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Dodd-Frank for foreign banks—New rules of the road

Read the potential implications for FBO’s following the formulation of the proposed prudential standards as set out by Dodd-Frank.

Overview

On December 14, 2012, the Federal Reserve Board proposed a set of new prudential standards and early remediation requirements applicable to Foreign Banking Organizations (FBOs) having significant presence in the United States. One primary effect of the proposed rules is the closing of current gaps in the supervision and regulation of FBOs, reflecting a shift from long standing country-by-country supervision.

The new prudential standards and early remediation requirements of Sections 165 and 166 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), once adopted, would apply to the U.S. operations of FBOs based on the size of their consolidated global and U.S. assets.

Background

The United States has traditionally accorded foreign banks the same national treatment as domestic banks, which has often resulted in competitive and countercyclical benefits to U.S. markets. Over the last decade, the Federal Reserve Board has provided flexibility to FBOs within its stipulated guidelines, allowing them to decide the structure of their U.S. entities to promote maximum efficiency at the consolidated level. These included setting up of cross-border branching, direct and indirect subsidiaries and other entities.

The Board also allowed well-managed and well-capitalized foreign banks to conduct a wide range of bank and nonbank activities in the United States under conditions comparable to those applied to U.S. banking organizations. However, this was at a time when FBOs had a less significant presence and their operations were less complex.

Over the past few years, the concentration of foreign banks and the profile of their operations have changed substantially and such changes have made FBOs both structurally diverse and complex. Along with an increase in total assets, their U.S. operations have become increasingly concentrated and more interconnected than ever before.

FBOs have grown very large and are highly interconnected with the U.S. financial system. The lessons about financial stability learned during the crisis appear to have affected the regulatory emphasis so that it addresses weaknesses observed in the current framework for supervising and regulating the U.S. operations of such large FBOs. This is critical, as any failure of such large FBOs could pose significant financial stability risks to the U.S. economy.  

Analysis

The Federal Reserve has taken a tiered approach in framing the Dodd-Frank enhanced prudential standards and remediation framework applicable to FBOs. Essentially, the proposal has been structured with levels of regulation applicable to an FBO based on the size of its global and U.S. consolidated assets. The proposal seems to be particularly stringent in dealing with FBOs having U.S. consolidated assets of $50 billion or more.

The proposed prudential standards would have profound implications for the FBOs as they pose a direct challenge to their current business and operating models. However, the exact extent of the ramifications would be difficult to assess at this point as it would be different for each FBO and dependent upon each FBO’s requirements.

The proposed rules would have a significant impact on the FBOs’ current business models as they would be required to introduce more discipline and maturity in terms of allocation and holding of capital within their various U.S. legal entities, not just at the parent company level. This is something that FBOs generally have not been doing until now. FBOs might be forced to take up a host of new activities such as altering their current legal structures, scouting for potential new sources of capital to inject into their U.S. units, moving broker-dealer operations to other geographic areas, relocating activities from U.S. subsidiaries into their U.S. branch and agency networks, and undertaking regulatory arbitrage to avoid non-compliance and tax implications.

Recommendations

It is important to note that the Federal Reserve has provided sufficient time in terms of receiving comments on the additional prudential standards—with a deadline of March 31, 2013– as well as an extended phase-in period until July 1, 2015, for implementing the proposed requirements. However, it is still critical that FBOs consider initiating the following activities early as part of their efforts to have a smooth path to implementation:

Internal core committee

  • Forming an internal core committee to perform a thorough assessment of the proposed rules and their impact on overall business strategy, examining areas such as the cost of doing business in the U.S. and the continuity of the U.S. operations, exit strategy (if feasible) including relocation to other geographies, and product rationalization based on new cost structures.

  • Prioritizing the proposed rules based on size of the organization, profile of U.S. business and entities, complexity of the activities and other elements.

  • Representation from LOBs (Lines of Businesses), Operations, Risk and Systems (IT) while agreeing on the next steps and taking key decisions.

External communication

  • Actively engaging in external communication with other FBOs, industry trade groups and forums.

  • Developing a list of issues and concerns and engaging in dialogue with the Federal Reserve Board (FRB).

  • Communicating with home country regulators concerning the possible implications.

Authors

A. Gupta – managing director, Capital Markets – Risk Management. Based in New York, Gupta has over 15 years of risk consulting and capital markets industry experience, delivering strategic solutions in a wide variety of client situations.

L. Klein – managing director, North American Banking Risk and Regulatory Management, Risk Management. Based in Atlanta, Klein brings over 14 years of extensive experience in financial services leading complex risk management, compliance and analytics initiatives at large banking and capital markets organizations.

J. Jamison – senior manager, Banking and Risk Management. Based in Philadelphia, Jamison has over 9 years of consulting and industry experience in the financial services and the risk management areas with clients across North America.

S. Panda – manager, Financial Services and Risk Management. Based in Atlanta, Panda has over 9 years of consulting experience in financial services and risk management with clients across North America.

Industry & topics highlighted

Financial Services