United States: Dodd-Frank: Enhanced Supervision Becomes Final

The Federal Reserve's proposed requirements for large US and non-US banking organizations to comply with enhanced supervisory requirements, required by Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, were adopted in final form on February 18 in substantially the form proposed. Several revisions address negative comments, in some cases providing significant relief, but the general requirements were unchanged. Final implementation dates were extended in order to give affected organizations additional time to come into compliance.

The original proposals were issued in December 2011 for domestic organizations and December 2012 for non-US ones. The final regulation ("Final Regulation") covers both proposals in a revised version of Regulation YY.1 In a nutshell, the Final Regulation requires that, with important exceptions, all US and non-US banking organizations, defined as bank holding companies ("BHCs") organized under US law and non-US organizations that are, or are treated as, BHCs ("FBOs"), with $50 billion or more in worldwide consolidated assets comply with the following:

  • Risk-based and leverage capital requirements;
  • Risk-management requirements, including the establishment of a risk management committee of the board of directors;
  • Liquidity minimums, including risk-management systems, stress testing of liquidity needs, and the holding of a buffer to cover asset/liability mismatches; and
  • Both supervisory and organization-run stress tests.

Subsets of these requirements apply to smaller organizations with total assets of $10 billion or more. These requirements generally become effective on January 1, 2015, for BHCs and on July 1, 2016, for FBOs, but with transition periods for certain requirements. The requirements are calibrated to take account of the size of BHCs' and FBOs' operations; the larger their operations, the stricter the requirements. The only notable additional requirement applicable to the largest FBOs is to establish a US intermediate holding company ("IHC") to hold ownership interests in US subsidiaries, which may have significant cost consequences.

The Final Regulation defers adoption of three additional requirements that had been proposed. Any non-BHC that is designated a systemically important financial institution by the Financial Stability Oversight Council ("FSOC") will be brought within these rules in a tailored fashion when so designated. Also, single-counterparty exposure limits will await final action by the Basel Committee on Bank Supervision ("BCBS"), and early remediation requirements are also being deferred for further consideration.

Following is a summary of the requirements imposed on BHCs followed by a summary of the ones imposed on FBOs. Due to the huge number of details associated with these requirements, the summary does not purport to include all relevant points; citations to portions of the Final Regulation providing the detail are included in footnotes.

US Organizations

For BHCs, the Final Regulation incorporated most of the provisions from the 2012 proposal with the one major exception noted above. Under the Final Regulation, enhanced prudential standards as set forth in the Final Regulation will not apply to nonbank financial companies; rather, standards for nonbank financial companies will be established following designation of those nonbank financial companies by the FSOC.

The Final Regulation generally retains almost all of the requirements of the proposal, calibrating enhanced supervision standards according to the size of the organization.

  • BHCs with total consolidated assets of more than $10 billion but less than $50 billion must, on a semi-annual basis, conduct company-run stress tests. This requirement also applies to savings and loan holding companies and US banks with more than $10 billion in total consolidated assets.2
  • In addition, those BHCs with total consolidated assets of $10 billion or more that are publicly traded must establish risk committees that will be responsible for the oversight of the enterprise-wide risk-management practices of the company.3

    • The requirements are substantially similar to the requirements of risk committees for BHCs with consolidated assets of $50 billion or more, summarized below.
    • The main difference lies in the qualifications for the "risk management expert" required by the Final Regulation to be a member of the risk committee. For a BHC with assets equal to or greater than $10 billion but less than $50 billion, an individual's risk-management experience in a nonbanking or nonfinancial field may satisfy the requirement.
  • BHCs with total consolidated assets of $50 billion or more must:

    • Submit an annual capital plan to the Board of Governors of the Federal Reserve System ("Board").4

      • This plan must demonstrate the BHC's ability to maintain capital above the Board's minimum risk-based capital ratios under both baseline and stressed conditions over a minimum nine-quarter, forward-looking planning horizon.
      • The plan must also 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.
    • Conduct semi-annual company-run and supervisory stress tests.

      • These company-run stress tests will be held in conjunction with annual supervisory stress tests run by the Board for the purpose of evaluating whether these organizations have the capital necessary to absorb losses as a result of adverse economic conditions.
      • A summary of the results of the annual supervisory stress test must be disclosed publicly by the BHC.5
    • Establish a risk-management framework.6
    • The framework must be commensurate with the company's structure, risk profile, complexity, activities, and size, and must include policies and procedures establishing risk-management governance, risk-management practices and risk-control infrastructure for the BHC's global operations and processes and systems for implementing and monitoring compliance with such policies and procedures.
    • As part of the risk-management framework, BHCs must appoint a chief risk officer and establish risk committees to approve and regularly review the enterprise-wide risk-management policies of the company.7

      • The Final Regulation requires the risk committee to approve and periodically review the enterprise-wide risk-management policies of the company, rather than its risk-management practices. The Board did not adopt a proposed requirement that the risk-management framework include specific risk limitations for each business line.
      • For BHCs with total consolidated assets of $50 billion or more, the risk committee must be a stand-alone committee and not be part of a joint committee and must receive and review regular reports from the chief risk officer at least quarterly.
  • Establish and maintain a liquidity risk-management plan.8

    • The board of directors of each BHC must approve the BHC's liquidity risk tolerance at least annually.
    • In addition, the board of directors must receive and review information from senior management at least semi-annually to determine whether the BHC is operating in accordance with its established liquidity risk tolerance. This includes obtaining board approval of the liquidity risk-management strategies, policies and procedures established by senior management.
    • The plan must establish limits on potential sources of liquidity risk, including: (1) concentrations of funding by instrument type, single counterparty, counterparty type, secured and unsecured funding and other liquidity risk identifiers; (2) the amount of liabilities that mature within various time horizons; and (3) off-balance sheet exposures and other exposures that could create funding needs during liquidity stress events.
  • Establish and maintain a contingency funding plan that sets out the BHC's strategies for responding to a liquidity crisis, with two components:9

    • Quantitative assessment – the BHC must identify stress events that have a significant impact on liquidity, assess the level and nature of the impact on the BHC's liquidity of such stress events, and assess available funding sources and needs during identified liquidity stress events; and
    • Event-management process – the plan must set forth procedures of managing liquidity during identified liquidity stress events.
    • Conduct liquidity stress testing in conjunction with establishing limits on liquidity risk, incorporating a minimum of three stress scenarios. These scenarios must account for (1) adverse market conditions, (2) an idiosyncratic stress event, and (3) combined market and idiosyncratic stresses.10

      • In addition, the BHC must hold highly liquid assets (called the "liquidity buffer") sufficient to meet liquidity needs as identified by the internal stress tests. The liquidity buffer must be sufficient to meet the projected net stressed cash flow need over a 30-day planning horizon of a liquidity stress test under each of the three scenarios.11
    • In extraordinary cases, maintain a debt-to-equity ratio of no more than 15-to-1 if the FSOC determines that the BHC poses a "grave threat" to the financial stability of the United States.12

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1 The Final Regulation has not yet been published in the Federal Register and is available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140218a1.pdf. The proposals were published at 77 Fed.Reg. 594 (Jan. 5, 2012) and 77 Fed.Reg. 76628 (Dec. 28, 2012). If you wish to review discussions of the proposals, you may find our client memoranda at http://www.shearman.com/~/media/Files/NewsInsights/Publications/2012/12/DoddFrank%20The%20Feds%20Proposal%20for%20Enhanced%20Supervi__/Files/View%20full%20memo%20DoddFrank%20The%20Feds%20Proposal%20for%20E__/FileAttachment/DoddFrankFedsProposalforEnhancedSupervisionofFor__.pdf and http://www.shearman.com/~/media/Files/NewsInsights/Publications/2012/01/Tightening%20the%20Limits%20on%20Big%20US%20Banks/Files/View%20full%20memo%20Tightening%20the%20Limits%20on%20Big%20US%20B__/FileAttachment/TighteningtheLimitsonBigUSBanksFIA010412.pdf.

2 This requirement had been imposed on BHCs and US banks earlier and accordingly is effectively affirmed as part of the package of enhanced supervisory requirements. Details are in the Final Regulation at Subpart B of Regulation YY. In September 2013, the Board issued an interim final rule that clarified how bank holding companies should incorporate recent revisions to the Board's regulatory capital rules into their capital plan and stress tests. See 78 FR 59779 (September 30, 2013). On March 5, the supervisors issued final guidance for the conduct of stress tests under this requirement, available at http://www.federalreserve.gov/newsevents/press/bcreg/20140305a.htm.

3 Details are in the Final Regulation at Subpart C of Regulation YY.

4 Details on this and stress tests, summarized in the next bullet, have applied to these BHCs since 2011 and are in the Final Regulation at Subparts E and F of Regulation YY. Heretofore they were in Subparts F and G of that regulation.

5 See Section 252.58 of Regulation YY. 6 Details are in the Final Regulation at Section 252.33 of Regulation YY.

7 The risk committee must have at least one independent director, and at least one member must be a "risk management expert" who must have experience in identifying, assessing and managing risk exposures of large, complex financial firms. All risk committees of BHCs must meet at least quarterly and fully document and maintain records of their proceedings, including risk-management decisions. See Section 252.33(a)(3) of Regulation YY.

8 Details are in the Final Regulation at Section 252.34(a) through (e) of Regulation YY.

9 Details are in the Final Regulation at Section 252.34(f) of Regulation YY.

10 Details are in the Final Regulation at Section 252.35(a) of Regulation YY.

11 See Section 252.35(b) of Regulation YY.

12 Details are in the Final Regulation at Subpart U of Regulation YY.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Barnabas W.B. Reynolds
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