Introduction

On March 4, 2016 the Federal Reserve Board (Board) announced proposed rulemaking that would impose single-counterparty credit limits on large US Bank Holding Companies, Foreign Banking Organizations (FBOs), and US Intermediate Holding Companies (IHCs).[1]  As part of the Enhanced Prudential Standards regulation codified in Section 165(e) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the proposed single-counterparty credit limits that would, “apply three increasingly stringent credit exposure standards to account for the increased risk to the financial system of interconnectedness among the largest and most complex financial firms.”[2]  When the final rules for §165 were published, the Single Counterparty Credit Exposure rulemaking was still in process. Therefore, these proposed rules serve as an important extension to the Dodd-Frank Act.

The Dodd-Frank Act authorizes the Board to establish single-counterparty credit limits for bank holding companies, FBOs, and US IHCs to limit the amount of credit risk exposure such companies can have on an unaffiliated company.[3]  Currently, supervised non-bank financial institutions and domestic and foreign bank holding companies with total consolidated assets of $50 billion or more are prohibited from having a credit exposure to any unaffiliated company where the exposure is greater than 25 percent of the capital stock and surplus of the covered company.[4]  The new rules propose to establish more stringent requirements based on the size and complexity of the financial organization. This proposal mirrors recent Federal Reserve Board Supervision and Regulatory letters (SR15-18 and SR 15-19), which consolidate and establish guidance for Comprehensive Capital Analysis and Review (CCAR) based on an institution’s size and complexity (Large Institution Supervision Coordinating Committee (LISCC), Large and Complex, and Large and Non-Complex).  In addition, the proposed rule has also defined a “counterparty” to include: a natural person, an unaffiliated company, a state and its agencies, and a foreign sovereign that is not assigned a zero percent risk weighting according to the Board’s capital rating.[5]

Compliance with the proposed rules may require certain large banking organizations, including domestic bank holding companies and FBOs, to contemplate ways to eliminate excess credit exposure amounts, as soon as one year following implementation of the final rule.

Proposal

Scope of Affected Financial Organizations

The following types of financial organizations would be affected by the proposed rule:

  • Bank Holding Companies with total consolidated assets of $50 billion or more (covered companies)
  • Foreign Banking Organizations (FBOs) with total consolidated assets of $50 billion or more and US Intermediate Holding Companies (IHCs; covered entities)[6]

Depending on its size and complexity, a banking organization may be subject to further credit exposure limits arising from special purpose vehicles, including investments in securitizations, investment fund, and other special purpose vehicles.

Proposed Credit Exposure Requirements for US Bank Holding Companies

Table 1: Proposed Credit Exposure Requirements for Domestic Bank Holding Companies

Type of US Bank Holding Company Proposed Credit Limits Compliance Timeline[7] Subsequent Compliance Requirement Others
Category 1

Greater than $50 billion, but less than $250 billion in total consolidated assets and less than $10 billion in on-balance sheet foreign exposures

Prohibited from having aggregate net credit exposure to an unaffiliated counterparty greater than 25 percent of the covered company’s total capital stock and surplus[8] Proposed two year compliance period Demonstrate compliance on a quarterly basis Not subject to special purpose vehicle (SPV) requirements
Category 2:

$250 or more in total consolidated assets or $10 billion or more in total on-balance sheet foreign exposures

Aggregate net credit exposure to any unaffiliated counterparty not to exceed 25 percent of the covered company’s tier 1 capital [9] Proposed one-year compliance period Demonstrate compliance on a monthly basis Subject to SPV requirements
Category 3

Major covered companies[10]

· a major covered company

· an FBO having the characteristics of a global systemically important bank (G-SIB)

· any non-bank financial company designated for supervision by the Financial Stability Oversight Council (FSOC)

Aggregate net credit exposure to any unaffiliated major counterparty not to exceed 15 percent of the major covered company’s tier 1 capital Proposed one-year compliance period Demonstrate compliance on a monthly basis Subject to SPV requirements
Any company that becomes a covered company after the effective date Dependent on size Required to comply with the requirements of the rule beginning on the first day of the fifth calendar quarter after it becomes a covered entity, unless that time is accelerated or extended by the Board in writing Dependent on size Dependent on size

Source: Accenture analysis based upon publicly available documents, February 2016

Proposed Credit Exposure Limits for Foreign Banking Organizations and US IHCs

Table 2: Proposed Credit Exposure Requirements for FBOs and US IHCs

Type of FBO / US IHC Proposed Credit Limits Compliance Timeline[11] Subsequent Compliance Requirement Others
Category 1

Less than $250 billion in total consolidated assets and less than $10 billion in on-balance sheet foreign exposures

Prohibit aggregate net credit exposure to an unaffiliated counterparty  greater than 25 percent of the consolidated capital stock and surplus of the covered entity[12] Proposed two year compliance period Demonstrate compliance on a quarterly basis Not subject to SPV requirements
Category 2

$250 or more in total consolidated assets or $10 billion or more in total on-balance sheet foreign exposures

Prohibit aggregate net credit exposure to any unaffiliated counterparty that is greater than 25 percent of the US IHC / FBO’s tier 1 capital[13], [14] Proposed one-year compliance period Demonstrate compliance on a monthly basis Subject to SPV requirements; same as BHCs
Category 3

Major IHCs and FBOs[15]

· “Major counterparty” would include a domestic or foreign G-SIB and any non-bank financial company supervised by the Board.[16]

· “Major foreign banking organizations” would consist of foreign banking organizations with total consolidated assets of $500 billion or more[17]

Aggregate net credit exposure limited to 15 percent of the IHC / FBO’s  Tier 1 capital to any unaffiliated major counterparty[18],[19] Proposed one-year compliance period Demonstrate compliance on a monthly basis Subject to SPV requirements; same as BHCs
Any company that becomes a covered entity after the effective date Dependent on size Required to comply with the requirements of the rule beginning on the first day of the fifth calendar quarter after it becomes a covered entity, unless that time is accelerated or extended by the Board in writing Dependent on size Dependent on size

Source: Accenture analysis based upon publicly available documents, February 2016

Overview of the Calculation of Aggregate Net Credit Exposure

Generally, to calculate the aggregate net credit exposure, the proposed rules suggest that covered companies should:

  • Calculate gross credit exposure arising from credit transactions with the counterparty; and
  • Reduce the gross credit exposure based on risk mitigants.

The proposal details requirements for the calculation of net credit exposure for repos, reverse repos, securities lending, and securities borrowing transactions.  Additionally, the proposal identifies eligible collateral, guarantees, credit and equity derivatives and other eligible hedges as credit mitigants in the calculation of net credit exposure. [20]

Special Purpose Vehicles and Other Considerations

The proposed rules address investments in and exposures to securitization vehicles, investment funds and other special purpose vehicles (SPVs). Generally, the proposed rules relating to SPVs are only applicable to covered companies with $250 billion or more in total consolidated assets, or $10 billion or more in on-balance sheet foreign exposures.[21]

The proposed rules would require a covered company to demonstrate that its exposure to each underlying asset held by an SPV is less than 0.25 percent of the covered company’s tier 1 capital (considering only exposures that arise from the SPV).  Covered companies unable to meet this proposed requirement would subsequently be  required to apply a look-through approach requiring the covered company to recognize exposures to each issuer of the assets held by the SPV.[22]  

High Level Impact of the Proposed Rules

Due to the relatively high correlation between systemically important banks, the proposed rules have been developed to boost a bank’s ability to withstand severe losses and reduce inter-connectedness in order to mitigate financial stability risks. We expect these banks to be impacted as follows.

Proposed Rule Description Impact
Credit exposure limit Depending on type and size of the BHC, FBO or IHC, they are prohibited from having aggregate net credit exposure to a single counterparty by one of three thresholds:

· Not to exceed 25% of total regulatory capital

· Not to exceed 25% of tier 1 capital

· Not to exceed 15% of tier 1 capital

· Potential increase in borrowing costs for the banks

· Potential increase in tier 1 capital and change in capital structure

· Expected improvement in counterparty identifier management

Counterparty definition Limits on the credit exposure to include an unaffiliated company, natural person (and the person’s immediate family), US State, and any foreign sovereign entity that is assigned a risk weight greater than zero under the Board’s capital rules · Expanded definition subject to single counterparty will drive technology and data management enhancements to align both risk rating framework to credit exposure aggregation

· Increased operational complexity on credit exposure monitoring due to a wider array of in-scope counterparties

Instruments applicable to counterparty  credit exposure · Credit lending and extensions

· Repurchase agreements (repos) and reverse repos

· Securities lending or securities borrowing

· Guarantees, acceptances, and letters of credit

· Purchase of, or investment in, counterparty-issued securities

· Credit exposures in connection with certain derivative transactions

· Including the credit risk mitigants of letters of credit, acceptances and guarantees

· Rating system changes to reflect alignment of rules to rating of counterparty, guarantor and issuer

· Technology and data changes to identify, monitor and aggregate in-scope products

SPVs · Covered company to recognize exposure to an SPV equal to the value of its investment in the SPV

· To apply a “look-through” approach which would require the BHC to recognize an exposure to each issuer of the assets that the SPV holds[23]

· Increased complexity to identify issuer of assets held by SPVs
Regulatory reporting compliance requirement Depending on type and size of the BHC, FBO or IHC, they are required to demonstrate ongoing compliance on a periodic basis to the regulator. New / enhancements to existing system capabilities perform regulatory reporting and monitoring, with increased reliance on effective challenge and internal validation

Source: Accenture analysis based upon publicly available documents, February 2016

Conclusion

The proposed rules aim to implement Section 165(e) of the Dodd-Frank Act and includes modifications based on comments received from earlier draft proposals released by the Board in 2011 and 2012. In addition, the Board plans to receive comments on the current proposal until June 3, 2016.  However, US bank holding companies, foreign banking organizations, US intermediate holding companies and other impacted organizations should begin to familiarize themselves with the proposal’s key requirements and begin to consider any compliance enhancements or modifications prior to the adoption of the proposal.  In particular, foreign banking operations should begin planning for single counterparty credit framework disparities between their US operations, overseas operations, and parent’s home jurisdiction.

References:

[1] Federal Reserve Press Release, March 4, 2016. Access at: http://www.federalreserve.gov/newsevents/press/bcreg/20160304b.htm

[2] FRB Staff Memo, February 26, 2016, p. 1. Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-board-memo-20160304.pdf

[3] 12 U.S.C. 5365(e)(1) (2011). Access at: https://www.gpo.gov/fdsys/pkg/USCODE-2011-title12/pdf/USCODE-2011-title12-chap53-subchapI-partC-sec5365.pdf

[4] 12 U.S.C. §5365(e)(2) (2011). Access at: https://www.gpo.gov/fdsys/pkg/USCODE-2011-title12/pdf/USCODE-2011-title12-chap53-subchapI-partC-sec5365.pdf

[5] FRB Staff Memo, February 26, 2016, p. 4. Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-board-memo-20160304.pdf;  See also, § 252.72(e)

[6] “Single-Counterparty Credit Limits for Large Banking Organizations,” Federal Reserve System, Notice of Proposed Rulemaking, p.1. Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[7] The Board has reserved the right to accelerate the compliance timeline if provided in writing to the institution.

[8] “Notice of Proposed Rulemaking,” proposed Rule § 252.72(a). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[9] “Notice of Proposed Rulemaking,” proposed Rule § 252.72(b). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[10] The proposal defines a “major covered company” as any domestic bank holding company that is a global systemically important banking organization, as well as any FBO or US IHC with total consolidated assets of $500 billion or more.

[11] The Board has reserved the right to accelerate the compliance timeline if provided in writing to the institution. See generally, FRB Staff Memo, February 26, 2016, p. 9. Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-board-memo-20160304.pdf

[12] “Notice of Proposed Rulemaking,” proposed rules §252.172(a)(1); §252.172(a)(2). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[13] Ibid

[14] “Notice of Proposed Rulemaking,” proposed rule §252.172(b)(2). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[15] A major foreign banking organization is defined as a FBO with total consolidated assets of $500 billion or more.

[16] “Notice of Proposed Rulemaking,” proposed rule §252.171(v). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[17] “Notice of Proposed Rulemaking, proposed rule §252.172(b)(3). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[18] “Notice of Proposed Rulemaking,” proposed rule §252.172 (c)(1). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[19] “Notice of Proposed Rulemaking,’ proposed rule §252.172(c) (2). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[20] FRB Staff Memo, February 26, 2016, p. 6. Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-board-memo-20160304.pdf

[21] Proposed rule §§ 252.75(a)(1) and 252.175(a)(2)(i). Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[22] Proposed rule §252.75. Access at: http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf

[23] Applicable to covered companies with total consolidated assets of $250 billion or more, or $10 billion or more in on-balance sheet foreign exposures that cannot demonstrate their exposure to each underlying investment in an SPV if smaller than 0.25 percent of the BHC’s eligible capital base.

Newsletter Author: Venetia Woo, Kevin Shum, Sal Cutrona

Newsletter Contact Person: Craig Unterseher

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