United States: Another Brick In The Wall: The Fed Reproposes Single-Counterparty Credit Limits For Large Banking Organizations

On March 4, 2016, the Board of Governors of the Federal Reserve System (the "Fed") issued a Notice of Proposed Rulemaking ("NPRM"), inviting comment on reproposed rules (the "Reproposed Rules") that would establish single counterparty credit limits for U.S. bank holding companies ("BHCs") and foreign banking organizations ("FBOs") with at least $50 billion in total consolidated assets.1  Pursuant to section 165(e) ("section 165(e)") of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), the Fed is required to prescribe rules that limit the amount of credit exposure that U.S. BHCs and FBOs can have to an unaffiliated company to reduce the risks that may arise from such a counterparty's sudden failure. In addition to the NPRM, the Fed also issued a white paper (the "White Paper") that provides the analytical and quantitative reasoning for the Reproposed Rules' more stringent 15% limit for credit exposures between systemically important financial institutions ("SIFIs").

The Fed originally proposed single-counterparty credit limits for U.S. BHCs and FBOs in December 2011 and December 2012, respectively (the "Originally Proposed Rules"),2  the Fed has issued the Reproposed Rules to take into consideration: (1) the extensive comments the Fed received in response to the Originally Proposed Rules; (2) the revised lending limit rules applicable to national banks;3  (3) the Basel Committee on Banking Supervision's introduction of large exposures standards;4  and (4) the results of quantitative impact studies and related analysis conducted by the Fed to gauge the impact of the Originally Proposed Rules.5

The Reproposed Rules represent another effort to reduce interconnectedness in the financial system. While the Fed has sought to gauge counterparty credit risk through annual stress testing of large financial institutions,6  the Reproposed Rules would establish hard limits on these exposures. Comments on the NPRM must be submitted to the Fed by June 3, 2016.

This alert is divided into four parts. Part I provides an overview of the general requirements under section 165(e). Part II highlights the requirements of the Reproposed Rules for both U.S. BHCs and FBOs. Part III provides a brief overview of the White Paper and discusses the Fed's justification for more stringent counterparty risk exposure requirements for SIFIs. Lastly, Part IV provides a chart summarizing several of the key requirements of the Reproposed Rules.

I. Section 165(e) of the Dodd-Frank Act

Under section 165(e), the Fed is required to establish single-counterparty credit limits for U.S. BHCs ("Covered Companies") and FBOs with at least $50 billion in total consolidated assets,78 While investment securities limits and lending limits are already in place for certain depository institutions, such as national banks, state-chartered banks, and state and federally chartered savings associations, pursuant to the National Bank Act of 1863 and the Federal Reserve Act, section 165(e) requires separate and independent enhanced single-counterparty credit limits.

The Dodd-Frank Act defines "credit exposure" to a particular company as:

  • all extensions of credit to a company, including loans, deposits, and lines of credit;
  • all repurchase agreements ("Repos"), reverse repurchase agreements ("Reverse Repos"), and securities borrowing and lending transactions with a company (to the extent that such transactions create credit exposure for the Covered Company or Covered Entity);
  • all guarantees, acceptances, and letters of 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 derivative transactions between the Covered Company, or Covered Entity, and the company; and
  • any other similar transaction that the Fed determines, through regulation, to be a credit exposure under section 165(e).9

Covered Companies and Covered Entities are prohibited from maintaining credit exposure to any unaffiliated companies that exceeds 25% of the "capital stock and surplus" of the Covered Company or Covered Entity, or any such amount that the Fed determines may be necessary to mitigate risks to the financial stability of the U.S. economy.10  The Fed may additionally issue any such regulations and orders as it deems necessary to administer and carry out the requirements set forth under section 165(e), as well as exempt from the definition of "credit exposure" certain transactions if it finds that the exemption is in the "public interest and consistent with the purposes of section 165(e)."11 Lastly, the Fed is authorized to establish single-counterparty credit limits for any nonbank financial companies designated as a SIFI by the Financial Stability Oversight Council.12

II. The Reproposed Rules

The Reproposed Rules establish separate requirements for U.S. BHCs (i.e., Covered Companies) and FBOs and IHCs (i.e., Covered Entities), albeit the requirements are largely analogous. Specifically, the Reproposed Rules establish: (1) three levels of increasingly stringent credit exposure limits; (2) the methodology for calculating "aggregate net credit exposures"; (3) exemptions from the credit exposure limits; (4) compliance requirements; and (5) the timing in which Covered Companies and Covered Entities must comply with the Reproposed Rules' requirements.

A. Credit Exposure Limits for U.S. BHCs (Covered Companies)

Overview of Reproposed Rules as Applied to U.S. BHCs. Section 165(e) directs the Fed to impose single-counterparty credit limits on the "capital stock and surplus" of a Covered Company, which is defined under the Reproposed Rules as the "sum of the [Covered Company's] total regulatory capital as calculated under the capital adequacy guidelines applicable to that [Covered Company] under Regulation Q . . . and the balance of the [Covered Company's allowance for loan and lease losses ("ALLL")] not included in tier 2 capital under the capital adequacy guidelines applicable to that [Covered Company] under Regulation Q."13

Under the Reproposed Rules, the "aggregate net credit exposure" of a Covered Company to a single counterparty would be subject to one of three categories of credit exposure limits, each with increasing stringency. The Reproposed Rules define "aggregate net credit exposure" as the sum of all net credit exposures of a Covered Company or Covered Entity to a single counterparty.14 The below credit exposure limits would apply to a Covered Company on a consolidated basis, including any of the Covered Company's subsidiaries, to any unaffiliated counterparty:15

  • Category 1. The first category of limits would apply to Covered Companies with less than $250 billion in total consolidated assets and less than $10 billion in on-balance-sheet foreign exposures.16  Such Covered Companies would be prohibited from maintaining aggregate net credit exposure to an unaffiliated counterparty in excess of 25% of the Covered Company's total capital stock and surplus.17
  • Category 2. The second category of exposure limits would prohibit any Covered Company with at least $250 billion or more in total consolidated assets or at least $10 billion or more in total on-balance-sheet foreign exposures from maintaining aggregate net credit exposure to an unaffiliated counterparty that exceeds 25% of the Covered Company's tier 1 capital.18
  • Category 3. The third category of exposure limits would prohibit any Covered Company that is a globally systemically important banking organization ("G-SIB" or "Major Covered Company") from maintaining aggregate net credit exposure that exceeds (i) 15% of the Major Covered Company's tier 1 capital to any "Major Counterparty"19  and (ii) 25% of the Major Covered Company's tier 1 capital to any other counterparty.20

To view the full article please click here.

Footnotes

1 Board of Governors of the Federal Reserve System, "Single-Counterparty Credit Limits for Large Banking Organizations," Notice of Proposed Rulemaking, Mar. 4, 2016, available at http://www.federalreserve.gov/aboutthefed/boardmeetings/sccl-fr-notice-20160304.pdf, at 1.

2 See Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies; Proposed Rule, 77 Fed. Reg. 594 (Jan. 5, 2012); and Enhanced Prudential Standards and Early Remediation Requirements for Foreign Banking Organizations and Foreign Nonbank Financial Companies, 77 Fed. Reg. 76628 (Dec. 28, 2012).

3 See Lending Limits, 78 Fed. Reg. 37930 (June 25, 2013).

4 See "Final standard for measuring and controlling large exposures published by the Basel Committee," BIS Press Release, Apr. 15, 2014, available at http://www.bis.org/press/p140415.htm.

5 NPRM, supra note 1 at 7.

6 See Remarks by Chair of the Federal Reserve Janet L. Yellen, "Finance and Society" Conference, Washington, D.C., May 6, 2015, available at http://www.federalreserve.gov/newsevents/speech/yellen20150506a.pdf ("We are also employing annual stress tests to gauge large institutions' ability to weather a very severe downturn and distress of counterparties and, importantly, continue lending to households and businesses.").

7 Notwithstanding section 165(a)(2), the Fed has not proposed a threshold higher than $50 billion for applying section 165(e).

8 See 12 U.S.C. § 5365(e)(1).

9 See 12 U.S.C. § 5365(e)(3).

10 See 12 U.S.C. § 5365(e)(2).

11 See 12 U.S.C. § 5365(e)(5)-(6).

12 See NPRM, supra note 1 at 5.

13 See Reproposed Rule § 252.71(d).

14 See Reproposed Rule § 252.71(b).

15 A "subsidiary" of a Covered Company includes any "company that is directly or indirectly controlled by the specified company for purposes of the Bank Holding Company Act of 1956." NPRM, supra note 1 at 13 (citing 12 U.S.C. § 1841). However, the Fed notes that, to the extent an investment fund or vehicle is not controlled by a Covered Company, the exposures of such a fund or vehicle to their counterparties would not be aggregated to the Covered Company for purposes of the Covered Company's single-counterparty credit limits. See NPRM, supra note 1 at 13.

16 NPRM, supra note 1 at 11.

17 The Reproposed Rules defines "total capital stock and surplus" as the Covered Company's total regulatory capital plus ALLL.

18 NPRM, supra note 1 at 11.

19 A "major counterparty" is defined as a G-SIB or a nonbank financial company supervised by the Fed (i.e., a nonbank SIFI). NPRM, supra note 1 at 12.

20 Pursuant to Section 165(a)(1)(B) of the Dodd-Frank Act, the Fed may establish enhanced prudential standards based on factors such as "the nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company." See 12 U.S.C. § 5323; and 12 U.S.C. § 5365(e). The establishment of enhanced credit exposure limitations for Major Covered Companies is consistent with section 165(a)(1)(1)(B) of the Dodd-Frank Act and discussed in further detail in Part III below.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions