Federal Reserve Issues Final Rule on Enhanced Prudential Standards for Foreign Banking Organizations

Transcription

1 MARCH 13, 2014 BANKING AND FINANCIAL SERVICES UPDATE Federal Reserve Issues Final Rule on Enhanced Prudential Standards for Foreign Banking Organizations On February 18, 2014, the Federal Reserve Board (the Federal Reserve ) approved a final rule (the Final Rule ) to implement certain enhanced prudential standards required under Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank Act ) for U.S. bank holding companies ( BHCs ) and foreign banking organizations ( FBOs ) with total consolidated assets of $50 billion or more ( Large BHCs and Large FBOs, respectively). 1 The enhanced prudential standards include risk-based and leverage capital requirements, liquidity standards, risk management and risk committee requirements, and stress testing, as well as debt-toequity limits for companies that are separately determined to pose a grave threat to the financial stability of the United States. Large FBOs with combined U.S. assets (U.S. branches, agencies and subsidiaries) of $50 billion or more are subject to greater requirements than Large FBOs with smaller U.S. footprints. In addition, Large FBOs with U.S. non-branch or agency assets of $50 billion or more are required to form a U.S. intermediate holding company (an IHC ) over their U.S. subsidiaries. The Final Rule also establishes risk committee requirements for publicly-traded bank holding companies and foreign banking organizations with total consolidated assets of $10 billion or more, and capital stress testing requirements for foreign banking organizations with total consolidated assets of more than $10 billion. This update provides a summary of the key aspects of the Final Rule for FBOs which are generally required to comply by July 1, I. Background Section 165 of the Dodd-Frank Act directs the Federal Reserve to adopt enhanced prudential standards applicable to domestic bank holding companies and FBOs with total consolidated assets of $50 billion or more and nonbank financial companies that have been designated for supervision by the Federal Reserve. The statute also permits the Federal Reserve to apply other prudential standards, including a contingent capital requirement, enhanced public disclosures, short-term debt limits and any other prudential standards that the Federal Reserve determines are appropriate. In applying Section 165 to an FBO, the Federal Reserve must give due regard to the principle of national treatment and equality of competitive opportunity, and take into account the extent to which the FBO is subject to home country standards that are comparable to those applied to financial companies in the United States. 1 The Final Rule is available at Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, ; One South Dearborn, Chicago, IL 60603, ; and 1501 K Street, N.W., Washington, D.C ,

2 Page 2 In accordance with this mandate, the Federal Reserve proposed rules (i) in January 2012 that applied Section 165 to U.S. BHCs and nonbank financial companies supervised by the Federal Reserve (the Domestic Proposal ) and (ii) in December 2012 that applied Section 165 to FBOs and foreign nonbank financial companies supervised by the Federal Reserve (the Foreign Proposal and together with the Domestic Proposal, the Proposals and each, a Proposal ). 2 The Proposals were broadly consistent with each other. However, the Foreign Proposal provisions were modified to reflect differences in the regulatory framework under which FBOs operate and, in some cases, to take into account the home country standards of the FBO. In addition, the Foreign Proposal provided that FBOs with significant U.S. non-branch assets would be required to form an IHC to serve as the U.S. top-tier holding company for the U.S. subsidiaries of the FBO. The Final Rule is intended to be responsive to vulnerabilities in FBO activities observed during and after the financial crisis, when many FBOs came to rely too heavily on short-term, wholesale U.S. dollar funding. The Final Rule is also intended to complement measures to address risks associated with large, interconnected banking organizations. Consistent with the Proposals, the Final Rule s graduated approach to the regulation of FBOs includes standards that increase in stringency depending on the size and scope of FBO operations in the United States. II. Key Changes from the Proposals The Final Rule implements many elements from the Proposals and makes some key changes with respect to FBOs. Threshold for IHC. The Foreign Proposal would have required a Large FBO with U.S. non-branch assets of $10 billion or more to establish an IHC. The Final Rule raises this IHC threshold from $10 billion to $50 billion. Implementation Timing for FBOs. The Final Rule extends the compliance date for FBOs by one year from July 1, 2015 to July 1, A Large FBO with U.S. non-branch assets that meets the IHC threshold as of June 30, 2015, must establish the IHC by July 1, An FBO that meets the IHC threshold after June 30, 2015 has two years to come into compliance with the Final Rule, instead of 12 months under the Proposal. The extended dates are intended to provide the FBO with a reasonable transition period to plan and execute any required restructuring and mitigate tax and reorganization costs. To ensure that the necessary steps are being taken, Large FBOs that meet the IHC threshold as of June 30, 2014 must submit to the Federal Reserve an implementation plan by January 1, IHC Requirements. IHCs must comply with U.S. risk-based capital and leverage requirements with some modifications: (1) IHCs are only subject to the standardized approach and do not have to apply the advanced approaches risk-based capital rules, even if they meet the thresholds for such rules; and (2) IHCs do not have to comply with the leverage ratio requirements until January 1, U.S. Branch and Agency Liquidity Buffer. The liquidity buffer required to be maintained for an FBO s U.S. branches and agencies is reduced from 30 days to 14 days. Reorganization of Rule Text. The Final Rule reorganizes the rule text of the Proposals by type of company (domestic or foreign) and by the size of the company such that the enhanced requirements applicable to a company are grouped together in one or more subparts FR 594 (January 5, 2012) and 77 FR (December 28, 2012). Each of the Proposals also included proposed rules under Section 166, which sets out early remediation requirements, but the Final Rule addresses only the Federal Reserve s Section 165 mandate.

3 Page 3 III. Scope of Application Similar to the Foreign Proposal, the Final Rule imposes the most stringent enhanced standards on Large FBOs with combined U.S. assets of $50 billion or more. Less stringent requirements apply to smaller FBOs and Large FBOs with fewer combined U.S. assets. Large FBOs. The Final Rule imposes enhanced risk-based and leverage capital, risk management, liquidity and stress testing requirements, as well as a debt-to-equity limit if a Large FBO is separately determined to pose a grave threat to U.S. financial stability. Large FBOs with combined U.S. non-branch assets of $50 billion or more must establish an IHC over their U.S. subsidiaries. The IHC is also subject to enhanced prudential standards. Medium FBOs and FSLHCs. The Final Rule imposes stress testing requirements on FBOs with total consolidated assets of more than $10 billion but less than $50 billion ( Medium FBOs ) and foreign savings and loan holding companies with total consolidated assets of more than $10 billion ( Medium FSLHCs ) and risk committee requirements on publicly-traded Medium FBOs ( Publicly-Traded Medium FBOs ). The following table sets forth the enhanced standards applicable to FBOs based on company type and size. Company Type and Size Medium FBOs and Medium FSLHCs (total consolidated assets of more than $10 billion but, in the case of FBOs, less than $50 billion) Publicly-Traded Medium FBOs (total consolidated assets of $10 billion or more, but less than $50 billion) Large FBOs (total consolidated assets of $50 billion or more), but combined U.S. assets of less than $50 billion Large FBOs (total consolidated assets of $50 billion or more), with combined U.S. assets of $50 billion or more Requirements Home-country capital stress testing Risk committee Risk-based and leverage capital Risk committee Liquidity stress testing Home-country capital stress testing Debt-to-equity limit (if separately determined to pose a grave threat) Risk-based and leverage capital Risk management and risk committee Liquidity risk management, stress testing and buffers Home-country capital stress testing plus related detailed reporting to the Federal Reserve Debt-to-equity limit (if separately determined to pose a grave threat) IHC requirement if the FBO has U.S. nonbranch assets of $50 billion or more 3 3 Note that IHCs are separately subject to many of the Section 165 enhanced prudential standards set out in the Final Rule.

4 Page 4 For purposes of calculating the asset thresholds, the following definitions apply: Total Consolidated Assets. o For Large FBOs, total consolidated assets equals the average of the FBO s total assets for the four most recent consecutive quarters as reported on the FR Y-7Q. If the FBO has not filed the FR Y 7Q for the four most recent consecutive quarters, the Federal Reserve will use an average of the FBO s total consolidated assets reported on its two most recent FR Y-7Qs. o For Medium FBOs and Publicly-Traded Medium FBOs, total consolidated assets equals the average of the total assets for the two most recent periods as reported by the FBO on the FR Y-7. Combined U.S. Assets. Combined U.S. assets of an FBO equals the sum of the consolidated assets of each top-tier U.S. subsidiary of the FBO (excluding any Section 2(h)(2) company, if applicable) 4 and the total assets of each U.S. branch and U.S. agency of the FBO. Combined U.S. assets are calculated as the average of the total combined assets of U.S. operations for the four most recent consecutive quarters as reported by the FBO on the FR Y-7Q, or if the FBO has not reported this information on the FR Y-7Q for each of the four most recent consecutive quarters, the average of the combined U.S. assets for the most recent quarter or consecutive quarters as reported on the FR Y-7Q. U.S. Non-Branch Assets. U.S. non-branch assets of an FBO equals the average of the sum of the total consolidated assets of the top-tier U.S. subsidiaries of an FBO (excluding any Section 2(h)(2) company and DPC branch subsidiary) 5 for the four most recent consecutive quarters, as reported by the FBO on the FR Y- 7Q, or, if the FBO has not reported this information on the FR Y-7Q for each of the four most recent consecutive quarters, the average for the most recent quarter or consecutive quarters as reported on the FR Y- 7Q. The FBO must reduce its U.S. non-branch assets by the amount corresponding to balances and transactions between a top-tier U.S. subsidiary and any other top-tier U.S. subsidiary (excluding any 2(h)(2) company or DPC branch subsidiary) to the extent such items are not already eliminated in consolidation. The Final Rule does not cover the following: Nonbanking Financial Companies. The Final Rule does not apply to nonbanking financial companies (including foreign nonbanking financial companies) that are designated by the Financial Stability Oversight Council (the FSOC ) for supervision by the Federal Reserve. The Federal Reserve intends to impose enhanced prudential standards on these companies by rule or order taking into consideration the business model, capital structure, risk profile and other relevant factors of each company, and if appropriate, tailor the application of the standards to the individual company or category of companies. Single-Counterparty Credit Limits and Early Remediation Requirements. The Final Rule does not cover single-counterparty credit limits or early remediation requirements. These requirements are still under development and review and will be implemented at a later date. Before finalizing single-counterparty credit limits, the Federal Reserve intends to take into consideration current efforts by the Basel Committee on Banking Supervision ( Basel Committee ) to develop a similar large exposure regime for global banks, the results of its own quantitative impact study, and comments on the Proposals. 4 Section 2(h)(2) of the Bank Holding Company Act allows qualifying FBOs to retain certain interests in foreign commercial firms that conduct business in the United States. 5 A DPC branch subsidiary means any subsidiary of a U.S. branch or agency acquired, or formed to hold assets acquired, in the ordinary course of business and for the sole purpose of securing or collecting debt previously contracted (DPC) in good faith by that branch or agency.

5 Page 5 IV. Implementation Dates Large FBOs. o Large FBOs must comply with the Final Rule beginning on July 1, An FBO that qualifies as a Large FBO after June 30, 2015 must comply with the Final Rule beginning on the first day of the ninth quarter following the date it qualifies. o Large FBOs with U.S. non-branch assets of $50 billion or more as of June 30, 2015 must: (i) by July 1, 2016, establish an IHC and transfer to the IHC its entire ownership interest in any BHC subsidiary (if not designated as its IHC), any insured depository institution subsidiary, and U.S. subsidiaries holding at least 90 percent of its U.S. non-branch assets not owned by such BHC subsidiary or insured depository institution subsidiary; and (ii) by July 1, 2017, hold its ownership interest in all U.S. subsidiaries (other than Section 2(h)(2) companies and DPC branch subsidiaries) through its IHC. A Large FBO that crosses the IHC threshold after June 30, 2015 must comply with the requirements beginning on the first day of the ninth quarter following the date it reaches the threshold, unless accelerated or extended by the Federal Reserve. If the Large FBO has U.S. non-branch assets of $50 billion or more as of June 30, 2014, it must submit an implementation plan by January 1, 2015 describing how it will comply with the IHC requirement. Medium FBOs. A Medium FBO (total consolidated assets of more than $10 billion but less than $50 billion) as of June 30, 2015, must comply with the Final Rule s company-run stress testing requirements beginning on July 1, An FBO that qualifies as a Medium FBO after June 30, 2015 must comply with the requirements beginning on the first day of the ninth quarter following the date it qualifies. Publicly-Traded Medium FBOs. A Publicly-Traded Medium FBO (class of stock or similar interest that is publicly traded and total consolidated assets of $10 billion or more but less than $50 billion) as of June 30, 2015, must comply with the Final Rule s risk committee requirements beginning on July 1, An FBO that qualifies as a Publicly-Traded Medium FBO after June 30, 2015 must comply with the requirements beginning on the first day of the ninth quarter following the date it qualifies. IHCs. An IHC required to be established by July 1, 2016 must comply with the Final Rule s risk-based capital and capital plan requirements, risk management, and liquidity requirements beginning on July 1, An IHC that is formed after July 1, 2016 must comply with these requirements beginning on the date it is required to be established. 6 o An IHC required to be established by July 1, 2016 must comply with the leverage capital requirements beginning on January 1, The Federal Reserve may accelerate the application of the leverage ratio to an IHC if it determines that the FBO has taken actions to evade the application of the leverage capital requirements. o An IHC required to be established by July 1, 2016 must comply with the stress test requirements beginning on October 1, The Federal Reserve may accelerate the application of the stress 6 U.S. BHC subsidiaries of a Large FBO must comply with enhanced prudential standards applicable to U.S. BHCs until an IHC is formed or designated and the IHC becomes subject to corresponding standards.

6 Page 6 test requirements to an IHC if it determines that the FBO has taken actions to evade the application of the requirements. V. U.S. Intermediate Holding Company ( IHC ) Requirement Background. FBOs operate in the United States through various structures. FBOs may conduct banking activities through U.S. branches and agencies, 7 or through bank subsidiaries either held directly or through a U.S. bank holding company. They may also conduct nonbanking activities through separate nonbank subsidiaries that may or may not be held through a U.S. bank holding company. Like the Foreign Proposal, the Final Rule requires certain FBOs to form or designate an IHC to hold and operate their U.S. bank and nonbank subsidiaries. Section 165 of the Dodd Frank Act does not itself require that an FBO establish an IHC. However, Section 165 permits the Federal Reserve to establish additional prudential standards for covered companies if it determines that such standards are appropriate. The preamble to the Final Rule explains that the IHC requirement directly addresses the risks to the financial stability of the United States by increasing the resiliency of the U.S. operations of Large FBOs. The IHC requirement also permits consistent application of prudential requirements across the non-branch U.S. operations of the FBO and provides a single nexus for risk management of such operations through consolidated supervision. Finally, the IHC requirement facilitates a level playing field between foreign and U.S. banking organizations operating in the United States in furtherance of national treatment and competitive equity. Establishing an IHC. A Large FBO with U.S. non-branch assets of $50 billion or more would be required to organize its U.S. subsidiaries (excluding any Section 2(h)(2) company and DPC branch subsidiary, if applicable) under an IHC. 8 o An FBO that establishes an IHC would generally be required to hold its entire interest in any U.S. subsidiary, other than a Section 2(h)(2) company or DPC branch subsidiary, through the IHC. However, the Final Rule does not require the FBO to be the 100% owner of any U.S. subsidiary. o Upon written request by an FBO, the Federal Reserve may permit the FBO to establish multiple IHCs, use an alternative organizational structure to hold its U.S. operations, or avoid transfer of ownership interests in certain subsidiaries to the IHC. The Federal Reserve may consider whether applicable law prohibits the FBO from owning its U.S. subsidiaries through a single IHC or whether the activities, scope of operations, or structure of the FBO s U.S. subsidiaries warrant an exception. In the narrow circumstance where an FBO is permitted to hold its interest in a U.S. subsidiary outside of an IHC, the Federal Reserve expects to require passivity commitments or other supervisory agreements to limit the exposure of the IHC to the excluded subsidiary. The FBO s request must be submitted at least 180 days before the date the FBO is required to form an IHC or the FBO acquires the ownership interest in a subsidiary that will not be transferred to the IHC. o The IHC must be governed by a board of directors or managers. 7 The Foreign Proposal would have referred to all U.S. branches and U.S. agencies of a foreign bank as the U.S. branch and agency network. The Final Rule does not use this defined term, and simply refers to U.S. branches and U.S. agencies of a foreign bank. 8 U.S. subsidiary would be defined as a U.S. company in which the FBO: (i) directly or indirectly or acting through one or more other persons owns, controls, or has power to vote 25 percent or more of any class of voting securities of the company; (ii) controls in any manner the election of a majority of the directors or trustees of the company; or (iii) directly or indirectly exercises a controlling influence over the management or policies of the company.

7 Page 7 o The IHC is required to serve as a source of strength for its subsidiaries that are insured depository institutions, if any. Notice requirements. Within 30 days of establishing or designating an IHC, the FBO must provide to the Federal Reserve: (1) a description of the IHC, including its name, location, corporate form, and organizational structure; (2) a certification that the IHC meets the requirements of the Final Rule; and (3) any other information that the Federal Reserve determines is appropriate. Implementation Plan. The Final Rule requires Large FBOs that meet the IHC threshold as of June 30, 2014 to submit to the Federal Reserve an implementation plan by January 1, The implementation plan must include: o A list of the FBO s U.S. subsidiaries and ownership interest, and an organizational chart showing the ownership hierarchy; o For each U.S. subsidiary that is a Section 2(h)(2) subsidiary or a DPC branch subsidiary, the name, asset size and description of why the subsidiary qualifies as a Section 2(h)(2) subsidiary or a DPC branch subsidiary; o For each U.S. subsidiary for which the FBO expects to request an exemption from the requirement to transfer all or a portion of its ownership interest to the IHC, the name, asset size and description of reasons for requesting the exemption; o A projected timeline for the transfer of the FBO s ownership interest in the subsidiaries to the IHC; o Quarterly pro forma financial statements for the IHC from December 31, 2015 to January 1, 2018; o A projected timeline of all planned capital actions or strategies for capital accumulation that will facilitate the IHC s compliance with risk-based and leverage capital requirements; o A description of the risk management and liquidity stress testing practices of the FBO s combined U.S. operations and plan for compliance with the liquidity and risk management requirements of the Final Rule; and o Any plans to reduce the FBO s U.S. non-branch assets below $50 billion for four consecutive quarters prior to July 1, Applicable standards. An IHC would be subject to the enhanced prudential standards set forth in the Final Rule, as well as to regulatory reporting requirements and examination by the Federal Reserve. The enhanced prudential standards include capital, risk management, liquidity, and stress test requirements. VI. Risk-Based Capital and Leverage Requirements IHCs. An IHC is generally subject to capital adequacy standards in the same manner as a U.S. bank holding company, including minimum risk-based capital and leverage requirements and restrictions associated with capital buffers. 9 However, IHCs are only subject to the standardized approach and do not have to apply the 9 The revised capital framework reorganized the Federal Reserve s capital adequacy guidelines into a harmonized, codified set of rules, located at 12 CFR Part 217. The requirements of 12 CFR Part 217 came into effect on January 1, 2014, for bank holding companies subject to the advanced approaches risk-based capital rule, and as of January 1, 2015 for all other bank holding companies. The predecessor capital adequacy guidelines for bank holding companies 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).

8 Page 8 advanced approaches risk-based capital rules, regardless of whether they meet the thresholds for such rules, unless they choose to do so. 10 In addition, the leverage ratios will not become applicable to IHCs until January 1, o Capital Plan Requirement. IHCs are subject to the Federal Reserve s capital plan rule in the same manner as a U.S. bank holding company. Under the capital plan rule, the IHC must submit annual capital plans to the Federal Reserve demonstrating its ability to maintain capital above the Federal Reserve s minimum risk-based capital and leverage ratios under both baseline and stressed conditions over a minimum nine-quarter, forward looking planning horizon. 11 An IHC that is unable to satisfy the capital plan rule requirements would generally be prohibited from making any capital distributions until a satisfactory capital plan is submitted. The Federal Reserve expects IHCs to reflect parent company support, through guarantees and keepwell agreements, in their capital plans. However, in demonstrating its ability to meet minimum capital requirements, an IHC would not be permitted to reflect these agreements as sources of capital. o U.S. Pillar 3 Disclosures. An IHC will not be required to make the U.S. Pillar 3 disclosures of the revised capital framework if its parent FBO can certify to the Federal Reserve that it meets home country standards that are consistent with the Basel Capital Framework. 12 Large FBOs. o Certification of Capital Adequacy. A Large FBO must certify to the Federal Reserve that it meets capital adequacy standards on a consolidated basis established by its home country supervisor that are consistent with the Basel Capital Framework, including Basel III. 13 If the FBO s home country capital adequacy standards are not consistent with the Basel Capital Framework, the FBO must demonstrate to the Federal Reserve s satisfaction that it would meet capital adequacy standards that are consistent with the Basel Capital Framework were it subject to such standards. o Reporting. A Large FBO must submit reports relating to its compliance with capital adequacy standards concurrently with its FR Y-7Q filing to the Federal Reserve. o Noncompliance with the Basel Capital Framework. For Large FBOs that do not meet capital adequacy standards that are consistent with the Basel Capital Framework, the Federal Reserve may impose requirements, conditions or restrictions on the FBO s U.S. operations, in coordination with any relevant Federal or state regulator. VII. Liquidity Requirements The Final Rule applies enhanced liquidity standards to Large FBOs. Large FBOs with combined U.S. assets of less than $50 billion are subject to a more limited set of requirements than Large FBOs with combined U.S. assets of $50 billion or more. Large FBOs with Combined U.S. Assets of Less Than $50 Billion. A Large FBO with combined U.S. assets of less than $50 billion must report the results of an internal liquidity stress test (either on a consolidated basis or for the combined U.S. operations) to the Federal Reserve on an annual basis. Such an 10 The Final Rule modifies the Proposal which required an IHC to apply the advanced approaches capital rules if it crossed the applicability threshold. 11 See 12 CFR An IHC formed by July 1, 2016 will be required to submit its first capital plan in January The Basel Capital Framework is the regulatory capital framework published by the Basel Committee, as amended from time to time. 13 Home country capital adequacy standards that are consistent with the Basel Capital Framework would include the minimum risk-based capital ratios, any minimum leverage ratio and all restrictions based on applicable capital buffers set forth in Basel III, and any transitional provisions therein.

9 Page 9 internal stress test should be consistent with the Basel Committee principles for liquidity risk management and incorporate 30-day, 90-day and one-year stress test horizons. 14 An FBO that does not comply with the annual stress test requirement must limit the net aggregate amount owed by the FBO s non-u.s. offices and its non-u.s. affiliates to the combined U.S. operations to 25 percent or less of the third party liabilities of its combined U.S. operations, on a daily basis. Large FBOs with Combined U.S. Assets of $50 Billion or More. For FBOs with combined U.S. assets of $50 billion or more, the Final Rule provides for qualitative enhanced liquidity requirements that build on the standards set forth in the Federal Reserve s Interagency Liquidity Risk Policy Statement issued in March The Final Rule clarifies that these enhanced liquidity standards are designed to complement the quantitative Basel III liquidity standards (i.e., the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR)). The Federal Reserve intends through future rulemakings to implement quantitative liquidity standards under Basel III for the U.S. operations of some or all of these FBOs. 16 o Responsibilities of the U.S. Risk Committee and U.S. Chief Risk Officer. The FBO must have an effective corporate governance structure to oversee liquidity risk management of the combined U.S. operations including a U.S. risk committee and a U.S. chief risk officer, as further described under Section VIII below. The U.S. risk committee (or a designated subcommittee thereof) of the FBO or IHC, as appropriate, is responsible for: Reviewing and approving the liquidity risk tolerance (i.e., the acceptable level of liquidity risk a company may assume in connection with its operating strategies) for the FBO s combined U.S. operations at least annually, with concurrence from the board of directors or the enterprise-wide risk committee (if different from the U.S. risk committee); Reviewing information provided by the senior management of the combined U.S. operations at least semi-annually to determine compliance with the established liquidity risk tolerance for the combined U.S. operations and consistency with the enterprise-wide liquidity risk tolerance of the FBO; and Approving the contingency funding plan for the combined U.S. operations at least annually and whenever the plan is revised. The U.S. chief risk officer is responsible for: Reviewing the liquidity risk management strategies, policies and procedures established by senior management of the U.S. operations; Reviewing information provided by senior management to determine whether the U.S. operations are managed in accordance with the established liquidity risk tolerance; Reporting at least semi-annually to the U.S. risk committee and enterprise-wide risk committee (or designated subcommittee thereof) on the liquidity risk profile of the combined U.S. operations and compliance with the established liquidity risk tolerance; 14 Basel Committee, Principles for Sound Liquidity Risk Management and Supervision (September 2008) (Basel Committee principles for liquidity risk management). 15 SR Letter 10-6, Interagency Policy Statement on Funding and Liquidity Risk Management (March 2010), available at (Interagency Liquidity Risk Policy Statement). 16 The Federal Reserve sought comment on a proposed liquidity coverage ratio based on the Basel III LCR (proposed U.S. LCR) in October 2013.

10 Page 10 Approving new products and business lines offered, managed or sold through the U.S. operations that could significantly affect the liquidity risk profile and evaluating the relevant liquidity costs, benefits, and risks; Reviewing approved significant business lines and products for any unanticipated liquidity risk and for compliance with the established liquidity risk tolerance for the U.S. operations, at least annually; On at least a quarterly basis: Reviewing cash flow projections to ensure that the liquidity risk is within the established liquidity risk tolerance; Reviewing compliance with established liquidity risk limits; Approving the liquidity stress testing practices, methodologies and assumptions; Reviewing the liquidity stress test results; and Approving the size and composition of the liquidity buffer; Reviewing and approving liquidity stress testing practices, methodologies, and assumptions whenever material revisions are made; and Establishing procedures governing the content of reports on the liquidity risk profile of the combined U.S. operations and compliance with the established risk tolerance. o Independent Review. The FBO would be required to maintain a review function that is independent of the management functions that execute funding to evaluate the liquidity risk management of its combined U.S. operations. The independent review function is responsible for: Regularly and at least annually, reviewing and evaluating the adequacy and effectiveness of the U.S. operations liquidity risk management processes, including liquidity stress test processes and assumptions; Assessing whether the U.S. operations liquidity risk management function complies with applicable laws, regulations, supervisory guidance, and sound business practices; and Reporting material liquidity risk management issues to the U.S. risk committee and the enterprise-wide risk committee for corrective action. o Cash Flow Projections. The FBO is required to produce comprehensive cash flow projections for its U.S. operations that project cash flows arising from assets, liabilities, and off-balance sheet exposures over short-term and long-term time horizons. The methodology employed must result in projections that: Include cash flows arising from contractual maturities and intercompany transactions, new business, funding renewals, customer options, and other potential events that may impact liquidity;

11 Page 11 Include reasonable assumptions regarding the future behavior of assets, liabilities, and offbalance sheet exposures; Identify and quantify discrete and cumulative cash flow mismatches over these time periods; and Provide sufficient detail to reflect the capital structure, risk profile, complexity, currency exposure, activities, and size of the FBO and its combined U.S. operations, and include analyses by business line, currency or legal entity, as appropriate. Short-term cash flow projections must be updated daily, and long-term cash flow projections must be updated at least monthly. o Contingency Funding Plan. The FBO must maintain a contingency funding plan for its combined U.S. operations that describes strategies for addressing liquidity needs during liquidity stress events. The plan must be updated at least annually and when changes to market and idiosyncratic conditions warrant. Quantitative Assessment. The plan must: (1) identify stress events that could significantly impact the liquidity of the FBO and its combined U.S. operations; (2) assess the level and nature of the impact on liquidity; (3) identify circumstances in which the FBO s action plan for liquidity shortfalls would be implemented; (4) assess available funding sources and needs during the liquidity stress events; (5) identify alternative funding sources; and (6) incorporate information generated by liquidity stress testing. Event Management Process. The plan must provide a process for managing liquidity during identified liquidity stress events, including: (1) an action plan that describes the strategies for responding to liquidity shortfalls and methods to access alternative funding sources for its U.S. operations; (2) designation of a liquidity stress event management team to execute the action plan; (3) a description of the process for invoking the contingency funding plan, decision-making during the events, and executing contingency measures; and (4) a mechanism for effective reporting and communication within the combined U.S. operations and with outside parties, including relevant supervisors, counterparties and other stakeholders. Monitoring. The plan must include procedures for monitoring emerging liquidity stress events that identify early warning indicators tailored to the capital structure, risk profile, complexity, activities and size of the FBO and its combined U.S. operations. Testing. The plan must be periodically tested to assess its reliability during liquidity stress events, the operational elements of the plan, and the methods used to access alternative funding sources to determine if these sources will be readily available. o Liquidity Risk Limits. The FBO must establish limits on sources of liquidity risk, including: Concentrations of funding by instrument type, single counterparty, counterparty type, secured and unsecured funding, and if applicable, other forms of liquidity risk;

12 Page 12 The amount of liabilities that mature within various time horizons; and Off-balance sheet exposures and other exposures that could create funding needs during liquidity stress events. The size of each limit must reflect the capital structure, risk profile, complexity, activities, size and the established liquidity risk tolerance of the FBO s combined U.S. operations. o Monitoring. The FBO must maintain the following procedures to monitor liquidity risk. Monitoring Collateral. The FBO should have procedures to monitor assets that have been, or are available to be, pledged as collateral, which include: Calculation of the collateral positions for its combined U.S. operations on a weekly basis specifying the value of pledged assets relative to the amount of security required under the relevant contracts, and the value of unencumbered assets; Monitoring the levels of unencumbered assets available to be pledged by legal entity, jurisdiction and currency exposure; Monitoring shifts in the FBO s funding patterns, such as shifts between intraday, overnight and term pledging of collateral; and Tracking operational and timing requirements associated with accessing collateral at its physical location. Monitoring Legal Entities, Currencies and Business Lines. The FBO must have procedures to monitor and control liquidity risk exposures and funding needs of its combined U.S. operations, within and across significant legal entities, currencies, and business lines, while taking into account legal and regulatory restrictions on the transfer of liquidity between legal entities. Monitoring Intraday Exposure. The FBO must have procedures for monitoring intraday liquidity risk exposure for its combined U.S. operations that address how the management will: Monitor and measure expected daily inflows and outflows; Maintain, manage and transfer collateral to obtain intraday credit; Identify and prioritize time-specific obligations so that the FBO can meet these obligations as expected, and settle less critical obligations as soon as possible; Control the issuance of credit to customers where necessary; and Consider the amounts of collateral and liquidity needed to meet payment systems obligations when assessing the overall liquidity needs of the combined U.S. operations. Monitoring Sources of Liquidity Risk. The FBO must monitor sources of liquidity risk for its combined U.S. operations.

13 Page 13 o Liquidity Stress Testing. The FBO must conduct stress tests at least monthly to separately assess the potential impact of various liquidity stress scenarios on the cash flows, liquidity position, profitability and solvency of its (1) combined U.S. operations as a whole, (2) U.S. branches and agencies in the aggregate, and (3) IHC (if any). General Requirements. In conducting the stress tests, the FBO must (1) take into account the current liquidity condition, risks, exposures, strategies and activities of its U.S. operations; (2) consider the balance sheet and off-balance sheet exposures, size, risk profile, complexity, business lines, organizational structure and other characteristics of the FBO and its U.S. operations affecting the combined U.S. operations liquidity risk profile; and (3) address the potential impact of associated market disruptions on the combined U.S. operations and the potential actions of other market participants experiencing liquidity stresses under the same market disruptions. Stress Scenarios. The liquidity stress tests must include, at a minimum, a scenario reflecting (1) adverse market conditions, (2) an idiosyncratic stress event for the U.S. branches and agencies and the IHC, and (3) combined market and idiosyncratic stresses. Planning Horizon. Each stress test must include an overnight, 30-day, 90-day and oneyear planning horizon, and any other planning horizon that is relevant to the liquidity risk profile of the combined U.S. operations, the U.S. branches and agencies, and the IHC, if any. The results of the stress test over the 30-day planning horizon must be used to calculate the size of the liquidity buffers. Assets Used as Cash Flow Sources. 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. Assets used as cash flow sources must also be diversified by collateral, counterparty, borrowing capacity, and other factors associated with liquidity risk of the asset. A line of credit may qualify as a cash flow source for purposes of a stress test with a planning horizon that exceeds 30 days. Tailoring. The stress testing must be tailored to and sufficiently detailed to reflect, the capital structure, risk profile, complexity, activities and size of the combined U.S. operations and the FBO. Governance. Policies and Procedures. The FBO must adopt policies and procedures governing its liquidity stress testing practices, methodologies and assumptions that provide for incorporation of liquidity stress test results in future testing and periodic enhancement of stress testing practices. Controls and Oversight. The FBO must maintain an effective system of controls and oversight to ensure that its liquidity stress testing processes comply with the Final Rule. Each stress test must incorporate conservative assumptions with respect to the stress scenario and other elements of the stress testing process, taking into consideration relevant factors of the U.S. operations. The assumptions must be approved by the U.S. chief risk officer and subject to independent review.

14 Page 14 Management Information Systems. The FBO must maintain management information systems and data processes that effectively and reliably collect, sort and aggregate data and other information related to liquidity stress testing of its combined U.S. operations. Reporting of Liquidity Stress Tests and Buffers Required by Home Country Regulator. The FBO must make available to the Federal Reserve the results of any liquidity internal stress tests and establishment of any liquidity buffers required (or expected under supervisory guidance) by the home country regulators. o Liquidity Buffers. The FBO must maintain separate liquidity buffers for its U.S. branches and agencies and for its IHC, if any. IHC Buffer. The liquidity buffer must be sufficient to meet the projected net stressed cash flow need (as calculated in accordance with the Final Rule) of the IHC based on the results of the liquidity stress test over the 30-day planning horizon under various scenarios. The IHC is required to maintain the full 30-day buffer in the United States. Cash assets may not be held in an account located at an affiliate that is not controlled by the IHC. U.S. Branch and Agency Buffer. The liquidity buffer must be sufficient to meet the projected net stressed cash flow need (as calculated in accordance with the Final Rule) of the U.S. branches and agencies over the first 14 days of a stress test with a 30-day planning horizon under various scenarios. Unlike the Foreign Proposal, the Final Rule does not require that U.S. branches and agencies maintain a buffer for days 15 through 30 of the 30- day stress scenario. The Federal Reserve expects, however, that FBOs would hold additional liquidity resources, either at the home office or in the United States, to protect against longer periods of funding pressure at their U.S. branches and agencies. The U.S. branches and agencies are required to maintain the 14-day buffer in the United States. Cash assets may not be held in an account located at the IHC or other affiliate. Highly Liquid Assets. The liquidity buffers must consist of highly liquid assets that are unencumbered. 17 A highly liquid asset includes cash, securities issued or guaranteed by the U.S. government, a U.S. government agency or a U.S. government-sponsored enterprise, or any other asset that the FBO demonstrates to the satisfaction of the Federal Reserve: (1) has low credit risk and low market risk; (2) is traded in an active secondary two-way market with committed market makers and 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; and (3) is a type of asset that investors historically have purchased in periods of financial market distress during which market liquidity has been impaired. High-quality liquid assets under the proposed U.S. LCR would be liquid for purposes of the Final Rule under most scenarios. However, the FBO must make the 17 An asset is unencumbered if it: (1) is free of legal, regulatory, contractual, or other restrictions on the ability of such company promptly to liquidate, sell or transfer the asset; and (2) is either: (a) not pledged or used to secure or provide credit enhancement to any transaction; or (b) pledged to a central bank or a U.S. government-sponsored enterprise, to the extent potential credit secured by the asset is not currently extended by such central bank or U.S. government-sponsored enterprise or any of its consolidated subsidiaries. The Final Rule eliminated the element of the Proposal s definition which required that the asset is not designated as a hedge on a trading position.

15 Page 15 demonstration to the Federal Reserve required above, meet the diversification requirement described below, and ensure that the inclusion of these assets in the buffer would be appropriate taking into consideration the liquidity risk profile. Fair Market Value Adjustment. The fair market value of a highly liquid asset included in the liquidity buffer must be discounted to reflect any credit risk and market price volatility of the asset. Diversification. The liquidity buffer may not contain significant concentrations of highly liquid assets by issuer, business sector, region or other factor related to the FBO s risk, except for cash and securities issued or guaranteed by the U.S. government, a U.S. government agency or a U.S. government-sponsored enterprise. VIII. Risk Management and Risk Committee Requirements Risk Committee Requirements for Publicly-Traded Medium FBOs and Large FBOs with Combined U.S. Assets of Less than $50 Billion. A Publicly-Traded Medium FBO (total consolidated assets of $10 billion or more but less than $50 billion) and a Large FBO with combined U.S. assets of less than $50 billion are required to certify annually 18 to the Federal Reserve that they maintain a U.S. risk committee of their global board of directors (on a standalone basis or as part of their enterprise-wide risk committee) that: (1) oversees the risk management policies of the FBO s combined U.S. operations and (2) includes at least one member with experience identifying, assessing and managing risk exposures of large, complex firms. o The FBO must take appropriate measures to ensure that its combined U.S. operations implement the risk management policies and provide sufficient information to the U.S. risk committee to carry out its responsibilities. o If the FBO does not satisfy the U.S. risk committee requirements, the Federal Reserve may impose requirements, conditions or restrictions on the business activities or operations of the combined U.S. operations, in coordination with relevant Federal or state regulators. Risk Committee and Risk Management Requirements for Large FBOs with Combined U.S. Assets of $50 Billion or More. A Large FBO with combined U.S. assets of $50 billion or more must maintain a U.S. risk committee and appoint a U.S. chief risk officer. o U.S. Risk Committee. The U.S. risk committee must approve and periodically review the risk management policies and oversee the risk management framework of the combined U.S. operations. 19 The committee s responsibilities also include the liquidity risk management responsibilities set forth in Section VII. Risk Management Framework. The risk management framework must be commensurate with the structure, risk profile, complexity, activities, and size of the combined U.S. operations and consistent with the FBO s enterprise-wide risk management policies. The framework must include: (1) policies and procedures establishing risk management governance and procedures, and risk control infrastructure; and (2) processes and systems for implementing and monitoring compliance with such policies and procedures, including those for: 18 The certification must be filed with the Federal Reserve concurrently with the FR Y The Final Rule clarifies that the risk committee, acting in its oversight role, should fully understand the risk-management policies and framework of the FBO s combined U.S. operations and have a general understanding of the risk management practices of the combined U.S. operations.

16 Page 16 Identifying and reporting risks and risk management deficiencies, including emerging risks; Ensuring effective and timely implementation of actions to address emerging risks and risk management deficiencies; Specifying managerial and employee responsibility for risk management; Ensuring the independence of the risk management function; and Integrating risk management and associated controls with management goals and the compensation structure. Placement of Committee. An FBO that conducts its U.S. operations solely through an IHC must maintain the U.S. risk committee as a committee of the board of directors of the IHC. An FBO that conducts its U.S. operations through U.S. branches or agencies (in addition to its IHC, if any) may maintain the U.S. risk committee either (1) as a committee of the global board of directors, on a standalone basis or as a joint committee with its enterprise-wide committee or (2) as a committee of the board of directors of its IHC, on a standalone basis or as a joint committee with the IHC s risk committee. Corporate Governance and Membership. The risk committee must meet at least quarterly, and fully document and maintain records of its proceedings, including risk management decisions. At least one member must have experience in identifying, assessing and managing risk exposures of large, complex financial firms. At least one member of the committee must be an independent member who is not: (1) an officer or employee of the FBO or its affiliates and has not been an officer or employee of the FBO or its affiliates during the previous three years; or (2) a member of the immediate family of a person who is, or has been within the last three years, an executive officer of the FBO or its affiliates. 20 o U.S. Chief Risk Officer. The FBO or its IHC, if any, must appoint a U.S. chief risk officer with experience in identifying, assessing and managing risk exposures of large, complex financial firms. The officer is responsible for overseeing: The measurement, aggregation and monitoring of risks undertaken by the combined U.S. operations; 20 Immediate family is defined in Section (b)(3) of the Federal Reserve s Regulation Y and executive officer is defined in Section 215.2(e)(1) of the Federal Reserve s Regulation O.