a covered company to comply
with the CFP and establish a viable and effective plan for the
management of liquidity stress events?
e. Specific Limits (Sec. 252.59)
To enhance management of liquidity risk, the proposed rule would
require a covered company to establish and maintain limits on potential
sources of liquidity risk, including three specified sources of
liquidity risk. The size of each limit must reflect the covered
company's capital structure, risk profile, complexity, activities,
size, and other appropriate risk related factors, and established
liquidity risk tolerance. The covered company would be required to
establish limits on:
(i) Concentrations of funding by instrument type, single
counterparty, counterparty type, secured and unsecured funding, and
other liquidity risk identifiers.
(ii) The amount of specified liabilities that mature within various
time horizons.
(iii) Off-balance sheet exposures and other exposures that could
create funding needs during liquidity stress events. Such exposures may
be contractual or non-contractual exposures, and include such
liabilities as unfunded loan commitments, lines of credit supporting
asset sales or securitizations, collateral requirements for derivative
transactions, and a letter of credit supporting a variable demand note.
Question 17: Should covered companies be required to establish and
maintain limits on other potential sources of liquidity risk in
addition to the three specific sources listed in the proposed rule? If
so, identify these additional sources of liquidity risk.
f. Monitoring (Sec. 252.60)
The proposed rule would require a covered company to monitor
liquidity risk related to collateral positions, liquidity risks across
the enterprise, and intraday liquidity positions. In addition, the
covered company would be required to monitor compliance with the
specific limits established under Sec. 252.59.
a. Collateral Positions
Under the proposed rule, a covered company would be required to
establish and maintain procedures for monitoring assets it has pledged
as collateral for an obligation or position, and assets that are
available to be pledged. The procedures must address the covered
company's ability to:
(i) Calculate all of the covered company's collateral positions in
a timely manner, including the value of assets pledged relative to the
amount of security required under the contract governing the obligation
for which the collateral was pledged, and the unencumbered assets
available to be pledged;
(ii) Monitor the levels of available collateral by legal entity,
jurisdiction, and currency exposure;
(iii) Monitor shifts between intraday, overnight, and term pledging
of collateral; and
(iv) Track operational and timing requirements associated with
accessing collateral at its physical location (for example, the
custodian or securities settlement system that holds the collateral).
b. Legal Entities, Currencies, and Business Lines
Regardless of its organizational structure, it is critical that a
covered company actively monitor and control liquidity risks at the
level of individual legal entities and the group as a whole. This
requires processes that aggregate data across multiple systems to
develop an enterprise-wide view of liquidity risk exposure and identify
constraints on the transferability of liquidity within the
organization.
To promote effective monitoring across the enterprise, the proposed
rule would require a covered company to establish and maintain
procedures for monitoring and controlling liquidity risk exposures and
funding needs within and across significant legal entities, currencies,
and business lines. In addition, the proposed rule would require the
covered company to maintain sufficient liquidity with respect to each
significant legal entity in light of legal and regulatory restrictions
on the transfer of liquidity between legal entities.\76\ The covered
company should
[[Page 612]]
ensure that legal distinctions and possible obstacles to cash movements
between specific legal entities or between separately regulated
entities are recognized. The Board expects a covered company to
maintain sufficient liquidity to ensure such compliance in normal times
and during liquidity stress events.
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\76\ For example, for bank holding companies such restrictions
include sections 23A and 23B of the Federal Reserve Act (12 U.S.C.
371c and 371c-1) and Regulation W (12 CFR part 223), which govern
covered transactions between banks and their affiliates.
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c. Intraday Liquidity Positions
Intraday liquidity monitoring is an important component of the
liquidity risk management process for a covered company engaged in
significant payment, settlement, and clearing activities. Given the
interdependencies that exist among payment systems, large complex
organizations' inabilities to meet critical payments have the potential
to lead to systemic disruptions that can prevent the smooth functioning
of payments systems and money markets.
The proposed rule would require a covered company to establish and
maintain procedures for monitoring their intraday liquidity risk
exposure. These procedures would address how the covered company will:
(i) Monitor and measure expected daily gross liquidity inflows and
outflows;
(ii) Manage and transfer collateral when necessary to obtain
intraday credit;
(iii) Identify and prioritize time-specific obligations so that the
covered company can meet these obligations as expected;
(iv) Settle less critical obligations as soon as possible;
(v) Control the issuance of credit to customers where necessary;
and
(vi) Consider the amounts of collateral and liquidity needed to
meet payment systems obligations when assessing its overall liquidity
needs.
The monitoring of intraday cash flows generally is an operational
risk management function. To ensure that liquidity risk is also
appropriately monitored, the Board expects a covered company to provide
for integrated oversight of intraday exposures within the operational
risk and liquidity risk functions. The Board also expects the
procedures for monitoring and managing intraday liquidity positions to
reflect in stringency and complexity, and scope of operations of the
covered company.
d. Specific Limits
The proposed rule would require a covered company to monitor
compliance with the specific limits on potential sources of liquidity
risk established under Sec. 252.59.
Question 18: Should the Board require a covered company to monitor
other areas of liquidity risk in addition to collateral positions, risk
across entities, currencies, and business lines, and intraday liquidity
positions? If so, what areas should be added to the list and why?
g. Documentation (Sec. 252.61)
Comprehensive documentation is necessary to achieve good liquidity
risk management and to support the supervisory process. The proposed
rule would require a covered company to adequately document all
material aspects of its liquidity risk management processes and its
compliance with the requirements of the proposed rule, and submit such
documentation to the risk committee. Material aspects of its liquidity
risk management process would include, but would not be limited to, the
methodologies and material assumptions used in cash flow projections
and the liquidity stress testing, and all elements of the comprehensive
CFP. The covered company must make this documentation available to the
Federal Reserve upon request.
Question 19: The Board requests comment on all aspects of the
proposed rule. Specifically, what aspects of the proposed rule present
implementation challenges and why? What alternative approaches to
liquidity risk management should the Board consider? Are the liquidity
management requirements of this proposal too specific or too narrowly
defined? If, so explain how. Responses should be detailed as to the
nature and impact of these challenges and should address whether the
Board should consider implementing transitional arrangements in the
rule to address these challenges.
V. Single-Counterparty Exposure Limits
A. Background
During the recent financial crisis, some of the largest financial
firms in the world collapsed or nearly did so, demonstrating the risk
that the failure of large financial companies poses to the financial
stability of the United States and the global financial system. The
effect of one large financial institution's failure or near collapse
was amplified by the interconnectedness of large, systemically
important firms-the degree to which they extended each other credit and
served as over-the-counter derivative counterparties to each other.
Counterparties of a failing firm were placed under severe strain when
the failing firm could not meet its financial obligations resulting in
the counterparties' inability to meet their own obligations.
The financial crisis also revealed inadequacies in the U.S.
supervisory approach to single-counter party credit concentration
limits, which failed to limit the interconnectedness among and
concentration of similar risks within large financial companies that
contributed to a rapid escalation of the crisis. While banks were
subject to single-borrower lending and investment limits, these limits
were applied at the bank level, rather than holding company level, and
excluded credit exposures generated by derivatives and some securities
financing transactions.\77\
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\77\ Section 610 of the Dodd-Frank Act amends the term ``loans
and extensions of credit'' for purposes of the lending limits
applicable to national banks to include any credit exposure arising
from a derivative transaction, repurchase agreement, reverse
repurchase agreement, securities lending transaction, or securities
borrowing transaction. See Dodd-Frank Act, Public Law 111-203, Sec.
610, 124 Stat. 1376, 1611 (2010). As discussed in more detail below,
these types of transactions are also all made subject to the single
counterparty credit limits of section 165(e). 12 U.S.C. 5365(e)(3).
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In an effort to address single-counterparty concentration risk
among large financial companies, section 165(e) of the Dodd-Frank Act
directs the Board to establish single-counterparty credit concentration
limits for covered companies in order to limit the risks that the
failure of any individual firm could pose to a covered company.\78\
This section directs the Board to prescribe regulations that prohibit
covered companies from having credit exposure to any unaffiliated
company that exceeds 25 percent of the capital stock and surplus of the
covered company.\79\ This section also authorizes the Board to lower
the 25 percent threshold if necessary to mitigate the risks to the
financial stability of the United States.\80\
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\78\ See 12 U.S.C. 5365(e)(1).
\79\ 12 U.S.C. 5365(e)(2).
\80\ See id.
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Credit exposure to a company is defined in section 165(e) of the
Dodd-Frank Act to mean all extensions of credit to the company,
including loans, deposits, and lines of credit; all repurchase
agreements, reverse repurchase agreements, securities borrowing and
lending transactions with the company (to the extent that such
transactions create credit exposure for the covered company); all
guarantees, acceptances, or letters of
[[Page 613]]
credit (including endorsement or standby letters of credit) issued on
behalf of the company; all purchases of or investments in securities
issued by the company; counterparty credit exposure to the company in
connection with a derivative transaction between the covered company
and the company; and any other similar transaction that the Board, by
regulation, determines to be a credit exposure for purposes of section
165.\81\
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\81\ See 12 U.S.C. 5365(e)(3).
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Section 165(e) also grants authority to the Board (i) to issue such
regulations and orders, including definitions consistent with section
165(e), as may be necessary to administer and carry out that section;
and (ii) to exempt transactions, in whole or in part, from the
definition of the term ``credit exposure,'' if the Board finds that the
exemption is in the public interest and consistent with the purposes of
section 165(e).\82\ Section 165(e) states that its provisions and any
implementing regulations and orders of the Board will not be effective
until 3 years after the date of enactment of the Dodd-Frank Act, and
the Board is authorized to extend the transition period for up to an
additional 2 years.\83\
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\82\ See 12 U.S.C. 5365(e)(5)-(6).
\83\ See 12 U.S.C. 5365(e)(7).
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The concept of single-counterparty credit limits for covered
companies is similar to, but also broader than, existing limits that
operate at the depository institution level of banking organizations,
including the investment securities limits and the lending limits
imposed on depository institutions.\84\ A depository institution
generally is limited, subject to certain exceptions, in the total
amount of investment securities of any one obligor that it may purchase
for its own account to no more than 10 percent of its capital stock and
surplus.\85\ In addition, a depository institution's total outstanding
loans and extensions of credit to one borrower may not exceed 15
percent of the bank's capital stock and surplus, plus an additional 10
percent of the bank's capital and surplus, if the amount that exceeds
the bank's 15 percent general limit is fully secured by readily
marketable collateral.\86\
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\84\ See, e.g., 12 U.S.C. 24(7); 12 U.S.C. 84; 12 CFR parts 1
and 32; see also 12 U.S.C. 335 (applying the provisions of 12 U.S.C.
24(7) to state member banks).
\85\ See 12 U.S.C. 24(7); 12 CFR part 1.
\86\ See 12 U.S.C. 84(a); 12 CFR part 32.
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Section 165(e) is a separate and independent limit from the
investment securities limits and lending limits in the National Bank
Act, and a covered company must comply with all of the limits that are
applicable to it and its subsidiaries. The Board believes that a
covered company should be able to comply with section 165(e) and the
proposed rule implementing it on a consolidated basis, in addition to
complying, as appropriate, with the investment securities limits and
lending limits applicable to a bank subsidiary.
Question 20: How would the limits of section 165(e) and the
proposed rule interact with the other existing limits such as the
investment and lending limits applicable to banks and what other
conflicts might arise in complying with these different regimes?
The financial crisis also revealed weaknesses in the large exposure
limits in place in other major financial markets. These limits also
failed to restrict interconnectedness among large global financial
companies. In response, the BCBS has established a working group to
examine challenges posed by weaknesses and inconsistencies in large
exposure limit regimes across jurisdictions and to carefully evaluate
the merits of reaching an international agreement on large exposure
limits. If an international agreement on large exposure limits for
banking firms is reached, the Board may amend this proposed rule, as
necessary, to achieve consistency with the international approach.
B. Overview of the Proposed Rule
The Board's proposal to implement section 165(e) introduces a two-
tier single-counterparty credit limit, with a more stringent single-
counterparty credit limit applied to the largest covered companies. The
proposed rule includes limits on the exposures of the covered company
as well as its subsidiaries--i.e., any company the parent company
directly or indirectly controls. ``Control'', for purposes of this
proposed rule, would exist when a covered company directly or
indirectly owns or controls 25 percent or more of a class of a
company's voting securities or 25 percent or more of a company's total
equity, or consolidates the company for financial reporting purposes.
The proposal would establish a general limit that prohibits a covered
company from having aggregate net credit exposure to any single
unaffiliated counterparty in excess of 25 percent of the covered
company's capital stock and surplus.\87\ In addition, the proposed rule
would establish a more stringent net credit exposure limit between a
major covered company and any major counterparty, i.e., a major covered
company's aggregate net credit exposure to any major counterparty would
be limited to 10 percent of the capital stock and surplus of the major
covered company.\88\ The proposal would define a ``major covered
company'' as any nonbank covered company or any bank holding company
with total consolidated assets of $500 billion or more.\89\ A ``major
counterparty'' would be defined as any major covered company, as well
as any foreign banking organization that is or is treated as a bank
holding company and that has total consolidated assets of $500 billion
or more.\90\
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\87\ See proposed rule Sec. 252.93(a). This general limit in
the proposed rule follows the 25 percent limit contained in section
165(e) of the Dodd-Frank Act. See 12 U.S.C. 5365(e)(2). Section
165(e) of the Dodd-Frank Act limits credit exposure of a covered
company to any unaffiliated company. 12 U.S.C. 5365(e)(2). The
proposed rule implements the statute by limiting the credit exposure
of a covered company to an unaffiliated ``counterparty'' as defined
in the proposed rule and as discussed further below. See proposed
rule Sec. 252.92(k) (defining ``counterparty'').
\88\ See proposed rule Sec. 252.93(b). Section 165(e)(2) grants
the Board authority to lower the limit on net credit exposure below
25 percent if necessary to mitigate risks to the financial stability
of the United States. See 12 U.S.C. 5365(e)(2).
\89\ See proposed rule Sec. 252.92(aa) (defining ``major
covered company'').
\90\ See proposed rule Sec. 252.92(z).
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The proposed definition of a counterparty would include a natural
person (including the person's immediate family), a company (including
its subsidiaries); the United States (including all of its agencies and
instrumentalities, but not including any State or political subdivision
of a State); a State (including all of its agencies, instrumentalities,
and political subdivisions); and a foreign sovereign entity (including
its agencies, instrumentalities, political subdivisions). Under the
proposal, credit exposures to sovereign entities are made subject to
the credit exposure limits (unless specifically exempted) in the same
manner as credit exposures to companies. As explained further below,
the Board proposes to include sovereign entities in the definition of
counterparty because the Board believes that credit exposures of a
covered company to such governmental entities create risks to the
covered company similar to those created by large exposures to other
types of entities, e.g., privately owned companies.
Both the general and more stringent credit limits would be measured
in terms of a covered company's capital stock and surplus. The proposed
rule would define ``capital stock and surplus'' of a covered company as
its total regulatory capital plus excess loan loss reserves. Under the
proposed rule, the single-counterparty credit limit
[[Page 614]]
would apply to a broad range of transactions with a counterparty, such
as extensions of credit (including loans, deposits, and lines of
credit), securities lending or securities borrowing transactions, as
well as credit derivative or equity derivative transactions in which
the covered company has sold protection to a third party referencing
the counterparty. The proposed rule also would allow the Board to
determine that any similar transaction should be a ``credit
transaction''.
The proposal also specifies how the gross credit exposure on a
credit transaction should be calculated for each type of credit
transaction defined in the proposed rule. For example, the proposed
rule would require that the gross credit exposure of a securities
borrowing transaction be valued at the amount of cash collateral plus
the market value of securities collateral transferred by the covered
company to the counterparty.
The general limit (25 percent of capital stock and surplus) and the
more stringent limit between major covered companies and major
counterparties (10 percent of capital stock and surplus) apply to the
aggregate net credit exposure between the covered company and the
counterparty, or between major covered companies and major
counterparties. The rule would specify how gross credit exposure
amounts are converted to net credit exposure amounts by taking into
account eligible collateral, eligible guarantees, eligible credit and
equity derivative hedges, other eligible hedges (i.e., a short position
in the counterparty's debt or equity security), and for securities
financing transaction, the effect of bilateral netting agreements.
Under the proposed rule, ``eligible collateral'' is generally defined
to include cash on deposit with a covered company (including cash held
for the covered company by a third-party custodian or trustee); debt
securities (other than mortgage- or asset-backed securities) that are
bank-eligible investments; equity securities that are publicly traded;
or convertible bonds that are publicly traded.
An ``eligible guarantee'' is a guarantee that meets certain
criteria described in the proposed rule, including being written by an
eligible protection provider. Similarly, eligible credit or equity
derivative hedges would also be required to be written by an eligible
protection provider and meet certain other criteria. For example, an
eligible credit derivative hedge would have to be in simple form,
including single-name or standard, non-tranched index credit
derivatives. Moreover, an eligible equity derivative hedge would only
include an equity-linked total return swap and would not include other,
more complex equity derivatives, e.g., purchased equity-linked options.
Section-by-Section Analysis
a. Section 252.91: Applicability
Section 252.91 states that, in general, the proposed rule would
apply to a company on the first day of the fifth quarter following the
date on which it became a covered company. Initially, the proposed rule
would not apply to any covered company until October 1, 2013.\91\
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\91\ See proposed rule Sec. 252.91(a)(2); see also 12 U.S.C.
5365(e)(7)(A) (stating that regulations and orders under section
165(e) shall not be effective until 3 years after the date of
enactment of the Dodd-Frank Act).
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Question 21: Should the Board consider a longer phase-in for all or
a subset of covered companies?
b. Section 252.92: Definitions
Section 252.92 of the proposed rule defines the key terms used in
the rule. As discussed above, the limits of the proposed rule apply to
credit exposure of a covered company, including its subsidiaries to any
unaffiliated counterparty. A ``subsidiary'' of a specified company
means a company that is directly or indirectly controlled by the
specified company.\92\ A company would control another company if it
(i) Owns or controls with the power to vote 25 percent or more of a
class of voting securities of the company; (ii) owns or controls 25
percent or more of the total equity of the company; or (iii)
consolidates the company for financial reporting purposes.\93\ The
proposed rule's definition of control would differ from that in the
Bank Holding Company Act and the Board's Regulation Y.\94\ The Board
proposes to vary from the Bank Holding Company Act/Regulation Y
definition of control for purposes of this proposed regulation because
a simpler, more objective definition of control is more consistent with
the objectives of single-counterparty credit limits.
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\92\ See proposed rule Sec. 252.92(jj).
\93\ See proposed rule Sec. 252.92(i). This definition of
control is similar to that in Appendix G of Regulation Y which
states that a person or company controls a company if it (i) owns,
controls, or holds with the power to vote 25 percent or more of a
class of voting securities of the company; or (ii) consolidates the
company for financial reporting purposes. See 12 CFR 225, App. G.
The only difference between the definition from Appendix G and the
proposed rule's definition of control is the addition of the prong
to capture total equity in the proposed rule.
\94\ See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e)(1).
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Question 22: Is the approach of including all subsidiaries of a
covered company in the definition of covered company for purposes of
the proposed rule appropriate? \95\ If not, explain why not.
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\95\ As described below, the same approach to subsidiaries is
used for counterparties that are companies. Such counterparties are
defined to include a company and its subsidiaries, thus requiring
aggregation of the entire organization's credit exposures to the
covered company it faces.
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Question 23: Should the Bank Holding Company Act/Regulation Y
definition of ``control'' be adopted for purposes of the proposed rule?
Are there alternative approaches to defining when a company is a
subsidiary of another the Board should consider?
Under the proposed rule, a fund or vehicle that is sponsored or
advised by a covered company would not be considered a subsidiary of
the covered company unless it was ``controlled'' by that covered
company. A covered company would not control a fund or vehicle that is
sponsored or advised by the covered company if (i) it did not own or
control more than 25 percent of the voting securities or total equity
of the fund or vehicle; and (ii) the fund or vehicle would not be
consolidated with the covered company for financial reporting
purposes.\96\ If a fund or vehicle is not controlled by a covered
company, the exposures of such fund or vehicle to its counterparties
would not be aggregated with those of the covered company.\97\ Such
arm's length treatment, however, may be at odds with the support that
some companies provided during the financial crisis to the funds they
advised and sponsored. For example, many money market mutual fund
(MMMF) sponsors, including banking organizations, supported their MMMFs
during the crisis in order to enable those funds to meet investor
redemption requests without having to sell assets into then-fragile and
illiquid markets.
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\96\ Financial Accounting Standards Board, ASC Section 810,
Consolidation. Further, these requirements are currently under
review. The Board may review the effect any change made to these
consolidation requirements has on whether a covered company is
required to consolidate such fund or vehicle for financial reporting
purposes and amend this rule, as necessary.
\97\ Instead, a non-controlled fund or vehicle would be treated
as a counterparty of the covered company and any exposure or
transaction between those entities would be subject to the limits of
the proposed rule.
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Question 24: Since a covered company may have strong incentives to
provide support in times of distress to MMMFs and certain other funds
or vehicles that it sponsors or advises, the Board seeks comment on
whether such funds or vehicles should be included as part of the
covered company for purposes of this rule.\98\ Is the proposed
[[Page 615]]
rule's definition of ``control'' effective, and should the proposal's
definition of ``subsidiary'' be expanded to include any investment fund
or vehicle advised or sponsored by a covered company or any other
entity?
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\98\ The same issued is raised with respect to the treatment of
funds sponsored and advised by counterparties. Such funds or
vehicles similarly would not be considered to be part of the
counterparty under the proposed rule's definition of control.
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The proposed rule would establish limits on the credit exposure of
a covered company to a single ``counterparty''.\99\ ``Counterparty''
would be defined to mean (i) With respect to a natural person, the
person and members of the person's immediate family, collectively;
\100\ (ii) with respect to a company, the company and all of its
subsidiaries, collectively; (iii) with respect to the United States,
the United States and all of its agencies and instrumentalities (but
not including any State or political subdivision of a State),
collectively; (iv) with respect to a State, the State and all of its
agencies, instrumentalities, and political subdivisions (including
municipalities), collectively; and (v) with respect to a foreign
sovereign entity, the foreign sovereign entity and all of its agencies,
instrumentalities, and political subdivisions, collectively.\101\
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\99\ See proposed rule Sec. 252.93.
\100\ ``Immediate family'' is defined in section 252.92(y) of
the proposed rule.
\101\ See proposed rule Sec. 252.92(k); see also proposed rule
Sec. 252.92(hh) (defining ``sovereign entity'').
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Section 165(e) directs the Board to limit credit exposure of a
covered company to ``any unaffiliated company''.\102\ The Board
included sovereign entities in the definition of counterparty to limit
the vulnerability of a covered company to default by a single sovereign
state, because the Board believes that credit exposures of a covered
company to such governmental entities create risks to the covered
company that are similar to those created by large exposures to other
types of entities. The severe distress or failure of a sovereign entity
could have effects on a covered company that are comparable to those
caused by the failure of a financial firm or nonfinancial corporation
to which the covered company has a large credit exposure. For these
reasons, credit exposures to sovereign governments are made subject to
the credit exposure limits in the same manner as credit exposures to
companies. The Board believes that the authority in the Dodd-Frank Act
and the Board's general safety and soundness authority in associated
banking laws are sufficient to encompass sovereign governments in the
definition of counterparty in this manner.\103\
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\102\ 12 U.S.C. 5365(e)(2)-(3). ``Company'' is defined for
purposes of the proposed rule to mean a corporation, partnership,
limited liability company, depository institution, business trust,
special purpose entity, association, or similar organization. See
proposed rule Sec. 252.92(h).
\103\ See 12 U.S.C. 5365(b)(1)(B)(iv) (allowing the Board to
establish additional prudential standards for covered companies as
the Board, on its own or pursuant to a recommendation made by the
Council in accordance with section 115, determines are appropriate)
and 5368 (providing the Board with general rulemaking authority);
see also section 5(b) of the BHC Act of 1956, as amended (12 U.S.C.
1844(b)); and section 8(b) of FDI Act (12 U.S.C. 1818(b)). Section
5(b) of the BHC Act provides the Board with the authority to issue
such regulations and orders as may be necessary to enable it to
administer and carry out the purposes of the BHC Act. Section 8(b)
of the FDI Act allows the Board to issue to bank holding companies
an order to cease and desist from unsafe and unsound practices.
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As discussed below, certain credit exposures of a covered company
to the U.S. government are exempt from the credit exposure limits.\104\
There is no similar exemption, however, for exposures to U.S. state or
local governments or foreign sovereigns. Accordingly, credit exposures
to U.S. state and local governments and foreign sovereigns would be
subject to the proposed limits.
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\104\ See generally proposed rule Sec. 252.97 (exempting direct
claims on, and portions of claims that are directly and fully
guaranteed as to principal and interest by, the United States and
its agencies and direct claims on, and portions of claims that are
directly and fully guaranteed as to principal and interest by, the
Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation, only while operating under the conservatorship
or receivership of the Federal Housing Finance Agency, and any
additional obligations by a U.S. government sponsored entity as
determined by the Board.)
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Question 25: Should the definition of ``counterparty''
differentiate between types of exposures to a foreign sovereign entity
including exposures to local governments? Should exposures to a company
controlled by a foreign sovereign entity be included in the exposure to
that foreign sovereign entity?
Question 26: Should certain credit exposures to foreign sovereign
entities be exempted from the limitations of the proposed rule--for
example, exposures to foreign central banks necessary to facilitate the
operation of a foreign banking business by a covered company?
The Board also notes that difficult issues are raised in connection
with the valuation of credit exposure arising from direct investments
in or indirect exposures to a collateralized debt obligation (CDO) or
other obligation issued by a special purpose vehicle (SPV). The failure
to look through an SPV to its sponsor or to the issuer of the
underlying assets may serve at times to improperly mask a covered
company's exposure to those parties. Accordingly, under the proposed
reservation of authority, the Board may look through some SPVs either
to the issuer of the underlying assets in the vehicle or to the
sponsor. In the alternative, the Board may require covered companies to
look through to the underlying assets of an SPV but only if the SPV
failed certain discrete concentration tests (such as having more than
20 underlying exposures).
Question 27: How should exposures to SPVs and their underlying
assets and sponsors be treated? What other alternatives should the
Board consider?
The credit exposure of a covered company to an unaffiliated
counterparty is limited to a percentage of the capital stock and
surplus of the covered company.\105\ Under the proposed rule, ``capital
stock and surplus'' of a bank holding company is the sum of the
company's total regulatory capital as calculated under the risk-based
capital adequacy guidelines applicable to that bank holding company
under Regulation Y (12 CFR part 225) and the balance of the allowance
for loan and lease losses of the bank holding company not included in
tier 2 capital under the capital adequacy guidelines applicable to that
bank holding company under Regulation Y (12 CFR part 225).\106\ This
definition of capital stock and surplus is generally consistent with
the definition of the same term in the Board's Regulations O and W and
the OCC's national bank lending limit regulation.\107\ For a nonbank
covered company, ``capital stock and surplus'' includes the total
regulatory capital of such company on a consolidated basis, as
determined under the risk-based capital rules the company is subject to
by rule or order of the Board.\108\
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\105\ See 12 U.S.C. 5365(e)(2); see also proposed rule Sec.
252.93.
\106\ See proposed rule Sec. 252.92(g); see also proposed rule
Sec. 252.92(kk) (defining ``total capital'').
\107\ See 12 CFR 12 CFR 215.3(i); 223.3(d); see also 12 CFR
32.2(b).
\108\ See proposed rule Sec. 252.92(g).
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An alternative measure of ``capital stock and surplus'' might focus
on common equity and, in that respect, be consistent with the post-
crisis global regulatory move toward tier 1 common equity as the
primary measure of loss absorbing capital for internationally active
banking firms. For example, Basel III introduces for the first time a
specific tier 1 common equity requirement and uses tier 1 common equity
measures in its capital conservation buffer and
[[Page 616]]
countercyclical buffer.\109\ In addition the, the BCBS capital
surcharge framework for G-SIBs builds on the tier 1 common equity
requirement in Basel III.\110\ In addition, the Federal Reserve focused
on tier 1 common equity in the SCAP conducted in early 2009 and again
in the CCAR conducted in early 2011 to assess the capacity of bank
holding companies to absorb projected losses.\111\
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\109\ See Basel III framework, supra note 34.
\110\ See BCBS capital surcharge framework, supra note 35.
\111\ See, e.g., The Supervisory Capital Assessment Program:
Overview of Results (May 7, 2009), available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf
(hereinafter SCAP Overview of Results); and 76 FR 74631, 74636
(December 1, 2011).
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Question 28: Are the measures of ``capital stock and surplus'' in
the proposed rule effective in light of the intent and purpose of
section 165(e) or would a measure of ``capital stock and surplus'' that
focuses on tier 1 common equity be more effective? What other
alternatives to the proposed definition of ``capital stock and
surplus'' should the Board consider?
c. Section 252.93: Credit Exposure Limit
Section 252.93 of the proposed rule contains the key quantitative
limitations on credit exposure of a covered company to a single
counterparty.\112\ As noted above, the Board has determined to limit
the ``aggregate net credit exposure'' of a covered company to a
counterparty. ``Aggregate net credit exposure'' is defined to mean the
sum of all net credit exposures of a covered company to a single
counterparty.\113\ As described in detail below, sections 252.94 and
252.95 of the proposed rule explain how to calculate gross and net
credit exposure in order to arrive at the aggregate net credit exposure
relevant to the single-counterparty credit limit in section
252.93.\114\
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\112\ See proposed rule Sec. 252.93.
\113\ See proposed rule Sec. 252.92(c).
\114\ See proposed rule Sec. Sec. 252.94 & 252.95.
---------------------------------------------------------------------------
There are two separate limits contained in section 252.93 of the
proposed rule. The general limit provides that no covered company may
have aggregate net credit exposure to any unaffiliated counterparty
that exceeds 25 percent of the capital stock and surplus of the covered
company.\115\ There is also a second, more stringent limit for
aggregate net credit exposure between major covered companies and major
counterparties. Specifically, no major covered company may have
aggregate net credit exposure to any unaffiliated major counterparty
that exceeds 10 percent of the capital stock and surplus of the major
covered company.\116\ As discussed above, the Dodd-Frank Act grants the
Board authority to impose stricter limits on covered companies with a
larger systemic footprint and indeed requires the Board to impose
stricter single-counterparty credit limits on covered companies with a
larger systemic footprint.
---------------------------------------------------------------------------
\115\ See proposed rule Sec. 252.93(a).
\116\ See proposed rule Sec. 252.93(b).
---------------------------------------------------------------------------
Question 29: What other limits or modifications to the proposed
limits on aggregate net credit exposure should the Board consider?
In accord with the directive of section 165, the proposed rule
imposes a more conservative limit on larger covered companies that have
a larger systemic footprint.\117\ The Board recognizes, however, that
size is only a rough proxy for the systemic footprint of a company.
Additional factors specific to a firm, including the nature, scope,
scale, concentration, interconnectedness, mix of its activities, its
leverage, and its off-balance-sheet exposures, among other factors, may
be determinative of a company's systemic footprint.\118\ The BCBS
proposal on capital surcharges for systemically important banking
organizations, for example, uses a twelve factor approach to determine
the systemic importance of a global banking organization.\119\
Moreover, the Board recognizes that drawing one line through the
covered company population and imposing stricter limits on exposures
between major covered companies and major counterparties may not take
into account nuances that might be captured by other approaches.
---------------------------------------------------------------------------
\117\ See 12 U.S.C. 5365(a).
\118\ See, e.g., 12 U.S.C. 5323(a).
\119\ See BCBS capital surcharge framework, supra note 35.
---------------------------------------------------------------------------
Question 30: Should the Board adopt a more nuanced approach, like
the BCBS approach, in determining which covered companies should be
treated as major covered companies or which counterparties should be
considered major counterparties?
Question 31: Should the Board introduce more granular categories of
covered companies to determine to appropriate net credit exposure
limit? If so, how could such granularity best be accomplished?
Section 165(e) provides the Board with discretion to determine how
a covered company measures the amount of credit exposure in various
transaction types. As noted above, the proposed rule limits aggregate
net credit exposure of a covered company to an unaffiliated
counterparty. ``Aggregate net credit exposure'' is defined in the
proposed rule to be a measure that recognizes certain credit risk
mitigants, including netting agreements for certain types of
transactions, most forms of collateral with a haircut, and guarantees
and other forms of credit protection.\120\ The Board recognizes that
while net credit exposure limits reduce the risk that the failure of a
single counterparty could significantly undermine the financial
strength of a covered company, net limits also understate the level of
interconnectedness among financial companies. While gross credit
exposure limits might more effectively capture interconnectedness among
financial companies, the Board has not proposed supplementary gross
limits at this time due to the tendency of gross limits to
significantly overstate the credit risk inherent in any given
transaction.
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\120\ See proposed rule Sec. 252.92(c) (defining ``aggregate
net credit exposure'') and Sec. 252.95 (describing how to calculate
aggregate net credit exposure taking into accounting netting,
collateral, guarantees and other forms of credit protection).
---------------------------------------------------------------------------
Question 32: Should the Board supplement the net credit exposure
limit with limits on gross credit exposure for all covered companies or
a subset of covered company, i.e., major covered companies? Explain why
or why not.
d. Section 252.94: Gross Credit Exposure
Section 252.94 of the proposed rule explains how a covered company
would be required calculate its ``gross credit exposure'' on a credit
transaction with a counterparty. ``Gross credit exposure'' is defined
to mean, with respect to any credit transaction, the credit exposure of
the covered company to the counterparty before adjusting for the effect
of qualifying master netting agreements, eligible collateral, eligible
guarantees, eligible credit derivatives and eligible equity
derivatives, and other eligible hedges, i.e., a short position in the
counterparty's debt or equity security.\121\ Consistent with the
statutory definition of credit exposure, the proposed rule defines
``credit transaction'' to mean, with respect to a counterparty, any (i)
Extension of credit to the counterparty, including loans, deposits, and
lines of credit, but excluding advised or other uncommitted lines of
credit; (ii) repurchase or reverse repurchase agreement with the
counterparty; (iii) securities lending or securities borrowing
transaction with the counterparty; (iv) guarantee, acceptance, or
letter of credit (including any
[[Page 617]]
confirmed letter of credit or standby letter of credit) issued on
behalf of the counterparty; (v) purchase of, or investment in,
securities issued by the counterparty; (vi) credit exposure to the
counterparty in connection with a derivative transaction between the
covered company and the counterparty; (vii) credit exposure to the
counterparty in connection with a credit derivative or equity
derivative transaction between the covered company and a third party,
the reference asset of which is an obligation or equity security issued
by the counterparty; \122\ and (viii) any transaction that is the
functional equivalent of the above, and any similar transaction that
the Board determines to be a credit transaction for purposes of this
subpart.\123\
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\121\ See proposed rule Sec. 252.92(x). Section 252.95 of the
proposed rule explains how these adjustments are made.
\122\ ``Credit derivative'' and ``equity derivative'' are
defined in sections 252.92(m) and (v) of the proposed rule,
respectively.
\123\ See proposed rule Sec. 252.92 (n). The definition of
``credit transaction'' in the proposed rule is similar to the
definition of ``credit exposure'' in section 165(e) of the Dodd-
Frank Act. See 12 U.S.C. 5365(e)(3).
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Question 33: Are the definitions of ``credit transaction''
appropriate in light of the purpose and intent of the Dodd-Frank Act?
If not, explain why not?
Question 34: What transactions, if any, should be exempt from the
definition of credit transaction?
Section 252.94 describes how the gross credit exposure of a covered
company to a counterparty on a credit transaction should be calculated
for each type of credit transaction described above.\124\ In
particular, section 252.94(a) of the proposed rule provides that, for
purposes of calculating gross credit exposure:
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\124\ See proposed rule Sec. 252.94(a)(1)-(12).
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(i) The value of loans by a covered company to a counterparty (and
leases in which the covered company is the lessor and the counterparty
is the lessee) is equal to the amount owed by the counterparty to the
covered company under the transaction.
(ii) The value of debt securities held by the covered company that
are issued by the counterparty is equal to the greater of (i) the
amortized purchase price or market value for trading and available for
sale securities, or (ii) the amortized purchase price for securities
held to maturity.
(iii) The value of equity securities held by the covered company
that are issued by the counterparty is equal to the greater of the
purchase price or market value.
(iv) The value of repurchase agreements is equal to (i) the market
value of the securities transferred by the covered company to the
counterparty plus (ii) an add-on equal to the market value of the
securities transferred multiplied by the collateral haircut set forth
in section 252.95 (Table 2) that is applicable to the securities
transferred.
(v) The value of reverse repurchase agreements is equal to the
amount of cash transferred by the covered company to the counterparty.
(vi) Securities borrowing transactions are valued at the amount of
cash collateral plus the market value of securities collateral
transferred by the covered company to the counterparty.
(vii) Securities lending transactions are valued at (i) the market
value of the securities lent by the covered company to the counterparty
plus (ii) an add-on equal to the market value of the securities lent
multiplied by the collateral haircut set forth in section 252.95 (Table
2) that is applicable to the securities lent.
(viii) Committed credit lines extended by a covered company to the
counterparty are valued at the face amount of the credit line.
(ix) Guarantees and letters of credit issued by a covered company
on behalf of the counterparty are equal to the maximum potential loss
to the covered company on the transaction.
(x) Derivative transactions between the covered company and the
counterparty not subject to a qualifying master netting agreement, are
valued in an amount equal to the sum of (i) the current exposure of the
derivatives contract equal to the greater of the mark-to-market value
of the derivative contract or zero and (ii) the potential future
exposure of the derivatives contract, calculated by multiplying the
notional principal amount of the derivative contract by the appropriate
conversion factor, set forth in section 252.94 (Table 1).
(xi) Derivative transactions between the covered company and the
counterparty subject to a qualifying master netting agreement, are
valued in an amount equal to the exposure at default amount calculated
under 12 CFR part 225, appendix G, Sec. 32(c)(6).
(xii) Credit or equity derivative transactions between the covered
company and a third party where the covered company is the protection
provider and the reference asset is an obligation or equity security of
the counterparty, are valued in an amount equal to the lesser of the
face amount of the transaction or the maximum potential loss to the
covered company on the transaction.
Question 35: What alternative or additional valuation rules should
the Board consider for calculating gross credit exposure?
Question 36: What impediments to calculating gross credit exposure
in the manner described above would covered companies face?
In the valuation rules described above, trading and available-for-
sale debt securities held by the covered company are valued at the
greater of amortized purchase price or market value in section
252.94(a)(2) of the proposed rule. Similarly, equity securities held by
the covered company are valued at the greater of purchase price or
market value in section 252.94(a)(3) of the proposed rule. The
valuation rule for these types of securities requires a covered company
to revalue upwards the amount of an investment in such securities when
the market value of the securities increases. In these circumstances,
the valuation rule merely reflects the covered company's greater
financial exposure to the counterparty and reduces the covered
company's ability to engage in additional transactions with a
counterparty as the covered company's exposure to the counterparty
increases.
The valuation rules also provide that the amount of the covered
company's investment in these securities can be no less than the
purchase price paid by the covered company for the securities, even if
the market value of the securities declines below the purchase price.
Using the purchase price of the securities as a floor for valuing them
would appear to be appropriate for several reasons. First, it ensures
that the value of the securities never falls below the amount of funds
actually transferred by the covered company to the counterparty in
connection with the investment. Second, the purchase price floor would
limit the ability of a covered company to provide additional funding to
a counterparty as the counterparty approaches insolvency. If the
proposed rule were to value investments in securities issued by a
counterparty strictly at market value, the covered company could lend
substantially more funds to the counterparty as the counterparty's
financial condition worsened. As the financial condition of the
counterparty declines, the market value of the counterparty's
securities held by the covered company would also likely decline,
allowing the covered company to provide additional funding to the
counterparty under the proposed rule. This type of increasing support
for a counterparty in distress could vitiate the public policy goals of
section 165(e) by permitting a covered company to exceed the regulatory
single-counterparty limits through serial credit extensions to a
collapsing counterparty.
[[Page 618]]
Question 37: Does the requirement to use the greater of purchase
price or market value introduce significant burden for covered
companies? Would the use of the market value alone be consistent with
the purposes of section 165(e)?
The add-on included in the gross valuation rule for repurchase
agreements and securities lending transactions (set forth in sections
252.94(a)(4) and 252.94(a)(7)) of the proposed rule is intended to
capture the market volatility (and associated potential increase in
counterparty exposure amount) of the securities transferred or lent by
the covered company in these transactions.
The final gross credit exposure calculation amounts noted in
sections 252.94(a)(10)-(12) of the proposed rule address derivative
transactions. The proposed rule addresses both credit exposure of a
covered company to a derivative counterparty, which is valued as the
sum of the current exposure and the potential future exposure of the
contract, and credit exposure of a covered company to the issuer of the
reference obligation of certain credit and equity derivatives when the
covered company is the protection provider, which is valued on a
notional basis.\125\
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\125\ See proposed rule Sec. 252.94(a)(10)-(12). ``Credit
derivative'' is defined in section 252.92(m) of the proposed rule,
and ``equity derivative'' is defined in section 252.92(v) of the
proposed rule. ``Derivative transaction'' is defined in section
252.92(p) of the proposed rule in the same manner as it is defined
in section 610 of the Dodd-Frank Act. See Dodd-Frank Act, Public Law
111-203, Sec. 610, 124 Stat. 1376, 1611 (2010).
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Question 38: The Board seeks comment on all aspects of the proposed
approach to calculating gross credit exposures for securities financing
and derivative transactions, including the add-on in the proposed gross
valuation rule for repurchase agreements and securities lending
transactions.
The Board recognizes that the credit risk targeted by the
valuation rule for securities lending transactions and repurchase
agreements--i.e., that a counterparty would fail at the same time that
the underlying securities are rising in value--may be smaller than the
credit risk associated with reverse repurchase agreements or securities
borrowing transactions. Should the Board consider a lower add-on than
the haircuts in section 252.95 (Table 2) to reflect this difference? If
so, how should the Board calibrate the add-on?
Will the proposed add-on approach to valuing credit
exposure for securities lending transactions and repurchase agreements
lead to significant changes in current practices in those markets?
Is the valuation approach for a derivative transaction
between a covered company and a counterparty--i.e., a combination of
the current exposure and a measure of potential future exposure of the
contract--appropriate? What alternative valuation approaches for
derivative transactions should the Board consider?
Is the valuation approach for a derivative transaction
between a covered company and a third party appropriate in the case of
a derivative transaction where the covered company is the protection
provider and the reference asset is issued by the counterparty?
The proposed rule generally allows covered companies to calculate
gross credit exposure to a counterparty for derivatives contracts with
that counterparty subject to a qualifying master netting agreement by
using the Basel II-based exposure at default calculation set forth in
the Board's advanced approaches capital rules (12 CFR part 225,
appendix G, Sec. 32(c)(6)).\126\
---------------------------------------------------------------------------
\126\ See proposed rule Sec. 252.95(a). ``Qualifying master
netting agreement'' is defined in section 252.92(ee) of the proposed
rule in a manner consistent with the Board's advanced risk-based
capital rules for bank holding companies.
---------------------------------------------------------------------------
With respect to cleared and uncleared derivatives, the amount of
initial margin and excess variation margin (i.e., variation margin in
excess of that needed to secure the mark-to-market value of a
derivative) posted to a counterparty should be treated as credit
exposure to the counterparty unless the margin is held in a segregated
account at a third party custodian. In the case of cleared derivatives,
a covered company's contributions to the guaranty fund of a central
counterparty (CCP) would be considered a credit exposure to the CCP and
valued at notional amount.\127\
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\127\ The Board notes that it has the authority to deem margin
posted to be a credit exposure as such exposure is part of
counterparty credit exposure to the covered company arising in
connection with a derivative transaction. The Board also has broad
authority in section 165(e) to determine that any similar
transaction is a credit exposure. 12 U.S.C. 5365(e)(3)(E)-(F).
---------------------------------------------------------------------------
Question 39: Should margin posted and contributions to a CCP
guaranty fund be considered a credit exposure for purposes of the
proposed rule? The Board recognizes that there are competing policy
concerns in considering whether to limit a covered company's exposure
to central counterparties. The Board seeks comment on the benefits and
drawbacks of such limits.
Section 252.94(b) of the proposed rule includes the statutory
attribution rule that provides that a covered company must treat a
transaction with any person as a credit exposure to a counterparty to
the extent the proceeds of the transaction are used for the benefit of,
or transferred to, that counterparty.\128\
---------------------------------------------------------------------------
\128\ See proposed rule Sec. 252.94(b); see also 12 U.S.C.
5365(e)(4).
---------------------------------------------------------------------------
The Board notes that an overly broad interpretation of the
attribution rule in the context of section 165(e) would lead to
inappropriate results and would create a daunting tracking exercise for
covered companies. For example, if a covered company makes a loan to a
counterparty that in turn uses the loan to purchase goods from a third
party, the attribution rule could be read to mean that the covered
company would have a credit exposure to that third party, because the
proceeds of the loan with the counterparty are used for the benefit of,
or transferred to, the third party. The Board recognizes the difficulty
in monitoring such transactions and the limited value in tracking such
money flows for purposes of maintaining the integrity of the single-
counterparty credit limit regime. The Board thus proposes to minimize
the scope of application of this attribution rule consistent with
preventing evasion of the single-counterparty credit limit.
Question 40: The Board requests comment on whether the proposed
scope of the attribution rule is appropriate or whether additional
regulatory clarity around the attribution rule would be appropriate.
What alternative approaches to applying the attribution rule should the
Board consider? What is the potential cost or burden of applying the
attribution rule as described above?
e. Section 252.95: Net Credit Exposure
As discussed above, the proposed rule imposes limits on a covered
company's net credit exposure to a counterparty. ``Net credit
exposure'' is defined to mean, with respect to any credit transaction,
the gross credit exposure of a covered company calculated under section
252.94, as adjusted in accordance with section 252.95.\129\ Section
252.95 of the proposed rule explains how to convert gross credit
exposure amounts to net credit exposure amounts by taking into account
eligible collateral, eligible guarantees, eligible credit and equity
derivatives, other eligible hedges (i.e., a short position in the
counterparty's debt or equity security), and for securities financing
transactions, the effect of bilateral netting agreements.\130\
---------------------------------------------------------------------------
\129\ See proposed rule Sec. 252.92(bb).
\130\ See proposed rule Sec. 252.95.
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[[Page 619]]
Collateral
Section 252.95(b) of the proposed rule explains the impact of
eligible collateral when calculating net credit exposure. ``Eligible
collateral'' is defined to include (i) Cash on deposit with a covered
company (including cash held for the covered company by a third-party
custodian or trustee); (ii) debt securities (other than mortgage- or
asset-backed securities) that are bank-eligible investments; (iii)
equity securities that are publicly traded; or (iv) convertible bonds
that are publicly traded.\131\ For any of these asset types to count as
eligible collateral for a credit transaction, the covered company
generally must have a perfected, first priority security interest in
the collateral (or, if outside of the United States, the legal
equivalent thereof). This list of eligible collateral is similar to the
list of eligible collateral in the Basel II standardized capital rules.
---------------------------------------------------------------------------
\131\ See proposed rule Sec. 252.92(q); see also proposed rule
Sec. 252.92(dd) (defining ``publicly traded'').
---------------------------------------------------------------------------
Question 41: Should the list of eligible collateral be broadened or
narrowed?
In computing its net credit exposure to a counterparty for a credit
transaction, a covered company may reduce its gross credit exposure on
a transaction by the adjusted market value of any eligible
collateral.\132\ ``Adjusted market value'' is defined in section
252.92(a) of the proposed rule to mean, with respect to any eligible
collateral, the fair market value of the eligible collateral after
application of the applicable haircut specified in section 252.95
(Table 2) for that type of eligible collateral. The haircuts in Table 2
are consistent with the standard supervisory market price volatility
haircuts in Appendix G to Regulation Y.
---------------------------------------------------------------------------
\132\ See proposed rule Sec. 252.95(b).
---------------------------------------------------------------------------
Question 42: Should a covered company be able to use its own
internal estimates for collateral haircuts as permitted under Appendix
G to Regulation Y?
A covered company has the choice of whether to reduce its gross
credit exposure to a counterparty by the adjusted market value of any
eligible collateral.\133\ If a covered company chooses to reduce its
gross credit exposure by the adjusted market value of eligible
collateral, however, the covered company would be required to include
the adjusted market value of the eligible collateral when calculating
its gross credit exposure to the issuer of the collateral. In effect,
the covered company would have shifted its credit exposure from the
original counterparty to the issuer of the eligible collateral. The
amount of credit exposure to the original counterparty and the issuer
of the eligible collateral will fluctuate over time based on the
adjusted market value of the eligible collateral. Collateral that
previously met the definition of eligible collateral under the proposed
rule but over time ceases to do so would no longer be eligible to
reduce gross credit exposure.
---------------------------------------------------------------------------
\133\ The Board notes that it has the authority to treat
eligible collateral as a gross credit exposure to the collateral
issuer as a consequence of the broad grant of authority to the Board
in section 165(e) to determine that any other similar transaction is
a credit exposure. See 12 U.S.C. 5365(e)(3)(F).
---------------------------------------------------------------------------
A covered company would have the option of whether or not to use
eligible collateral as a credit risk mitigation tool in recognition of
the fact that tracking the market movements of a diverse pool of
collateral can, in some circumstances, be operationally burdensome. In
this respect, a covered company may opt not to recognize eligible
collateral and thus avoiding potentially burdensome tracking of
collateral.
Question 43: Is recognizing the fluctuations in the value of
eligible collateral the correct approach, and what would be the burden
on covered companies in calculating such changes on a daily basis?
Question 44: What is the burden on a covered company associated
with the proposed rule's approach to changes in the eligibility of
collateral? Should the Board instead consider introducing stricter
collateral haircuts for collateral that ceases to be eligible
collateral?
So as not to dis-incentivize overcollateralization, the credit
exposure to the collateral issuer is capped so that it will never
exceed the credit exposure to the original counterparty.\134\ A covered
company would, in every case, continue to have credit exposure to the
original counterparty to the extent that the adjusted market value of
the eligible collateral does not equal the full amount of the credit
exposure to the original counterparty.
---------------------------------------------------------------------------
\134\ See proposed rule Sec. 252.95(b).
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For example, under the proposed rule, the treatment of eligible
collateral would work as follows. Assume a covered company makes a
$1,000 loan to a counterparty, creating $1,000 of gross credit exposure
to that counterparty, and the counterparty provides eligible collateral
issued by a third party that has $700 of adjusted market value. The
covered company may choose to reduce its credit exposure to the
original counterparty by the adjusted market value of the eligible
collateral. As a result, the covered company would have gross credit
exposure of $700 to the issuer of the collateral and $300 net credit
exposure to the original counterparty that posted the collateral.
As noted above, the amount of credit exposure to the original
counterparty and the issuer of the eligible collateral will fluctuate
over time based on movements in the adjusted market value of the
eligible collateral. For example, if the adjusted market value of the
eligible collateral decreases to $400 in the previous example, the
covered company's net credit exposure to the original counterparty
would increase to $600, and its gross credit exposure to the collateral
issuer would decrease to $400. By contrast, in the event of an increase
in the adjusted market value of the eligible collateral to $800, the
covered company's gross credit exposure to the issuer of the eligible
collateral would increase to $800 and its net credit exposure to the
original counterparty would decline to $200. In each case, the covered
company's credit exposure would be capped at the original amount of the
exposure created by the loan or $1,000--even if the adjusted market
value of the eligible collateral exceeded $1,000.
Question 45: Is the approach to eligible collateral that allows the
covered company to choose whether or not to recognize eligible
collateral and shift credit exposure to the issuer of eligible
collateral appropriate? What alternatives to this approach should the
Board consider?
Question 46: Alternatively, should eligible collateral be treated
the same way eligible guarantees and eligible credit and equity
derivative hedges are treated (as described below), thus requiring a
mandatory look-through to eligible collateral?
Unused Credit Lines
Section 252.95(c) of the proposed rule concerns the unused portion
of certain extensions of credit. In computing its net credit exposure
to a counterparty for a credit line or revolving credit facility, a
covered company may reduce its gross credit exposure by the amount of
the unused portion of the credit extension to the extent that the
covered company does not have any legal obligation to advance
additional funds under the facility until the counterparty provides
qualifying collateral equal to or greater than the entire used portion
of the facility.\135\ To qualify for this reduction, the credit
contract must specify that any used portion of the credit extension
must be fully secured at all times by collateral that is either (i)
Cash; (ii)
[[Page 620]]
obligations of the United States or its agencies; or (iii) obligations
directly and fully guaranteed as to principal and interest by, the
Federal National Mortgage Association or the Federal Home Loan Mortgage
Corporation, only while operating under the conservatorship or
receivership of the Federal Housing Finance Agency, and any additional
obligations issued by a U.S. government sponsored entity as determined
by the Board.\136\
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\135\ See proposed rule Sec. 252.95(c).
\136\ Id.
---------------------------------------------------------------------------
Question 47: What alternative approaches, if any, to the proposed
treatment of the unused portion of certain credit facilities should the
Board consider?
Eligible Guarantees
Section 252.95(d) of the proposed rule describes how to reflect
eligible guarantees in calculations of net credit exposure to a
counterparty.\137\ Eligible guarantees are guarantees that meet certain
conditions, including having been written by an eligible protection
provider.\138\ An eligible protection provider includes a sovereign
entity, the Bank for International Settlements, the International
Monetary Fund, the European Central Bank, the European Commission, a
multilateral development bank, a Federal Home Loan Bank, the Federal
Agricultural Mortgage Corporation, a depository institution, a bank
holding company, a savings and loan holding company, a securities
broker or dealer registered with the SEC, an insurance company that is
subject to supervision by a State insurance regulator, a foreign
banking organization, a non-U.S.-based securities firm or non-U.S.-
based insurance company that is subject to consolidated supervision and
regulation comparable to that imposed on U.S. depository institutions,
securities broker-dealers, or insurance companies (as the case may be),
and a qualifying central counterparty.\139\
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\137\ See proposed rule Sec. 252.95(d).
\138\ See proposed rule Sec. 252.92(t) for the definition of
``eligible guarantee'' and for a description of the requirements of
an eligible guarantee.
\139\ See proposed rule Sec. 252.29(u). Eligible credit and
equity derivatives, as described below, also must be written by
eligible protection providers. ``Qualifying central counterparty''
is defined in section 252.92(ee) of the proposed rule.
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Question 48: In what ways should the definition of eligible
protection provider be expanded or narrowed?
Question 49: Are there any additional or alternative requirements
the Board should place on eligible protection providers to ensure their
capacity to perform on their guarantee obligations?
In calculating its net credit exposure to the counterparty, a
covered company would be required to reduce its gross credit exposure
to the counterparty by the amount of any eligible guarantee from an
eligible protection provider.\140\ The covered company would then have
to include the amount of the eligible guarantee when calculating its
gross credit exposure to the eligible protection provider.\141\ Also,
as is the case with eligible collateral, in no event would a covered
company's gross credit exposure to an eligible protection provider with
respect to an eligible guarantee be in excess of its gross credit
exposure to the original counterparty on the credit transaction prior
to the recognition of the eligible guarantee.\142\ The exposure to the
eligible protection provider is effectively capped at the amount of the
credit exposure to the original counterparty even if the amount of the
eligible guarantee is larger than the original exposure. A covered
company would continue to have credit exposure to the original
counterparty to the extent that the eligible guarantee does not equal
the full amount of the credit exposure to the original counterparty.
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\140\ See proposed rule Sec. 252.95(d).
\141\ See proposed rule Sec. 252.95(d)(1).
\142\ See proposed rule Sec. 252.95(d)(2).
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For example, assume a covered company makes a $1,000 loan to an
unaffiliated counterparty and obtains a $700 eligible guarantee on the
loan from an eligible protection provider. The covered company would
have gross credit exposure of $700 to the protection provider as a
result of the eligible guarantee and $300 net credit exposure to the
original counterparty. As a second example, assume a covered company
makes a $1,000 loan to an unaffiliated counterparty and obtains a
$1,500 eligible guarantee from an eligible protection provider. The
covered company would have $1,000 gross credit exposure to the
protection provider (capped at the amount of the original exposure),
but the covered company would have no net credit exposure to the
original counterparty as a result of the eligible guarantee.
The Board proposes to require a covered company to reduce its gross
exposure to a counterparty by the amount of an eligible guarantee in
order to ensure that concentrations in exposures to guarantors are
captured by the regime. This requirement is meant to limit the ability
of a covered company to extend loans or other forms of credit to a
large number of high risk borrowers that are guaranteed by a single
guarantor. The proposed rule also would narrow the set of eligible
protection providers to sovereign entities and regulated financial
companies in order to limit the ability of covered companies to
arbitrage the rule by obtaining multiple small guarantees (each beneath
the covered company's limit) from high-risk guarantors to offset a
large exposure (exceeding the covered company's limit) to a single
counterparty.
Question 50: Should covered companies have the choice of whether or
not to fully shift exposures to eligible protection providers in the
case of eligible guarantees or to divide an exposure between the
original counterparty and the eligible protection provider in some
manner?
Question 51: Would a more conservative approach to eligible
guarantees be more appropriate to penalize financial sector
interconnectedness-for example, one in which the covered company would
be required to recognize gross credit exposure both to the original
counterparty and the eligible protection provider in the full amount of
the original credit exposure? What other alternative approaches to the
treatment of eligible guarantees should the Board consider?
Eligible Credit and Equity Derivative Hedges
Section 252.95(e) describes the treatment of eligible credit and
equity derivatives in the case where the covered company is the
protection purchaser.\143\ In the case where a covered company is a
protection purchaser, such derivatives can be used to mitigate gross
credit exposure and are treated in the same manner as an eligible
guarantee. A covered company may only recognize eligible credit and
equity derivative hedges for purposes of calculating net credit
exposure.\144\ These derivatives must meet certain criteria, including
having been written by an eligible protection provider.\145\ An
eligible credit derivative hedge must be simple in form, including
single-name or standard, non-tranched index credit derivatives. An
eligible equity derivative hedge may only include an
[[Page 621]]
equity-linked total return swap and does not include other more,
complex forms of equity derivatives, such as purchased equity-linked
options.
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\143\ See proposed rule Sec. 252.95(e).
\144\ By contrast, in section 252.94(a)(12) of the proposed
rule, where the covered company is the protection provider, any
credit or equity derivative written by the covered company is
included in the calculation of the covered company's gross credit
exposure to the reference obligor.
\145\ See proposed rule Sec. 252.92(r) and (s) defining
``eligible credit derivative'' and ``eligible equity derivative'',
respectively. ``Eligible protection provider'' is defined in Sec.
252.92(u) of the proposed rule. The same types of organizations that
are eligible protection providers for the purposes of eligible
guarantees are eligible protection providers for purposes of
eligible credit and equity derivatives.
---------------------------------------------------------------------------
Question 52: What types of derivatives should be eligible for
mitigating gross credit exposure and, in particular, are there are more
complex forms of derivatives that should be eligible hedges?
The treatment of eligible credit and equity derivative hedges in
the proposed rule is much like that of guarantees. A covered company
would be required to reduce its gross credit exposure to a counterparty
by the notional amount of any eligible credit or equity derivative
hedge that references the counterparty if the covered company obtains
the derivative from an eligible protection provider.\146\ In these
circumstances, the covered company would be required to include the
notional amount of the eligible credit or equity derivative hedge in
calculating its gross credit exposure to the eligible protection
provider.\147\ As is the case for eligible collateral and eligible
guarantees, the gross exposure to the eligible protection provider may
in no event be greater than it was to the original counterparty prior
to recognition of the eligible credit or equity derivative.\148\
---------------------------------------------------------------------------
\146\ See proposed rule Sec. 252.95(e).
\147\ See proposed rule Sec. 252.95(e)(1).
\148\ See proposed rule Sec. 252.95(e)(2).
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For example, a covered company holds $1,000 in bonds issued by
Company A, and the covered company purchases an eligible credit
derivative in a notional amount of $800 from Protection Provider X,
which is an eligible protection provider, to hedge its exposure to
Company A. The covered company would now treat Protection Provider X as
its counterparty, and has an $800 credit exposure to it. The covered
company also continues to have credit exposure of $200 to Company A.
Similarly, consider the case of an eligible equity derivative, where a
covered company holds $1,000 in equity securities issued by Company B
and purchases an eligible equity-linked total return swap in a notional
amount of $700 from Protection Provider Y, an eligible protection
provider, to hedge its exposure to Company B. The covered company would
now treat Protection Provider Y as its counterparty, and has a credit
exposure to it of $700. The covered company also has credit exposure to
Company B of $300.
The proposed rule generally treats eligible credit and equity
derivatives in the same manner as non-derivative credit enhancement
instruments such as eligible guarantees, and requires covered companies
generally to consider themselves as having credit exposure to the
protection provider in an amount equal to the notional or face value of
the hedge instrument. In essence, the rule only recognizes simple
derivative hedges on a transaction-to-transaction basis. The rule does
not accommodate proxy hedging or portfolio hedging and uses a simple
substitution approach of guarantor for obligor.
Question 53: What alternative approaches, if any, should the Board
consider to capture the risk mitigation benefits of proxy or portfolio
hedges or to permit covered companies to use internal models to measure
potential exposures to sellers of credit protection?
Question 54: Should covered companies have the choice to recognize
and shift exposures to protection providers in the case of eligible
credit or equity derivative hedges or to apportion the exposure between
the original counterparty and the eligible protection provider?
Question 55: Would a more conservative approach to eligible credit
or equity derivative hedges be more appropriate, such as one in which
the covered company would be required to recognize gross notional
credit exposure both to the original counterparty and the eligible
protection provider?
Other Eligible Hedges
In addition to eligible credit and equity derivatives, a covered
company may reduce exposure to a counterparty by the face amount of a
short sale of the counterparty's debt or equity security.
Question 56: Rather than requiring firms to calculate gross trading
exposures and offset that exposure with eligible credit and equity
derivatives or short positions, should the Board allow covered
companies to use internal pricing models to calculate the net mark-to-
market loss impact of an issuer default, applying a zero percent
recovery rate assumption, to all instruments and positions in the
trading book? Under this approach, gains and losses would be estimated
using full revaluation to the greatest extent possible, and simply
summed. For derivatives products, all pricing inputs other than those
directly related to the default of the issuer would remain constant.
Similar to the proposed approach, only single-name and index credit
default swaps, total return swaps, or equity derivatives would be
included in this valuation. Would such a models-based approach better
reflect traded credit exposures? If so, why?
Netting of Securities Financing Transactions
In calculating its credit exposure to a counterparty, a covered
company may net the gross credit exposure amounts of (i) its repurchase
and reverse repurchase transactions with a counterparty, and (ii) its
securities lending and borrowing transactions with a counterparty, in
each case, where the transactions are subject to a bilateral netting
agreement with that counterparty.
e. Section 252.96: Compliance
Section 252.96(a) of the proposed rule indicates that a covered
company must comply with the requirements of the proposed rule on a
daily basis as of the end of each business day and must submit a
monthly compliance report.\149\ Section 252.96(b) addresses the
consequences if a covered company fails to comply with the proposed
rule.\150\ This section states that if a covered company is not in
compliance with respect to a counterparty due to a decrease in the
covered company's capital, the merger of a covered company with another
covered company, or the merger of two unaffiliated counterparties of
the covered company, the covered company will not be subject to
enforcement actions with respect to such noncompliance for a period of
90 days (or such shorter or longer period determined by the Board to be
appropriate to preserve the safety and soundness of the covered company
or financial stability) if the company uses reasonable efforts to
return to compliance with the proposed rule during this period. The
covered company may not engage in any additional credit transactions
with such a counterparty in contravention of this rule during the
compliance period, except in cases where the Board determines that such
additional credit transactions are necessary or appropriate to preserve
the safety and soundness of the covered company or financial stability.
In granting approval for any such special temporary exceptions, the
Board may impose supervisory oversight and reporting measures that it
determines are appropriate to monitor compliance with the foregoing
standards. The Board notes that section 165(e) of the Dodd-Frank Act
contains a provision allowing the Board to exempt transactions, in
whole or part, from the definition of the term ``credit exposure'' if
the Board finds that the exemption is in the public
[[Page 622]]
interest and is consistent with the purposes of this subsection.\151\
---------------------------------------------------------------------------
\149\ See proposed rule Sec. 252.96(a). Also, see supra note
17.
\150\ See proposed rule Sec. 252.96(b).
\151\ See 12 U.S.C. 5365(e)(6).
---------------------------------------------------------------------------
Question 57: Are there additional non-compliance circumstances for
which some cure period should be provided?
Question 58: Is the 90-day cure period appropriate and is it
appropriate to generally prohibit additional credit transactions with
the affected counterparty during the cure period? If not, why not?
Section 252.97: Exemptions
Section 252.97 of the proposed rule sets forth certain
exemptions.\152\ Section 165(e)(6) of the Dodd-Frank Act states that
the Board may, by regulation or order, exempt transactions, in whole or
in part, from the definition of the term ``credit exposure'' for
purposes of this subsection, if the Board finds that the exemption is
in the public interest and is consistent with the purposes of this
subsection.\153\
---------------------------------------------------------------------------
\152\ See proposed rule Sec. 252.97.
\153\ See 12 U.S.C. 5365(e)(6).
---------------------------------------------------------------------------
The first exemption is for direct claims on, and the portions of
claims that are directly and fully guaranteed as to principal and
interest by the United States and its agencies.\154\ The exemption in
section 252.97 of the proposed rule clarifies that, despite the fact
that the United States is defined as a counterparty, a covered
company's credit exposures to the U.S. government are exempt. Thus,
exposures to the U.S. government will not be subject to the limits of
the proposed rule. This includes direct holdings of securities issued
by the U.S. government and indirect exposure such as the case where
U.S. government securities are pledged as collateral. Section 252.95(b)
of the proposed rule provides a covered company with the option to
shift credit exposure to the issuer of eligible collateral.\155\ Where
the eligible collateral pledged is U.S. government securities that are
directly and fully guaranteed as to principal and interest by the
United States and its agencies, the credit exposure would be exempted.
---------------------------------------------------------------------------
\154\ See proposed rule Sec. 252.97(a)(1).
\155\ See proposed rule Sec. 252.95(b).
---------------------------------------------------------------------------
Question 59: Is the scope of the exemption for direct claims on,
and the portions of claims that are directly and fully guaranteed as to
principal and interest by, the United States and it agencies
appropriate? If not, explain the reasons why in detail and indicate
whether there are alternatives the Board should consider. Are there
other governmental entities that should receive an exemption from the
limits of the proposed rule?
A second exemption from the proposed rule is for direct claims on,
and the portions of claims that are directly and fully guaranteed as to
principal and interest by, the Federal National Mortgage Association
and the Federal Home Loan Mortgage Corporation, while these entities
are operating under the conservatorship or receivership of the Federal
Housing Finance Agency.\156\ This provision reflects a policy decision
that credit exposures to these government-sponsored entities should not
be subject to a regulatory limit for so long as the entities are in the
conservatorship or receivership of the U.S. government. As determined
by the Board, obligations issued by another U.S. government-sponsored
entity would also be exempt. The Board requests comment on whether
these exemptions are appropriate.
---------------------------------------------------------------------------
\156\ See proposed rule Sec. 252.97(a)(2).
---------------------------------------------------------------------------
The third exemption from the proposed rule is for intraday credit
exposure to a counterparty.\157\ As noted above, the proposed rule
requires compliance on a daily end-of-business day basis.\158\ This
exemption would help minimize the impact of the rule on the payment and
settlement of financial transactions. The Board requests comment on
whether the exemption for intraday transactions is appropriate in light
of the intent and purpose of the proposed rule.
---------------------------------------------------------------------------
\157\ See proposed rule Sec. 252.97(a)(3).
\158\ See proposed rule Sec. 252.96(a).
---------------------------------------------------------------------------
The fourth exemption implements section 165(e)(6) of the Dodd-Frank
Act and provides a catchall category to exempt any transaction which
the Board determines to be in the public interest and consistent with
the purposes of section 165(e).\159\
---------------------------------------------------------------------------
\159\ See 12 U.S.C. 5365(e)(6); proposed rule Sec.
252.97(a)(4).
---------------------------------------------------------------------------
Question 60: Should other credit exposures be exempted from the
limitations of the proposed rule. If so, explain why?
Section 252.97(b) of the proposed rule implements section 165(e)(6)
of the Dodd-Frank Act, which provides an exemption for Federal Home
Loan Banks.
VI. Risk Management
A. Background
The recent financial crisis highlighted the need for large, complex
financial companies to have more robust, enterprise-wide risk
management. A number of companies that experienced material financial
distress or failed during the crisis had significant deficiencies in
key areas of risk management. Two recent reviews of risk management
practices of banking companies conducted by the Senior Supervisors
Group (SSG) illustrated these deficiencies.\160\
---------------------------------------------------------------------------
\160\ See 2008 SSG Report and 2009 SSG, supra notes 58 and 59.
---------------------------------------------------------------------------
The SSG found that effective oversight of an organization as a
whole is one of the most fundamental requirements of prudent risk
management. For example, the SSG found that business line and senior
risk managers did not jointly act to address a company's risks on an
enterprise-wide basis; business line managers made decisions in
isolation and at times increased, rather than mitigated, risk; and
treasury functions were not closely aligned with risk management
processes, preventing market and counterparty risk positions from being
readily assessed on an enterprise-wide basis.\161\
---------------------------------------------------------------------------
\161\ See 2008 SSG Report, supra note 58, at 3-5.
---------------------------------------------------------------------------
The SSG reviews also revealed that solid senior management
oversight and engagement was a key factor that differentiated
companies' performance during the crisis. Senior managers at successful
companies were actively involved in risk management, which includes
determining the company's overall risk preferences and creating the
incentives and controls to induce employees to abide by those
preferences. Successful risk management also depends on senior managers
having access to adaptive management information systems to identify
and assess risks based on a range of dynamic measures and assumptions.
In addition, the SSG found that active involvement of the board of
directors in determining a company's risk tolerance was critical to
effective risk management and curbing of excessive risk taking. The SSG
reported that ``firms are more likely to maintain a risk profile
consistent with the board and senior management's tolerance for risk if
they establish risk management committees that discuss all significant
risk exposures across the firm * * * [and] meet on a frequent basis * *
*.'' \162\
---------------------------------------------------------------------------
\162\ See 2008 SSG Report, supra note 58, at 8; see also 2009
SSG Report, supra note 59, at 2-5.
---------------------------------------------------------------------------
Section 165(b)(1)(A) of the Dodd-Frank Act requires the Board to
establish overall risk management requirements as part of the
prudential standards to ensure that strong risk management standards
are part of the regulatory and supervisory framework
[[Page 623]]
for covered companies.\163\ More generally, section 165(h) of the Dodd-
Frank Act directs the Board to issue regulations requiring publicly
traded nonbank covered companies and publicly traded bank holding
companies with total consolidated assets of $10 billion or more to
establish risk committees.\164\ Under the statute, a risk committee
required by section 165(h) must be responsible for the oversight of
enterprise-wide risk management practices of the company, include such
number of independent directors as the Board may determine appropriate,
and include at least one risk management expert having experience in
identifying, assessing, and managing risk exposures of large, complex
financial firms.
---------------------------------------------------------------------------
\163\ 12 U.S.C. 5365(b)(1)(A).
\164\ 12 U.S.C. 5365(h).
---------------------------------------------------------------------------
The Board is proposing to address the risk management weaknesses
observed during the recent crisis and implement the risk management
requirements of the Dodd-Frank Act by establishing risk management
standards for all covered companies that would (i) Require oversight of
enterprise-wide risk management by a stand-alone risk committee of the
board of directors and chief risk officer (CRO); (ii) reinforce the
independence of a firm's risk management function; and (iii) ensure
appropriate expertise and stature for the chief risk officer. The
proposal would also require bank holding companies with total
consolidated assets of $10 billion or more that are publicly traded and
are not covered companies (over $10 billion bank holding companies) to
establish an enterprise-wide risk committee of the board of directors.
Over $10 billion bank holding companies that are not covered companies
and are not publicly traded would not be subject to the risk management
requirements in this proposal.
The proposed rule seeks to address the risk management problems
noted by the SSG and others by mandating the major responsible parties
within a company for its enterprise-wide risk management: the risk
committee and the CRO. The proposal sets out certain responsibilities
of a risk committee, which include the oversight and documentation of
the enterprise-wide risk management practices of the company. The
proposal also would establish various requirements for a risk
committee, including membership with appropriate risk management
expertise and an independent chair. The proposed rule also requires a
covered company to employ a CRO who will implement appropriate
enterprise-wide risk management practices and report to the covered
company's risk committee and chief executive officer.
These standards should help address the risk management failures
observed during the crisis and their potential contribution to the
failure or instability of financial companies by mandating an
enterprise-wide structure for managing risk and identifying the
responsible parties that supervisors will look to when evaluating a
company's risk management practices. This should facilitate more
effective identification and management of the company's risk as well
as supervisors' ability to monitor the risk management of companies
subject to the rule.
In addition, the proposed standards seek to meet the requirements
of the Dodd-Frank Act by imposing regulatory standards for risk
management on covered companies and over $10 billion bank holding
companies that are publicly traded. The Board does not currently impose
regulatory risk management standards on bank holding companies
generally; the Board traditionally has addressed risk management
through supervisory guidance. The proposed standards would be more
stringent for risk committees of covered companies than for risk
committees of over $10 billion bank holding companies. The Board
expects the expertise of the risk committee membership to be
commensurate with the complexity and risk profile of the organizations.
Thus, the requirements of the proposed rule would increase in
stringency with the systemic footprint of the company.
The Board emphasizes that the risk committee and overall risk
management requirements contained in the proposed rule supplement the
Board's existing risk management guidance and supervisory
expectations.\165\ All banking organizations supervised by the Board
should continue to follow such guidance to ensure appropriate oversight
of and limitations on risk.
---------------------------------------------------------------------------
\165\ See Supervision and Regulation Letter SR 08-8 (Oct. 16,
2008), available at http://www.federalreserve.gov/boarddocs/srletters/2008/SR0808.htm, and Supervision and Regulation Letter SR
08-9 (Oct. 16, 2008), available at http://www.federalreserve.gov/boarddocs/srletters/2008/SR0809.htm.
---------------------------------------------------------------------------
B. Overview of the Proposed Rule
1. Risk Committee Requirements
The proposed rule would require that each covered company and each
over $10 billion bank holding company establish a risk committee of the
board of directors to document and oversee, on an enterprise-wide
basis, the risk management practices of the company's worldwide
operations. Additional proposed requirements relating to the structure
and responsibilities of such risk committees are described below.
a. Structure of Risk Committee
Section 252.126(b) of the proposed rule establishes requirements
governing the membership and proceedings of a company's risk committee.
Consistent with section 165(h)(3)(B) of the Act, the Board proposes
that a covered company and over $10 billion bank holding company's risk
committee must be chaired by an independent director. The Board views
the active involvement of independent directors as vital to robust
oversight of risk management and encourages companies generally to
include additional independent directors as members of their risk
committees.
The concept of director independence is a concept familiar in
federal securities law. To promote consistency, the Board proposes to
refer to the definition of ``independent director'' in the Securities
and Exchange Commission's (SEC) Regulation S-K for companies that are
publicly traded in the United States. Under this definition, the Board
would not consider a director to be independent unless the company
indicates in its securities filings, pursuant to the SEC's Regulation
S-K, that the director satisfies the applicable independence
requirements of the securities exchange on which the company's
securities are listed. These independence requirements generally
include limitations on compensation paid to the director or director's
family members by the company and prohibitions on material business
relationships between the director and the company. In all cases, and
consistent with the listing standards of many securities exchanges, the
proposed rule excludes from the definition of ``independent director''
a director who is or recently was employed by the company or whose
immediate family member is or recently was an executive officer of the
company.
In the case of a director of a covered company that is not publicly
traded in the United States, the proposed rule would provide that the
director is independent only if the company demonstrates to the
satisfaction of the Federal Reserve that such director would qualify as
an independent director under the listing standards of a securities
exchange, if the company were publicly traded on such an exchange. The
Board proposes to make these determinations on a case-by-case basis, as
appropriate. At a minimum, the
[[Page 624]]
proposed rule provides that the Board would not find a director to be
independent if the director or a member of the director's immediate
family member is or recently was an executive officer of the company.
In making independence determinations, the Board expects to analyze
other indicia of independence, including compensation limitations and
business relationship prohibitions discussed above.
In addition to the independent director requirements, the proposed
rule would require at least one member of a company's risk committee to
have risk management expertise that is commensurate with the company's
capital structure, risk profile, complexity, activities, size, and
other appropriate risk-related factors. However, given the importance
of risk management oversight, the Board expects that a risk committee's
members generally will have an understanding of risk management
principles and practices relevant to the company. Risk committee
members should also have experience developing and applying risk
management practices and procedures, measuring and identifying risks,
and monitoring and testing risk controls with respect to banking
organizations (or, if applicable, nonbank financial companies).
The Board believes that the requisite level of risk management
expertise for a company's risk committee can vary depending on the
risks posed by the company to the stability of the U.S. financial
system. The Board expects that a company's risk committee members
should have risk management expertise commensurate with the company's
capital structure, risk profile, complexity, activities, size and other
appropriate risk-related factors. Thus, the Board expects that the risk
committees of covered companies that pose greater risks to the U.S.
financial system would have members with commensurately greater risk
management expertise than the risk committees of other companies that
pose less risk.
The proposed rule also would establish certain procedural
requirements for risk committees. Specifically, the proposed rule would
require a company's risk committee to have a formal, written charter
that is approved by the company's board of directors. In addition, the
proposed rule would require that a risk committee meet regularly and as
needed, and that the company fully document and maintain records of
such proceedings, including risk management decisions. The Board
expects that these procedural requirements will help ensure that a
company's risk management has the appropriate stature within the
company's corporate governance framework.
Question 61: Should the Board consider specifying by regulation
additional qualifications for director independence? If so, what
factors should the Board consider in establishing these qualifications?
Question 62: Would it be appropriate for the Board to require the
membership of a risk committee to include more than one independent
director under certain circumstances? If so, what factors should the
Board consider in establishing these requirements?
Question 63: Should the Board consider specifying by regulation the
minimum qualifications, including educational attainment and
professional experience, for risk management expertise on a risk
committee?
Question 64: What alternatives to the requirements for the
structure of the risk committee and related requirements should the
Board consider?
b. Responsibilities of Risk Committee
Section 252.126(c) of the proposed rule sets out certain
responsibilities of a risk committee. The proposed rule would generally
require a company's risk committee to document and oversee the
enterprise-wide risk management policies and practices of the company.
Consistent with the enterprise-wide risk management requirement in
section 165(h)(3)(A) of the Act, a company's risk committee would be
required to take into account both its U.S. and foreign operations as
part of its risk management oversight.
The proposed rule would require a risk committee to review and
approve an appropriate risk management framework that is commensurate
with the company's capital structure, risk profile, complexity,
activities, size, and other appropriate risk-related factors. The
proposed rule specifies that a company's risk management framework must
include: Risk limitations appropriate to each business line of the
company; appropriate policies and procedures relating to risk
management governance, risk management practices, and risk control
infrastructure; processes and systems for identifying and reporting
risks, including emerging risks; monitoring compliance with the
company's risk limit structure and policies and procedures relating to
risk management governance, practices, and risk controls; effective and
timely implementation of corrective actions; specification of
management's authority and independence to carry out risk management
responsibilities; and integration of risk management and control
objectives in management goals and the company's compensation
structure.
In general, the Board believes that larger and more complex
companies should have more robust risk management practices and
frameworks than smaller, less complex companies. Accordingly, as a
company grows or increases in complexity, the company's risk committee
should ensure that its risk management practices and framework adapt to
changes in the company's operations and the inherent level of risk
posed by the company to the U.S. financial system.
Question 65: What is the appropriate role of the members of the
risk committee in overseeing enterprise-wide risk management practices
at the company and is that role effectively addressed by this proposal?
Question 66: Is the scope of review of enterprise-wide risk
management that this proposal would require appropriate for a committee
of the board of directors? Why or why not?
Question 67: How can the Board ensure that risk committees at
companies have sufficient resources to effectively carry out the
oversight role described in this proposal?
2. Additional Enhanced Risk Management Standards for Covered Companies
Consistent with section 165(b)(1)(A)(iii) of the Dodd-Frank Act,
the proposed rule establishes certain overall risk management standards
for covered companies. These enhanced standards are in addition to, and
in some cases expand upon, the risk committee requirements discussed
above that apply to covered companies and over $10 billion bank holding
companies.
a. Appointment of CRO
The Board believes that, in light of the complexity and size of a
covered company's operations, it is important for each covered company
to have a designated executive officer in charge of implementing and
maintaining the risk management framework and practices approved by the
risk committee. Accordingly, section 252.126(d) of the proposed rule
directs each covered company to appoint a CRO to implement and maintain
appropriate enterprise-wide risk management practices for the company.
The proposed rule provides that the specific responsibilities of a
covered company's CRO must include direct oversight for: allocating
delegated risk
[[Page 625]]
limits and monitoring compliance with such limits; establishing
appropriate policies and procedures relating to risk management
governance, practices, and risk controls; developing appropriate
processes and systems for identifying and reporting risks, including
emerging risks; managing risk exposures and risk controls; monitoring
and testing risk controls; reporting risk management issues and
emerging risks; and ensuring that risk management issues are
effectively resolved in a timely manner. The proposed rule specifies
that these responsibilities are to be executed on an enterprise-wide
basis.
Under the proposed rule, a CRO would be required to have risk
management expertise that is commensurate with the covered company's
capital structure, risk profile, complexity, activities, size, and
other appropriate risk related factors. For example, the Board would
expect that an executive whose qualifications and experience are highly
focused in a specific area (e.g., an executive whose primary skills
relate to the risks taken by a firm engaged predominantly in consumer
or commercial lending) would be unlikely to possess the expertise
necessary to effectively manage the risks taken by a firm engaged in
more diverse activities (e.g., a large, more complex universal banking
organization).
In light of the CRO's central role in ensuring the effective
implementation of a covered company's risk management practices, the
proposed rule would require a covered company's CRO to report directly
to the risk committee and the chief executive officer. Further, the
proposed rule would require that the compensation of a covered
company's CRO be appropriately structured to provide for an objective
assessment of the risks taken by the covered company. This requirement
supplements existing Board guidance on incentive compensation.
Question 68: Should the Board consider specifying by regulation the
minimum qualifications, including educational attainment and
professional experience, for a CRO? If so, what type of additional
experience or education is generally expected in the industry for
positions of this importance?
Question 69: What alternative approaches to implementing the risk
committee requirements established pursuant to the Dodd-Frank Act
should the Board consider?
b. Additional Risk Committee Requirements for Covered Companies
The Board proposes that risk committees of covered companies should
meet certain additional requirements beyond those described above to
ensure that covered companies' risk committees are appropriately
structured to oversee the risk of a company with a significant role in
the U.S. financial system. Specifically, the Board believes that best
practices for covered companies require a risk committee that reports
directly to the Board and not as part of or combined with another
committee. Thus, section 252.126(b)(5)(i) of the proposed rule would
require that a covered company's risk committee not be housed within
another committee or be part of a joint committee. In addition, section
252.126(b)(5)(ii) of the proposed rule would require a covered
company's risk committee to report directly to the covered company's
board of directors.
As mentioned above, the proposed rule requires a covered company's
CRO to report to the company's risk committee. To ensure that a covered
company's risk committee appropriately considers and evaluates the
information it obtains from the CRO, the proposed rule would direct a
covered company's risk committee to receive and review regular reports
from the covered company's CRO.
Request for Comment
The Board requests comment on all aspects of this proposal.
VII. Stress Test Requirements
A. Background
As part of the effort during the recent crisis to stabilize the
U.S. financial system, the Federal Reserve began stress testing large,
complex bank holding companies as a forward-looking exercise designed
to estimate losses, revenues, allowance for loan losses and capital
needs under various economic and financial market scenarios. In early
2009, the Federal Reserve led the Supervisory Capital Assessment
Program (SCAP) as a key element of the plan to stabilize the U.S.
financial system. By looking at the broad capital needs of the
financial system and the specific needs of individual companies, these
stress tests provided valuable information to market participants and
had an overall stabilizing effect.
Building on SCAP and other supervisory work coming out of the
crisis, the Federal Reserve initiated the annual Comprehensive Capital
Analysis and Review (CCAR) in late 2010 to assess the capital adequacy
and evaluate the internal capital planning processes of large, complex
bank holding companies. The CCAR represents a substantial strengthening
of previous approaches to assessing capital adequacy and aiming to
ensure that large organizations have thorough and robust processes for
managing and allocating their capital resources. The CCAR also focuses
on the risk measurement and management practices supporting
organizations' capital adequacy assessments, including their ability to
deliver credible inputs to their loss estimation techniques.
Building on the SCAP and CCAR, the Board proposes to implement
section 165(i)(1) of the Dodd-Frank Act, which requires the Board to
conduct annual analyses of the financial condition of covered companies
to evaluate the potential effect of adverse economic and financial
market conditions on the capital of these companies (supervisory stress
tests). The Board also proposes to implement section 165(i)(2) of the
Act, which requires the Board to issue regulations that (i) require
financial companies with total consolidated assets of more than $10
billion and for which the Board is the primary federal financial
regulatory agency to conduct stress tests on an annual basis, and (ii)
require covered companies to conduct semi-annual stress tests (together
company-run stress tests).
The supervisory stress tests involve the Board's analyses of the
capital of each covered company, on a total consolidated basis, and an
evaluation of the ability of the covered company to absorb losses as a
result of adverse economic and financial conditions. The Act requires
the Board to provide for at least three different possible sets of
conditions--baseline, adverse, and severely adverse conditions--under
which the Board would conduct this evaluation.\166\ The Act also
requires the Board to publish a summary of the supervisory stress test
results.\167\
---------------------------------------------------------------------------
\166\ See 12 U.S.C. 5365(i)(1).
\167\ Id.
---------------------------------------------------------------------------
For the company-run stress tests, the Act requires that the Board
issue regulations that: (i) Define the term ``stress test'' for
purposes of the regulations; (ii) establish methodologies for the
conduct of the company-run stress tests that provide for at least three
different sets of conditions, including baseline, adverse, and severely
adverse conditions; (iii) establish the form and content of a required
report on the company-run stress tests that companies subject to the
regulation must submit to the Board; and (iv) require subject companies
to publish a summary of the results of the required stress tests.\168\
---------------------------------------------------------------------------
\168\ See 12 U.S.C. 5365(i)(2).
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[[Page 626]]
B. Overview of the Proposed Rule
1. Annual Supervisory Stress Tests Conducted by the Board
a. Purpose
The Board has long held the view that bank holding companies
generally should operate with capital positions well above the minimum
regulatory capital ratios, with an amount of capital that is
commensurate with each bank holding company's risk profile.\169\ Bank
holding companies should have internal processes for assessing their
capital adequacy that reflect a full understanding of the risks
associated with all aspects of their operations and ensure that they
hold capital commensurate with those risks.\170\ Stress testing is one
tool that helps both supervisors and supervised companies ensure that
there is adequate capital through periods of stress.
---------------------------------------------------------------------------
\169\ See 12 CFR part 225, appendix A; see also Supervision and
Regulation Letter SR 99-18 (July 1, 1999), available at http://www.federalreserve.gov/boarddocs/srletters/1999/SR9918.htm
(hereinafter SR 99-18).
\170\ See Supervision and Regulation Letter SR 09-4 (revised
March 27, 2009), available at http://www.federalreserve.gov/boarddocs/srletters/2009/SR0904.htm (hereinafter SR 09-4).
---------------------------------------------------------------------------
The stress testing requirements described below are designed to
work in tandem with the Board's capital plan rule \171\ to allow the
Federal Reserve and covered companies to better understand the full
range of their risks and the potential impact of stressful events and
circumstances on their overall capital adequacy and financial
condition. The Board and the other federal banking agencies previously
have highlighted the use of stress testing as a means to better
understand the range of a banking organization's potential risk
exposures.\172\ The 2007-2009 financial crisis further underscored the
need for banking organizations to incorporate stress testing into their
risk management, as banking organizations that are unprepared for
stressful events and circumstances are more vulnerable to acute threats
to their financial condition and viability.\173\
---------------------------------------------------------------------------
\171\ See 12 CFR 225.8.
\172\ See, e.g., 76 FR 35072 (June 15, 2011); Supervision and
Regulation Letter SR 10-6, Interagency Policy Statement on Funding
and Liquidity Risk Management (March 17, 2010), available at http://www.federalreserve.gov/boarddocs/srletters/2010/sr1006.htm;
Supervision and Regulation Letter SR 10-1, Interagency Advisory on
Interest Rate Risk (January 11, 2010), available at http://www.federalreserve.gov/boarddocs/srletters/2010/sr1001.htm; SR 09-4,
supra note 170; Supervision and Regulation Letter SR 07-1,
Interagency Guidance on Concentrations in Commercial Real Estate
(January 4, 2007), available at http://www.federalreserve.gov/boarddocs/srletters/2007/SR0701.htm; SR 99-18, supra note 169;
Supervisory Guidance: Supervisory Review Process of Capital Adequacy
(Pillar 2) Related to the Implementation of the Basel II Advanced
Capital Framework, 73 FR 44620 (July 31, 2008); SCAP Overview of
Results, supra note 111; and Comprehensive Capital Analysis and
Review: Objectives and Overview (March 18, 2011), available at
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20110318a1.pdf.
\173\ See Basel Committee on Banking Supervision, Principles for
Sound Stress Testing Practices and Supervision (May 2009), available
at http://www.bis.org/publ/bcbs155.htm.
---------------------------------------------------------------------------
The supervisory stress tests would provide supervisors with
forward-looking information to help them identify downside risks and
the potential impact of adverse outcomes on capital adequacy at covered
companies. Supervisory stress tests would also provide a means to
assess capital adequacy across companies more fully and support the
Board's financial stability efforts. In addition, the publication of
summary results from supervisory stress tests would enhance public
disclosure of information about covered companies' financial condition
and the ability of those companies to absorb losses as a result of
adverse economic and financial conditions. Inputs from the supervisory
stress tests, along with the results of any company-run stress tests,
would be used by the Federal Reserve in its supervisory evaluation of a
covered company's capital plan.
Table 1--Process Overview of Annual Supervisory Stress Test and Capital Plan Cycle
----------------------------------------------------------------------------------------------------------------
Supervisory stress test steps Capital plan steps Proposed timeframe
----------------------------------------------------------------------------------------------------------------
Regulatory reports submitted (using data ............................... By Mid-November.
as of Sept. 30 and other required
information).
Capital plan submitted By January 5.
(including individual results
of company-run stress tests).
Board communicates results to each ............................... By early March.
covered company.
Federal Reserve response to By March 31.
capital plan.
Board publishes summary results of the ............................... By Mid-April.
supervisory stress test.
----------------------------------------------------------------------------------------------------------------
The design of the supervisory stress tests focuses on determining
post-stress capital positions at covered companies to inform
assessments of capital adequacy. Because the Board's supervisory stress
tests would be standardized across covered companies and not adjusted
for each company, they are not expected to fully capture all potential
risks that may affect a specific company's capital position.
Supervisory stress tests are one of several supervisory assessment
tools, accordingly, a full assessment of a company's capital adequacy
should be informed by a broad range of information including a covered
company's internal capital adequacy processes and the results of its
own internal stress tests. In particular, a full assessment of a
company's capital adequacy must take into account a range of factors,
including idiosyncratic aspects of individual companies that a
standardized supervisory stress test applicable across companies cannot
be expected to cover as sufficiently as the companies' internal stress
testing practices. Idiosyncratic factors would include evaluation of a
company's internal stress testing results, its capital planning
processes, the governance over those processes, regulatory capital
measures, and market assessments. As the parties primarily responsible
for the financial condition of a covered company, its board of
directors and senior management bear the primary responsibility for
developing, implementing, and monitoring a covered company's capital
planning strategies and internal capital adequacy processes and are in
the best position to oversee these processes. Thus, along with the
results of a covered company's capital plan, any company-run stress
tests, and other supervisory information, the Board would use the
results of the supervisory stress tests as one factor in the overall
supervisory assessment of a covered company's capital adequacy.\174\
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\174\ The Board notes that the design of the supervisory stress
tests focuses on capital adequacy and does not focus on all aspects
of financial condition.
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[[Page 627]]
b. Applicability
Except as otherwise provided in the proposed rule, a bank holding
company that becomes a covered company no less than 90 days before
September 30 of a calendar year must comply with the requirements of
the proposed rule regarding stress tests, including the timing of
required submissions to the Board, from that September 30 forward. With
respect to initial applicability, a bank holding company that is a
covered company on the effective date of the proposed rule must comply
with the proposed requirements as of the effective date of the rule,
including the timing of required submissions to the Board. A company
that the Council designates for supervision by the Board on a date 180
days before September 30 of a calendar year must comply with the
requirements of the proposed rule regarding stress tests, including the
timing of required submissions to the Board, from that September 30
forward.
Question 70: Are the timing requirements of this proposal
sufficient to allow a covered company or nonbank covered company to
prepare, collect, and submit to the Board the information necessary to
support the supervisory stress test? If not, what alternative timing
should the Board consider?
c. Process Overview of Annual Supervisory Stress Test Cycle
The Board expects to use the following general process and
timetables in connection with the supervisory stress tests.
i. Information Collection From Covered Companies
For a supervisory stress test conducted within any given calendar
year, covered companies would be required to submit to the Board data
and other information to support the conduct of that year's tests. To
the greatest extent possible, the data schedules, and any other data
requests, would be designed to minimize burden on the covered company
and to avoid duplication, particularly in light of other reporting
requirements that may be imposed by the Board. The Board envisions
collecting the requisite information from covered companies primarily
through the regulatory reporting process, and these reports may change
from time to time. The confidentiality of any information submitted to
the Board for the supervisory stress tests will be determined in
accordance with the Board's rules regarding availability of
information.\175\ As discussed below in section e.iv., the Board
proposes to publish a summary of the results the supervisory stress
test, as required by the Dodd-Frank Act.\176\ The Board may obtain
supplemental information, as needed, through the supervisory process.
The Board plans to publish for notice and comment any new or revised
data requirements and related reporting instructions in a separate
information collection proposal.\177\
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\175\ See generally 12 CFR part 261; see also 5 U.S.C. 552(b).
\176\ 12 U.S.C. 5365(i)(1)(B)(v).
\177\ To minimize burden on covered companies, the Board plans
to leverage, to the extent possible, any pre-existing data
collections that are relevant for the proposed rule's stress testing
purposes (for example, see the proposed agency information
collection available at http://www.federalreserve.gov/reportforms/formsreview/FRY14Q_FRY14A_20110907_ifr.pdf).
---------------------------------------------------------------------------
Question 71: What is the potential burden on covered companies
stemming from the requirements to submit internal data to support the
supervisory stress tests?
ii. Publication of Scenarios and Methodologies
The Board plans to publish the scenarios in advance of conducting
the annual stress tests. The Board also plans to publish an overview of
its related stress testing methodologies.
iii. Conducting Stress Tests
The Board intends to conduct the supervisory stress tests using
data collected from covered companies as well as supplemental
information. In the course of conducting the stress tests, the Board
intends to consult with covered companies as necessary throughout the
process, particularly if the company's data submissions or other
information provided are unclear or the supervisory stress test raises
questions more generally. After conducting its analyses, the Board
plans to communicate to each covered company the results within a
reasonable period of time.
iv. Publishing Results
Subsequent to communicating results of the analyses to each covered
company, the Board would publish a summary of the supervisory stress
test results, as discussed further below.
v. Proposed Steps for Annual and Additional Stress Tests
Table 2 describes proposed steps in the Board's annual supervisory
stress test cycle, including proposed general timeframes for each step.
The Board devised this proposed process in conjunction with the
proposed process outlined below for the company-run stress tests, given
the overlap in applicability for certain companies. As noted above, the
timeline is also intended to facilitate the use of supervisory stress
tests to inform the Board's analysis of companies' capital plan
submissions under the annual CCAR process, where applicable. The
proposed timeframes are illustrative and are subject to change.
Table 2--Process Overview of Annual Supervisory Stress Testing Cycle
[Using data collected as of September 30, except for trading and
counterparty data, for a planning horizon of at least nine calendar
quarters]
------------------------------------------------------------------------
Step Proposed timeframe
------------------------------------------------------------------------
1. Board publishes scenarios No later than mid-November.
for upcoming annual cycle.
2. Covered companies submit By mid-November.
regulatory reports and any
other required information.
3. Board completes supervisory By mid-February.
stress tests and compiles
results.
[[Page 628]]
4. Board communicates By early March.
individual company results to
covered companies.
5. Board publishes a summary of By early April.
the supervisory stress test
results.
------------------------------------------------------------------------
d. General Approach to Supervisory Stress Tests
The Board anticipates that its framework for conducting its annual
stress test of covered companies would assess the impact of different
economic and financial market scenarios on the consolidated capital of
each covered company over a forward-looking planning horizon, taking
into account all relevant exposures and activities of that company. The
proposed rule defines the planning horizon as the period of time over
which the supervisory stress test projections would extend,
specifically at least nine quarters. The key feature of this framework
would be an estimate of projected net income and other factors
affecting capital in each quarter of the stress test planning horizon,
leading to an estimate of how each covered company's capital resources
would be affected under the scenarios. The primary outputs produced
under the framework would be pro forma projections of capital positions
(including capital levels and regulatory and other capital ratios) for
each quarter-end over the planning horizon.
i. Scenarios
Under the proposed rule, prior to conducting the analyses of
covered companies, the Board would publish a minimum of three different
sets of economic and financial conditions, including baseline, adverse,
and severely adverse conditions (``scenarios''), under which the Board
would conduct its annual analyses. As discussed above, the Board would
update, make additions to, or otherwise revise these scenarios as
appropriate, and would publish any such changes to the scenarios in
advance of conducting each year's analyses. The Board expects that the
stress test framework would produce at least three sets of projections
using quarterly intervals over the planning horizon based upon the
scenarios specified by the Board. The Board envisions that the
scenarios would consist of future paths of a series of economic and
financial variables over the stress test planning horizon, including
projections for a range of macroeconomic and financial indicators, such
as real GDP, the unemployment rate, equity and property prices, and
various other key financial variables. The Board recognizes that
certain trading positions and trading-related exposures are highly
sensitive to adverse market events, potentially leading to large short-
term volatility in covered companies' earnings. As a result, to address
these scenarios, the Board would supplement the scenarios in some cases
with market price and rate ``shocks'' that are consistent with
historical or other adverse market events specified by the Board. The
scenarios, in some cases, may also include stress factors that may not
be directly correlated to macroeconomic or financial assumptions but
nevertheless can materially affect covered companies' risks, such as
factors that affect operational risks.
Each year, the scenarios specified by the Board would reflect
changes in the outlook for economic and financial conditions. In
general, the baseline scenario would consider the most recently
available views of the macroeconomic outlook expressed by government
agencies, other public-sector organizations, and private-sector
forecasters as of the beginning of the annual stress-test cycle. The
adverse scenario could include economic and financial conditions
consistent with a recession of at least moderate intensity, including a
shortfall of economic activity and increase in unemployment relative to
the baseline scenario, weakness in household incomes, declines in asset
prices (including equities, corporate bonds, and property prices) and
changes in short- and long-term yields on government bonds. The
severely adverse scenario would consist of economic and financial
conditions that are more unfavorable than those of the adverse scenario
and that also include, in some instances, salient factors that are
likely to place notable strains on at least some lines of business. For
example, such severely adverse conditions could include precipitous
declines in property or other asset prices; shifts in the shape of the
yield curve; marked changes in the propensity of households or firms to
enter bankruptcy; or strains on households, businesses, or real
property markets in particular regions of the United States.
ii. Data and Information Requirements of Covered Companies
The Board's stress test framework would rely on consolidated data
and other information supplied by each covered company. The proposed
rule would require each covered company to provide data and information
to the Board, generally no later than 40 days after the end of each
calendar quarter, although some items may need to be collected only on
an annual basis and others may need to be collected on a monthly basis.
For data related to trading and counterparty exposures, the Board
expects to communicate the as-of date for those exposures during the
fourth quarter of each year. Covered companies would need to provide
such data and other information in the manner and form prescribed by
the Board to enable the Board to estimate net income, losses, and pro-
forma capital levels and ratios for those companies over the planning
horizon under baseline, adverse, and severely adverse scenarios (or
other such conditions as determined appropriate by the Board). This
data would include information:
(i) Related to the covered company's on- and off-balance sheet
exposures, including in some cases information on individual items
(such as loans and securities) held by the company, and including
exposures in the covered company's trading portfolio, other trading-
related exposures (such as counterparty-credit risk exposures) or other
items sensitive to changes in market factors, including, as
appropriate, information about the sensitivity of positions in the
trading portfolio--including counterparty credit exposures--to changes
in market prices and interest rates;
(ii) To assist the Board in estimating the sensitivity of the
covered company's revenues and expenses to changes in economic and
financial conditions; and
(iii) To assist the Board in estimating the likely evolution of the
covered company's balance sheet (such as the composition of its loan
and securities portfolios) and allowance for loan losses, in response
to changes in
[[Page 629]]
economic and financial conditions in each of the scenarios provided.
As noted above, the Board plans to issue a separate information
collection proposal to support its annual supervisory stress test
analyses.\178\ The specific data requirements would be outlined in that
proposal and the Board would publish any updates to its information
requirements in a manner that provides covered companies with
sufficient lead time to implement the changes. In addition, under the
proposed rule, the Board may require a covered company to submit any
other information the Board deems necessary in order to: (i) Ensure
that the Board has sufficient information to conduct its analysis; and
(ii) derive robust projections of a company's losses, pre-provision net
revenues, allowance for loan losses, and future pro forma capital
positions under the baseline, adverse, and severely adverse scenarios
(or other such conditions as determined appropriate by the Board). The
confidentiality of any information submitted to the Board for the
supervisory stress tests will be determined in accordance with the
Board's rules regarding availability of information.\179\ As discussed
below in section e.iv., the Board proposes to publish a summary of the
results of the supervisory stress test, as required by the Dodd-Frank
Act.\180\
---------------------------------------------------------------------------
\178\ To the greatest extent possible, the data templates, and
any other data requests, would be designed to minimize burden on the
bank holding company and to avoid duplication, particularly in light
of potential new reporting requirements arising from the Dodd-Frank
Act.
\179\ See generally 12 CFR part 261; see also 5 U.S.C. 552(b).
\180\ 12 U.S.C. 5365(i)(1)(B)(v).
---------------------------------------------------------------------------
iii. Methodology for Estimating Losses and Revenues
While the Board expects to publish an overview of its methodology
for the supervisory stress tests, the Board believes it is useful to
provide, as part of this proposal, a general overview of the
anticipated methodology in advance of that publication. The Board would
calculate each covered company's projected losses, revenues, and other
factors affecting capital using a series of models and estimation
techniques that relate the economic and financial variables in the
baseline, adverse, and severely adverse scenarios to the company's
losses and revenues. The Board would develop a series of models to
estimate losses on various types of loans and securities held by the
covered company, using data submitted by that company. These models may
be adjusted over time. The Board would use a separate methodology or a
combination of methodologies--potentially including covered companies'
internal models, if appropriate--to estimate projected losses related
to covered companies' trading portfolio or counterparty credit-risk
exposures in the event of an adverse market shock, taking into account
the complexity and idiosyncrasy of each covered company's positions.
The framework may also incorporate an approach to estimate potential
losses from stress factors specifically affecting the covered
companies' other risks. Finally, the framework would include a set of
methodologies to assess the impact of losses, pre-provision net
revenue, allowance for loan losses, and other factors on future pro
forma capital levels and ratios.
Another element of the framework would be a set of models or rules
to describe how a covered company's balance sheet would change over
time, as well as a set of assumptions or models for other actions or
decisions by the covered company that affect capital, such as its
provisioning, dividend, and share repurchase policy. Information about
planned future acquisitions and divestitures by the companies would
also be incorporated. These projections would then be analyzed to
assess their combined impact on the company's capital positions,
including projected capital levels and capital ratios, at the end of
each quarter in the planning horizon. The framework would thus
incorporate all minimum regulatory capital requirements, including all
appropriate limits and deductions. These projections used in the
supervisory stress tests also would incorporate, as appropriate, any
significant changes in or the significant effects of accounting
requirements during the planning period.
Question 72: What alternative models or methodologies for
estimating a covered company's losses and revenues should the Board
consider?
e. Results of Annual Analyses
i. Description of Supervisory Assessment
The Board, through its annual analyses, would evaluate each covered
company as to whether the covered company has the capital, on a total
consolidated basis, necessary to absorb losses under economic and
financial market conditions as contained in the designated scenarios.
This evaluation would include, but would not be limited to, a review of
the covered company's estimated losses, pre-provision net revenue,
allowance for loan losses, and the extent of their impact on the
company's capital levels and ratios, including regulatory capital
ratios.
ii. Communication of Results to Covered Companies
The Board notes that, under the Dodd-Frank Act, it is required to
publish a summary of the results of its annual analyses.\181\ Under the
proposed rule, prior to publishing a summary of the results of its
annual analyses, the Board would convey to each covered company the
results of the Board's analyses of that company and explain to the
firms information that the Board expects to make public.
---------------------------------------------------------------------------
\181\ 12 U.S.C. 5365(i)(1)(B)(v).
---------------------------------------------------------------------------
iii. Post-Assessment Actions by Covered Companies
As a general matter, under the proposed rule, subsequent to
receiving the results of the Board's annual analyses, each covered
company must take the results of the analysis conducted by the Board
under the proposed rule into account in making changes, as appropriate,
to the company's capital structure (including the level and composition
of capital); its exposures, concentrations, and risk positions; any
plans of the company for recovery; and for improving overall risk
management. In addition, each covered company must make such updates to
its resolution plan (required to be submitted annually to the Board
pursuant to the Board's Regulation QQ (12 CFR part 243)) as the Board,
based on the results of its analyses of the company under this subpart,
determines appropriate within 90 days of the Board publishing the
results of its analyses. Additionally, each covered company that is
subject to the requirement to submit a capital plan to the Board under
section 225.8 of the Board's Regulation Y (12 CFR 225.8) would be
required to consider the results of the analysis of the company
conducted by the Board under the proposed rule when updating its
capital plan. Stress testing results may also result in the application
of early remediation requirements as described further below.
iv. Publication of Results by the Board
Under the proposed rule, within a reasonable period of time after
completing the annual analyses of covered companies (but no later than
mid-April of a calendar year), the Board would publish a summary of the
results of such analyses. The Board emphasizes that there are certain
factors to bear in mind when interpreting any published
[[Page 630]]
results from the Board's annual analyses under the proposed rule. For
example, the outputs of the analyses might not align with those
produced by other parties conducting similar exercises, even if a
similar set of assumptions were used. In addition, the outputs under
the adverse and severely adverse scenarios should not be viewed as most
likely forecasts or expected outcomes or as a measure of any covered
company's solvency. Instead, those outputs are the resultant estimates
from forward-looking exercises that consider possible outcomes based on
a set of different hypothetical scenarios.
The Board proposes to publish a high-level summary of supervisory
stress test results for each covered company, i.e., company-specific
results. This will support one of the key objectives of the supervisory
stress tests, namely to enhance transparency of covered companies'
risks and financial condition and its ability to absorb loss as a
result of adverse economic and financial conditions. The annual set of
published results for each company for each quarter-end over the
specified planning horizon is expected to include:
Estimated losses, including overall losses on loans by
subportfolio, available-for-sale and held-to-maturity securities,
trading portfolios, and counterparty exposures;
Estimated pre-provision net revenue;
Estimated allowance for loan losses;
Estimated pro forma regulatory and other capital ratios.
The Board recognizes that there are important considerations
related to disclosure of such information that must be taken into
account with respect to publishing company-specific results from
supervisory stress tests, and has carefully analyzed the issues
surrounding public disclosure of such results in formulating this
proposal. The Board requests comment on its proposal to publish
company-specific results.
Question 73: What are the benefits and drawbacks associated with
company-specific disclosures? What, if any, company-specific items
relating to the supervisory stress tests would present challenges or
raise issues if disclosed, and what is the nature of those challenges
or issues? What specific concerns about the possible release of a
company's proprietary information exist? What alternatives to the
company-specific disclosures being proposed should the Board consider?
2. Annual and Additional Stress Tests Conducted by the Companies
a. Purpose
The Board views the company-run stress tests under the proposed
rule as having a shared purpose with the supervisory stress tests. The
company-run stress tests would provide forward-looking information to
supervisors to assist in their overall assessments of a company's
capital adequacy, help to better identify downside risks and the
potential impact of adverse outcomes on the company's capital adequacy,
and assist in achieving the financial stability goals of the Dodd-Frank
Act. Further, the company-run stress tests are expected to improve
companies' stress testing practices with respect to their own internal
assessments of capital adequacy and overall capital planning.
The proposed rule would apply to two sets of companies: covered
companies and over $10 billion companies, as defined below. Covered
companies would be required to conduct semi-annual company-run stress
tests and over $10 billion companies would be required to conduct
annual company-run stress tests.
For purposes of the company-run stress tests, the proposed rule
defines a stress test as a process to assess the potential impact on a
covered company or an over $10 billion company of economic and
financial conditions (scenarios) on the consolidated earnings, losses
and capital of the company over a set planning horizon, taking into
account the current condition of the company and the company's risks,
exposures, business strategies, and activities.
The Board expects that the company-run stress tests required under
the proposed rule would be one component of the broader stress testing
activities conducted by covered companies and over $10 billion
companies. The broader stress testing activities should address the
impact of a broad range of potentially adverse outcomes across a wide
set of risk types beyond capital adequacy, affecting other aspects of a
company's financial condition (e.g., liquidity risk). In addition, a
full assessment of a company's capital adequacy must take into account
a range of factors, including evaluation of its capital planning
processes, the governance over those processes, regulatory capital
measures, results of supervisory stress tests where applicable, and
market assessments, among others. The Board notes that the company-run
stress tests described in this proposed rule focus on capital adequacy
and do not focus on other aspects of financial condition.
b. Applicability
i. General
The proposed rule would apply to covered companies and over $10
billion companies. Over $10 billion companies are defined as any bank
holding company (other than a bank holding company that is a covered
company), any state member bank, or any savings and loan holding
company that (i) has more than $10 billion in total consolidated
assets, as determined based on the average of the total consolidated
assets as reported on the bank holding company's four most recent FR Y-
9C reports, the state member bank's four most recent Consolidated
Report of Condition and Income (Call Report), or the savings and loan
holding company's four most recent relevant quarterly regulatory
reports; and (ii) since becoming an over $10 billion company, has not
had $10 billion or less in total consolidated assets for four
consecutive calendar quarters as reported on the bank holding company's
four most recent FR Y-9C reports, the state member bank's four most
recent Call Reports, or the savings and loan holding company's four
most recent relevant quarterly regulatory reports.\182\ This
calculation will be effective as of the due date of the company's most
recent regulatory report.
---------------------------------------------------------------------------
\182\ Under section 165(i)(2), the requirements to conduct
annual stress tests apply to any financial company with more than
$10 billion in total consolidated assets and that is regulated by a
primary federal financial regulatory agency. 12 U.S.C. 5365(i)(2).
The Dodd-Frank Act defines primary financial regulatory agency in
section 2 of the Act. See 12 U.S.C. 5301(12). The Board, Office of
the Comptroller of the Currency, and Federal Deposit Insurance
Corporation have consulted on rules implementing section 165(i)(2).
---------------------------------------------------------------------------
c. Process Overview
Except as otherwise provided in the proposed rule, a bank holding
company that becomes a covered company or a bank holding company,
savings and loan holding company (subject to the delayed effective date
for savings and loan holding companies) or state member bank that
becomes an over $10 billion company no less than 90 days before
September 30 of a calendar year must comply with the requirements,
including the timing of required submissions to the Board, of the
proposed rule from September 30 forward. In addition, except as
otherwise provided in the rule, a bank holding company that becomes a
covered company no less than 90 days before March 31 of a calendar year
must
[[Page 631]]
comply with the requirements, including timing of required submissions
to the Board, of the proposed rule from March 31 forward.
A company that the Council has determined shall be supervised by
the Board on a date no less than 180 days before September 30 of a
calendar year must comply with the requirements of this subpart,
including timing of required submissions, from September 30 of that
calendar year and thereafter. Further, a company that the Council has
determined shall be supervised by the Board on a date no less than 180
days before March 31 of a calendar year must comply with the
requirements of this subpart, including timing of the required
submissions from March 31 of that calendar year and thereafter.
With respect to initial applicability, a bank holding company that
is a covered company or a bank holding company or state member bank
that is an over $10 billion company on the effective date of the
proposed rule would be subject to the proposed requirements as of the
effective date, including timing of required submissions to the Board.
Also with respect to initial applicability, a savings loan and holding
company that is an over $10 billion company on or after the effective
date of the rule would not be subject to the proposed requirements,
including timing of required submissions to the Board, until savings
and loan holding companies are subject to minimum risk-based capital
and leverage requirements.
The Board expects to use the following general process and
timetables in connection with the company-run stress tests.
i. Reporting by Companies
Under this proposal, the Board would collect the covered companies'
and over $10 billion companies' stress test results and additional
qualitative and quantitative information about the tests on a
confidential basis and may require companies to provide other
information on a supplemental basis. The Board plans to publish for
comment both specific requirements for the report to be submitted to
the Board, as described below, and related instructions in a separate
information collection proposal before requiring companies to perform
the company-run stress tests that would be required under the proposed
rule.
Following the stress test, each covered company and each over $10
billion company would be required to publish a summary of its results
as described further below.
ii. Annual Company-Run Stress Test
Each year, in advance of the annual company-run stress test
required of all covered companies and over $10 billion companies on a
schedule to be established, the Board would provide to such companies
at least three scenarios, including baseline, adverse, and severely
adverse, that each covered company and each over $10 billion company
must use to conduct its annual stress test required under the proposed
rule. The Board expects that these will be the same scenarios published
for use in supervisory stress tests also required by the Act.
iii. Additional Company-Run Stress Test Cycle for Covered Companies
Within a given year, covered companies (but not over $10 billion
companies) would be required to conduct one company-run stress test in
addition to the annual stress test described above. For this additional
company-run test, each covered company would be required to develop and
employ scenarios reflecting a minimum of three sets of economic and
financial conditions, including baseline, adverse, and severely adverse
scenarios, and such additional conditions as the Board determines
appropriate.
iv. Proposed Steps for Annual and Additional Company-Run Stress Tests
Table 3 below describes proposed steps for the company-run stress
test cycle for covered companies and over $10 billion companies,
including proposed general timeframes for each step. The proposed
timeframes are illustrative and are subject to change.
Table 3--Process Overview of Annual and Additional Company-Run Stress Test Cycles
[With annual test using data as of September 30 and additional test using data as of March 31]
----------------------------------------------------------------------------------------------------------------
Step Proposed timeframe
----------------------------------------------------------------------------------------------------------------
Annual company-run stress test cycle for all covered companies and over $10 billion companies
----------------------------------------------------------------------------------------------------------------
1. Board provides covered companies and over $10 billion No later than mid-November.
companies with scenarios for annual stress tests.
2. Covered companies and over $10 billion companies By January 5.
submit required regulatory report to the Board on their
stress tests.
3. Covered companies and over $10 billion companies make By early April.
required public disclosures.
----------------------------------------------------------------------------------------------------------------
Additional company-run stress test cycle for covered companies
----------------------------------------------------------------------------------------------------------------
4. Covered companies submit required regulatory report to By July 5.
the Board on their additional stress tests.
5. Covered companies make required public disclosures.... By early October.
----------------------------------------------------------------------------------------------------------------
d. Overview of Stress Test Requirements
i. General Requirements for Company-Run Stress Tests
Under the proposed rule, each covered company and each over $10
billion company would be required to conduct annual stress tests using
the company's financial data as of September 30 of that year, with the
exception of trading and counterparty exposures, to assess the
potential impact of different scenarios on the consolidated earnings
and capital of that company and certain related items over at least a
nine-quarter forward-looking planning horizon taking into account all
relevant exposures and activities.\183\ The Board would communicate the
required as of date for data related to trading and counterparty
exposures of a company during the fourth quarter of each calendar year.
Each covered company would also be required to conduct an additional
stress test using the company's financial data as of March 31 of that
year.
---------------------------------------------------------------------------
\183\ The Board expects to communicate the as-of date for data
on trading and counterparty exposures sometime in the fourth quarter
of each year.
---------------------------------------------------------------------------
The Board recognizes that certain parent company structures of
covered companies and over $10 billion companies may include one or
more subsidiary banks, each with total consolidated assets greater than
$10 billion. The company-run stress test requirements of Section
165(i)(2) would apply to the parent company and to each subsidiary
regulated by a primary federal financial regulatory agency that
[[Page 632]]
has more than $10 billion in total consolidated assets. To minimize any
undue burden associated with multiple entities within one parent
structure having to meet the proposed rule's requirements, the Board
intends to coordinate with the other federal financial regulatory
agencies, as appropriate. For example, the Board would aim to
coordinate with the other federal financial regulatory agencies in
providing scenarios to be used by multiple entities within a holding
company structure when meeting the requirements of the annual stress
tests described in the proposed rule.
ii. Scenarios
The proposed rule would require each covered company and each over
$10 billion company to use a minimum of three sets of economic and
financial conditions (scenarios), including baseline, adverse, and
severely adverse conditions, or such additional conditions as the Board
determines appropriate.
(1) Annual Company-Run Stress Tests
In advance of the annual stress tests, the Board would provide at
least three scenarios (baseline, adverse, and severely adverse) that
all covered companies and over $10 billion companies would be required
to use to conduct the stress tests required under the proposed rule.
These scenarios would be expected to be the same as the scenarios used
by the Board in conducting the supervisory stress tests.
(2) Additional Company-Run Stress Tests for Covered Companies
The Board would not provide scenarios to covered companies for the
additional company-run stress tests. Rather, for the additional stress
test, a covered company would be required to develop and employ its own
scenarios reflecting a minimum of three sets of economic and financial
conditions--baseline, adverse, and severely adverse conditions--or such
additional conditions as the Board determines appropriate.
iii. Methodologies and Practices
Under the proposed rule, each covered company and each over $10
billion company would be required to use the applicable scenarios
discussed above in conducting its stress tests to calculate, for each
quarter-end within the planning horizon, potential losses, pre-
provision revenues, allowance for loan losses, and future pro forma
capital positions over the planning horizon, including the impact on
capital levels and ratios. Each covered company and over $10 billion
company would also be required to calculate, for each quarter-end
within the planning horizon, the potential impact of the specific
scenarios on its capital ratios, including regulatory and any other
capital ratios specified by the Board.
The proposed rule would require each covered company and over $10
billion company to establish and maintain a system of controls,
oversight, and documentation, including policies and procedures,
designed to ensure that the stress testing processes used by the
company are effective in meeting the requirements of the proposed rule.
The company's policies and procedures must, at a minimum, outline the
company's stress testing practices and methodologies, validation, use
of stress test results and processes for updating the company's stress
testing practices consistent with relevant supervisory guidance. Each
covered company would also need to include in its policies information
describing its processes for scenario development for the additional
stress test required under the proposed rule. The board of directors
and senior management of each covered company and each over $10 billion
company must approve and annually review the controls, oversight, and
documentation, including policies and procedures, of the company
established pursuant to the proposed rule.
iv. Stress Test Information and Results
1. Required Report to the Board of Stress Test Results and Related
Information
On or before January 5 each year, each covered company and each
over $10 billion company would be required to report to the Board, in
the manner and form prescribed in the proposed rule, the results of the
stress tests conducted by the company. To the extent possible and where
relevant, a covered company would be able to refer to information
submitted in connection with capital plan rule requirements when
submitting the report required under this rule. The Board plans to
publish for comment a description of items to be included in the
required report to the Board. The Board anticipates that the report
would include (but not necessarily be limited to) the following
qualitative and quantitative information.
Qualitative information:
A general description of the use of stress tests required
by the proposed rule in the company's capital planning and capital
adequacy assessments;
A description of the types of risks (e.g., credit, market,
operational, etc.) being captured in the stress test;
A general description of the methodologies employed to
estimate losses, pre-provision net revenues, allowance for loan losses,
changes in capital levels and ratios, and changes in the company's
balance sheet over the planning horizon;
Assumptions about potential capital distributions over the
planning horizon;
For covered companies subject to additional stress tests,
a description of scenarios developed by the company for its additional
test, including key variables used; and
Any other relevant qualitative information to facilitate
supervisory assessment of the tests, upon request by the Board.
Quantitative information under each scenario:
Estimated pro forma capital levels and capital ratios,
including regulatory and any other capital ratios specified by the
Board;
Estimated losses by exposure category;
Estimated pre-provision net revenue;
Estimated allowance for loan losses;
Estimated total assets and risk-weighted assets;
Estimated aggregate loan balances;
Potential capital distributions over the planning horizon;
and
Any other relevant quantitative information to facilitate
supervisory understanding of the tests, upon request by the Board.
A covered company subject to an additional stress test would also
be required to report to the Board the results of its additional test
on or before July 5 each year, in a manner similar to its report
required for its annual stress test. The Board may also request
supplemental information as needed. Under the Dodd-Frank Act, companies
are required to publish a summary of their stress test results (see
discussion in section 3. below).\184\
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\184\ 12 U.S.C. 5365(i)(2)(C)(iv).
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2. Supervisory Review of Companies' Stress Test Processes and Results
Based on information submitted by a covered company or an over $10
billion company in the required report to the Board described above as
well as other relevant information, the Board would conduct an analysis
of the quality of the company's stress tests processes and related
results. The Board envisions that feedback about such analysis would be
provided to a company through the supervisory process. In addition,
each covered company and each over $10 billion company would be
required to take the results of the annual stress test (or additional
stress tests in the case of a covered company), in conjunction
[[Page 633]]
with the Board's analyses of those results, into account in making
changes, as appropriate, to the company's capital structure (including
the level and composition of capital); its exposures, concentrations,
and risk positions; any plans of the company for recovery and
resolution; and to improve the overall risk management of the company.
Additionally, each covered company would be required to consider the
results of its company-run stress tests in developing and updating its
capital plan. The Board may also require other actions consistent with
safety and soundness of the company.
3. Publication of Results by the Company
Consistent with the requirements of the Act, the proposed rule
would require each covered company and each over $10 billion company to
publish a summary of the results of its annual company-run stress tests
within 90 days of submitting its required report to the Board. A
covered company subject to the additional stress test would also be
required to publish a summary of the results of its additional test
within 90 days of submitting its required report to the Board for that
test. The summary may be published on a covered company's or an over
$10 billion company's Web site or in any other forum that is reasonably
accessible to the public; further, it is expected that an over $10
billion company that is a subsidiary of another covered company or
another over $10 billion company could publish its summary on the
parent company's Web site or in another form along with the parent
company's summary. The required information publicly disclosed by each
covered company and each over $10 billion company, as applicable,
would, at a minimum, include:
(i) A description of the types of risks being included in the
stress test;
(ii) For each covered company, a high-level description of
scenarios developed by the company for its additional stress test,
including key variables used (such as GDP, unemployment rate, housing
prices);
(iii) A general description of the methodologies employed to
estimate losses, revenues, allowance for loan losses, and changes in
capital positions over the planning horizon;
(iv) Aggregate losses, pre-provision net revenue, allowance for
loan losses, net income, and pro forma capital levels and capital
ratios (including regulatory and any other capital ratios specified by
the Board) over the planning horizon under each scenario;
Question 74: What alternative to the public disclosure requirements
of the proposed rule should the Board consider? What are the potential
consequences of the proposed public disclosures of the company-run
stress test results?
C. Request for Comments
The Board requests comment on all aspects of the proposed rule for
the annual and additional company-run stress testing cycles.
Question 75: Is the proposed timing of stress testing appropriate,
and why? If not, what alternatives would be more appropriate? What, if
any, specific challenges exist with respect to the proposed steps and
timeframes? What specific alternatives exist to address these
challenges that still allow the Board to meet its statutory
requirements? Please comment on the use of the ``as of'' date of
September 30 (and March 31 for additional stress tests), the January 5
reporting date (and July 5 for additional stress test) the publication
date, and the sufficiency of time for completion of the stress tests.
Question 76: Does the immediate effectiveness of the proposed rule
provide sufficient time for an institution that is covered at the
effective date of the rule to conduct its first annual stress test?
Would over $10 billion companies, in particular, have sufficient time
to prepare for the first annual stress test, under either the proposed
initial or proposed ongoing applicability rules?
VIII. Debt-to-Equity Limits for Certain Covered Companies
A. Background
Section 165(j) provides that the Board must require a covered
company to maintain a debt-to-equity ratio of no more than 15-to-1,
upon a determination by the Council that such company poses a grave
threat to the financial stability of the United States and that the
imposition of such requirement is necessary to mitigate the risk that
such company poses to the financial stability of the Unites
States.\185\ The Act requires that, in making its determination, the
Council must take into consideration the criteria in Dodd-Frank Act
sections 113(a) and (b). These criteria include, among other things,
the extent of the leverage of the company, the nature, scope, size,
scale, concentration, interconnectedness, and mix of the activities of
the company, and the importance of the company as a source of credit
for U. S. households, businesses, and State and local governments and
as a source of liquidity for the U.S. financial system. The Board is
required to promulgate regulations to establish procedures and
timelines for compliance with section 165(j).\186\
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\185\ The statute expressly exempts any federal home loan bank
from the debt-to-equity ratio requirement. See 12 U.S.C. 5366(j)(1).
\186\ 12 U.S.C. 5366(j)(3).
---------------------------------------------------------------------------
The Board seeks comment on this proposed rule that would establish
procedures to notify a covered company that the Council has made a
determination under section 165(j) that the company must comply with
the 15-to-1 debt-to-equity ratio requirement (identified company), as
well as procedures for terminating the requirement. The proposed rule
also defines the components of the debt-to-equity requirement and
establishes a time period of 180 days for an identified company to
comply with the debt-to-equity ratio requirement, and provides that the
time for compliance may be extended if an extension would be in the
public interest.
B. Overview of the Proposed Rule
The debt-to-equity limitation in section 165(j) applies to any
covered company where the Council makes two findings: (i) That the
covered company poses a grave threat to the financial stability of the
United States; and (ii) that the imposition of the specified debt-to-
equity requirement is necessary to mitigate that systemic risk. Under
the proposal, ``debt'' and ``equity'' would have the same meaning as
``total liabilities'' and ``total equity capital'' respectively, as
calculated in an identified company's reports of financial condition.
The 15-to-1 debt-to-equity would be calculated as the ratio of total
liabilities to total equity capital minus goodwill.
Section 252.152(a) provides for notice to the identified company
and establishes the maximum debt-to-equity ratio requirement for an
identified company. An identified company would receive written notice
from the Board that the Council has made a determination under section
165(j) that the company poses a grave threat to the financial stability
of the United States and that the imposition of the statutory debt-to-
equity ratio requirement is necessary. An identified company would be
permitted 180 calendar days from the date of receipt of the notice to
comply with the 15-to-1 debt-to-equity ratio requirement. The proposed
rule does not establish a specific set of actions to be taken by a
company in order to comply with the debt-to-equity ratio requirement;
however, the Board would expect a company to come into compliance with
the ratio in a manner
[[Page 634]]
that is consistent with the company's safe and sound operation and
preservation of financial stability. For example, a company generally
would be expected to make a good faith effort to increase equity
capital through limits on distributions, share offerings, or other
capital raising efforts prior to liquidating margined assets in order
to achieve the required ratio.
While it is important that a company that presents a grave threat
to U.S. financial stability take prompt action to reduce risks to
financial stability, section 252.152(b) provides that an identified
company may request an extension of time to comply with the debt-to-
equity ratio requirement for up to two additional periods of 90 days
each. Requests for an extension of time to comply must be received in
writing by the Board not less than 30 days prior to the expiration of
the existing time period for compliance, and must provide information
sufficient to demonstrate that the company has made good faith efforts
to comply with the debt-to-equity ratio requirement and that each
extension would be in the public interest. The proposed 180-day period
is intended to provide sufficient time for an identified company to
take appropriate action to comply with the debt-to-equity ratio
requirement. In the event that an extension of time is requested, the
Board would review the request in light of the relevant facts and
circumstances, including the extent of the identified company's efforts
to comply with the ratio and whether the extension would be in the
public interest.
Section 252.152(c) provides that an identified company would no
longer be subject to the debt-to-equity ratio requirement of this
subpart as of the date it receives notice of a determination by the
Council that the company no longer poses a grave threat to the
financial stability of the United States and that the imposition of a
debt-to-equity requirement is no longer necessary.
The Board requests comment on all aspects of the proposed rule, and
specifically on the definitions of debt and equity and on whether the
proposed 180-day time period for compliance is appropriate.
Question 77: What alternatives to the definitions and procedural
aspects of this proposed rule should the Board consider?
IX. Early Remediation
A. Background
The recent financial crisis revealed that the condition of large
banking organizations can deteriorate rapidly even during periods when
their reported capital ratios are well above minimum requirements. The
crisis also revealed fundamental weaknesses in the U.S. regulatory
community's tools to deal promptly with emerging issues. As detailed in
the Government Accountability Office's (GAO) June 2011 study on the
effectiveness of the prompt corrective action (PCA) regime, the PCA
regime's triggers, based primarily on regulatory capital ratios,
limited its ability to promptly address problems at insured depository
intuitions.\187\ The study also concluded that the PCA regime failed to
prevent widespread losses to the deposit insurance fund, and that while
supervisors had the discretion to act more quickly, they did not
consistently do so.\188\
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\187\ See Government Accountability Office, Modified Prompt
Corrective Action Framework Would Improve Effectiveness, GAO-11-612
(June 23, 2011), available at http://www.gao.gov/new.items/d11612.pdf (hereinafter GAO Study). PCA is required by section 38 of
the Federal Deposit Insurance Act. 12 U.S.C. 1831(o). PCA applies
only to insured depository institutions, rather than to consolidated
banking organizations.
\188\ See id.
---------------------------------------------------------------------------
Section 166 of the Dodd-Frank Act was designed to address these
problems by directing the Board to promulgate regulations providing for
the early remediation of financial weaknesses at covered companies. The
Dodd-Frank Act requires the Board to define measures of a covered
company's financial condition, including, but not limited to,
regulatory capital, liquidity measures and other forward-looking
indicators that would trigger remedial action. The Act also mandates
that remedial action requirements increase in stringency as the
financial condition of a covered company deteriorates and include: (i)
limits on capital distributions, acquisitions and asset growth in the
early stages of financial decline; and (ii) capital restoration plans,
capital raising requirements, limits on transactions with affiliates,
management changes and asset sales in the later stages of financial
decline.\189\
---------------------------------------------------------------------------
\189\ 12 U.S.C. 5366.
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B. Overview of the Proposed Rule
The proposed rule establishes a regime for the early remediation of
financial distress at covered companies that includes four levels of
remediation requirements and several forward-looking triggers designed
to identify emerging or potential issues before they develop into
larger problems. The four levels of remediation are: (i) Heightened
supervisory review, in which the Board would conduct a targeted review
of the covered company to determine if it should be moved to the next
level of remediation; (ii) initial remediation, in which a covered
company would be subject to restrictions on growth and capital
distributions; (iii) recovery, in which a firm would be subject to a
prohibition on growth and capital distributions, limits on executive
compensation, and requirements to raise additional capital, and
additional requirements on a case-by-case basis; and (iv) recommended
resolution, in which the Board would consider whether to recommend to
the Treasury Department and the FDIC that the firm be resolved under
the orderly liquidation authority provided for in Title II of the Dodd-
Frank Act.
While the proposed framework includes regulatory capital triggers,
which the Board recognizes can be a lagging indicator, non-
discretionary restrictions on growth and capital distributions would
occur once a covered company's capital levels fall below the ``well
capitalized'' threshold. In contrast, similar actions do not occur
under the PCA regime until a depository institution falls below the
``adequately capitalized'' level.\190\
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\190\ See 12 CFR 208.45.
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Further, in December 2010, the BCBS adopted a series of reforms
directed at improving the quantity and quality of capital held by
internationally active banking organizations. Specifically, the Basel
III reforms introduce a minimum tier 1 common risk-based capital ratio,
heighten the qualification standards for regulatory capital, introduce
a capital conservation buffer on top of minimum regulatory capital
ratios, and raise the minimum tier 1 capital risk-based requirement. In
addition, under the Basel II-based advanced approaches rule, companies
are required to estimate expected credit losses and deduct from capital
the amount by which expected credit losses exceed eligible credit
reserves, as defined in the rule.\191\ The reforms are expected to
result in regulatory capital ratios that provide a more accurate
reflection of a company's condition. As noted above, the Board and the
other federal banking agencies are in the process of developing a
proposal to implement the Basel III framework in the United States. The
Board expects to evaluate the interaction between the early remediation
framework for covered companies and any revised capital standards as
those standards are incorporated into U.S. regulation, and may propose
conforming changes to the
[[Page 635]]
early remediation framework at that time.
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\191\ See 12 CFR part 225, appendix G.
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In addition to regulatory capital-based triggers, the proposed rule
includes forward-looking triggers based on (i) supervisory stress
tests, which provide an assessment of the covered company's ability to
withstand adverse economic and financial market conditions; and (ii)
market indicators, which provide a third-party assessment of the
covered company's financial position. The Board also has sought to
harmonize the proposed rule with the risk management and risk committee
requirements as well as the liquidity risk management standards that
would be applicable to covered companies under this proposed rule.
Identified weakness in any of the enhanced risk management and
liquidity risk management standards may also trigger supervisory
actions, including non-discretionary actions specified in the early
remediation regime.
The Board considered including an explicit quantitative liquidity
trigger in the proposal, but is concerned that such a trigger could
exacerbate funding pressures at affected covered companies, rather than
provide for early remediation of issues. The Board also considered
including certain balance sheet measures as triggers, including
nonperforming loans and loan concentrations, in the early remediation
regime. In its recent study, the GAO identified asset quality as an
important predictor of future bank failure.\192\ However, the Board is
concerned that such triggers would be inappropriate for firms engaged
predominantly in activities other than commercial banking, and
therefore would provide limited value in an early remediation regime
applicable to all covered companies.
---------------------------------------------------------------------------
\192\ See GAO Study, supra note 187, at 2.
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In implementing the proposed rule, the Board expects to notify the
primary regulators of a covered company's subsidiaries and the FDIC as
the covered company enters into or changes remediation levels.
Question 78: The Board recognizes that liquidity ratios can provide
an early indication of difficulties at a covered company and seeks
comment on the costs and benefits of including a quantitative liquidity
trigger in the early remediation regime. If the Board were to include a
quantitative liquidity trigger in the regime, what quantitative
liquidity trigger should be used and how should it be calibrated?
Question 79: The Board also seeks comment on the value of including
balance sheet measures, such as nonperforming loans and loan
concentrations, in the early remediation regime as triggers. What
balance sheet measures, if any, should the Board include, and how
should they be calibrated?
Tables 4 and 5 below provide a summary of all triggers and
associated remediation actions in this proposed rule.
Table 4--Early Remediation Triggers
--------------------------------------------------------------------------------------------------------------------------------------------------------
Enhanced risk Enhanced liquidity
Risk-based capital/ Stress tests management and risk risk management Market indicators
leverage committee standards standards
--------------------------------------------------------------------------------------------------------------------------------------------------------
Level 1 (Heightened Supervisory Meets all risk-based Covered company's Covered company has Covered company has The median value of
Review (HSR)). and leverage regulatory capital manifested signs of manifested signs of any of the covered
requirements for a ratios exceed minimum weakness in meeting weakness in meeting company's market
well capitalized requirements under enhanced risk the enhanced indicators exceeds
covered company: the supervisory management or risk liquidity risk the trigger
Tier 1 RBC ratio > stress test severely committee management standards threshold for the
6.0%. adverse scenario but requirements for for covered entire breach
Total RBC ratio > it is otherwise in covered companies. companies. period.
10.0%. noncompliance with
Tier 1 Leverage ratio the Board's capital
> 5.0%. plan or stress
However, the covered testing rules.
company has
demonstrated capital
structure or capital
planning weaknesses.
Level 2 (Initial Remediation)...... Fails to meet any one Under the supervisory Covered company has Covered company has n.a.
of the Level 1 stress test severely demonstrated demonstrated
capital levels and adverse scenario, the multiple multiple
maintains: company's Tier 1 deficiencies in deficiencies in
Tier 1 RBC ratio > common RBC ratio meeting the enhanced meeting the enhanced
4.0%. falls below 5% during risk management and liquidity risk
Total RBC ratio > 8.0% any quarter of the risk committee management standards
Tier 1 Leverage ratio nine quarter planning requirements for for covered
> 4.0%. horizon. covered companies. companies.
[[Page 636]]
Level 3 (Recovery)................. Fails to meet any one Under the severely Covered company is in Covered company is in n.a.
of the Level 2 adverse scenario, the substantial substantial
capital levels and covered company's noncompliance with noncompliance with
maintains: Tier 1 common RBC enhanced risk enhanced liquidity
Tier 1 RBC ratio > ratio falls below 3% management and risk risk management
3.0%. during any quarter of committee standards for
Total RBC ratio > 6.0% the nine quarter requirements for covered companies.
Tier 1 Leverage ratio planning horizon. covered companies.
> 3.0%.
Or institution's risk-
based capital ratios
remain below 6.0%
Tier 1 RBC, 10.0%
Total RBC, or 5.0%
Leverage, for more
than two complete
consecutive calendar
quarters.
Level 4 (Recommended resolution)... Covered company's n.a................... n.a.................. n.a.................. n.a.
regulatory capital
ratios are below any
of the following
thresholds:
3.0% Tier 1 RBC.......
6.0% Total RBC........
3.0% Tier 1 Leverage
ratio.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Table 5--Remediation Actions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Enhanced risk
Risk-based capital/ management and risk Enhanced liquidity
leverage Stress tests committee risk management Market indicators
requirements standards
--------------------------------------------------------------------------------------------------------------------------------------------------------
Level 1 (Heightened Supervisory Heightened Supervisory HSR................... HSR.................. HSR.................. HSR.
Review). Review (HSR):
The Board will produce
an internal report on
the elements
evidencing
deterioration within
30 days of a Level 1
trigger breach and
determine whether the
institution should be
elevated to a higher
level of remediation.
----------------------------------------------------------------------------------------------
Level 2 (Initial Remediation)...... All capital distributions (e.g., dividends and buybacks) are restricted to no more than 50% n.a.
of the average of the covered company's net income in the previous two quarters.
Covered company faces restrictions on growth (no more than 5% growth in total assets or
total RWA per quarter or per annum), and is generally prohibited from directly or
indirectly acquiring controlling interest in any company.
Covered company will be subject to a non-public MOU.
Covered company may be subject to other limitations and conditions on its conduct or
activities as the Board deems appropriate.
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[[Page 637]]
Level 3 (Recovery)................. Covered company is placed under a written agreement that prohibits all capital n.a.
distributions, any quarterly growth of total assets or RWA, and material acquisitions. The
written agreement will also include a requirement to raise additional capital to restore
the covered company's capital level to or above regulatory minimums. If written agreement
timeframes are not met, the covered company may be subject to divestiture requirements.
Covered company will also be subject to a prohibition on discretionary bonus payments and
restrictions on pay increases.
Supervisors may also remove culpable senior management and limit transactions between
affiliates.
Covered company may be subject to other limitations and conditions on its conduct or
activities as the Board deems appropriate.
----------------------------------------------------------------------------------------------
Level 4 (Recommended Resolution)... The Board will n.a. n.a.
consider whether to
recommend to the
Treasury Department
and the FDIC that the
covered company be
resolved under the
orderly liquidation
authority provided
for in Title II of
the Dodd-Frank Act.
--------------------------------------------------------------------------------------------------------------------------------------------------------
1. Early Remediation Requirements
a. Level 1 Remediation (Heightened Supervisory Review)
The proposed rule provides that the first level of remediation
consists of heightened supervisory review. Level 1 remediation would be
triggered when a covered company first shows signs of financial
distress or material risk management weaknesses such that further
decline of the company is probable. Level 1 remediation would require
the Board to produce a report on the elements evidencing deterioration
within 30 days and determine whether the institution should be elevated
to a higher level of remediation.
In determining whether to elevate the covered company to a higher
level of remediation, the Board would consider the extent to which the
factors giving rise to a triggering event were caused by financial
weakness or material risk management weaknesses at the covered company,
such that further decline of the company is probable. The Board may
also use other supervisory authority to cause the covered company to
take appropriate actions to address the problems reviewed by the Board
under level 1 remediation.
b. Level 2 Remediation (Initial Remediation)
The Dodd-Frank Act provides that remedial actions required of
covered companies in the initial stages of financial decline shall
include limits on capital distributions, acquisitions and asset growth.
The proposed rule provides that a covered company that triggers level 2
remediation (because it does not meet certain risk-based capital,
leverage, or stress test thresholds, or has ongoing weaknesses in
multiple requirements under the enhanced liquidity risk management
standards and enterprise-wide risk management requirements included in
this proposal) would be prohibited from distributing in any calendar
quarter more than 50 percent of the average of its net income for the
preceding two calendar quarters. The company would also be prohibited
from permitting (i) its daily average total assets and daily average
total risk-weighted assets in any calendar quarter to exceed daily
average total assets and daily average total risk-weighted assets,
respectively, during the preceding calendar quarter by more than 5
percent; and (ii) its daily average total assets and daily average
total risk-weighted assets in any calendar year to exceed daily average
total assets and daily average total risk-weighted assets,
respectively, during the preceding calendar year by more than 5
percent.
The covered company would also be prohibited from directly or
indirectly acquiring a controlling interest in any company without the
prior approval of the Board. This includes controlling interests in any
nonbank company and the establishment or acquisition of any office or
place of business. Non-controlling acquisitions, such as the
acquisition of less than 5 percent of the voting shares of a company,
generally would not require prior approval. The covered company would
also be required to enter into a non-public memorandum of understanding
or undergo another enforcement action acceptable to the Board.
As part of level 2 remediation, the Board would also be able to
impose limitations or conditions on the conduct or activities of the
covered company or any of its affiliates as the Board deems appropriate
and consistent with the purposes of Title I of the Dodd-Frank Act,
including limitations or conditions deemed necessary to improve the
safety and soundness of the covered company, promote financial
stability, or limit the external costs of the potential failure of the
covered company.
The restriction on capital distributions under level 2 remediation
would apply to all capital distributions (common stock dividends and
share repurchases) and would help to ensure that covered companies
preserve capital through retained earnings during the earliest periods
of financial stress, thereby building a capital cushion to absorb
losses that the covered company may continue to accrue due to the
weaknesses that caused it to enter level 2 remediation. This cushion is
important to making the covered company's failure less likely, and also
to minimize the external costs that the
[[Page 638]]
covered company's distress or possible failure could impose on markets
and the economy generally.
In developing this proposed rule, the Board considered the impact
of the proposed restriction on capital distributions under level 2
remediation. According to data reviewed by the Board, prohibiting a
weakened covered company from distributing more than 50 percent of its
recent earnings should promote the important purpose of building a
capital cushion at the covered company to absorb potential additional
losses while still allowing the firm some room to pay dividends and
repurchase shares. The Board notes that the capital conservation buffer
under Basel III is similarly designed to impose increasingly stringent
restrictions on capital distributions and employee bonus payments by
banking organizations as their capital ratios approach regulatory
minima.\193\
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\193\ See Basel III framework, supra note 34, at 60.
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Furthermore, the level 2 remediation restrictions on asset growth
is intended to prevent covered companies that are encountering the
initial stages of financial difficulties from growing at a rate
inconsistent with preserving capital and focusing on resolving material
financial or risk management weaknesses. A 5 percent limit should
generally be consistent with reasonable growth in the normal course of
a covered company's business.
The level 2 remediation restriction on acquisitions of controlling
interests in other companies without prior Board approval is also
intended to prevent covered companies that are experiencing initial
stages of financial difficulties from materially increasing their size
or systemic interconnectedness. A company in early stages of financial
stress needs to focus its energies on improving its financial
condition, not on seeking major acquisition opportunities or
integrating major new acquisitions. Under this provision, the Board
would evaluate the materiality of acquisitions on a case-by-case basis
to determine whether approval is warranted. Acquisition of non-
controlling interests would continue to be permitted to allow covered
companies to proceed with ordinary business functions (such as equity
securities dealing) that may involve acquisitions of shares in other
companies that do not rise to the level of control.
The proposed rule would also require covered companies that are
subject to level 2 remediation to enter into a non-public memorandum of
understanding with the Federal Reserve in order to facilitate the
establishment of a reasonable action plan for the covered company to
improve its condition.
c. Level 3 Remediation (Recovery)
The Act provides that remediation actions required of covered
companies in advanced stages of financial stress shall include a
capital restoration plan and capital raising requirements, limits on
transactions with affiliates, management changes and asset sales.
Accordingly, under the proposed rule, a covered company that has
entered level 3 remediation (because the covered company did not meet
certain risk-based capital, leverage or stress test thresholds, or is
in substantial non-compliance with the enhanced risk management or
enhanced liquidity standards of this proposal) would be subject to a
number of fixed limitations. The covered company would be prohibited
from making any capital distributions and from increasing the
compensation of, or paying any bonus to, its senior executive officers
or directors. Additionally, the covered company could not permit its
average total assets or average total risk-weighted assets during any
calendar quarter to exceed average total assets or average total risk-
weighted assets during the previous quarter. The covered company would
also be prohibited from (i) directly or indirectly acquiring any
interest in any company; (ii) establishing or acquiring any office or
other place of business; or (iii) engaging in any new line of business.
Furthermore, the covered company would be required to enter into a
written agreement or other form of formal enforcement action with the
Board that would specify that it must raise capital and take other
actions to improve capital adequacy. If the covered company
subsequently did not satisfy the requirements of the written agreement,
the Board could require the company to divest assets identified by the
Board as contributing to the covered company's financial decline or
that pose substantial risk of contributing to the company's further
financial decline.
Under the proposal, the Board could also require a covered company
under level 3 remediation to conduct new elections for its board of
directors, dismiss directors or senior executive officers that have
been in office for more than 180 days, hire senior executive officers
approved by the Board, or limit transactions with its affiliates.
The Board believes that these restrictions would appropriately
limit a covered company's ability to increase its risk profile and
ensure maximum capital conservation when its condition or risk
management failures have deteriorated to the point that it is subject
to this level of remediation. These restrictions, while potentially
disruptive to aspects of the company's business, are consistent with
the purpose of section 166 of the Dodd-Frank Act: to arrest a covered
company's decline and help to mitigate external costs associated with
its potential failure.
Furthermore, to the extent that a covered company's management is a
primary cause of its level 3 remediation status, the proposal would
allow the Board to take appropriate action to ensure that such
management could not increase the risk profile of the company or make
its failure more likely. Taken together, the mandatory and optional
restrictions and actions of level 3 remediation provide the Board with
important tools to make a covered company's failure less likely and if
failure were to occur, less costly to the financial system.
d. Level 4 Remediation (Resolution Assessment)
Under the proposed rule, if level 4 remediation is triggered
(because the covered company did not meet certain risk-based capital or
leverage requirements), the Board would consider whether to recommend
to the Treasury Department and the FDIC that the firm be resolved under
the orderly liquidation authority provided for in Title II of the Dodd-
Frank Act, based on whether the covered company is in default or in
danger of default and poses a risk to the stability of the U.S.
financial system pursuant to section 203 of the Dodd-Frank Act.
Question 80: The Board seeks comment on the proposed mandatory
actions that would occur at each level of remediation. What, if any,
additional or different restrictions should the Board impose on
distressed covered companies?
2. Early Remediation Triggering Events
The proposed rule provides triggering events based on the Board's
existing definitions of minimum risk-based capital and leverage ratios,
the results of the Board's supervisory stress tests under this proposed
rule, weaknesses in complying with enhanced risk management and
liquidity standards under this proposed rule and market indicators.
a. Risk-Based Capital and Leverage
The Act specifies that capital and leverage will be among the
elements used to evaluate the financial condition of a covered company
under the early
[[Page 639]]
remediation framework. The risk-based capital and leverage ratios for
each covered company would be measured using periodic statements, in
connection with inspections of a covered company, or upon request of
the Board.
Although there is no fixed capital-related threshold for level 1
remediation, weaknesses in a covered company's capital structure or
capital planning processes could lead to level 1 remediation, even
where the covered company's capital ratios exceed the minimum levels
for level 2 remediation. Thus, if a covered company maintains a total
risk-based capital ratio of 10.0 percent or greater, a tier 1 risk-
based capital ratio of 6.0 percent or greater, and a tier 1 leverage
ratio of 5.0 percent or greater, but the Board determines that its
financial condition is not commensurate with the risks posed by its
activities, then level 1 remediation would apply. Level 2 remediation
(initial remediation) would apply if a covered company has a total
risk-based capital ratio of less than 10.0 percent and greater than or
equal to 8.0 percent, a tier 1 risk-based capital ratio of less than
6.0 percent and greater than or equal to 4.0 percent, or a tier 1
leverage ratio of less than 5.0 percent and greater than or equal to
4.0 percent.
A covered company would be subject to level 3 remediation
(recovery) if:
(i) For two complete consecutive quarters, the covered company has
a total risk-based capital ratio of less than 10.0 percent, a tier 1
risk-based capital ratio of less than 6.0 percent, or a tier 1 leverage
ratio of less than 5.0 percent; or
(ii) The covered company has a total risk-based capital ratio of
less than 8.0 percent and greater than or equal to 6.0 percent, a tier
1 risk-based capital ratio of less than 4.0 percent and greater than or
equal to 3.0 percent or a tier 1 leverage ratio of less than 4.0
percent and greater than or equal to 3.0 percent.
Finally, a covered company would be subject to level 4 remediation
(resolution assessment) if it has a total risk-based capital ratio of
less than 6.0 percent, a tier 1 risk-based capital ratio of less than
3.0 percent or a tier 1 leverage ratio of less than 3.0 percent. The
Board believes that the remediation requirements listed above are
reasonable restraints on covered companies that are unable to meet
these regulatory capital thresholds.
Question 81: The Board seeks comment on the proposed risk-based
capital and leverage triggers. What alternative or additional risk-
based capital or leverage triggering events, if any, should the Board
adopt? Provide a detailed explanation of such alternative triggering
events with supporting data.
b. Stress Tests
As discussed more fully in section VII of this proposal, the
supervisory stress test gauges a covered company's capital adequacy
under baseline, adverse and severely adverse scenarios. The proposed
rule would use the results of the stress test under the severely
adverse scenario to trigger early remediation. A covered company whose
tier 1 common risk-based capital ratio falls below certain minimum
thresholds under the severely adverse scenario during any quarter of
the planning horizon (which extends for at least nine quarters) would
be subject to early remediation. Under the rule as proposed, the lower
the tier 1 common risk-based capital ratio under the stress test, the
more stringent the required remedial actions would be. Specifically:
(i) Level 1 remediation. A covered company would be subject to
level 1 remediation if it is not in compliance with any regulations
adopted by the Board relating to capital plans and stress tests.\194\
The Board believes that even if a covered company meets the minimum
regulatory capital requirements under the severely adverse stress
scenario, noncompliance with the Board's capital plan or stress testing
regulations is sufficient to warrant level 1 remediation.
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\194\ See 12 CFR 225.8.
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(ii) Level 2 remediation. A covered company would be subject to
level 2 remediation if, under the results of the severely adverse
stress test in any quarter of the planning horizon, the covered
company's tier 1 common risk-based capital ratio fell below 5.0 percent
and remained above 3.0 percent.
(iii) Level 3 remediation. A covered company would be subject to
level 3 remediation if, under the results of the severely adverse
stress test in any quarter of the planning horizon, the covered
company's tier 1 common risk-based capital ratio fell below 3.0
percent.
Question 82: What additional factors should the Board consider when
incorporating stress test results into the early remediation framework?
Is the severely adverse scenario appropriately incorporated as a
triggering event? Why or why not?
c. Risk Management
The Board believes that material weaknesses and deficiencies in
risk management could contribute significantly to a firm's decline and
ultimate failure. The proposed rule provides that, if the Board
determines that a covered company has failed to comply with the
enhanced risk management provisions of Subpart E of this proposed rule,
it would be subject to level 1, 2, or 3 remediation, depending on the
severity of the compliance failure.
Thus, for example, level 1 remediation would be appropriate if a
covered company has manifested signs of weakness in meeting the
proposal's enhanced risk management and risk committee requirements.
Similarly, level 2 remediation would be appropriate if a covered
company has demonstrated multiple deficiencies in meeting the enhanced
risk management or risk committee requirements, and level 3 remediation
would be appropriate if the covered company is in substantial
noncompliance with the enhanced risk management and risk committee
requirements.
Question 83: The Board seeks comment on triggers tied to risk
management weaknesses. Should the Board consider specific risk
management triggers tied to particular events? If so, what might such
triggers involve? How should failure to promptly address material risk
management weaknesses be addressed by the early remediation regime?
Under such circumstances, should companies be moved to progressively
more stringent levels of remediation, or are other actions more
appropriate? Provide a detailed explanation.
d. Liquidity
The Dodd-Frank Act provides that the measures of financial
condition to be included in the early remediation framework shall
include liquidity measures. Under the proposal, a covered company would
be subject to level 1, level 2, or level 3 remediation if the Board
determines that the company's measurement or management of its
liquidity risks is not in compliance with the requirements of Subpart C
of this proposed rule. The level of remediation to which a covered
company would be subject shall vary, at the discretion of the Board,
depending on the severity of the compliance failure.
Thus, for example, level 1 remediation would be appropriate if a
covered company has manifested signs of weakness in meeting the
proposal's enhanced liquidity risk management standards. Similarly,
level 2 remediation would be appropriate if a covered company has
demonstrated multiple deficiencies in meeting the enhanced liquidity
risk management standards, and level 3 remediation would be appropriate
if the covered
[[Page 640]]
company is in substantial noncompliance with the enhanced liquidity
risk management standards.
e. Market Indicators
Section 166(c)(1) of the Dodd-Frank Act directs the Board, in
defining measures of a covered company's condition, to utilize ``other
forward-looking indicators''. A review of market indicators in the lead
up to the recent financial crisis reveals that market-based data often
provided an early signal of deterioration in a company's financial
condition. Moreover, numerous academic studies have concluded that
market information is complementary to supervisory information in
uncovering problems at financial companies.\195\ Accordingly, the Board
proposes to use a variety of market-based triggers designed to capture
both emerging idiosyncratic and systemic risk across covered companies
in the early remediation regime. The Board proposes to implement a
system of market-based triggers that prompts a heightened supervisory
review (level 1 remediation) of a covered company's financial condition
and risk management. The Board would produce a report on the elements
evidencing deterioration within 30 days of a covered company hitting a
market indicator trigger and determine whether the institution should
be elevated to a higher level of remediation. In determining whether to
elevate the covered company to a higher level of remediation, the Board
would consider the extent the factors giving rise to a triggering event
were caused by financial weakness or material risk management
weaknesses at the covered company such that further decline of the
company is probable. The Board may also use other supervisory authority
to cause the covered company to take appropriate actions to address the
problems reviewed by the Board under level 1 remediation.
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\195\ See, e.g., Berger, Davies, and Flannery, Comparing Market
and Supervisory Assessments of Bank Performance: Who Knows What
When? Journal of Money, Credit, and Banking, 32 (3), at 641-667
(2000). Krainer and Lopez, How Might Financial Market Information Be
Used for Supervisory Purposes?, FRBSF Economic Review, at 29-45
(2003). Furlong and Williams, Financial Market Signals and Banking
Supervision: Are Current Practices Consistent with Research
Findings?, FRBSF Economics Review, at 17-29 (2006).
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The Board recognizes that market-based early remediation triggers--
like all early warning metrics--have the potential to trigger
remediation for firms that have no material weaknesses (false
positives) and fail to trigger remediation for firms whose financial
condition has deteriorated (false negatives), depending on the sample,
time period and thresholds chosen. Further, the Board notes that if
market indicators are used to trigger corrective actions in a
regulatory framework, market prices may adjust to reflect this use and
potentially become less revealing over time. Accordingly, the Board is
not proposing to use market-based triggers to subject a covered company
directly to early remediation levels 2, 3, or 4 at this time. The Board
expects to review this approach after gaining additional experience
with the use of market data in the supervisory process.
Given that the informational content and availability of market
data will change over time, the Board also proposes to publish for
notice and comment the market-based triggers and thresholds on an
annual basis (or less frequently depending on whether the Board
determines that changes to an existing regime would be appropriate),
rather than specifying these triggers in this rule. In order to ensure
transparency, the Board's disclosure of market-based triggers would
include sufficient detail to allow the process to be replicated in
general form by market participants. The Board seeks comment on the use
of market indicators described below. Before commencing use of any
particular market-based indicator the Board intends to publish such
indicators for notice and comment.
i. Proposed Market Indicators
In selecting market indicators to incorporate into the early
remediation regime, the Board focused on indicators that have
significant information content, i.e. for which prices quotes are
available, and provide a sufficiently early indication of emerging or
potential issues. The Board proposes to use the following or similar
market-based indicators in its early remediation framework:
1. Equity-Based Indicators
Expected default frequency (EDF). The EDF measures the expected
probability of default in the next 365 days. The Board uses EDFs
calculated using Moody's KMV RISKCALC model.
Marginal expected shortfall (MES). The MES of a financial
institution is defined as the expected loss on its equity when the
overall market declines by more than a certain amount. Each financial
institution's MES depends on the volatility of its stock price, the
correlation between its stock price and the market return, and the co-
movement of the tails of the distributions for its stock price and for
the market return. The Board uses MES calculated following the
methodology of Acharya, Pederson, Phillipon, and Richardson (2010). MES
data are available at http://vlab.stern.nyu.edu/welcome/risk.
Market Equity Ratio. The market equity ratio is defined as the
ratio of market value of equity to market value of equity plus book
value of debt.
Option-implied volatility. The option-implied volatility of a
firm's stock price is calculated from out-of-the-money option prices
using a standard option pricing model, reported as an annualized
standard deviation in percentage points by Bloomberg.
2. Debt-Based Indicators
Credit default swaps (CDS). The Board uses CDS offering protection
against default on a 5-year maturity, senior unsecured bond by a
financial institution.
Subordinated debt (bond) spreads. The Board uses financial
companies' subordinated bond spreads with a remaining maturity of at
least 5 years over the Treasury rate with the same maturity or the
LIBOR swap rate published by Bloomberg.
The Board recognizes that all market indicators for different
covered companies are not traded with the same frequency and therefore
may not contain the same level of informational content.
Question 84: The Board seeks comment on the proposed approach to
market-based triggers detailed below, alternative specifications of
market-based indicators, and the potential benefits and challenges of
introducing additional market-based triggers for levels 2, 3, or 4 of
the proposed early remediation regime. In addition, the Board seeks
comment on the sufficiency of information content in market-based
indicators generally.
ii. Proposed Trigger Design
The Board's proposed market indicator-based regime would trigger
heightened supervisory review when any of the covered company's
indicators cross a threshold based on different percentiles of
historical distributions. The Board seeks comment on the use of both
time-variant and time-invariant triggers, as follows:
Time-variant triggers capture changes in the value of a company's
market-based indicator relative to its own past performance and the
past performance of its peers. Peer groups would be determined on an
annual basis. Current values of indicators, measured in levels and
changes, would be evaluated relative to a covered company's own time
series (using a rolling 5-year window) and relative to the median of a
group of predetermined low-risk peers
[[Page 641]]
(using a rolling 5-year window), and after controlling for market or
systematic effects.\196\ The value represented by the percentiles for
each signal varies over time as data is updated for each indicator.
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\196\ Market or systemic effects are controlled by subtracting
the median of corresponding changes from the peer group.
---------------------------------------------------------------------------
For all time-variant triggers, heightened supervisory review would
be required when the median value of at least one market indicator over
a period of 22 consecutive business days, either measured as its level,
its 1-month change, or its 3-month change, both absolute and relative
to the median of a group of predetermined low-risk peers, is above the
95th percentile of the firm's or the median peer's market indicator 5-
year rolling window time series. The Board proposes to use time-variant
triggers based on all six market indicators listed above.
Time-invariant triggers capture changes in the value of a company's
market-based indicators relative to the historical distribution of
market-based variables over a specific fixed period of time and across
a predetermined peer group. Time-invariant triggers are used to
complement time-variant triggers since time-variant triggers could lead
to excessively low or high thresholds in cases where the rolling window
covers only an extremely benign period or a highly disruptive financial
period. The Board acknowledges that a time-invariant threshold should
be subject to subsequent revisions when warranted by circumstances.
As currently contemplated, the Board would consider all pre-crisis
panel data for the peer group (January 2000-December 2006), which
contain observations from the subprime crisis in the late 1990s and
early 2000s as well as the tranquil period of 2004-2006. For each
market indicator, percentiles of the historical distributions would be
computed to calibrate time-invariant thresholds. The Board would focus
on five indicators for time-invariant triggers, calibrated to balance
between their propensity to produce false positives and false
negatives: CDS prices, subordinated debt spreads, option-implied
volatility, EDF and MES. The market equity ratio is not used in the
time-invariant approach because the cross-sectional variation of this
variable was not found to be informative of early issues across
financial companies. Time-invariant thresholds would trigger heightened
supervisory review if the median value for a covered company over 22
consecutive business days was above the threshold for any of the market
indicators used in the regime.
In considering all thresholds for each time-invariant trigger, the
Board evaluated the tradeoff between early signals and supervisory
burden associated with potentially false signals. Data limitations in
the time-invariant approach also require the construction of different
thresholds for different market indicators. The Board proposes the
following calibration:
CDS. The CDS price data used to create the distribution consist of
an unbalanced panel of daily CDS price observations for 25 financial
companies over the 2001- 2006 period. Taking the skewed distribution of
CDS prices in the sample and persistent outliers into account, the
threshold was set at 44 basis points, which corresponds to the 80th
percentile of the distribution.
Subordinated debt (bond) spreads. The data covered an unbalanced
panel of daily subordinated debt spread observations for 30 financial
companies. Taking the skewed distribution into account, the threshold
was set to 124 basis points, which corresponds to the 90th percentile
of the distribution.
MES. The data covered a balanced panel of daily observations for 29
financial companies. The threshold was set to 4.7 percent, which
corresponds to the 95th percentile of the distribution.
Option-implied volatility. The data covered a balanced panel of
daily option-implied volatility observations for 29 financial
companies. The threshold was set to 45.6 percent, which corresponds to
the 90th percentile of the distribution.
EDF. The monthly EDF data cover a balanced panel of 27 financial
companies. The threshold was set to 0.57 percent, which corresponds to
the 90th percentile of the distribution.
The Board invites comment on the use of market indicators to prompt
early remediation actions.
Question 85: Should the Board include market indicators described
above in the early remediation regime? If not, what other forward-
looking indicators should the Board include?
Question 86: Are the indicators outlined above the correct set of
indicators to consider? Should other market-based triggers be
considered?
Question 87: How should the Board consider the liquidity of an
underlying security when it chooses indicators?
Question 88: The Board proposes using both absolute levels and
changes in indicators. Over what period should changes be calculated?
Question 89: Should the Board use both time-variant and time-
invariant indicators? What are the comparative advantages of using one
or the other?
Question 90: Is the proposed trigger time (when the median value
over a period of 22 consecutive business days crosses the predetermined
threshold) to trigger heightened supervisory review appropriate? What
periods should be considered and why?
Question 91: Should the Board use a statistical threshold to
trigger heightened supervisory review or some other framework?
Question 92: Should the Board consider using market indicators to
move covered companies directly to level 2 (initial remediation)? If
so, what time thresholds should be considered for such a trigger? What
would be the drawbacks of such a second trigger?
Question 93: To what extent do these indicators convey different
information about the short-term and long-term performance of covered
companies that should be taken into account for the supervisory review?
Question 94: Should the Board use peer comparisons to trigger
heightened supervisory review? If so, should the Board consider only
low-risk covered companies for the peer group or a broader range of
financial companies? If a broader a range is more appropriate, how
should the peer group be defined?
Question 95: How should the Board account for overall market
movements in order to isolate idiosyncratic risk of covered companies?
C. Notice and Remedies
The proposed rule provides that the initiation of early remediation
and the transfer of a covered company from one level of remediation to
another would occur upon notice from the Board. Similarly, a covered
company shall remain subject to the requirements imposed by early
remediation until the Board notifies the covered company that its
financial condition no longer warrants application of the requirement.
Covered companies have an affirmative duty to notify the Board of
triggering events and other changes in circumstances that could result
in changes to the early remediation provisions that apply to it.
D. Relationship to Other Laws and Requirements
The early remediation regime that would be established by the
proposed rule would supplement rather than replace the Board's other
supervisory processes with respect to covered companies. The proposed
rule would not limit the existing supervisory authority vested in the
Board, including the Federal Reserve's authority to
[[Page 642]]
initiate supervisory actions to address deficiencies, unsafe or unsound
conduct, practices, or conditions, or violations of law. For example,
the Board may respond to signs of a covered company's financial stress
by requiring corrective measures in addition to remedial actions
required under the proposed rule. The Board also may use other
supervisory authority to cause a covered company to take remedial
actions enumerated in the early remediation regime on a basis other
than a triggering event.
X. Administrative Law Matters
A. Solicitation of Comments on the Use of Plain Language
Section 722 of the Gramm-Leach-Bliley Act (Pub. L. 106-102, 113
Stat. 1338, 1471, 12 U.S.C. 4809) requires the Federal banking agencies
to use plain language in all proposed and final rules published after
January 1, 2000. The Board has sought to present the proposed rule in a
simple and straightforward manner, and invites comment on the use of
plain language.
B. Paperwork Reduction Act Analysis
Request for Comment on Proposed Information Collection
In accordance with section 3512 of the Paperwork Reduction Act of
1995 (44 U.S.C. 3501-3521) (PRA), the Board may not conduct or sponsor,
and a respondent is not required to respond to, an information
collection unless it displays a currently valid Office of Management
and Budget (OMB) control number. The Board reviewed the proposed rule
under the authority delegated to the Board by OMB.
The proposed rule contains requirements subject to the PRA. The
reporting requirements are found in section 252.164(b); the
recordkeeping requirements are found in sections 252.61 \197\ and
252.145(b)(1); \198\ and the disclosure requirements are found in
section 252.148. The recordkeeping burden for the following sections is
accounted for in the section 252.61 burden: 252.52(b)(3), 252.56,
252.58, 252.60(a), and 252.60(c). These information collection
requirements would implement section 165 and 166 of the Dodd-Frank Act,
as mentioned in the Abstract below.
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\197\ Most of the recordkeeping requirements for Subpart C--
Liquidity Requirements have been addressed in the Funding and
Liquidity Risk Management Guidance (FR 4198; OMB No. 7100-0326).
Only new recordkeeping requirements are being addressed with this
proposed rulemaking.
\198\ Some of the recordkeeping requirements for Subpart G--
Company-Run Stress Test Requirements have been addressed in the
proposed Recordkeeping and Disclosure Provisions Associated with
Stress Testing Guidance (FR 4202). See the Federal Register notice
published on June 15, 2011 (76 FR 35072). Only new recordkeeping
requirements are being addressed with this proposed rulemaking.
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The reporting requirements found in section 252.136(b) have been
addressed in the Resolution Plans Required Regulation (Reg QQ).\199\
The reporting requirements found in sections 252.13(a), 252.96(a),
252.134(a), 252.146(a), and 252.146(b) will be addressed in a separate
Federal Register notice at a later date.
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\199\ See 76 FR 67323 (November 1, 2011).
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Comments are invited on:
(a) Whether the proposed collections of information are necessary
for the proper performance of the Federal Reserve's functions,
including whether the information has practical utility;
(b) The accuracy of the Federal Reserve's estimate of the burden of
the proposed information collections, including the validity of the
methodology and assumptions used;
(c) Ways to enhance the quality, utility, and clarity of the
information to be collected;
(d) Ways to minimize the burden of the information collections on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
(e) Estimates of capital or start up costs and costs of operation,
maintenance, and purchase of services to provide information.
All comments will become a matter of public record. Comments on
aspects of this notice that may affect reporting, recordkeeping, or
disclosure requirements and burden estimates should be sent to the
addresses listed in the ADDRESSES section. A copy of the comments may
also be submitted to the OMB desk officer for the Federal banking
agencies: By mail to U.S. Office of Management and Budget, 725 17th
Street, NW., 10235, Washington, DC 20503 or by facsimile to
(202) 395-5806, Attention, Commission and Federal Banking Agency Desk
Officer.
Proposed Information Collection
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Regulation YY.
Frequency of Response: Annual, semiannual, and on occasion.
Affected Public: Businesses or other for-profit.
Respondents: U.S. bank holding companies, savings and loan holding
companies, nonbank financial companies, and state member banks.
Abstract: Section 165 of the Dodd-Frank Act requires the Board to
implement enhanced prudential standards and section 166 requires the
Board to implement an early remediation framework. The enhanced
standards include risk-based capital and leverage requirements,
liquidity standards, requirements for overall risk management
(including establishing a risk committee), single-counterparty credit
limits, stress test requirements, and debt-to-equity limits for
companies that the Council has determined pose a grave threat to
financial stability.
Section 252.61 would require a covered company to adequately
document all material aspects of its liquidity risk management
processes and its compliance with the requirements of Subpart C and
submit all such documentation to the risk committee.
Section 252.145(b)(1) would require that each covered company or
over $10 billion company must establish and maintain a system of
controls, oversight, and documentation, including policies and
procedures, designed to ensure that the stress testing processes used
by the covered company or over $10 billion company are effective in
meeting the requirements in Subpart G. These policies and procedures
must, at a minimum, describe the covered company's or over $10 billion
company's stress testing practices and methodologies, validation and
use of stress tests results, and processes for updating the company's
stress testing practices consistent with relevant supervisory guidance.
Policies of covered companies must describe processes for scenario
development for the additional stress test required under section
252.144.
Section 252.148 would require public disclosure of results required
for stress tests of covered companies and over $10 billion companies.
Within 90 days of submitting a report for its required stress test
under section 252.143 and section 252.144, as applicable, a covered
company and over $10 billion company shall disclose publicly a summary
of the results of the stress tests required under section 252.143 and
section 252.144, as applicable. The information disclosed by each
covered company and over $10 billion company, as applicable, shall, at
a minimum, include: (i) A description of the types of risks being
included in the stress test; (ii) for each covered company, a high-
level description of scenarios developed by the company under section
252.144(b), including key variables used (such as GDP, unemployment
rate, housing prices); (iii) a general description of the methodologies
employed to estimate losses, revenues, allowance for loan
[[Page 643]]
losses, and changes in capital positions over the planning horizon; and
(iv) aggregate losses, pre-provision net revenue, allowance for loan
losses, net income, and pro forma capital levels and capital ratios
(including regulatory and any other capital ratios specified by the
Board) over the planning horizon, under each scenario.
Section 252.164(b) would require that when a covered company
becomes aware of (i) one or more triggering events set forth in section
252.163; or (ii) a change in condition that it believes should result
in a change in the remediation provisions to which it is subject, such
covered company must provide notice to the Board within 5 business
days, identifying the nature of the triggering event or change in
circumstances.
Estimated Paperwork Burden
Estimated Burden per Response:
Section 252.61 recordkeeping--200 hours (Initial setup 160 hours).
Section 252.145(b)(1) recordkeeping--40 hours (Initial setup 280
hours for U.S. bank holding companies $50 billion and over in total
consolidated assets; 240 hours for institutions over $10 million in
total consolidated assets).
Section 252.148 disclosure--80 hour (Initial setup 200 hours).
Section 252.164(b) reporting--2 hours.
Number of respondents: 34 U.S. bank holding companies with total
consolidated assets of $50 billion or more, 39 U.S. bank holding
companies with total consolidated assets over $10 billion and less than
$50 billion, 21 state member banks with total consolidated assets over
$10 billion, 39 savings and loan holding companies with total
consolidated assets over $10 billion.
Total estimated annual burden: 97,736 hours (72,188 hours for
initial setup and 25,548 hours for ongoing compliance).
C. Regulatory Flexibility Act Analysis
In accordance with section 3(a) of the Regulatory Flexibility Act
\200\ (RFA), the Board is publishing an initial regulatory flexibility
analysis of the proposed rule. The RFA requires an agency either to
provide an initial regulatory flexibility analysis with a proposed rule
for which a general notice of proposed rulemaking is required or to
certify that the proposed rule will not have a significant economic
impact on a substantial number of small entities. Based on its analysis
and for the reasons stated below, the Board believes that this proposed
rule will not have a significant economic impact on a substantial
number of small entities. Nevertheless, the Board is publishing an
initial regulatory flexibility analysis. A final regulatory flexibility
analysis will be conducted after comments received during the public
comment period have been considered.
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\200\ 5 U.S.C. 601 et seq.
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In accordance with sections 165 and 166 of the Dodd-Frank Act, the
Board is proposing to adopt Regulation YY (12 CFR 252 et seq.) to
establish enhanced prudential standards and early remediation
requirements applicable for covered companies.\201\ The enhanced
standards include risk-based capital and leverage requirements,
liquidity standards, requirements for overall risk management
(including establishing a risk committee), single-counterparty credit
limits, stress test requirements, and debt-to-equity limits for
companies that the Council has determined pose a grave threat to
financial stability.
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\201\ See 12 U.S.C. 5365 and 5366.
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Under regulations issued by the Small Business Administration
(SBA), a ``small entity'' includes those firms within the ``Finance and
Insurance'' sector with asset sizes that vary from $7 million or less
in assets to $175 million or less in assets.\202\ The Board believes
that the Finance and Insurance sector constitutes a reasonable universe
of firms for these purposes because such firms generally engage in
actives that are financial in nature. Consequently, bank holding
companies or nonbank financial companies with assets sizes of $175
million or less are small entities for purposes of the RFA.
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\202\ 13 CFR 121.201.
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As discussed in the SUPPLEMENTARY INFORMATION, the proposed rule
generally would apply to a covered company, which includes only bank
holding companies with $50 billion or more in total consolidated
assets, and nonbank financial companies that the Council has determined
under section 113 of the Dodd-Frank Act must be supervised by the Board
and for which such determination is in effect. However, the enterprise
wide risk committee requirements required under section 165(h) of the
Act would apply to any publicly traded bank holding company with total
assets of $10 billion or more. The company-run stress test requirements
part of the proposal being established pursuant to section 165(i)(2) of
the Act also would apply to any bank holding company, savings and loan
holding company, and state member bank with more than $10 billion in
total assets. Companies that are subject to the proposed rule therefore
substantially exceed the $175 million asset threshold at which a
banking entity is considered a ``small entity'' under SBA
regulations.\203\ The proposed rule would apply to a nonbank financial
company designated by the Council under section 113 of the Dodd-Frank
Act regardless of such a company's asset size. Although the asset size
of nonbank financial companies may not be the determinative factor of
whether such companies may pose systemic risks and would be designated
by the Council for supervision by the Board, it is an important
consideration.\204\ It is therefore unlikely that a financial firm that
is at or below the $175 million asset threshold would be designated by
the Council under section 113 of the Dodd-Frank Act because material
financial distress at such firms, or the nature, scope, size, scale,
concentration, interconnectedness, or mix of it activities, are not
likely to pose a threat to the financial stability of the United
States.
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\203\ The Dodd-Frank Act provides that the Board may, on the
recommendation of the Council, increase the $50 billion asset
threshold for the application of certain of the enhanced standards.
See 12 U.S.C. 5365(a)(2)(B). However, neither the Board nor the
Council has the authority to lower such threshold.
\204\ See 76 FR 4555 (January 26, 2011).
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As noted above, because the proposed rule is not likely to apply to
any company with assets of $175 million or less, if adopted in final
form, it is not expected to apply to any small entity for purposes of
the RFA. The Board does not believe that the proposed rule duplicates,
overlaps, or conflicts with any other Federal rules. In light of the
foregoing, the Board does not believe that the proposed rule, if
adopted in final form, would have a significant economic impact on a
substantial number of small entities supervised. Nonetheless, the Board
seeks comment on whether the proposed rule would impose undue burdens
on, or have unintended consequences for, small organizations, and
whether there are ways such potential burdens or consequences could be
minimized in a manner consistent with sections 165 and 166 of the Dodd-
Frank Act.
List of Subjects in 12 CFR Part 252 and 12 CFR Chapter II
Administrative practice and procedure, Banks, Banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
Authority and Issuance
For the reasons stated in the SUPPLEMENTARY INFORMATION, the Board
[[Page 644]]
of Governors of the Federal Reserve System proposes to add the text of
the rule as set forth at the end of the SUPPLEMENTARY INFORMATION as
part 252 to 12 CFR chapter II as follows:
PART 252--ENHANCED PRUDENTIAL STANDARDS (REGULATION YY)
1. The authority citation for part 252 shall read as follows:
Authority: 12 U.S.C. 321-338a, 1467a(g), 1818, 1831p-1,
1844(b), 5365, 5366.
2. Part 252 is added to read as follows:
PART 252--ENHANCED PRUDENTIAL STANDARDS
Subpart A--General Provisions
Sec.
252.1 Authority, purpose, applicability, and reservation of
authority.
252.2 through 252.9 [Reserved]
Subpart B--Risk-Based Capital Requirements and Leverage Limits
252.11 Applicability.
252.12 Definitions.
252.13 Enhanced risk-based capital and leverage requirements.
252.14 Nonbank covered companies: reporting and enforcement.
Subpart C--Liquidity Requirements
252.51 Definitions.
252.52 Board of directors and risk committee responsibilities.
252.53 Senior management responsibilities.
252.54 Independent review.
252.55 Cash flow projections.
252.56 Liquidity stress testing.
252.57 Liquidity buffer.
252.58 Contingency funding plan.
252.59 Specific limits.
252.60 Monitoring.
252.61 Documentation.
Subpart D--Single-Counterparty Credit Limits
252.91 Applicability.
252.92 Definitions.
252.93 Credit exposure limit.
252.94 Gross credit exposure.
252.95 Net Credit Exposure.
252.96 Compliance.
252.97 Exemptions.
Subpart E--Risk Management
252.125 Definitions.
252.126 Establishment of risk committee and appointment of chief
risk officer.
Subpart F--Supervisory Stress Test Requirements
252.131 Applicability.
252.132 Definitions.
252.133 Annual analysis conducted by the Board.
252.134 Data and information required to be submitted in support of
the Board's analyses.
252.135 Review of the Board's analysis; publication of summary
results.
252.136 Post-assessment actions by covered companies.
Subpart G--Company-Run Stress Test Requirements
252.141 Applicability.
252.142 Definitions.
252.143 Annual stress test.
252.144 Additional stress test for covered companies.
252.145 Methodologies and practices.
252.146 Required report to the Board of stress test results and
related information.
252.147 Post-assessment actions by covered companies.
252.148 Publication of results by covered companies and over $10
billion companies.
Subpart H--Debt-to-Equity Limits for Certain Covered Companies
252.151 Definitions.
252.152 Debt-to-equity ratio limitation.
Subpart I--Early Remediation Framework
252.161 Definitions.
252.162 Remediation Actions.
252.163 Remediation triggering events.
252.164 Notice and remedies.
Subpart A--General Provisions
Sec. 252.1 Authority, purpose, applicability, and reservation of
authority.
(a) Authority. This part is issued by the Board of Governors of the
Federal Reserve System (the Board) under sections 165 and 166 of Title
I of the Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (the Dodd-Frank Act) (Pub. L. 111-203, 124 Stat. 1376, 1423-32, 12
U.S.C. 5365 and 5366); section 9 of the Federal Reserve Act (12 U.S.C.
321-338a); section 5(b) of the Bank Holding Company Act of 1956, as
amended (12 U.S.C. 1844(b)); section 10(g) of the Home Owners' Loan
Act, as amended (12 U.S.C. 1467a(g)); and sections 8 and 39 of the
Federal Deposit Insurance Act (12 U.S.C. 1818(b) and 1831p-1).
(b) Purpose. This part implements certain provisions of sections
165 and 166 of the Dodd-Frank Act (12 U.S.C. 5365 and 5366), which
requires the Board to establish enhanced prudential standards for
covered companies, as defined herein.
(c) Applicability. (1) In general. Except as otherwise provided in
this part, a covered company is subject to the requirements of this
part beginning on the first day of the fifth quarter following the date
on which it became a covered company.
(2) Initial applicability. Except as provided in this part, a
company that is a covered company on the effective date of this subpart
is subject to the requirements of this subpart beginning on the first
day of the fifth quarter following the effective date.
(3) U.S. bank holding company subsidiaries of foreign banking
organizations. Except with respect to the liquidity requirements in
subpart C, the risk management requirements of subpart E, and the debt-
to-equity limits in subpart H, the requirements of this part will not
apply to any bank holding company subsidiary of a foreign banking
organization that is currently relying on Supervision and Regulation
Letter SR 01-01 issued by the Board (as in effect on May 19, 2010)
until July 21, 2015.
(d) Reservation of authority. (1) In general. If the Board
determines that compliance with the requirements of this part does not
sufficiently mitigate the risks to U.S. financial stability posed by
the failure or material financial distress of a covered company, the
Board may require the covered company to be subject to additional or
further enhanced prudential standards, including, but not limited to,
additional capital or liquidity requirements, limits on exposures to
single-counterparties, risk management requirements, stress tests, or
other requirements or restrictions the Board deems necessary to carry
out the purposes of this subpart or Title I of the Dodd-Frank Act.
(2) Other supervisory authority. Nothing in this part limits the
authority of the Board under any other provision of law or regulation
to take supervisory or enforcement action, including action to address
unsafe and unsound practices or conditions, or violations of law or
regulation.
(3) Application of enhanced prudential standards to bank holding
companies in general. In order to preserve the safety and soundness of
a bank holding company and thereby mitigate risks to the stability of
the U.S. financial system, the Board may determine that a bank holding
company that is not a covered company shall be subject to one or more
of the standards established under this part based on the company's
capital structure, size, complexity, risk profile, scope of operations,
or financial condition and any other risk related factors that the
Board deems appropriate.
Subpart B--Risk-Based Capital Requirements and Leverage Limits
Sec. 252.11 Applicability.
(a) Applicability. A nonbank covered company is subject to the
requirements of sections 252.13(b)(1) and (2) on the later of the
effective date of this subpart or 180 days following the date on which
the Council determined that the company shall be supervised by the
Board. A company the Council has determined shall be supervised by the
Board on a date no less than 180 days before September 30 of a calendar
year
[[Page 645]]
must comply with the requirements of sections 252.13(b)(3) from
September 30 of that calendar year and thereafter.
Sec. 252.12 Definitions.
For purposes of this subpart:
(a) Bank holding company is defined as in section 2 of the Bank
Holding Company Act, as amended (12 U.S.C. 1841), and the Board's
Regulation Y (12 CFR part 225).
(b) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(c) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(d) Covered company means
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company).
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered company for purposes
of this part unless and until the company has less than $50 billion in
total consolidated assets as determined based on each of the bank
holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph (3) is not subject to the requirements of this subpart
beginning on the first day of the calendar quarter following the
reporting date on which it ceased to be a covered company.
(e) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(f) Nonbank covered company means any company organized under the
laws of the United States or any State that the Council has determined
under section 113 of the Dodd-Frank Act (12 U.S.C. 5323) shall be
supervised by the Board and for which such determination is still in
effect.
Sec. 252.13 Enhanced risk-based capital and leverage requirements.
(a) Bank holding companies. A covered company that is a bank
holding company must comply with, and hold capital commensurate with
the requirements of any regulations adopted by the Board relating to
capital plans and stress tests.
(b) Nonbank covered companies. A nonbank covered company must:
(1) Calculate its minimum risk-based and leverage capital
requirements as if it were a bank holding company in accordance with
any minimum capital requirements established by the Board for bank
holding companies, including 12 CFR part 225, appendix A (general risk-
based capital rule), 12 CFR part 225, appendix D (leverage rule), 12
CFR part 225, appendix E (market risk rule), and 12 CFR part 225,
appendix G (advanced approaches risk-based capital rule);
(2) Hold capital sufficient to meet (i) a tier 1 risk based capital
ratio of 4 percent and a total risk-based capital ratio of 8 percent,
as calculated according to the general risk-based capital rules, and
(ii) a tier 1 leverage ratio of 4 percent as calculated under the
leverage rule; \205\ and
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\205\ 12 CFR part 225, appendix D, section II.
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(3) Comply with, and hold capital commensurate with, the
requirements of any regulations adopted by the Board relating to
capital plans and stress tests as if the covered company were a bank
holding company, including but not limited to section 225.8 of the
Board's Regulation Y (12 CFR 225.8).
Sec. 252.14 Nonbank covered companies: reporting and enforcement.
(a) Reporting. Each nonbank financial company must report to the
Board on a quarterly basis its risk-based capital and leverage ratios
as calculated under section 252.13(b).
(b) Notice of non-compliance. A nonbank financial company must
notify the Board immediately upon ascertaining that it has failed to
meet its enhanced risk-based capital and leverage requirements under
section 252.13(b).
Subpart C--Liquidity Requirements
Sec. 252.51 Definitions.
For purposes of this subpart:
(a) Bank holding company is defined as in section 2 of the Bank
Holding Company Act, as amended (12 U.S.C. 1841), and the Board's
Regulation Y (12 CFR part 225).
(b) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(c) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(d) Covered company means
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company).
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered company for purposes
of this subpart unless and until the company has less than $50 billion
in total consolidated assets as determined based on each of the bank
holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph
[[Page 646]]
(3) is not subject to the requirements of this subpart beginning on the
first day of the calendar quarter following the reporting date on which
it ceased to be a covered company.
(e) Depository institution has the same meaning as in section 3 of
the Federal Deposit Insurance Act, 12 U.S.C. 1813(c).
(f) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(g) Highly liquid assets means:
(1) Cash;
(2) Securities issued or guaranteed by the U.S. government, a U.S.
government agency, or a U.S. government-sponsored entity; and
(3) Any other asset that the covered company demonstrates to the
satisfaction of the Federal Reserve:
(i) Has low credit risk and low market risk;
(ii) Is traded in an active secondary two-way market that has
observable market prices, committed market makers, a large number of
market participants, and a high trading volume; and
(iii) Is a type of asset that investors historically have purchased
in periods of financial market distress during which market liquidity
is impaired.
(h) Liquidity means, with respect to a covered company, the covered
company's capacity to efficiently meet its expected and unexpected cash
flows and collateral needs at a reasonable cost without adversely
affecting the daily operations or the financial condition of the
covered company.
(i) Liquidity risk means the risk that a covered company's
financial condition or safety and soundness will be adversely affected
by its inability or perceived inability to meet its cash and collateral
obligations.
(j) Publicly traded means traded on:
(1) Any exchange registered with the U.S. Securities and Exchange
Commission as a national securities exchange under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers to
buy and sell so that a sales price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined promptly and a trade can be settled at such a price within a
reasonable time period conforming with trade custom.
(k) Risk committee means the enterprise-wide risk committee
established by a covered company's board of directors under section
252.126 of subpart E of this part.
(l) Trading position means a position that is held by a covered
company for the purpose of short-term resale or with the intent of
benefitting from actual or expected short-term price movements, or to
lock-in arbitrage profits.
(m) Two-way market means a market with independent bona fide offers
to buy and sell so that a price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined within one day and settled at that price within a reasonable
time period conforming with trade custom.
(n) Unencumbered means, with respect to an asset, that:
(1) The asset is not pledged, does not secure, collateralize, or
provide credit enhancement to any transaction, and is not subject to
any lien;
(2) The asset is not designated as a hedge on a trading position;
and
(3) There are no legal or contractual restrictions on the ability
of the covered company to promptly liquidate, sell, transfer, or assign
the asset.
(o) U.S. government agency means an agency or instrumentality of
the U.S. government whose obligations are fully and explicitly
guaranteed as to the timely payment of principal and interest by the
full faith and credit of the U.S. government.
(p) U.S. government-sponsored entity means an entity originally
established or chartered by the U.S. government to serve public
purposes specified by the U.S. Congress, but whose obligations are not
explicitly guaranteed by the full faith and credit of the U.S.
government.
Sec. 252.52 Board of directors and risk committee responsibilities.
(a) Oversight. The covered company's board of directors (or the
risk committee) must oversee the covered company's liquidity risk
management processes, and must review and approve the liquidity risk
management strategies, policies, and procedures established by senior
management.
(b) Actions.
(1) Liquidity risk tolerance. (i) The board of directors must
establish the covered company's liquidity risk tolerance at least
annually. The liquidity risk tolerance is the acceptable level of
liquidity risk the covered company may assume in connection with its
operating strategies. In determining the covered company's liquidity
risk tolerance, the board of directors must consider the covered
company's capital structure, risk profile, complexity, activities,
size, and other appropriate risk-related factors.
(ii) The board of directors must review information provided by
senior management at least semi-annually to determine whether the
covered company is managed in accordance with the established liquidity
risk tolerance.
(2) Business strategies and products. (i) The risk committee or a
designated subcommittee thereof must review and approve the liquidity
costs, benefits, and risks of each significant new business line and
each significant new product before the covered company implements the
business line or offers the product. In connection with this review,
the risk committee or a designated subcommittee thereof must consider
whether the liquidity risk of the new business line or product under
current conditions and under liquidity stress is within the covered
company's established liquidity risk tolerance.
(ii) At least annually, the risk committee or designated
subcommittee thereof must review approved significant business lines
and products to determine whether each line or product has created any
unanticipated liquidity risk, and to determine whether the liquidity
risk of each strategy or product continues to be within the covered
company's established liquidity risk tolerance.
(3) Contingency funding plan. The board of directors must review
and approve the contingency funding plan described in section 252.58 at
least annually, and whenever the covered company materially revises the
plan.
(4) Other reviews. (i) At least quarterly, the risk committee or
designated subcommittee thereof must:
(A) Review the cash flow projections produced under section 252.55
of this subpart that use time periods in excess of 30-days to ensure
that the covered company's liquidity risk is within the established
liquidity risk tolerance;
(B) Review and approve liquidity stress testing described in
section 252.56 of this subpart, including stress testing practices,
methodologies, and assumptions. The risk committee or designated
subcommittee thereof must also review and approve liquidity stress
testing whenever the covered company materially revises its liquidity
stress testing;
(C) Review liquidity stress testing results produced under section
252.56 of this subpart;
[[Page 647]]
(D) Approve the size and composition of the liquidity buffer
established under section 252.57 of this subpart;
(E) Review and approve the specific limits established under
section 252.59 of this subpart and review the covered company's
compliance with those limits; and
(F) Review liquidity risk management information necessary to
identify, measure, monitor, and control liquidity risk and to comply
with this subpart.
(ii) The risk committee or designated subcommittee thereof must
periodically review the independent validation of the liquidity stress
tests produced under section 252.56(c)(2)(ii) of this subpart.
(iii) The risk committee or designated subcommittee thereof must
establish procedures governing the content of senior management reports
on the liquidity risk profile of the covered company and other
information described at section 252.53(b) of this subpart.
(c) Frequency of reviews. Paragraph (b) of this section establishes
minimum requirements for the frequency of certain reviews and
approvals. The board of directors (or the risk committee) must conduct
more frequent reviews and approvals as market and idiosyncratic
conditions warrant.
Sec. 252.53 Senior management responsibilities.
(a) Senior management of a covered company must establish and
implement strategies, policies, and procedures for managing liquidity
risk. This includes overseeing the development and implementation of
liquidity risk measurement and reporting systems, cash flow
projections, liquidity stress testing, liquidity buffer, contingency
funding plan, specific limits, and monitoring procedures required under
this subpart.
(b) Senior management must regularly report to the risk committee
or designated subcommittee thereof on the liquidity risk profile of the
covered company and must provide other relevant and necessary
information to the board of directors (or risk committee) to facilitate
its oversight of the liquidity risk management process.
Sec. 252.54 Independent review.
(a) The covered company must establish and maintain a review
function, independent of management functions that execute funding, to
evaluate its liquidity risk management.
(b) The independent review function must:
(1) Regularly, but no less frequently than annually, review and
evaluate the adequacy and effectiveness of the covered company's
liquidity risk management processes;
(2) Assess whether the covered company's liquidity risk management
complies with applicable laws, regulations, supervisory guidance, and
sound business practices; and
(3) Report statutory and regulatory noncompliance and other
material liquidity risk management issues to the board of directors or
the risk committee in writing for corrective action.
Sec. 252.55 Cash flow projections.
(a) Requirement. The covered company must produce comprehensive
cash flow projections in accordance with the requirements of this
section. The covered company must update short-term cash flow
projections daily and must update long-term cash flow projections at
least monthly.
(b) Methodology. The covered company must establish a robust
methodology for making cash flow projections. The methodology must
include reasonable assumptions regarding the future behavior of assets,
liabilities, and off-balance sheet exposures.
(c) Cash flow projections. The covered company must produce
comprehensive cash flow projections that:
(1) Project cash flows arising from assets, liabilities, and off-
balance sheet exposures over short-term and long-term periods that are
appropriate to the covered company's capital structure, risk profile,
complexity, activities, size, and other risk related factors;
(2) Identify and quantify discrete and cumulative cash flow
mismatches over these time periods;
(3) Include cash flows arising from contractual maturities, as well
as cash flows from new business, funding renewals, customer options,
and other potential events that may impact liquidity; and
(4) Provide sufficient detail to reflect the covered company's
capital structure, risk profile, complexity, activities, size, and any
other risk related factors that are appropriate. Such detail may
include cash flow projections broken down by business line, legal
entity, or jurisdiction, and cash flow projections that use more time
periods than the minimum required under paragraph (c)(1) of this
section.
Sec. 252.56 Liquidity stress testing.
(a) Requirement. (1) The covered company must regularly stress test
its cash flow projections in accordance with the requirements of this
section. Stress test analysis consists of identifying liquidity stress
scenarios and assessing the effects of these scenarios on the covered
company's cash flow and liquidity. The covered company must use the
results of stress testing to determine the size of its liquidity buffer
under section 252.57 of this subpart, and must incorporate the
information generated by stress testing in the quantitative component
of the contingency funding plan under section 252.58(b) of this
subpart.
(2) The covered company must conduct stress testing in accordance
with the requirements of this section at least monthly. The covered
company must be able to perform stress testing more frequently and to
vary underlying assumptions as conditions change or as required by the
Federal Reserve due to deterioration in the company's financial
condition, market conditions, or to address other supervisory concerns.
(b) Stress testing requirements.
(1) Stress scenarios. (i) Stress testing must incorporate a range
of stress scenarios that may significantly impact the covered company's
liquidity, taking into consideration the covered company's balance
sheet exposures, off-balance sheet exposures, business lines,
organizational structure, and other characteristics.
(ii) At a minimum, stress testing must incorporate separate stress
scenarios to account for market stress, idiosyncratic stress, and
combined market and idiosyncratic stresses.
(iii) The stress scenarios must address the potential impact of
market disruptions on the covered company and must address the
potential actions of other market participants experiencing liquidity
stresses under the same market disruptions.
(iv) The stress scenarios must be forward-looking and must
incorporate a range of potential changes in a covered company's
activities, exposures, and risks, as well as changes to the broader
economic and financial environment.
(v) The stress scenarios must use a variety of time horizons. At a
minimum, these time horizons must include an overnight time horizon, a
30-day time horizon, 90-day time horizon, and a one-year time horizon.
(2) Stress testing must comprehensively address the covered
company's activities, exposures, and risks, including off-balance sheet
exposures.
(3) Stress testing must be tailored to, and provide sufficient
detail to reflect, the covered company's capital structure, risk
profile, complexity, activities, size, and any other risk related
factors that are appropriate. This may require analyses by business
line, legal entity, or jurisdiction, and stress scenarios that use more
time horizons than the
[[Page 648]]
minimum required under paragraph (b)(1)(v) of this section.
(4) A covered company must incorporate the following assumptions in
its stress testing:
(i) For the first 30 days of a liquidity stress scenario, only
highly liquid assets that are unencumbered may be used as cash flow
sources to offset projected funding needs.
(ii) For time periods beyond the first 30 days of a liquidity
stress scenario, highly liquid assets that are unencumbered and other
appropriate funding sources may be used as cash flow sources to offset
projected funding needs.
(iii) If an asset is used as a cash flow source to offset projected
funding needs, the fair market value of the asset must be discounted to
reflect any credit risk and market volatility of the asset.
(iv) Throughout each stress test time horizon, assets used as
sources of funding must be sufficiently diversified.
(c) Process and systems requirements. (1) The covered company must
establish and maintain policies and procedures that outline its
liquidity stress testing practices, methodologies and assumptions,
detail the use of each stress test employed, and provide for the
enhancement of stress testing practices as risks change and as
techniques evolve.
(2) The covered company must have an effective system of control
and oversight over the stress test function to ensure that:
(i) Each stress test is designed in accordance with the
requirements of this section; and
(ii) The stress process and assumptions are validated. The
validation function must be independent of functions that develop or
design the liquidity stress testing, and independent of management
functions that execute funding.
(3) The covered company must maintain management information
systems and data processes sufficient to enable it to effectively and
reliably collect, sort, and aggregate data and other information
related to liquidity stress testing.
Sec. 252.57 Liquidity buffer.
(a) A covered company must maintain a liquidity buffer of highly
liquid assets that are unencumbered. The liquidity buffer must be
sufficient to meet projected net cash outflows and the projected loss
or impairment of existing funding sources for 30 days over a range of
liquidity stress scenarios.
(b) The covered company must determine the size of its liquidity
buffer requirement using the results of its liquidity stress testing
under section 252.56 of this subpart, and must align the size of the
buffer to the covered company's capital structure, risk profile,
complexity, activities, size, and any other risk related factors that
are appropriate, and established liquidity risk tolerance.
(c) In computing the amount of an asset included in the liquidity
buffer, the covered company must discount the fair market value of the
asset to reflect any credit risk and market volatility of the asset.
(d) The pool of unencumbered highly liquid assets included in the
liquidity buffer must be sufficiently diversified.
Sec. 252.58 Contingency funding plan.
(a) Contingency funding plan. The covered company must establish
and maintain a contingency funding plan that sets out the covered
company's strategies for addressing liquidity needs during liquidity
stress events. The contingency funding plan must be commensurate with
the covered company's capital structure, risk profile, complexity,
activities, size, and any other risk related factors that are
appropriate, and established liquidity risk tolerance. The covered
company must update the contingency funding plan at least annually, and
must update the plan when changes to market and idiosyncratic
conditions warrant an update.
(b) Components of the contingency funding plan. The contingency
funding plan must include the following components:
(1) Quantitative Assessment. The contingency funding plan must
incorporate information generated by liquidity stress testing described
in section 252.56. The stress tests are used to:
(i) Identify liquidity stress events that have a significant impact
on the covered company's liquidity;
(ii) Assess the level and nature of impact on the covered company's
liquidity that may occur during identified liquidity stress events;
(iii) Assess available funding sources and needs during the
identified liquidity stress events; and
(iv) Identify alternative funding sources that may be used during
the liquidity stress events.
(2) Event management process. The contingency funding plan must
include an event management process that sets out the covered company's
procedures for managing liquidity during identified liquidity stress
events. This process must:
(i) Include an action plan that clearly describes the strategies
the covered company will use to respond to liquidity shortfalls for
identified liquidity stress events, including the methods that the
covered company will use to access alternative funding sources;
(ii) Identify a liquidity stress event management team;
(iii) Specify the process, responsibilities, and triggers for
invoking the contingency funding plan, escalating the responses
described in the action plan, decision-making during the identified
liquidity stress events, and executing contingency measures identified
in the action plan; and
(iv) Provide a mechanism that ensures effective reporting and
communication within the covered company and with outside parties,
including the Federal Reserve and other relevant supervisors,
counterparties, and other stakeholders.
(3) Monitoring. The contingency funding plan must include
procedures for monitoring emerging liquidity stress events. The
procedures must identify early warning indicators that are tailored to
the covered company's capital structure, risk profile, complexity,
activities, size, and other appropriate risk related factors.
(4) Testing. The covered company must periodically test the
components of the contingency funding plan to assess the plan's
reliability during liquidity stress events.
(i) The covered company must test the operational elements of the
contingency funding plan to ensure that the plan functions as intended.
These tests must include operational simulations to test
communications, coordination, and decision-making involving relevant
managers, including managers at relevant legal entities within the
corporate structure.
(ii) The covered company must periodically test the methods it will
use to access alternative funding sources to determine whether these
funding sources will be readily available when needed.
Sec. 252.59 Specific limits.
(a) Required limits. The covered company must establish and
maintain limits on potential sources of liquidity risk including the
following:
(1) Concentrations of funding by instrument type, single
counterparty, counterparty type, secured and unsecured funding, and
other liquidity risk identifiers;
(2) The amount of specified liabilities that mature within various
time horizons; and
(3) Off-balance sheet exposures and other exposures that could
create
[[Page 649]]
funding needs during liquidity stress events.
(b) Size of limits. The size of each limit described in paragraph
(a) of this section must reflect the covered company's capital
structure, risk profile, complexity, activities, size, other
appropriate risk related factors, and established liquidity risk
tolerance.
Sec. 252.60 Monitoring.
(a) Collateral monitoring requirements. The covered company must
establish and maintain procedures for monitoring assets that it has
pledged as collateral for an obligation or position, and assets that
are available to be pledged. These procedures must address the covered
company's ability to:
(1) Calculate all of the covered company's collateral positions in
a timely manner, including: (i) the value of assets pledged relative to
the amount of security required under the contract governing the
obligation for which the collateral was pledged; and (ii) unencumbered
assets available to be pledged;
(2) Monitor the levels of available collateral by legal entity,
jurisdiction, and currency exposure;
(3) Monitor shifts between intraday, overnight, and term pledging
of collateral; and
(4) Track operational and timing requirements associated with
accessing collateral at its physical location (for example, the
custodian or securities settlement system that holds the collateral).
(b) Legal entities, currencies and business lines.
(1) The covered company must establish and maintain procedures for
monitoring and controlling liquidity risk exposures and funding needs
within and across significant legal entities, currencies, and business
lines.
(2) The covered company must maintain sufficient liquidity with
respect to each significant legal entity in light of legal and
regulatory restrictions on the transfer of liquidity between legal
entities.
(c) Intraday liquidity positions. The covered company must
establish and maintain procedures for monitoring intraday liquidity
risk exposure. These procedures must address how the covered company
will:
(1) Monitor and measure expected daily gross liquidity inflows and
outflows;
(2) Manage and transfer collateral when necessary to obtain
intraday credit;
(3) Identify and prioritize time-specific obligations so that the
covered company can meet these obligations as expected;
(4) Settle less critical obligations as soon as possible;
(5) Control the issuance of credit to customers where necessary;
and
(6) Consider the amounts of collateral and liquidity needed to meet
payment systems obligations when assessing the covered company's
overall liquidity needs.
(d) Monitoring of limits. The covered company must monitor its
compliance with all limits established and maintained under section
252.59 of this subpart.
Sec. 252.61 Documentation.
The covered company must adequately document all material aspects
of its liquidity risk management processes and its compliance with the
requirements of this subpart and submit all such documentation to the
risk committee.
Subpart D--Single-Counterparty Credit Limits
Sec. 252.91 Applicability.
(a) Applicability. (1) In general. Except as otherwise provided in
this subpart, a covered company is subject to the requirements of this
subpart beginning on the first day of the fifth quarter following the
date on which it became a covered company.
(2) Initial applicability. A company that is a covered company on
the effective date of this subpart will be subject to the requirements
of this subpart beginning on October 1, 2013. A company that becomes a
covered company after the effective date of this part and before
September 30, 2012 will be subject to the requirements of this subpart
beginning on October 1, 2013.
Sec. 252.92 Definitions.
For purposes of this subpart:
(a) Adjusted market value means, with respect to any eligible
collateral, the fair market value of the eligible collateral after
application of the applicable haircut specified in Table 2 of this
subpart for that type of eligible collateral.
(b) Affiliate means, with respect to a company, any company that
controls, is controlled by, or is under common control with, the
company.
(c) Aggregate net credit exposure means the sum of all net credit
exposures of a covered company to a single counterparty.
(d) Applicable accounting standards means U.S. generally applicable
accounting principles (GAAP), international financial reporting
standards (IFRS), or such other accounting standards that a company
uses in the ordinary course of its business in preparing its
consolidated financial statements.
(e) Bank eligible investments means investment securities that a
national bank is permitted to purchase, sell, deal in, underwrite, and
hold under 12 U.S.C. 24 (Seventh) and 12 CFR part 1.
(f) Bank holding company is defined as in section 2 of the Bank
Holding Company Act, as amended (12 U.S.C. 1841), and the Board's
Regulation Y (12 CFR part 225).
(g) Capital stock and surplus means with respect to a bank holding
company, the sum of the following amounts in each case as reported by
the bank holding company on the most recent FR Y-9C report, or with
respect to a nonbank covered company, on the most recent regulatory
report required by the Board:
(1) The company's total capital, as calculated under the capital
adequacy guidelines applicable to that bank holding company under
Regulation Y (12 CFR part 225) or nonbank covered company under this
subpart; and
(2) The balance of the allowance for loan and lease losses of the
bank holding company or nonbank covered company not included in tier 2
capital under the capital adequacy guidelines applicable to that bank
holding company under Regulation Y (12 CFR part 225) or that nonbank
covered company under this subpart.
(h) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(i) Control. A company controls another company if it (1) owns,
controls, or holds with power to vote 25 percent or more of a class of
voting securities of the company; (2) owns or controls 25 percent or
more of the total equity of the company; or (3) consolidates the
company for financial reporting purposes.
(j) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(k) Counterparty means
(1) With respect to a natural person, the person, and members of
the person's immediate family;
(2) With respect to a company, the company and all of its
subsidiaries, collectively;
(3) With respect to the United States, the United States and all of
its agencies and instrumentalities (but not including any State or
political subdivision of a State) collectively;
[[Page 650]]
(4) With respect to a State, the State and all of its agencies,
instrumentalities, and political subdivisions (including any
municipalities) collectively; and
(5) With respect to a foreign sovereign entity, the foreign
sovereign entity and all of its agencies, instrumentalities, and
political subdivisions, collectively;
(l) Covered company means:
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company); and
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered company for purposes
of this subpart unless and until the company has less than $50 billion
in total consolidated assets as determined based on each of the bank
holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph (3) is not subject to the requirements of this subpart
beginning on the first day of the calendar quarter following the
reporting date on which it ceased to be a covered company.
(m) Credit derivative means a financial contract that allows one
party (the protection purchaser) to transfer the credit risk of one or
more exposures (reference exposure) to another party (the protection
provider).
(n) Credit transaction means, with respect to a counterparty:
(1) Any extension of credit to the counterparty, including loans,
deposits, and lines of credit, but excluding advised or other
uncommitted lines of credit;
(2) Any repurchase or reverse repurchase agreement with the
counterparty;
(3) Any securities lending or securities borrowing transaction with
the counterparty;
(4) Any guarantee, acceptance, or letter of credit (including any
confirmed letter of credit or standby letter of credit) issued on
behalf of the counterparty;
(5) Any purchase of, or investment in, securities issued by the
counterparty;
(6) Any credit exposure to the counterparty in connection with a
derivative transaction between the covered company and the
counterparty;
(7) Any credit exposure to the counterparty in connection with a
credit derivative or equity derivative transaction between the covered
company and a third party, the reference asset of which is an
obligation or equity security of the counterparty; and
(8) Any transaction that is the functional equivalent of the above,
and any similar transaction that the Board determines to be a credit
transaction for purposes of this subpart.
(o) Depository institution has the same meaning as in section 3 of
the Federal Deposit Insurance Act, 12 U.S.C. 1813(c).
(p) Derivative transaction means any transaction that is a
contract, agreement, swap, warrant, note, or option that is based, in
whole or in part, on the value of, any interest in, or any quantitative
measure or the occurrence of any event relating to, one or more
commodities, securities, currencies, interest or other rates, indices,
or other assets.
(q) Eligible collateral means collateral in which the covered
company has a perfected, first priority security interest or, outside
of the United States, the legal equivalent thereof (with the exception
of cash on deposit and notwithstanding the prior security interest of
any custodial agent) and is in the form of:
(1) Cash on deposit with the covered company (including cash held
for the covered company by a third-party custodian or trustee);
(2) Debt securities (other than mortgage- or asset-backed
securities) that are bank eligible investments;
(3) Equity securities that are publicly traded; or
(4) Convertible bonds that are publicly traded.
(r) Eligible credit derivative means a single-name credit
derivative or a standard, non-tranched index credit derivative provided
that:
(1) The derivative contract meets the requirements of an eligible
guarantee and has been confirmed by the protection purchaser and the
protection provider;
(2) Any assignment of the derivative contract has been confirmed by
all relevant parties;
(3) If the credit derivative is a credit default swap, the
derivative contract includes the following credit events:
(i) Failure to pay any amount due under the terms of the reference
exposure, subject to any applicable minimal payment threshold that is
consistent with standard market practice and with a grace period that
is closely in line with the grace period of the reference exposure; and
(ii) Bankruptcy, insolvency, or inability of the obligor on the
reference exposure to pay its debts, or its failure or admission in
writing of its inability generally to pay its debts as they become due
and similar events;
(4) The terms and conditions dictating the manner in which the
derivative contract is to be settled are incorporated into the
contract;
(5) If the derivative contract allows for cash settlement, the
contract incorporates a robust valuation process to estimate loss with
respect to the derivative reliably and specifies a reasonable period
for obtaining post-credit event valuations of the reference exposure;
(6) If the derivative contract requires the protection purchaser to
transfer an exposure to the protection provider at settlement, the
terms of at least one of the exposures that is permitted to be
transferred under the contract provides that any required consent to
transfer may not be unreasonably withheld; and
(7) If the credit derivative is a credit default swap, the
derivative contract clearly identifies the parties responsible for
determining whether a credit event has occurred, specifies that this
determination is not the sole responsibility of the protection
provider, and gives the protection purchaser the right to notify the
protection provider of the occurrence of a credit event.
(s) Eligible equity derivative means an equity-linked total return
swap, provided that:
(1) The derivative contract has been confirmed by the
counterparties;
(2) Any assignment of the derivative contract has been confirmed by
all relevant parties; and
(3) The terms and conditions dictating the manner in which the
derivative contract is to be settled are incorporated into the
contract.
(t) Eligible guarantee means a guarantee from an eligible
protection provider that:
[[Page 651]]
(1) Is written and is either unconditional or the enforceability of
the guarantee is contingent only to the extent it is dependent upon
affirmative action on the part of the beneficiary of the guarantee or a
third party (for example, servicing requirements);
(2) Covers all or a pro rata portion of all contractual payments of
the obligor on the reference entity;
(3) Gives the beneficiary a direct claim against the protection
provider;
(4) Is not unilaterally cancelable by the guarantor for reasons
other than the breach of the contract by the beneficiary;
(5) Is legally enforceable against the guarantor in a jurisdiction
where the guarantor has sufficient assets against which a judgment may
be attached and enforced;
(6) Requires the guarantor to make payment to the beneficiary on
the occurrence of a default (as defined in the guarantee) of the
obligor on the reference entity in a timely manner without the
beneficiary first having to take legal actions to pursue the obligor
for payment; and
(7) Does not increase the beneficiary's cost of credit protection
on the guarantee in response to deterioration in the credit quality of
the reference entity.
(u) Eligible protection provider means:
(1) A sovereign entity;
(2) The Bank for International Settlements, the International
Monetary Fund, the European Central Bank, the European Commission, or a
multilateral development bank;
(3) A Federal Home Loan Bank;
(4) The Federal Agricultural Mortgage Corporation;
(5) A depository institution;
(6) A bank holding company;
(7) A savings and loan holding company (as defined in 12 U.S.C.
1467a);
(8) A securities broker or dealer registered with the SEC under the
Securities Exchange Act of 1934 (15 U.S.C. 78o et seq.);
(9) An insurance company that is subject to the supervision by a
State insurance regulator;
(10) A foreign banking organization;
(11) A non-U.S.-based securities firm or a non-U.S.-based insurance
company that is subject to consolidated supervision and regulation
comparable to that imposed on U.S. depository institutions, securities
broker-dealers, or insurance companies; and
(12) A qualifying central counterparty.
(v) Equity derivative means an equity-linked swap, purchased
equity-linked option, forward equity-linked contract, or any other
instrument linked to equities that gives rise to similar counterparty
credit risks.
(w) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(x) Gross credit exposure means, with respect to any credit
transaction, the credit exposure of the covered company before
adjusting for the effect of qualifying master netting agreements,
eligible collateral, eligible guarantees, eligible credit derivatives
and eligible equity derivatives.
(y) Immediate family means the spouse of an individual, the
individual's minor children, and any of the individual's children
(including adults) residing in the individual's home.
(z) Major counterparty is any
(1) Major covered company and all of its subsidiaries,
collectively; and
(2) Any foreign banking organization (and all of its subsidiaries,
collectively) that has total consolidated assets equal to or greater
than $500 billion determined based on the foreign banking
organization's total consolidated assets in the most recent year, for
annual filers, or the average of the four most recent quarters, for
quarterly filers, as reported on the foreign banking organization's
Capital and Asset Reports for Foreign Banking Organizations (Federal
Reserve Form FR Y-7Q).
(aa) Major covered company is any
(1) Covered company that is a bank holding company and that has
total consolidated assets equal to or greater than $500 billion
determined based on the average of the bank holding company's total
consolidated assets in the four most recent quarters as reported
quarterly on the bank holding company's FR Y-9C; and
(2) Nonbank covered company.
(bb) Net credit exposure means, with respect to any credit
transaction, the gross credit exposure of a covered company calculated
under section 252.94, as adjusted in accordance with section 252.95.
(cc) Nonbank covered company means any company organized under the
laws of the United States or any State that the Council has determined
under section 113 of the Dodd-Frank Act (12 U.S.C. 5323) shall be
supervised by the Board and for which such determination is still in
effect.
(dd) Publicly traded means traded on:
(1) Any exchange registered with the U.S. Securities and Exchange
Commission as a national securities exchange under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers to
buy and sell so that a sales price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined promptly and a trade can be settled at such a price within a
reasonable time period conforming with trade custom.
(ee) Qualifying central counterparty means an entity that
(1) Facilitates trades between counterparties in one or more
financial markets by either guaranteeing trades or novating contracts;
(2) Requires all participants in its arrangements to be fully
collateralized on a daily basis; and
(3) Is subject to effective oversight by a national supervisory
authority.
(ff) Qualifying master netting agreement means a legally
enforceable bilateral agreement such that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default, including bankruptcy, insolvency, or similar proceeding of the
counterparty;
(2) The agreement provides the covered company the right to
accelerate, terminate, and close-out on a net basis all transactions
under the agreement and to liquidate or set off collateral promptly
upon an event of default, including upon event of bankruptcy,
insolvency, or similar proceeding, of the counterparty, provided that,
in any such case, any exercise of rights under the agreement will not
be stayed or avoided under applicable law in the relevant jurisdiction;
(3) The covered company has conducted sufficient legal review to
conclude with a well-founded basis (and has maintained sufficient
written documentation of that legal review) that the agreement meeting
the requirements of paragraph (2) of this definition and that in the
event of a legal challenge (including one resulting from default or
from bankruptcy, insolvency or similar proceeding) the relevant court
and administrative authorities would find the agreement to be legal,
valid, binding, and enforceable under the law of the relevant
jurisdiction;
(4) The covered company establishes and maintains procedures to
monitor possible changes in relevant law and to ensure that the
agreement continues to
[[Page 652]]
satisfy the requirements of this definition; and
(5) The agreement does not contain a walkaway clause (that is, a
provision that permits a non-defaulting counterparty to make lower
payments than it would make otherwise under the agreement, or no
payment at all, to a defaulter or the estate of a defaulter, even if
the defaulter is a net creditor under the agreement).\206\
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\206\ The Board considers the following jurisdictions to be
relevant for a qualifying master netting agreement: The jurisdiction
in which the counterparty is chartered or equivalent location in the
case of non-corporate entities, and if a branch of a counterparty is
involved, then also the jurisdiction in which the branch is located;
the jurisdiction that governs the individual transactions covered by
the agreement; and the jurisdiction that governs the agreement.
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(gg) Short sale means any sale of a security which the seller does
not own or any sale which is consummated by the delivery of a security
borrowed by, or for the account of, the seller.
(hh) Sovereign entity means a central government (including the
U.S. government) or an agency, department, ministry, or central bank.
(ii) State means any State, territory or possession of the United
States, and the District of Columbia.
(jj) Subsidiary of a specified company means a company that is
directly or indirectly controlled by the specified company.
(kk) Total capital means qualifying total capital as defined in 12
CFR part 225, appendix A or total qualifying capital as defined in 12
CFR part 225, appendix G, as applicable, or any successor regulation
thereto.
Sec. 252.93 Credit exposure limit.
(a) General limit on aggregate net credit exposure. No covered
company shall, together with its subsidiaries, have an aggregate net
credit exposure to any unaffiliated counterparty that exceeds 25
percent of the consolidated capital stock and surplus of the covered
company.
(b) Major covered company limits on aggregate net credit exposure.
No major covered company shall, together with its subsidiaries, have
aggregate net credit exposure to any unaffiliated counterparty that is
a major counterparty that exceeds 10 percent of the consolidated
capital stock and surplus of the major covered company.
Sec. 252.94 Gross credit exposure.
(a) Calculation of gross credit exposure. Under this subpart,
exposures of a covered company to a counterparty include the exposures
of its subsidiaries to the counterparty. The amount of gross credit
exposure of a covered company to a counterparty with respect to credit
transactions is, in the case of:
(1) Loans by a covered company to the counterparty and leases in
which the covered company is the lessor and the counterparty is the
lessee, equal to the amount owed by the counterparty to the covered
company under the transaction.
(2) Debt securities held by the covered company that are issued by
the counterparty, equal to:
(i) The greater of the amortized purchase price or market value,
for trading and available for sale securities, and
(ii) The amortized purchase price, for securities held to maturity.
(3) Equity securities held by the covered company that are issued
by the counterparty, equal to the greater of the purchase price or
market value.
(4) Repurchase agreements, equal to:
(i) The market value of securities transferred by the covered
company to the counterparty; plus
(ii) The amount in paragraph (4)(i) multiplied by the collateral
haircut in Table 2 applicable to the securities transferred by the
covered company to the counterparty.
(5) Reverse repurchase agreements, equal to the amount of cash
transferred by the covered company to the counterparty.
(6) Securities borrowing transactions, equal to the amount of cash
collateral plus the market value of securities collateral transferred
by the covered company to the counterparty.
(7) Securities lending transactions, equal to:
(i) The market value of securities lent by the covered company to
the counterparty; plus
(ii) The amount in paragraph (7)(i) multiplied by the collateral
haircut in Table 2 applicable to the securities lent by the covered
company to the counterparty.
(8) Committed credit lines extended by a covered company to a
counterparty, equal to the face amount of the credit line.
(9) Guarantees and letters of credit issued by a covered company on
behalf of a counterparty, equal to the lesser of the face amount or the
maximum potential loss to the covered company on the transaction.
(10) Derivative transactions between the covered company and the
counterparty not subject to a qualifying master netting agreement, in
an amount equal to the sum of (i) the current exposure of the
derivatives contract equal to the greater of the mark-to-market value
of the derivative contract or zero and (ii) the potential future
exposure of the derivatives contract, calculated by multiplying the
notional principal amount of the derivative contract by the appropriate
conversion factor, set forth in Table 1.
(11) Derivative transactions between the covered company and the
counterparty subject to a qualifying master netting agreement, in an
amount equal to the exposure at default amount calculated under 12 CFR
part 225, appendix G, Sec. 32(c)(6).
(12) Credit or equity derivative transactions between the covered
company and a third party where the covered company is the protection
provider and the reference asset is an obligation or equity security of
the counterparty, equal to the lesser of the face amount of the
transaction or the maximum potential loss to the covered company on the
transaction.
Table 1--Conversion Factor Matrix for OTC Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Credit (bank-
eligible Credit (non- Precious
Remaining maturity \2\ Interest rate Foreign investment bank-eligible Equity metals (except Other
exchange rate reference reference gold)
obligor) \3\ obligor)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................ 0.00 0.01 0.05 0.10 0.06 0.07 0.10
Greater than one year and less than or 0.005 0.05 0.05 0.10 0.08 0.07 0.12
equal to five years....................
[[Page 653]]
Greater than 5 years.................... 0.015 0.075 0.05 0.10 0.10 0.08 0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For an OTC derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
the market value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A company must use the column labeled ``Credit (bank-eligible investment reference obligor)'' for a credit derivative whose reference obligor has an
outstanding unsecured debt security that is a bank eligible investment. A company must use the column labeled ``Credit (non-bank-eligible investment
reference obligor)'' for all other credit derivatives.
(b) Attribution rule. A covered company must treat any of its
transactions with any person as a credit exposure to a counterparty to
the extent the proceeds of the transaction are used for the benefit of,
or transferred to, that counterparty.
Sec. 252.95 Net credit exposure.
(a) Calculation of initial net credit exposure for securities
financing transactions.
(1) Repurchase and reverse repurchase transactions. For repurchase
and reverse repurchase transactions with a counterparty that are
subject to a bilateral netting agreement with that counterparty, a
covered company may use the net credit exposure associated with the
netting agreement.
(2) Securities lending and borrowing transactions. For a securities
lending and borrowing transactions with a counterparty that are subject
to a bilateral netting agreement with that counterparty, a covered
company may use the net credit exposure associated with the netting
agreement.
(b) Market value adjustments. In computing its net credit exposure
to a counterparty for any credit transaction (including securities
financing transactions), a covered company may reduce its gross credit
exposure (or as applicable, net credit exposure for securities
financing transactions calculated under section 252.95(a)) on the
transaction by the adjusted market value of any eligible collateral,
provided that:
(1) The covered company includes the adjusted market value of the
eligible collateral when calculating its gross credit exposure to the
issuer of the collateral;
(2) The collateral used to adjust the covered company's gross
credit exposure to a counterparty cannot be used to adjust the covered
company's gross credit exposure to any other counterparty; and
(3) In no event will the covered company's gross credit exposure to
the issuer of collateral be in excess of its gross credit exposure to
the counterparty on the credit transaction.
(c) Unused portion of certain extensions of credit. (1) In
computing its net credit exposure to a counterparty for a credit line
or revolving credit facility, a covered company may reduce its gross
credit exposure by the amount of the unused portion of the credit
extension to the extent that the covered company does not have any
legal obligation to advance additional funds under the extension of
credit, until the counterparty provides the amount of adjusted market
value of collateral required with respect to the entire used portion of
the extension of credit.
(2) To qualify for this reduction, the credit contract must specify
that any used portion of the credit extension must be fully secured by
collateral that is (i) cash, (ii) obligations of the United States or
its agencies, or (iii) obligations directly and fully guaranteed as to
principal and interest by, the Federal National Mortgage Association
and the Federal Home Loan Mortgage Corporation, while operating under
the conservatorship or receivership of the Federal Housing Finance
Agency, and any additional obligations issued by a U.S. government
sponsored entity as determined by the Board.
(d) Eligible guarantees. In calculating net credit exposure to a
counterparty for a credit transaction, a covered company must reduce
its gross credit exposure to the counterparty by the amount of any
eligible guarantees from an eligible protection provider that covers
the transaction, provided that:
(1) The covered company includes the amount of the eligible
guarantees when calculating its gross credit exposure to the eligible
protection provider; and
(2) In no event will the covered company's gross credit exposure to
an eligible protection provider with respect to an eligible guarantee
be in excess of its gross credit exposure to the counterparty on the
credit transaction prior to recognition of the eligible guarantee.
(e) Eligible credit and equity derivatives. In calculating net
credit exposure to a counterparty for a credit transaction, a covered
company must reduce its gross credit exposure to the counterparty by
the notional amount of any eligible credit or equity derivative from an
eligible protection provider that references the counterparty, as
applicable, provided that:
(1) The covered company includes the face amount of the eligible
credit and equity derivative when calculating its gross credit exposure
to the eligible protection provider; and
(2) In no event will the covered company's gross credit exposure to
an eligible protection provider with respect to an eligible credit or
equity derivative be in excess of its gross credit exposure to the
counterparty on the credit transaction prior to recognition of the
eligible credit or equity derivative.
(f) Other eligible hedges. In calculating net credit exposure to a
counterparty for a credit transaction, a covered company may reduce its
gross credit exposure to the counterparty by the face amount of a short
sale of the counterparty's debt or equity security.
[[Page 654]]
Table 2--Collateral Haircuts
[Sovereign entities]
------------------------------------------------------------------------
Haircut without
Residual maturity currency mismatch
\207\
------------------------------------------------------------------------
OECD Country Risk Classification <= 1 year......... 0.005
\208\ 0-1.
>1 year, <= 5 0.02
years.
> 5 years......... 0.04
OECD Country Risk Classification <= 1 year......... 0.01
2-3.
>1 year, <= 5 0.03
years.
> 5 years......... 0.06
------------------------------------------------------------------------
---------------------------------------------------------------------------
\207\ In cases where the currency denomination of the collateral
differs from the currency denomination of the credit transaction, an
addition 8 percent haircut will apply.
\208\ OECD Country Risk Classification means the country risk
classification as defined in Article 25 of the OECD's February 2011
Arrangement on Officially Supported Export Credits Arrangement.
Corporate and Municipal Bonds That Are Bank-Eligible Investments
------------------------------------------------------------------------
Residual maturity Haircut without
for debt securities currency mismatch
------------------------------------------------------------------------
All............................. <= 1 year.......... 0.02
All............................. >1 year, <= 5 years 0.06
All............................. > 5 years.......... 0.12
------------------------------------------------------------------------
Other Eligible Collateral
------------------------------------------------------------------------
------------------------------------------------------------------------
Main index \209\ equities (including 0.15.
convertible bonds).
Other publicly traded equities 0.25.
(including convertible bonds).
Mutual funds........................... Highest haircut applicable to
any security in which the fund
can invest.
Cash collateral held................... 0.
------------------------------------------------------------------------
Sec. 252.96 Compliance.
(a) Scope of compliance. A covered company must comply with the
requirements of this section on a daily basis at the end of each
business day and submit on a monthly basis a report demonstrating its
daily compliance.
---------------------------------------------------------------------------
\209\ Main index means the Standard & Poor's 500 Index, the FTSE
All-World Index, and any other index for which the covered company
can demonstrate to the satisfaction of the Federal Reserve that the
equities represented in the index have comparable liquidity, depth
of market, and size of bid-ask spreads as equities in the Standard &
Poor's 500 Index and FTSE All-World Index.
---------------------------------------------------------------------------
(b) Noncompliance. Except as otherwise provided in this section, if
a covered company is not in compliance with this subpart with respect
to a counterparty solely due to the circumstances specified in this
section 252.96, the covered company will not be subject to enforcement
actions for a period of 90 days (or such other period determined by the
Board to be appropriate to preserve the safety and soundness of the
covered company or U.S. financial stability) if the company uses
reasonable efforts to return to compliance with this subpart during
this period. The covered company may not engage in any additional
credit transactions with such a counterparty in contravention of this
rule during the compliance period, except in cases where the Board
determines that such credit transactions are necessary or appropriate
to preserve the safety and soundness of the covered company or U.S.
financial stability. In granting approval for such a special temporary
credit exposure limit, the Board will consider the following:
(1) A decrease in the covered company's capital stock and surplus.
(2) The merger of the covered company with another covered company.
(3) A merger of two unaffiliated counterparties.
(4) Any other circumstance the Board determines is appropriate.
The Board may impose supervisory oversight and reporting measures
that it determines are appropriate to monitor compliance with the
foregoing standards as set forth in this paragraph.
Sec. 252.97 Exemptions.
(a) Exempted exposure categories. The following categories of
credit transactions are exempt from the limits on credit exposure under
this subpart:
(1) Direct claims on, and the portions of claims that are directly
and fully guaranteed as to principal and interest by, the United States
and its agencies.
(2) Direct claims on, and the portions of claims that are directly
and fully guaranteed as to principal and interest by, the Federal
National Mortgage Association and the Federal Home Loan Mortgage
Corporation, only while operating under the conservatorship or
receivership of the Federal Housing Finance Agency, and any additional
obligations issued by a U.S. government sponsored entity as determined
by the Board.
(3) Intraday credit exposure to a counterparty.
(4) Any transaction that the Board exempts if the Board finds that
such exemption is in the public interest and is consistent with the
purpose of this subsection.
(b) Exemption for Federal Home Loan Banks. For purposes of this
subpart, a covered company does not include any Federal Home Loan Bank.
Subpart E--Risk Management
Sec. 252.125 Definitions.
For purposes of this subpart:
(a) Bank holding company is defined as in section 2 of the Bank
Holding
[[Page 655]]
Company Act, as amended (12 U.S.C. 1841), and the Board's Regulation Y
(12 CFR part 225).
(b) Chief risk officer means a management official of a covered
company who fulfills the responsibilities described in section
252.126(d) of this subpart.
(c) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(d) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(e) Covered company means
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company).
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered company for purposes
of this subpart unless and until the company has less than $50 billion
in total consolidated assets as determined based on each of the bank
holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph (3) is not subject to the requirements of this subpart
beginning on the first day of the calendar quarter following the
reporting date on which it ceased to be a covered company.
(f) Depository institution has the same meaning as in section 3 of
the Federal Deposit Insurance Act, 12 U.S.C. 1813(c).
(g) Enterprise-wide risk committee means a committee of a covered
company's or over $10 billion bank holding company's board of directors
that oversees the risk management practices of such company's worldwide
operations.
(h) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(i) Independent director means
(1) In the case of a covered company or over $10 billion bank
holding company that has a class of securities outstanding that is
traded on a national securities exchange, a member of the board such
company who:
(i) Is not an officer or employee of the company and has not been
an officer or employee of the company during the previous three years;
and
(ii) Is not a member of the immediate family, as defined in section
225.41(a)(3) of the Board's Regulation Y (12 CFR 225.41(a)(3)), of a
person who is, or has been within the last three years, an executive
officer of the company, as defined in section 215.2(e)(1) of the
Board's Regulation O (12 CFR 215.2(e)(1)); and
(iii) Is an independent director under Item 407 of the Securities
and Exchange Commission's Regulation S-K, 17 CFR 229.407(a).
(2) In the case of a director of a covered company or over $10
billion bank holding company that does not have a class of securities
outstanding that is traded on a national securities exchange, a member
of the board of directors of such company who:
(i) Meets the requirements of paragraphs (1)(i) and (ii) of this
section; and
(ii) The company demonstrates to the satisfaction of the Federal
Reserve would qualify as an independent director under the listing
standards of a national securities exchange if the company were
publicly traded on a national securities exchange.
(j) National securities exchange means any exchange registered with
the U.S. Securities and Exchange Commission as a national securities
exchange under section 6 of the Securities Exchange Act of 1934 (15
U.S.C. 78f).
(k) Publicly traded means traded on:
(1) A national securities exchange; or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers to
buy and sell so that a sales price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined promptly and a trade can be settled at such a price within a
reasonable time period conforming with trade custom.
(l) Risk management expertise means
(1) An understanding of risk management principles and practices
with respect to banking holding companies or depository institutions,
or, if applicable, nonbank financial companies, and the ability to
assess the general application of such principles and practices; and
(2) Experience developing and applying risk management practices
and procedures, measuring and identifying risks, and monitoring and
testing risk controls with respect to banking organizations or, if
applicable, nonbank financial companies.
(m) Over $10 billion bank holding company means any bank holding
company (other than a foreign banking organization) that is not a
covered company, and that:
(1) Has $10 billion or more in total consolidated assets, as
determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(2) Once an over $10 billion bank holding company meets the
requirements described in paragraph (1), the company shall remain an
over $10 billion bank holding company for purposes of this part unless
and until the company has less than $10 billion in total consolidated
assets as determined based on each of the bank holding company's four
most recent FR Y-9Cs.
(3) Nothing in paragraph (2) shall preclude a company from becoming
an over $10 billion bank holding company pursuant to paragraph (1).
[[Page 656]]
(4) A bank holding that has ceased to be an over $10 billion bank
holding company under paragraph (2) is not subject to the requirements
of this subpart beginning on the first day of the calendar quarter
following the reporting date on which it ceased to be an over $10
billion bank holding company.
Sec. 252.126 Establishment of risk committee and appointment of chief
risk officer.
(a) Risk committee. Each covered company and each publicly-traded
over $10 billion bank holding company, shall maintain an enterprise-
wide risk committee consisting of members of its board of directors,
and, for each covered company, that satisfies the requirements of
section 252.126(d).
(b) Structure of risk committee. An enterprise-wide risk committee
shall:
(1) Have a formal, written charter, approved by the company's board
of directors;
(2) Have at least one member with risk management expertise that is
commensurate with the company's capital structure, risk profile,
complexity, activities, size, and other appropriate risk related
factors;
(3) Be chaired by an independent director;
(4) Meet with an appropriate frequency and as needed, and fully
document and maintain records of its proceedings, including risk
management decisions;
(5) In addition, in the case of a covered company:
(i) Not be housed within another committee or be part of a joint
committee;
(ii) Report directly to the covered company's board of directors;
and
(iii) Receive and review regular reports from the covered company's
chief risk officer.
(c) Responsibilities of risk committee. A risk committee shall
document, review and approve the enterprise-wide risk management
practices of the company. Specifically, the risk committee shall
oversee the operation of, on an enterprise wide-basis, an appropriate
risk management framework commensurate with the company's capital
structure, risk profile, complexity, activities, size, and other
appropriate risk-related factors. A company's risk management framework
shall include:
(1) Risk limitations appropriate to each business line of the
company;
(2) Appropriate policies and procedures relating to risk management
governance, risk management practices, and risk control infrastructure
for the enterprise as a whole;
(3) Processes and systems for identifying and reporting risks and
risk-management deficiencies, including emerging risks, on an
enterprise-wide basis;
(4) Monitoring of compliance with the company's risk limit
structure and policies and procedures relating to risk management
governance, practices, and risk controls across the enterprise;
(5) Effective and timely implementation of corrective actions to
address risk management deficiencies;
(6) Specification of management and employees' authority and
independence to carry out risk management responsibilities; and
(7) Integration of risk management and control objectives in
management goals and the company's compensation structure.
(d) Chief risk officer. A covered company shall employ a chief risk
officer who:
(1) Has risk management expertise that is commensurate with the
company's capital structure, risk profile, complexity, activities,
size, and other risk-related factors that are appropriate;
(2) Is appropriately compensated and incentivized to provide an
objective assessment of the risks taken by the company;
(3) Reports directly to both the risk committee and chief executive
officer of the company; and
(4) Directly oversees the following responsibilities on an
enterprise-wide basis:
(i) Allocating delegated risk limits and monitoring compliance with
such limits;
(ii) Implementation of and ongoing compliance with, appropriate
policies and procedures relating to risk management governance,
practices, and risk controls and monitoring compliance with such
policies and procedures;
(iii) Developing appropriate processes and systems for identifying
and reporting risks and risk-management deficiencies, including
emerging risks, on an enterprise-wide basis;
(iv) Managing risk exposures and risk controls within the
parameters of the company's risk control framework; and
(v) Monitoring and testing of the company's risk controls;
(vi) Reporting risk management deficiencies and emerging risks to
the enterprise-wide risk committee; and
(vii) Ensuring that risk management deficiencies are effectively
resolved in a timely manner.
Subpart F--Supervisory Stress Test Requirements
Sec. 252.131 Applicability.
(a) Applicability. (1) In general. A bank holding company that
becomes a covered company no less than 90 days before September 30 of a
calendar year must comply with the requirements of this subpart from
September 30 of that calendar year and thereafter. A company the
Council has determined shall be supervised by the Board on a date no
less than 180 days before September 30 of a calendar year must comply
with the requirements of this subpart from September 30 of that
calendar year and thereafter.
(2) Initial applicability. A bank holding company that is a covered
company on the effective date of this subpart must immediately comply
with the requirements, including timing of required submissions to the
Board, of this subpart.
Sec. 252.132 Definitions.
For purposes of this subpart:
(a) Bank holding company is defined as in section 2 of the Bank
Holding Company Act, as amended (12 U.S.C. 1841), and the Board's
Regulation Y (12 CFR part 225).
(b) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(c) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(d) Covered company means
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company).
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered
[[Page 657]]
company for purposes of this subpart unless and until the company has
less than $50 billion in total consolidated assets as determined based
on each of the bank holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph (3) is not subject to the requirements of this subpart
beginning on the first day of the calendar quarter following the
reporting date on which it ceased to be a covered company.
(e) Depository institution has the same meaning as in section 3 of
the Federal Deposit Insurance Act, 12 U.S.C. 1813(c).
(f) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(g) Planning horizon means the period of time over which stress
test projections must extend. The planning horizon cannot be less than
nine quarters.
(h) Publicly traded means traded on:
(1) Any exchange registered with the U.S. Securities and Exchange
Commission as a national securities exchange under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers to
buy and sell so that a sales price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined promptly and a trade can be settled at such a price within a
reasonable time period conforming with trade custom.
(i) Scenarios are a set of economic and financial conditions that
the Board publishes for the use in the supervisory stress tests
annually, including baseline, adverse, and severely adverse.
Sec. 252.133 Annual analysis conducted by the Board.
(a) In general. The Board, in coordination with the appropriate
primary financial regulatory agencies, as defined in section 2(12) of
Dodd-Frank Act (12 U.S.C. 5301(12)), and the Federal Insurance Office,
will, on an annual basis, conduct an analysis of the capital, on a
total consolidated basis and taking into account all relevant exposures
and activities of each covered company to evaluate the ability of the
covered company to absorb losses in adverse economic and financial
conditions. The analysis will include the projected net income, losses,
and pro forma, post-stress capital levels and ratios for the covered
company and use the analytical techniques that the Board determines are
appropriate to identify, measure, and monitor risks of the covered
company and to the financial stability of the United States.
(b) Economic and financial scenarios related to analyses. The Board
will conduct its analysis under section 252.133(a) using a minimum of
three different sets of economic and financial conditions (scenarios),
including baseline, adverse, and severely adverse conditions. The Board
will notify covered companies of the conditions the Board will apply in
advance of conducting the analysis.
Sec. 252.134 Data and information required to be submitted in support
of the Board's analyses.
(a) Regular submissions. The Board will require each covered
company to submit the data, on a consolidated basis, that the Board
determines is necessary for it to estimate relevant pro forma estimates
discussed in 252.133(a), of the covered company over a period of at
least 9 calendar quarters under baseline, adverse, and severely adverse
scenarios, or other such conditions as determined appropriate by the
Board, including:
(1) Information related to the covered company's on- and off-
balance sheet exposures, including in some cases information on
individual items (such as loans and securities) held by the company,
and including exposures in the covered company's trading portfolio,
other trading-related exposures (such as counterparty-credit risk
exposures) or other items sensitive to changes in market factors,
including, as appropriate, information about the sensitivity of
positions in the trading portfolio to changes in market prices and
interest rates.
(2) Information to assist the Board in estimating the sensitivity
of the covered company's revenues and expenses to changes in economic
and financial conditions.
(3) Information to assist the Board in estimating the likely
evolution of the covered company's balance sheet (such as the
composition of its loan and securities portfolios) and allowance for
loan losses, in response to changes in economic and financial
conditions.
(b) Additional submissions required by the Board. The Board may
require a covered company to submit any other information on a
consolidated basis the Board deems necessary in order to:
(1) Ensure that the Board has sufficient information to conduct its
analysis under this subpart; and
(2) Derive robust projections of a company's losses, pre-provision
net revenue, allowance for loan losses, and future pro forma capital
positions under the baseline, adverse, and severely adverse scenarios,
or other such conditions as determined appropriate by the Board.
(c) Confidential treatment of information submitted. The
confidentiality of information submitted to the Board under this
subpart and related materials shall be determined in accordance with
applicable exemptions under the Freedom of Information Act (5 U.S.C.
552(b)) and the Board's Rules Regarding Availability of Information (12
CFR part 261).
Sec. 252.135 Review of the Board's analysis; publication of summary
results.
(a) Review of results. Based on the results of the analysis
conducted under this subpart, the Board will evaluate each covered
company to determine whether the covered company has the capital, on a
total consolidated basis, necessary to absorb losses and continue to
function as a credit intermediary as a result of adverse and severely
adverse economic and financial market conditions.
(b) Communication of results to covered companies. The Board will
convey to each covered company the results of the Board's analyses of
such covered company within a reasonable period of time.
(c) Publication of results by the Board. Within a reasonable period
of time after completing the analyses of the covered companies under
this subpart, the Board will publish a summary of the results of such
analyses.
Sec. 252.136 Post-assessment actions by covered companies.
(a) In general. Each covered company shall take the results of the
analysis conducted by the Board under this subpart into account in
making changes, as appropriate, to the covered company's capital
structure (including the level and composition of capital); its
exposures, concentrations, and risk positions; any plans of the covered
company for recovery; and for improving overall risk management.
(b) Resolution plan updates. Each covered company shall make such
updates to its resolution plan as the
[[Page 658]]
Board determines appropriate, based on the results of its analyses of
the covered company under this subpart, within 90 days of the Board
publishing the summary results of its analyses.
Subpart G--Company-Run Stress Test Requirements
Sec. 252.141 Applicability.
(a) Applicability. (1) In general. (i) A bank holding company that
becomes a covered company, or a bank holding company, a state member
bank, or except as provided in paragraph (a)(2) of this section, a
savings and loan holding company becomes an over $10 billion company no
less than 90 days before September 30 of a calendar year must comply
with the requirements of this subpart from September 30 of that
calendar year and thereafter. A company that the Council has determined
shall be supervised by the Board on a date no less than 180 days before
September 30 of a calendar year must comply with the requirements of
this subpart from September 30 of that calendar year and thereafter.
(ii) A bank holding company that becomes a covered company no less
than 90 days before March 31 of a calendar year must comply with the
requirements of this subpart from March 31 of that calendar year and
thereafter. A company that the Council has determined shall be
supervised by the Board on a date no less than 180 days before March 31
of a calendar year must comply with the requirements of this subpart
from March 31 of that calendar year and thereafter.
(2) Initial applicability. (i) In general. A bank holding company
that is a covered company or an over $10 billion company on the
effective date of this subpart must immediately comply with the
requirements, including timing of required submissions to the Board, of
this subpart.
(ii) Savings and loan holding companies. A savings and loan holding
company that is an over $10 billion company, before or after the
effective date of this subpart, would not be subject to the proposed
requirements, including timing of required submissions to the Board,
until savings and loan holding companies are subject to minimum risk-
based capital and leverage requirements.
Sec. 252.142 Definitions.
For purposes of this subpart:
(a) Bank holding company is defined as in section 2 of the Bank
Holding Company Act, as amended (12 U.S.C. 1841), and the Board's
Regulation Y (12 CFR part 225).
(b) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(c) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(d) Covered company means
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company).
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered company for purposes
of this subpart unless and until the company has less than $50 billion
in total consolidated assets as determined based on each of the bank
holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph (3) is not subject to the requirements of this subpart
beginning on the first day of the calendar quarter following the
reporting date on which it ceased to be a covered company.
(e) Depository institution has the same meaning as in section 3 of
the Federal Deposit Insurance Act, 12 U.S.C. 1813(c).
(f) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(g) Planning horizon means the period of time over which stress
test projections must extend. The planning horizon cannot be less than
nine quarters.
(h) Publicly traded means traded on:
(1) Any exchange registered with the U.S. Securities and Exchange
Commission as a national securities exchange under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers to
buy and sell so that a sales price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined promptly and a trade can be settled at such a price within a
reasonable time period conforming with trade custom.
(i) Over $10 billion company means any:
(1) Bank holding company (other than a foreign banking
organization) that is not a covered company and that has more than $10
billion in total consolidated assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's FR Y-9C; or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters;
(2) Savings and loan holding company that is not a covered company
and that has more than $10 billion in total consolidated assets, as
determined based on:
(i) The average of the savings and loan holding company's total
consolidated assets in the four most recent quarters as reported
quarterly on the savings and loan holding company's relevant regulatory
report; or
(ii) The average of the savings and loan holding company's total
consolidated assets in the most recent consecutive quarters as reported
quarterly on the savings and loan holding company's relevant regulatory
reports, if the savings and loan holding company has not filed such a
report for
[[Page 659]]
each of the most recent four quarters; and
(3) State member bank that has more than $10 billion in total
consolidated assets, as determined based on:
(i) The average of the state member bank's total consolidated
assets in the four most recent quarters as reported quarterly on the
state member bank's Consolidated Report of Condition and Income (Call
Report); or
(ii) The average of the state member bank's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the state member bank's Call Report, if the state member bank has not
filed a Call Report for each of the most recent four quarters.
(4) Once a company or bank meets the requirements described in
paragraphs (1), (2), or (3), the company shall remain an over $10
billion company for purposes of this part unless and until the company
has $10 billion or less in total consolidated assets as determined
based on each of the bank holding company's four most recent FR Y-9Cs,
the savings and loan holding company's four most recent relevant
regulatory reports, or the bank's four most recent Call Reports.
(5) Nothing in paragraph (2) shall preclude a company from becoming
an over $10 billion company pursuant to paragraph (1).
(6) A company or bank that has ceased to be an over $10 billion
company under paragraphs (1), (2), or (3) is not subject to the
requirements of this subpart beginning on the first day of the calendar
quarter following the reporting date on which it ceased to be an over
$10 billion company.
(j) Scenarios are sets of economic and financial conditions used in
the companies' stress tests, including baseline, adverse, and severely
adverse.
(k) State member bank has the same meaning as in section 208.2(g)
of the Board's Regulation H (12 CFR 208.2(g)).
(l) Stress test is a process to assess the potential impact on a
covered company or an over $10 billion company of economic and
financial conditions (scenarios) on the consolidated earnings, losses
and capital of the company over a set planning horizon, taking into
account the current condition of the company and the company's risks,
exposures, strategies, and activities.
Sec. 252.143 Annual stress test.
(a) In general.
(1) Each covered company and each over $10 billion company shall
complete an annual stress test of itself based on data of the covered
company or the over $10 billion company as of September 30 of that
calendar year, except for data related to the covered company's trading
and counterparty exposures for which the Board will communicate the
required as of date in the fourth quarter of each year.
(2) The stress test shall be conducted in accordance with this
section and the methodologies and practices described in section
252.145.
(b) Scenarios provided by the Board. In conducting its annual
stress tests under this section, each covered company and each over $10
billion company must use scenarios provided by the Board that reflect a
minimum of three sets of economic and financial conditions, including a
baseline, adverse, and severely adverse scenario. In advance of these
stress tests, the Board will provide to all covered companies and over
$10 billion companies a description of the baseline, adverse, and
severely adverse scenarios that each covered company and each over $10
billion company shall use to conduct its annual stress tests under this
subpart.
Sec. 252.144 Additional stress test for covered companies.
(a) Additional stress test requirement.
(1) Each covered company must complete an additional stress test
each year based on data of that company as of March 31 of that calendar
year except for data related to the covered company's trading and
counterparty exposures for which the Board will communicate the
required as of date in the fourth quarter of each year.
(2) The stress test shall be conducted in accordance with this
section and the methodologies and practices described in section
252.145.
(b) Scenarios related to additional stress tests.
(1) In general. Each company subject to a stress test under this
section 252.144 shall develop and employ scenarios reflecting a minimum
of three sets of economic and financial conditions, including a
baseline, adverse, and severely adverse scenario, or such additional
conditions as the Board determines appropriate, in conducting each
stress test required under this paragraph.
Sec. 252.145 Methodologies and practices.
(a) Potential impact on capital.
(1) In conducting a stress test under section 252.143 and section
252.144, each covered company and each over $10 billion company shall
calculate how each of the following are impacted during each quarter of
the stress test planning horizon, for each scenario:
(i) Potential losses, pre-provision net revenues, allowance for
loan losses, and future pro forma capital positions over the planning
horizon; and
(ii) Capital levels and capital ratios, including regulatory and
any other capital ratios specified by the Board.
(b) Controls and oversight of stress testing processes.
(1) Each covered company and each over $10 billion company must
establish and maintain a system of controls, oversight, and
documentation, including policies and procedures, designed to ensure
that the stress testing processes used by the covered company or over
$10 billion company are effective in meeting the requirements in this
subpart. These policies and procedures must, at a minimum, describe the
covered company's or over $10 billion company's stress testing
practices and methodologies, validation and use of stress tests
results, and processes for updating the company's stress testing
practices consistent with relevant supervisory guidance. Policies of
covered companies must describe processes for scenario development for
the additional stress test required under section 252.144.
(2) The board of directors and senior management of each covered
company and each over $10 billion company shall approve and annually
review the controls, oversight, and documentation, including policies
and procedures, of the covered company or the over $10 billion company
established pursuant to this subpart.
Sec. 252.146 Required report to the Board of stress test results and
related information.
(a) Report required for stress tests. On or before January 5 of
each year, each covered company and each over $10 billion company must
report the results of the stress test required under section 252.143 to
the Board in accordance with section 252.146(b). On or before July 5 of
each year, each covered company must report the results of the stress
test required under section 252.144 to the Board, in accordance with
section 252.146(b).
(b) Content of report for both annual and additional stress tests.
Each covered company and each over $10 billion company must file a
report in the manner and form established by the Board.
(c) Confidential treatment of information submitted. The
confidentiality of information submitted to the Board under this
subpart and related materials shall be determined in accordance with
applicable exemptions under the Freedom of Information Act (5 U.S.C.
552(b)) and the Board's Rules Regarding Availability of Information (12
CFR part 261).
[[Page 660]]
Sec. 252.147 Post-assessment actions by covered companies.
(a) Each covered company and each over $10 billion company shall
take the results of the stress tests conducted under section 252.143
and, if applicable, section 252.144, into account in making changes, as
appropriate, to the covered company's capital structure (including the
level and composition of capital); its exposures, concentrations, and
risk positions; any plans for recovery and resolution; and to improve
overall risk management.
Sec. 252.148 Publication of results by covered companies and over $10
billion companies.
(a) Public disclosure of results required for stress tests of
covered companies and of over $10 billion companies. Within 90 days of
submitting a report for its required stress test under section 252.143
and section 252.144, as applicable, a covered company and an over $10
billion company shall disclose publicly a summary of the results of the
stress tests required under section 252.143 and section 252.144, as
applicable.
(b) Information to be disclosed in the summary. The information
disclosed by each covered company and each over $10 billion company, as
applicable, shall, at a minimum, include--
(1) A description of the types of risks being included in the
stress test;
(2) For each covered company, a high-level description of scenarios
developed by the company under section 252.144(b), including key
variables used (such as GDP, unemployment rate, housing prices);
(3) A general description of the methodologies employed to estimate
losses, pre-provision net revenue, allowance for loan losses, and
changes in capital positions over the planning horizon; and
(4) Aggregate losses, pre-provision net revenue, allowance for loan
losses, net income, and pro forma capital levels and capital ratios
(including regulatory and any other capital ratios specified by the
Board) over the planning horizon, under each scenario.
Subpart H--Debt-to-Equity Limits for Certain Covered Companies
Sec. 252.151 Definitions.
(a) Bank holding company is defined as in section 2 of the Bank
Holding Company Act, as amended (12 U.S.C. 1841), and the Board's
Regulation Y (12 CFR part 225).
(b) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(c) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(d) Covered company means
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company).
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered company for purposes
of this part unless and until the company has less than $50 billion in
total consolidated assets as determined based on each of the bank
holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph (3) is not subject to the requirements of this subpart
beginning on the first day of the calendar quarter following the
reporting date on which it ceased to be a covered company.
(e) Debt-to-equity ratio means the ratio of a company's total
liabilities to a company's total equity capital less goodwill.
(f) Debt and equity have the same meaning as ``total liabilities''
and ``total equity capital'', respectively, as reported:
(1) In the case of a nonbank financial company supervised by the
Board, in a report of financial condition filed pursuant to section
161(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(12 U.S.C. 5361(a)), or otherwise as required by the Board.
(2) In the case of a bank holding company (other than a foreign
banking organization), on the Federal Reserve's Form FR Y-9C
(Consolidated Financial Statements for Bank Holding Companies) or any
successor form.
(g) Depository institution has the same meaning as in section 3 of
the Federal Deposit Insurance Act, 12 U.S.C. 1813(c).
(h) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(i) Publicly traded means traded on:
(1) Any exchange registered with the U.S. Securities and Exchange
Commission as a national securities exchange under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers to
buy and sell so that a sales price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined promptly and a trade can be settled at such a price within a
reasonable time period conforming with trade custom.
Sec. 252.152 Debt-to-equity ratio limitation.
(a) Notice and maximum debt-to-equity ratio requirement. Beginning
no later than 180 days after receiving written notice from the Council
that it has made a determination, pursuant to section 165(j) of the
Dodd-Frank Act that a covered company poses a grave threat to the
financial stability of the United States (identified company) and that
the imposition of a debt to equity requirement is necessary to mitigate
such risk, an identified company shall achieve and maintain a debt to
equity ratio of no more than 15-to-1.
(b) Extension. The Board may, upon request by an identified
company, extend the time period for compliance established under
paragraph (a) for up to two additional periods of 90 days each, if the
Board determines that the identified company has made good faith
efforts to comply with the debt to equity ratio requirement and that
each extension would be in the public interest.
[[Page 661]]
(c) Termination. The debt to equity ratio requirement in paragraph
(a) shall cease to apply to an identified company as of the date it
receives notice from the Council of a determination, based on the
factors described in subsections (a) and (b) of section 113 of the
Dodd-Frank Act (12 U.S.C. 5323), that the company no longer poses a
grave threat to the financial stability of the United States and that
the imposition of a debt to equity requirement is no longer necessary.
Subpart I--Early Remediation Framework
Sec. 252.161 Definitions.
For purposes of this subpart:
(a) Affiliate means, with respect to a company, any company that
controls, is controlled by, or is under common control with, the
company.
(b) Bank holding company is defined as in section 2 of the Bank
Holding Company Act, as amended (12 U.S.C. 1841), and the Board's
Regulation Y (12 CFR part 225).
(c) Capital distribution means a redemption or repurchase of any
debt or equity capital instrument, a payment of common or preferred
stock dividends, a payment that may be temporarily or permanently
suspended by the issuer on any instrument that is eligible for
inclusion in the numerator of any minimum regulatory capital ratio, and
any similar transaction that the Board determines to be in substance a
distribution of capital.
(d) Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
(e) Control is defined as in section 2 of the Bank Holding Company
Act, as amended (12 U.S.C. 1841), and the Board's Regulation Y (12 CFR
part 225).
(f) Council means the Financial Stability Oversight Council
established by section 111 of the Dodd-Frank Act (12 U.S.C. 5321).
(g) Covered company means
(1) Any company organized under the laws of the United States or
any State that the Council has determined under section 113 of the
Dodd-Frank Act (12 U.S.C. 5323) shall be supervised by the Board and
for which such determination is still in effect (nonbank covered
company).
(2) Any bank holding company (other than a foreign banking
organization), that has $50 billion or more in total consolidated
assets, as determined based on:
(i) The average of the bank holding company's total consolidated
assets in the four most recent quarters as reported quarterly on the
bank holding company's Consolidated Financial Statements for Bank
Holding Companies (the Federal Reserve's FR Y-9C (FR Y-9C)); or
(ii) The average of the bank holding company's total consolidated
assets in the most recent consecutive quarters as reported quarterly on
the bank holding company's FR Y-9Cs, if the bank holding company has
not filed an FR Y-9C for each of the most recent four quarters.
(3) Once a covered company meets the requirements described in
paragraph (2), the company shall remain a covered company for purposes
of this part unless and until the company has less than $50 billion in
total consolidated assets as determined based on each of the bank
holding company's four most recent FR Y-9Cs.
(4) Nothing in paragraph (3) shall preclude a company from becoming
a covered company pursuant to paragraph (2).
(5) A bank holding that has ceased to be a covered company under
paragraph (3) is not subject to the requirements of this subpart
beginning on the first day of the calendar quarter following the
reporting date on which it ceased to be a covered company.
(h) Depository institution has the same meaning as in section 3 of
the Federal Deposit Insurance Act, 12 U.S.C. 1813(c).
(i) Foreign banking organization means any foreign bank or company
that is a bank holding company or is treated as a bank holding company
under section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)).
(j) Net income means:
(1) For a bank holding company (other than a foreign banking
organization), the net income as reported on line 14 schedule HI of the
company's FR Y-9C report.
(2) For a nonbank covered company that is publicly traded, the net
income as reported on the company's quarterly financial statements.
(3) For a nonbank covered company that is not publicly traded, net
income as reported on the company's most recent audited financial
statement.
(k) Planning horizon means the period of time over which stress
test projections must extend. The planning horizon cannot be less than
nine quarters.
(l) Publicly traded means traded on:
(1) Any exchange registered with the U.S. Securities and Exchange
Commission as a national securities exchange under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question, meaning that there are enough independent bona fide offers to
buy and sell so that a sales price reasonably related to the last sales
price or current bona fide competitive bid and offer quotations can be
determined promptly and a trade can be settled at such a price within a
reasonable time period conforming with trade custom.
(m) Risk-weighted assets means total weighted risk assets, as
calculated in accordance with 12 CFR part 225, appendix A or 12 CFR
part 225, appendix G, as applicable, or any successor regulation
thereto.
(n) Senior executive officer of a covered company means a person
who holds the title or, without regard to title, salary, or
compensation, performs the function of one or more of the following
positions: President, chief executive officer, executive chairman,
chief operating officer, chief financial officer, chief investment
officer, chief legal officer, chief lending officer, chief risk
officer, or head of a major business line.
(o) Severely adverse scenario has the same meaning as defined in
the context of Subpart F of this part.
(p) Tier 1 capital means tier 1 capital as defined in 12 CFR part
225, appendix A or 12 CFR part 225, appendix G, as applicable, or any
successor regulation thereto.
(q) Tier 1 common risk-based capital ratio means the ratio of tier
1 capital less the non-common elements of tier 1 capital, including
perpetual preferred stock and related surplus, minority interest in
subsidiaries, trust preferred securities and mandatory convertible
preferred securities, to risk-weighted assets.
(r) Tier 1 leverage ratio means the ratio of tier 1 capital to
total assets as defined in 12 CFR part 225 appendix D, or any successor
regulation thereto.
(s) Tier 1 risk-based capital ratio means the ratio of tier 1
capital to risk-weighted assets, as calculated in accordance with 12
CFR part 225, appendix A or 12 CFR part 225, appendix G, as applicable,
or any successor regulation thereto.
(t) Total capital means qualifying total capital as defined in 12
CFR part 225, appendix A or total qualifying capital as defined in 12
CFR part 225, appendix G, as applicable, or any successor regulation
thereto.
[[Page 662]]
(u) Total assets means:
(1) For a bank holding company (other than a foreign banking
organization), total consolidated assets as reported quarterly on the
bank holding company's FR Y-9C.
(2) For a nonbank covered company that is publicly traded, total
consolidated assets as reported nonbank covered company's quarterly
financial statements.
(3) For a nonbank covered company that is not publicly traded,
total consolidated assets as determined based on the company's audited
financial statements.
(v) Total risk-based capital ratio means the ratio of total capital
to risk-weighted assets, as calculated in accordance with 12 CFR part
225, appendix A or 12 CFR part 225, appendix G, as applicable, or any
successor regulation thereto.
Sec. 252.162 Remediation Actions.
(a) Level 1 remediation (heightened supervisory review). Under
level 1 remediation, the Board shall conduct a targeted supervisory
review of a covered company to evaluate whether the covered company is
experiencing financial distress or material risk management weaknesses
such that further decline of the covered company is probable and that
the covered company should be subject to initial remediation (level 2
remediation).
(1) The review required by this section 252.162(a) must be
completed within 30 days of the company's entrance into level one
remediation.
(2) If, upon completion of the review, the Board determines that
the covered company is experiencing financial distress or material risk
management weaknesses such that further decline of the covered company
is probable, the covered company shall be subject to initial
remediation (level 2 remediation).
(b) Level 2 remediation (initial remediation). A covered company
subject to level 2 remediation:
(1) Shall not make capital distributions during any calendar
quarter in an amount that exceeds 50 percent of the average of the
covered company's net income in the preceding two calendar quarters.
(2) Shall not:
(i) Permit its daily average total assets during any calendar
quarter to exceed its daily average total assets during the preceding
calendar quarter by more than 5 percent; or
(ii) Permit its daily average total assets during any calendar year
to exceed its daily average total assets during the preceding calendar
year by more than 5 percent; or
(iii) Permit its daily average risk-weighted assets during any
calendar quarter to exceed its daily average risk-weighted assets
during the preceding calendar quarter by more than 5 percent;
(iv) Permit its daily average risk-weighted assets during any
calendar year to exceed its daily average risk-weighted assets during
the preceding calendar year by more than 5 percent;
(v) Directly or indirectly acquire any controlling interest in any
company (including an insured depository institution, establish or
acquire any office or other place of business, or engage in any new
line of business), without the prior approval the Board.
(3) Shall be required to enter into a non-public memorandum of
understanding, or other enforcement action acceptable to the Board.
(4) In addition, may be subject to the following additional
limitations imposed by the Board:
(i) Limitations or conditions on the conduct or activities of the
company or any of its affiliates that the Board finds to be appropriate
and consistent with the purposes of Title I of the Dodd-Frank Act.
(c) Level 3 remediation (recovery). A covered company subject to
level 3 remediation:
(1) May not make any capital distribution.
(2) Shall not:
(i) Permit its average total assets during any calendar quarter to
exceed its average total assets during the preceding calendar quarter;
or
(ii) Permit its average total risk-weighted assets during any
calendar quarter to exceed its average total risk-weighted assets
during the preceding calendar quarter; or
(iii) Directly or indirectly acquire any interest in any company
(including any insured depository institution), establish or acquire
any office (or other place of business), or engage in any new line of
business;
(3) Must enter into a written agreement or other form of
enforcement action with the Board that specifies that the covered
company must raise additional capital and take other appropriate
actions to improve its capital adequacy.
(i) If a covered company fails to satisfy the requirements of such
a written agreement, the covered company may be required to divest
assets identified by the Board as contributing to the covered company's
financial decline or posing substantial risk of contributing to further
financial decline of the covered company.
(4) Shall not increase the compensation of, or pay any bonus to,
its senior executive officers or directors.
(5) May also be required by the Board to:
(i) Conduct a new election for the institution's board of
directors;
(ii) Dismiss from office any director or senior executive officer
of the covered company who had held office for more than 180 days
immediately prior to receipt of notice pursuant to section 252.164 that
the covered company is subject to level 3 remediation; or
(iii) Employ qualified senior executive officers approved by the
Board.
(6) The Board may place restrictions on a covered company engaging
in transactions with its affiliates if it is subject to level 3
remediation.
(d) Level 4 remediation (resolution assessment). The Board shall
consider whether the covered company poses a risk to the stability of
the U.S. financial system. If the Board determines, based on the
covered company's financial decline and the risk posed to U.S.
financial stability by the failure of the covered company or other
relevant factors, that the covered company should be placed into
receivership under Title II of the Dodd-Frank Act, the Board shall make
a written recommendation that the covered company be placed in
resolution under Title II of the Dodd-Frank Act.
Sec. 252.163 Remediation triggering events.
(a) Capital and leverage.
(1) Level 1 remediation triggering events. A covered company that
has a total risk-based capital ratio of 10.0 percent or greater, a tier
1 risk-based capital ratio of 6.0 percent or greater, and a tier 1
leverage ratio of 5.0 percent or greater, is subject to level 1
remediation (heightened supervisory review) if the Board determines
that the covered company's capital structure, capital planning
processes, or the amount of capital it holds is not commensurate with
the level and nature of the risks to which it is exposed.
(2) Level 2 remediation triggering events. A covered company is
subject to level 2 remediation (initial remediation) if it has a total
risk-based capital ratio of less than 10.0 percent and greater than or
equal to 8.0 percent, a tier 1 risk-based capital ratio of less than
6.0 percent and greater than or equal to 4.0 percent or a tier 1
leverage ratio of less than 5.0 percent and greater than or equal to
4.0 percent.
(3) Level 3 remediation triggering events. A covered company is
subject to level 3 remediation (recovery) if:
(i) For two complete consecutive quarters, the covered company has
a
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total risk-based capital ratio of less than 10.0 percent, a tier 1
risk-based capital ratio of less than 6.0 percent or a tier 1 leverage
ratio of less than 5.0 percent; or
(ii) The covered company has a total risk-based capital ratio of
less than 8.0 percent and greater than or equal to 6.0 percent, a tier
1 risk-based capital ratio of less than 4.0 percent and greater than or
equal to 3.0 percent or a tier 1 leverage ratio of less than 4.0
percent and greater than or equal to 3.0 percent.
(iii) Level 4 remediation triggering events. A covered company is
subject to level 4 remediation (resolution assessment) if it has a
total risk-based capital ratio of less than 6.0 percent, a tier 1 risk-
based capital ratio of less than 3.0 percent or a tier 1 leverage ratio
of less than 3.0 percent.
(b) Stress Tests.
(1) Level 1 remedial triggering events. A covered company is
subject to level 1 remediation if it is not in compliance with any
regulations adopted by the Board relating to capital plans pursuant to
12 CFR 225.8 and stress tests pursuant to Subparts F and G of this
part.
(2) Level 2 remediation triggering events. A covered company is
subject to level 2 remediation (initial remediation) if its results
under the severely adverse scenario in any quarter of the planning
horizon produced pursuant to a stress test executed pursuant to Subpart
F of this part reflect a tier 1 common risk-based capital ratio of less
than 5.0 percent and greater than or equal to 3.0 percent.
(3) Level 3 remediation triggering events. A covered company is
subject to level 3 remediation (recovery) if its results under the
severely adverse scenario in any quarter of the planning horizon
produced pursuant to a stress test executed pursuant to Subpart F of
this part reflect a tier 1 common risk-based capital ratio of less than
3.0 percent.
(c) Risk Management.
(1) Level 1 remedial triggering events. A covered company is
subject to level 1 remediation if it has manifested signs of weakness
in meeting the enhanced risk management and risk committee requirements
under Subpart E of this part.
(2) Level 2 remediation triggering events. A covered company is
subject to level 2 remediation if it has demonstrated multiple
deficiencies in meeting the enhanced risk management or risk committee
requirements under Subpart E of this part.
(3) Level 3 remediation triggering events. A covered company is
subject to level 3 remediation if it is in substantial noncompliance
with the enhanced risk management and risk committee requirements under
Subpart E of this part.
(d) Liquidity.
(1) Level 1 remedial triggering events. A covered company is
subject to level 1 remediation if it has manifested signs of weakness
in meeting the enhanced liquidity risk management requirements under
Subpart C.
(2) Level 2 remediation triggering events. A covered company is
subject to level 2 remediation if it has demonstrated multiple
deficiencies in meeting the enhanced liquidity risk management
requirements under Subpart C.
(3) Level 3 remediation triggering events. A covered company is
subject to level 3 remediation if it is in substantial noncompliance
with the enhanced liquidity risk management requirements under Subpart
C.
(e) Market indicators.
(1) Definitions.
(i) Market indicator means an indicator based on publicly available
market data that is identified in the annual indicator list, as
specified by the Board.
(ii) Indicator list means a list of the market indicators and
market indicator thresholds that will be used during a defined period,
as specified by the Board.
(iii) Breach period means the number of consecutive business days,
as specified by the Board, over which the median value of a market
indicator must exceed the market indicator threshold to trigger
remediation.
(iv) Market indicator threshold means, with respect to each market
indicator described on the indicator list, the level, as specified by
the Board, indicating that a covered company is experiencing financial
distress or material risk management weaknesses such that further
decline of the covered company is probable based on historic measures
of data.
(2) The Board shall publish for comment annually, or less
frequently as appropriate, the indicator list, market indicator
thresholds, and breach period that will be used during a twelve-month
period.
(3) A covered company shall be subject to level 1 remediation upon
receipt of a notice indicating that the Board has found that, with
respect to the covered company, any single market indicator has
exceeded the market indicator threshold for the breach period.
(f) Measurement and timing of remediation action events.
(1) Capital. For the purposes of this subpart, the capital of a
covered company is deemed to have been calculated as of the most recent
of the following:
(i) The FR Y-9C report;
(ii) Calculations of capital by the covered company submitted to
the Board, pursuant to a Board request to the covered company to
calculate its ratios;
(iii) A final inspection report is delivered to the covered company
that includes capital ratios calculated more recently than the most
recent FR Y-9C report submitted by the covered company to the Board.
(2) Stress tests. For purposes of this paragraph, the ratios
calculated under the supervisory stress test apply as of the date the
Board's report of the test results is transmitted to the covered
company pursuant to section 252.135(b) of Subpart F.
Sec. 252.164 Notice and remedies.
(a) Notice to covered company of remediation action event. If the
Board ascertains that a remediation triggering event set forth in
section 252.163 has occurred with respect to a covered company, the
Board shall notify the covered company of the event and the remediation
action under section 252.162 applicable to the covered company as a
result of the event.
(b) Notification of Change in Status. If a covered company becomes
aware of (i) one or more triggering events set forth in section
252.163; or (ii) a change in condition that it believes should result
in a change in the remediation provisions to which it is subject, such
covered company must provide notice to the Board within 5 business
days, identifying the nature of the triggering event or change in
circumstances.
(c) Termination of remediation action. A covered company subject to
a remediation action under this subpart shall remain subject to the
remediation action until the Board provides written notice to the
covered company that its financial condition or risk management no
longer warrants application of the requirement.
By order of the Board of Governors of the Federal Reserve
System, December 22, 2011.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 2011-33364 Filed 1-4-12; 8:45 am]
BILLING CODE 6210-01-P