status of reform in the u.s. · 2016. 8. 5. · 3 • dodd-frank act implementation – 300-400...

• The New Regulatory Paradigm

– A barrage of rules, regulations and guidance from every angle

– Regulators taking a hard-line stance

– Similarities and differences in reg. response across regions

• E.g., capital vs. the Volcker Rule

– Macroeconomic factors (e.g., European fiscal crisis) influencingregulatory outcomes

– Bottom line: the regulatory reform process is far from over

• The Market Response

– More resources devoted to compliance

– Structural reform = potential competitive opportunity

– Strategic positioning is key

Status of Reform Worldwide

• Dodd-Frank Act Implementation

– 300-400 rules required or contemplated (depending on how counted)

• Finalized: roughly 40%

• Proposed: roughly 30%

• Deadlines missed thus far: roughly 30%

– U.S. financial regulatory agencies extremely busy

– Likely 3-5 years (or larger) before full implementation

Status of Reform in the U.S.

Dodd Frank Act

CRD IV

Crisis Management Directive

EMIR (Derivatives)

MiFID II and MiFIR

CRD III

Credit Rating Agencies Regulation

AIFMD / UCITS V

Implementation of G20 Commitments – EU and US

1. Derivatives and Collateral Transformation

2. Capital / Basel III

– Leverage Ratio

– Liquidity

3. Shadow Banking and Securities Lending

4. Enhanced Prudential Standards

– Single Counterparty Credit Limits

– Lending Limits

– Foreign Banking Organizations

5. European Bank Financial Transaction Reform

6. The Orderly Liquidation Authority

What We Will Cover Today

Derivatives&

Collateral Transformation

• OTC Derivatives reform through

– Regulatory capital

– Clearing

– Regulation of CCPs

– Trade repositories

– Regulation of swap dealers and major swap participants

Dodd-Frank Regulatory Regime of OTC Derivatives

• Swap Dealers (SDs) and Major Swap Participants (MSPs) will be subject to new capital requirements to be determined by their prudential regulator with respect to the derivatives activities

• All SDs and MSPs will be subject to capital and margin rules:

– If they are subject to capital and margin rules of a prudential regulator, then by such prudential regulator

– If they are not subject to capital and margin rules of a prudential regulation, then by the CFTC and/or the SEC

Dodd-Frank Regulatory Regime of OTC Derivatives (cont’d)

• Further, derivatives between SDs, MSPs and Financial Institutions will have to be cleared (unless an exemption or an exception applies), and cleared derivatives will be subject to margin requirements to be determined by the derivatives clearing organizations

• Both the CFTC and the SEC have proposed capital and margin rules for non-bank SDs and MSPs

• The SEC proposed rules were only released on October 18, 2012

• Under the CFTC proposed rules, the subsidiary of a US bank holding company that is a SD or MSP will have to comply with the Fed’s regulatory capital requirements as if it is a US bank holding company (i.e., minimum ratio of qualifying total capital to risk-weighted assets of 8%, of which at least half (or 4%) must be in Tier 1 capital (subject to a minimum of at least $20 million of Tier 1 capital)

• The SEC proposed capital and margin rules for SDs are modeled after existing broker-dealer capital and margin rules

• There are differences in the CFTC and the SEC proposed capital and margin rules

• Capital for SDs and MSPs that are FCMs, the greatest of:

– $20 million

– Capital amount required for FCMs acting as retail forex exchangedealers

– 8% of risk margin required for customers and non-customers exchange-traded futures and OTC swaps that are cleared

– Amount of adjusted net capital required by a futures association of which FCM is member

– FCM that is a registered securities broker-dealer, SEC required net capital

CFTC Proposed Capital Rules

• Capital for SDs and MSPs that are not FCMs:

– Maintain tangible net equity (GAAP determination, minus intangibles such as goodwill) of at least $20 million, plus additional amounts for market risk and over-the-counter derivatives credit risk.

– To calculate the market risk and over-the-counter derivatives credit risk amounts, firms could use internal models that are approved by the Fed or the SEC can use their models. Otherwise, firms must use the methodologies adopted by the CFTC, which are similar to those of the Basel Accord.

CFTC Proposed Capital Rules (cont’d)

• Between entities that are SDs and/or MSPs, there will be required payment and collection of initial and variation margins

• Between SDs/MSPs and a financial entity, the SDs and MSPs will be required to collect (but not pay) initial and variation margins

• There will not be required initial or variation margin required to be collected from non-financial entities by SDs or MSPs

CFTC Proposed Margin Rules

• Minimum Net Capital Requirements for stand-alone SDs, not using internal models: $20 million + 8% of risk margin amount

• Minimum Net Capital Requirements for stand-alone SDs, using internal models: $100 million of tentative net capital (net capital before haircuts), and at least $20 million + 8% of risk margin amount

• Minimum Net Capital Requirements for SDs that are also broker-dealers, not using internal models: $20 million + 8% of risk margin amount + current net capital ratio required by broker-dealer regulations

• Minimum Net Capital Requirements for ANC broker-dealers, using internal models: $5 billion of tentative net capital, and at least $1 billion + 8% of risk margin amount + current net capital ratio required by broker-dealer regulations

• MSPs are treated differently under SEC rules, they are only required to have positive tangible net worth

SEC Proposed Capital Rules

• SDs are required to collect margin:

– From other SDs, but the SEC proposes two alternatives: (A) SDs required to collect variation margin only, or (B) SDs required to collect initial and variation margin, but initial margin must be held at a third party

• SDs are not required to collect margin from commercial end users, but will have to take a capital charge for such unmargined swaps

• MSPs are required to pay and collect variation margin to their counterparties and calculate such margin amount daily

SEC Proposed Margin Rules

• As proposed, the CFTC margin rules require:

– Initial Margin and Variation Margin:

• From SD, MSP or financial entity: cash, US treasury, US agency, senior debt of FNMA, FHLMC, FHLB, FAMC, “insured obligations” of a Farm Credit System bank

– Initial Margin and Variation Margin:

• From non-financial entity: assets with value that is reasonably ascertainable on a periodic basis

• Rehypothecation of margin assets is severely restricted. The swap parties are not permitted to rehypothecate the assets for swaps with SDs, MSPs, or financial entities

Collateral Management and Transformation

• Margin assets for swaps between SDs, MSPs and financial entities must be held under a tri-party custodial arrangement and the assets can only be invested in assets eligible to used as collateral

• As proposed, the SEC margin rules require:

– Cash, securities and/or money market instruments as collateral

• An SBSD under the SEC rules are required to treat collateral for cleared swaps as customer property

Collateral Management and Transformation (cont’d)

• An SBSD and MSBSP must permit their counterparties to require segregation of collateral

• In addition, cleared swaps will be subject to initial and variation margins to be posted to the central counterparty (CCP), directly or through a clearing broker

• Mandatory swap clearing and proposed margin rules result in:

– Increased demand for high quality collateral

– Collateral being segregated and/or increased use of third-party custodial arrangement

• The Bank for International Settlements estimated that $470bn of collateral will be necessary for interest rate swaps in a medium stress environment and $700bn in a high stress environment

• Collateral management and transformation will become important tools in the new collateral space

• Morgan Stanley/Oliver Wyman Report (April 11, 2013)

– Revenue opportunities of $5-$8 bn

– Global Custodians/Sell-side to be around 80%

• Enhanced Collateral Management:

– CCPs will have to establish system to track, monitor and allocate collateral

– Some swap buy-side parties have turned to third-party collateral agent to help them monitor and manage collateral

– Third-party custodial arrangement for swap collateral will continue togrow

• Collateral Transformation:

– Assets that are ineligible swap collateral can be transformed, through repo/securities-lending like transactions, into eligible collateral

– A number of banks (clearing brokers and custodians) are proposing to offer collateral transformation services

– Some pension funds or sovereign funds with large portfolio of high-quality assets will be able to provide the liquidity

• Risks of collateral transformation:

– In time of market stress, collateral lenders tend to pull back their collateral

– Price fluctuation relating to the lower-quality assets in collateral transformation transactions to have potentially important impact on the related swap transactions

– Banks and other intermediaries that offer collateral transformation services will need to have prudent risk management on haircuts and restrictions on the types of acceptable lower-quality assets

– Similarly, volatility in swap valuation will also have potentially important impact on the collateral transformation market resulting in:

• Fluctuation on the price of eligible collateral (i.e., volatility in funding costs)

• Stress on liquidity of collateral transformation market (i.e., risk of loss of funding)

– In times of market stress, volatility in swap valuation and in market price of the lower-quality assets could lead to a vicious cycle

Capital / Basel III

*** Comptroller Curry 3/28/13, “Hope to finalize all Basel elements by Summer”

• Basel III – international response to financial crisis

– Substantially increases capital, procedural requirements on “banking institutions”

– Particular focus on counterparty activities, like securities finance and derivatives

• Status (Basel Committee – As of March, 2013)

– Capital Finalized, in force – 11 countries (Includes Switzerland)

– Capital Finalized – 3 countries

– Capital draft regulations – 10

• Includes EU countries, U.S.

– Leverage finalized 2013, NSFR/Large Exposure 2014

– Initiating work on variation in RWA (Report in July)

Capital: Basel III – Implementation

Structure of U.S. Proposed Capital Framework

Proposed New Capital Framework

Capital NPR

Denominator NPR

Advanced Approach NPR

• Capital Ratios• Capital Composition

• Risk-weighting(significant changes)

• Enhancements to Basel II

�Comment period ended October 22, 2012*** FRB Gov. Tarullo 2/14/13 Speech – LCR proposal due in 2013

NPR 1 – Capital NPR(Phase-In 2013-2019)

** Delay from January 1 implementation announced on November 9, 2012

Capital RatiosEnd-State Ratios

Common Equity Tier 1 Capital

7% total

Tier 1 Capital

8.5% total

10.5% Total

Capital Conservation

Buffer

0% – 2.5%Countercyclical

Buffer

0% – 2.5%Countercyclical Buffer

Additional Tier 1

Countercyclical Buffer: Starts at 0 but could be as high as 2.5% upon agency discretion. Applies only to Advanced Approaches institutions.

Capital Conservation Buffer: Additional buffer to avoid limitations on capital contributions & certain discretionary bonuses.

Supplemental LeverageLeverage

Buffer

Supplemental Leverage: Tier 1 capital to total leverage exposure must be ≥ 3%. Applies only to Advanced Approaches institutions. Incorporates certain off-balance sheet assets in the denominator (e.g., guarantees, financial standby letters of credit, forward agreements).

Treatment of securities finance under discussion.

Tier 2

March 2013 – U.S. Senate votes 99-0 to “end subsidies”; May 2013 – Tarullo – Possible higher capital if not surplus liquidity

• April 2013 – Hoenig suggests a minimum 10% leverage

• Brown/Vittner bill

– 15% leverage for banks with assets >$500B

• SNL estimates $900B shortfall

– 8% leverage for banks with assets >$50B

• Tarullo – May 3, 2013

– “The new Basel III leverage ratio does include off-balance sheet assets, but it may have been set too low”

Focus on Leverage

Current G-SIB Buckets(As of November 1, 2012)

Bucket Selected G-SIBs

5-3.5% 0

4-2.5% Citi, Deutsche, HSBC, JPM

3-2.0% Barclays, BNP

2-1.5% BAC, BNY, CS, GS, MUFG, MS, RBS, UBS

1-1% Bank of China, BBVA, Credit Agricole, ING, Santander, Soc Gen, Standard Chartered, State Street, Wells

• D-SIB designations for many others?

– BIS finalized framework – October 2012

– More national discretion

• FRB Gov. Tarullo 2/14/13 Speech – US proposal to implement due this year

NPR 2 – The Denominator – Standardized Approach (Effective Date January 2015)

• Punishes non-cash, but correlated collateral

• Overrides interpretive relief granted to banks?

• Agencies “considering” simple VaR

– Basel III permits

• Collins Amendment creates int’l competitive issues

• Tarullo – May 2013 –Capital rules for community banks will be simpler than proposed rules

Simple VaR and IMM Not Expressly Permitted

NPR 3 – Denominator – Changes to Advanced Approach

• Tier 1 to total capital ratio of 3%

• Proposal includes off-balance sheet items

– But, does not currently include indemnification

• Formal Requirement January 1, 2018

Advanced ApproachSupplemental Leverage Ratio

• 5,000 trades

– Extends holding period to 20 business days

• Margin disputes

– More than 2/two quarters doubles minimum holding period

• F/X mismatch

• 1.25x exposure multiplier for large counterparties

Advanced ApproachOther Possible Burdens

EU ImplementationCRD IV

EU Progress

CRD II

In force:

31.12.2010

CRD III

CRD IV

1.1.2011

31.12.2011

April 16,

≈ Basel II, internal and external ratings based

approaches, operational risk charges, securitization

framework

≈ Basel II.5, Incremental Risk Charge and stressed

VAR, introduction of remuneration principles, higher

risk weights for resecuritizations, prudent valuation of

fair value positions in the banking book, additional

disclosure requirements

≈ Basel III plus move to single EU rule book, corporate

governance rules, etc.

• Must be adopted by EC → (expected by 9/30)

• Expected to come into force by January 1, 2014

• Same basic capital requirements as US proposal

– EBA – As of June, 2012 EU’s biggest banks had US $147B shortfall

• Also capped bankers’ bonuses

– 1:1 salary to bonus rate default

– 1:2 possible if approved by a least 66% of shares

CRD IV – Key Facts

Liquidity Ratios

*** Tarullo – 5/3/13 – More work needed to address risks with wholesale funding (including via SFT) – higher liquidity likely appropriate for largest banks

• “LCR” – Liquidity Coverage Ratio Basel III internal proposal:

– store enough cash or liquid assets for expected net outflows over 30-day nightmare scenario

– Test: 1 Jan 2012

– Comply: Begin 1 Jan 2015

– Amended in January 2013

• “NSFR” – Net Stable Funding Ratio:

– illiquid assets must be funded safely

– Test: 1 Jan 2012

– Comply: 1 Jan 2018

– TBD if to be amended

Liquidity – Two New Rules underBasel III

• Amendments made to the December 2010 LCR Provisions in Basel III Framework, include:

– Inclusion of Level 2B assets

• at discretion of national authority

• Widens range of “high quality liquid assets” (“HQLA”)

– Unencumbered

– Corporate bonds

– RMBS

– Equities

– Right of use during periods of stress

• Haircuts to apply

– 25% to 50%

• Cap on Level 2 Assets at 40%

– 2B Assets capped at 15% of HQLA

LCR – Relaxation of LCR

• LCR – from 1 January 2015

• Implementation in stages

– HQLA of 60% in year 1

– rising 10% per year

– 100% HQLA by 1 January 2019

LCR Timing

• Issued April 2013

• Enhances Principle 8 of “Principles for Sound Liquidity Risk Management and Supervision”

• Supplements LCR (which does not cover intra day risk)

• Applies to internationally active banks

– National supervisors determine other applicability

• Results not required to be publicly disclosed

Intraday Liquidity –Basel Committee Guidance – Overview

Intraday Liquidity –Basel Committee Guidance – Reporting

All Reporting Banks

•Time Specific Obligations

•Total (gross) via LVPS

•Available at Start of Day

•Daily Maximum Usage

• Intraday throughout • Intraday credit lines• Payments for correspondents

If direct participant If co

• Stress

– Own stress

– Counterparty stress

– Market-wide stress

• Timing

– Monthly basis from January 1, 2015

• Coincides with LCR

Intraday Liquidity –Basel Committee Guidance – Stress/Timing

Shadow Banking and Securities Lending

1)Banks’ interactions with shadow banking entities

2)Money market funds

3)Other shadow banking entities

4)Securitization

5)Securities lending and repos

FSB Shadow Banking Initiative: Five Workstreams

• Nov. 2012

– Proposals issued for public comment

• End 2012 / Early 2013

– Quantitative impact assessment

• Sept. 2013 G20 Summit

– Provide final set of recommendations

FSB Shadow Banking Initiative: Timeline

• FSB April 2012 Interim Report on Securities Lending:

– Discusses market regulation, transparency and other issues

– Comment period closed May 25, 2012

• Generally involves interaction of

FSB Shadow Banking Initiative on Securities Lending and Repos

Less regulated institutions

• Report states focus from a shadow banking system on

Securities Lending: FSB Areas of Concern

Maturity & Liquidity Transformation

Maturity Transformation and Leverage

Chain TransactionsCollateral

downgrades/upgrades

(Short term liabilities vs. long term assets)

(Possible through leveraged investment

fund financing)

Short sale cash (Often used by banks to obtain repo

financing)Securities borrowing collateral

Reinvested cash collateral into longer term assets

Cash collateral to riskier investments

further lengthens

1 2 3 4

1) Lack of Transparency (due to bilateral nature)

– Macro-level market data

– Micro-level (institution-specific) market data

– Corporate (balance sheet disclosure)

– Risk reporting (e.g., re-hypothecation) by intermediaries to clients

2) Procyclicality of system leverage/interconnectedness

– Varies depending on: a) Value of collateral

b) Size of haircuts

c) Collateral “velocity” (rate reused)

3) Other Risks of Reuse of Collateral

– Interconnectedness

– Leverage

Financial Stability Issues

4) Fire-Sale of Collateral Assets

– Particularly with counterparties with large collateral pools

5) Agent Lender Practices

– Lender Agent Bank Borrower

– Indemnity eliminates lender concern of borrower risk

6) Cash Collateral Reinvestment

– AIG-Lending as short term funding for investment

– Collateral Pools may promote rapid withdrawal

7) Cash Collateral Valuation Rigor

– MBS collapse

Financial Stability Issues (cont.)

Indemnity

• Background

– FSB issued November 2012 consultative document:A Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos

– Comment period closed January 2013

– Industry comments / meetings with FSB personnel

• Consultative document addresses:

– Financial stability risks in securities lending and repo markets

– Policy recommendations related to:

• Improvements in transparency

• Regulation

• Structural aspects of securities financing markets

Consultative Document on Shadow Banking and Securities Lending

• Improvements in transparency

– Reporting of transaction-level data to trade repositories

– Enhanced public disclosure requirements for securities lending activities

– Enhanced reporting to fund investors

– Tarullo (2/14/13) – Specifically cites need for ↑ transparency in securities finance

• Regulation

– Minimum haircuts (“High level” vs. “Back-Stop” approach)

• Tarullo (5/3/13) speaks approvingly

– Minimum standards for cash collateral reinvestment

– Minimum standards for collateral valuation and management

– Tarullo (5/3/13) – Consider limiting re-hypothecation

• Market structure

– Evaluation of central clearing in securities lending markets

– Changes to bankruptcy law treatment of securities lending transactions

FSB Consultative Document: Key Policy Recommendations

• Key Commenters

– IIF

– ISLA

– SIFMA

• Key Issues

– Regulatory reform incomplete – need to see “whole picture”

– “One size fits all” regulatory approach inappropriate

– “Exposure”-based, rather than transaction reporting

– Opposition to mandatory minimum haircuts

– Support view that changes to bankruptcy law currently unworkable

Industry Comments / Response

Enhanced Prudential Standards

• FRB Issued Proposed Rules on December 20, 2011

– Statutory Authority: Sections 165 and 166 of Dodd-Frank

• Applicable to banking organizations with > $50 B assets

• Applicable to Nonbank SIFIs

– Comments were due April 30, 2012

– Proposed Rules do not apply to foreign banks, but

– FRB Separately Issued FBO Prudential Rules

• FRB 3/28/13 Speech – QIS starting shortly

– Coordinate with Basel Committee?

US Proposed Rules: Process

Basel Committee Limits on Large Exposures

Comment Period Ends – June 28, 2013

Intended full Implementation –January 1, 2019

• Places limits on consolidated exposure to counterparties – daily limit / monthly compliance reports

• General limit of 25% of banking group’s CET 1 or Tier 1 Capital and of exposure to any single counterparty (and affiliates)

– E.g., December 31, 2012 – Bank Tier 1 capital = $150 B

– Bank standard exposure limit $37.5 B

• More stringent limit of 10% - 15% of “net” credit exposure of G-SIBs to other G-SIBs

– Bank current exposure limit = $15 B

• Note – US proposal based on capital stock and surplus

Single-Counterparty Exposure Limits: Basel Framework – Counterparties/Limits

• Exposures to a counterparty aggregated across the covered company and all its subsidiaries

– “Subsidiary” broadly defined as directly or indirectly “controlled” (50% of any class of voting securities) by covered company (systems issue)

• 25% voting or equity in US proposal

• “Counterparty” includes:

– Company and all its subsidiaries collectively

– Unlike U.S. proposal, sovereigns excluded

“Counterparties” Limit

Single-Counterparty Exposure Limits: Framework – Depicted

BankBHC

Nonbank Sub

BHCForeign

Counterparty

CounterpartySub 1

CounterpartyForeign Sub 2

Counterparty30% owned entity

• All above exposures aggregated for test• Note – Q-CCP treatment in Basel unclear; appears covered in U.S.

• Gross credit exposure. Gross credit exposure calculation varies by transaction

– “Haircut Approach” – Securities lending and repo

• Collateral haircuts (E.g., U.S. proposal)

– Sovereign debt: 0.005 to 0.06 depending on maturity, OECD Country Risk Classification

– Bank eligible corporate and muni bonds: 0.02 to 0.12 depending on residual maturity

– Main index equities: 0.15

– Other publicly traded equities: 0.25

– Mutual funds: Highest applicable haircut

– Cash collateral “held on deposit”: 0

• Substitution of credit provider also permitted

Gross Credit Exposure; Haircuts

• Aggregate net credit exposure

The sum of the following calculation for all transactions between a BHC and a counterparty and its affiliates:

– Gross credit exposure for the transaction (calculated using any applicable haircuts)

• Less market value of eligible collateral (reduced by applicable collateral haircut);

• Less value of any eligible guarantee;

• Less value of derivatives / other hedges

– BUT: any adjusted value of collateral, guarantee, derivatives, etc. is shifted to count toward the credit exposure limit of the issuer / guarantor / etc.

Single-Counterparty Exposure Limits: Framework – Calculation

Principal Reverse Repo – Fixed Income Collateral

BHC transfers $100 in cash to Broker Dealer. Broker Dealer provides $102 in 10-year sovereign bond collateral (OECD country 0-1).

• Credit Exposure to Broker Dealer

– BHC Gross Exposure = $100

– BHC Net Exposure = $100 – $102*96%= $2.08

• Credit Exposure to Foreign Sovereign

– BHC Gross Exposure = $100 – $2.08 = $97.92

Single-Counterparty Credit Limits – U.S. Examples

The following examples show counterparty credit exposures calculated for repurchase and reverse repurchase transactions:

Indemnified Reverse Repo – Equity Collateral

BHC acts as an agent for Mutual Fund as part of a securities lending arrangement and transfers $100 in cash to Broker Dealer. BrokerDealer provides $105 in main index equity collateral.

• Credit Exposure to Broker Dealer

– BHC Gross Exposure = $100

– BHC Net Exposure = $100 – $105*85% = $10.75

• Credit Exposure to Equity issuer

– BHC Gross Exposure = $100 – $10.75 = $89.25

Single-Counterparty Credit Limits – U.S. Examples (cont’d)

Tri-Party Repo

BHC transfers $105 in main index equity securities to BNY Mellon as intermediary for Broker Dealer. BNY Mellon holds $100 in cash provided by Broker Dealer as custodian for BHC.

• BHC Credit Exposure to Broker Dealer

– BHC Gross Exposure = $105+$15.75= $120.75

– BHC Net Exposure = $120.75 – $100 = $20.75 (eligible cash collateral includes cash held on deposit by a third-party custodian)

Single-Counterparty Credit Limits – U.S. Examples (cont’d)

• Liquidity Requirements

– Prescriptive liquidity risk management requirements for boards, management

– Liquidity stress testing, liquidity buffer, contingency funding plan

• Risk Management / Governance Provisions

– Risk Committee

– Chief Risk Officer

• Stress Testing

– Supervisory stress tests

– Company-run stress tests

• Debt-to-Equity Limit

• Early Remediation Requirements

– Focus on capital, liquidity, and strength of risk management framework

– Potential restrictions on asset growth, acquisitions, capital distributions

D/F 165 – Other Issues

• D/F 610 revised “loans and extensions of credit” to include derivative transactions and securities finance transactions

• OCC published interim rule in July 2012

• Comment period ended August 6, 2012

• Rule currently scheduled to become effective July, 2013

National Bank Lending LimitsBackground and Timing

FRB FBO Proposed Prudential Rules

• Reference Date – July 1, 2014

• Compliance Date – July 1, 2015

• But – per Michael Gibson (FRB BS&R Director) 3/28/13– Not finalized before U.S. regulation– Compliance date may be delayed

Morgan Stanley/Oliver Wyman Report (April 11, 2013)

•Global “Balkanization” reduces RoE by 2-3 %

– Need to duplicate infrastructure at local levels

•US is a key global profit and growth driver

– Americas in 2012

• Represented 47% of global revenues

• Represented 55 – 60 % of global profits

FBO Proposed Prudential RulesData Points

FBO > U.S. $50B Global;Combined U.S. Presence > U.S. $50B

Based on FRY-7Q FBO

Liquidity

Certify/demonstrate to FRB meet BIII .212(c)Provide FRB relevant capital ratios with FRY-7Q .212(c)

Capital

• US Liquidity Risk Cttee .222– Annual review /approval of liquidity risk tolerance for US .222– Consistent with enterprise-wide– Consider capital/risk profile/complexity/size/activities

• US Chief Risk Officer .222– Review liquidity rules with each new US business line/product– Annual review of significant US products/business lines– Annual review/approval of contingency funding plan [.228]– Quarterly

• Cash flow projection review [.225]• Review liquidity stress testing practices [.226]• Review liquidity stress testing results [.226]• Approve size/composition of liquidity buffer [.227]• Review specific limits [.229]• Review sufficiency of liquidity risk management info

– Review liquidity risk policies established by US operation management .223

– Regularly report to US Risk Cttee• Independent liquidity risk function .224

– At least annually review US liquidity risk mgmt– Report issues for corrective action

Net credit exposure of US ops may not exceed 25% of FBO’s cap and surplus .242• Lower limit if FBO exceeds $500 B global assets • Generally like US SCCL, except treats home country sovereigns like US gov’ts

SCCLStress Testing

Either comply with and provide FRB info regarding req’d home county stress tests, or hold assets equal to 108% of liabilities of US branch and agency network and engage in US non-IHC sub operation stress tests .263

Risk Mgmt• See IHC, may

be at FBO if has US Ops other than through the FHC

FBO Focus

Risk Mgmt

Cash Flow Projections .225

• Update short-term daily

• Update long-term monthly

• Must:

– Project flows arising from assets/liabilities/off-balance sheet over short- and long-term periods

– Identify discrete/cumulative mismatches over time periods

– Include flows arising from contractual maturities, etc.

Liquidity stress testing .226

• At least monthly, conduct separately for

– US branch/agency network

– US IHC

– Done pursuant to policies and procedures

FBO Liquidity Requirement Detailed (FBO > U.S. $50B Global; Combined U.S. Presence > U.S. $50B)

FBO Focus

• Use stress testing for liquidity buffer [.227]

• Use stress testing for contingency funding plan [.228]

• Stress scenarios = market stress, idiosyncratic stress, and both

– Overnight/30-day/90-day/1-year horizons

• For 30-day scenario, only unencumbered, highly liquid assets may satisfy liquidity buffer

– Cash/US gov’ts, others with FRB approval

• Report US stress tests/any home county stress tests to FRB within 14 days

FBO Focus (cont’d)

Liquidity Buffer .227

• Separately maintain for US branch/agency network and IHC

• Consist of highly liquid, unencumbered, sufficient for net stressed cash flow (internal and external) over 30 days

• Location

– IHC – maintain 30-day level in US (not at branch/affiliate)

– Branch – at least 14 days in US (remainder of 30 days may be elsewhere)

Contingency funding plan .228

• Establish/annually update plan

• Periodically test

Specific Limits .229

– Must maintain limits on potential sources of liquidity risk

• E.g., concentrations, maturities

Collateral Monitoring .230

• Monitor assets pledged in connection with US operations

• Monitor intraday liquidity risk exposure

• Update at least weekly

FBO Focus (cont’d)

FBO > U.S. $50B Global;U.S. IHC Presence > US $50B

Assets based on avg consolidated assets of US top tier subs (as reported on FRY-7Q)

– Reduce by intercompany consolidation IHC

Risk Mgmt

Capital

Must comply with stress testing requirements to same extent as US BHC with consolidated assets of US $50B .262 Stress

Testing

Holds all US subs except 2(h)(2)

All capital requirements of US BHCs .212• Regardless of whether controls bank

Comply with 225.8 capital planning (CCAR) .212

Net credit exposure may not exceed 25% of cap and surplus– Lower limit if exceeds $500B assets– Largely tracks US SCCL

• Except treats home country sovereigns like US gov’ts

Must certify to FRB has US risk committee at IHC if IHC controls all US operations .251

• Otherwise may be at FBO– Must have at least 1 member with appropriate risk mgmt expertise– Must review and develop policies .252– Must meet at least quarterly– Must have at least 1 member who is not officer/director of FBO or its

affiliates• Must have Chief Risk Officer .253• Must have a board of directors/operate like US corporation

Req’d regardless of whether controls bank

May be formed with 30 day post-FRB notice

IHC Focus

• FBO must meet home country:

– capital requirements that are consistent with Basel framework

– stress test requirements that are consistent with U.S. rules

• FBO must establish and maintain U.S. risk committee

• FBO must establish IHC to hold U.S. assets (other than branch/agency assets)

• IHC subject to:

– U.S. BHC capital requirements

– Company-run stress tests

– Liquidity stress tests

• FBO’s U.S. operations subject to early remediation triggers

FBOs > $10B but < $50B U.S. Assets

European Bank FinancialTransaction Reform

• The Commission published its proposal for a FTT in the EU in September 2011

• Each financial institution party to a financial transaction is liable to pay the tax in its Member State of establishment

• January 2013: ECOFIN resolved to use enhanced cooperation to implement FTT in 11 countries – Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain (the “FTT Zone”).

• EC published detailed proposal on February 14, 2013

• FFT Zone countries expected to publish implementing legislation by September 30, 2013

• Implementation scheduled for January 1, 2014

EU FTT – Timing

• FTT Zone Member States free to set rates, subject to minimum levels: 0.1% for financial instruments (base on value) and 0.01% for derivatives (notional amount)

• Applies to all financial instruments and derivatives but NOT loans

• Repos

• Securities lending and collateral transfers

EU FTT – Transaction Application

• “Financial Institution” very broad, includes:

– Banks

– Broker-dealers

– Insurers

– Pension funds

– Financial leasing companies

• Exempt

– Member States

– ECB

– European Financial Stability Fund

– European Stability Mechanism

– EU

– No intermediary/intra-group exemption

EU FTT – Entity Coverage

• The FTT cascades across the parties to a transaction.

• So, if everyone is within the FTT Zone:

How Could an ECP FTT Work?

VendorVendor BrokerBroker Clearing

member

Clearing

memberClearing

system

Clearing

systemClearing

member

Clearing

member BrokerBroker BuyerBuyer

0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%(exempt)

• This “cascade effect” is an intentional feature of most designs of financial transaction tax

• Acting outside the FTT Zone may therefore only somewhat reduce the tax:

member

Clearing

memberClearing

system

Clearing

systemClearing

member

Clearing

0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%(exempt)

• If a transaction is cleared through a clearance service in the FTT Zone then the FTT will apply, even if all parties are outside the FTT Zone:

member

Clearing

memberClearing

member

Clearing

0.1% 0.1%(exempt)

0.2%Clearing

system

Clearing

system

The Orderly Liquidation Authority

1) Credit Rating / Funding

– Immediate

2) OLA Designation of Failed Counterparty

– Risk Generally �� with Economic Stress

3) “Big Bank” OLA Funding Requirement

– Risk Generally �� with Economic Stress

4) FRB Director BS&R Michael Gibson (3/28/13)

– Subordinated debt required for largest holding companies (particularly G-SIBs) to support FDIC “top down” approach?

– On average – OK with where G-SIBs are on debt

OLA Impact Overview

⇒ (1) and (3) largely unavoidable, (2) can be mitigated (to an extent)

• OLA is designed to combine elements of 2 existing regimes, and provide a novel approach to funding:

OLA Designation of Failed CounterpartyGeneral Framework

FDIA Receivership Rules Bankruptcy Code

Administrative ResolutionStreamlined Process

Funding/Maintenance of Key Systems

FDIC Recoveries &

Assessments

Treasury BorrowingRepaid By

TaxpayerBailout

Creditor Rights& Protections

• Scope – Potentially applies to almost any systemically important U.S.financial institution

• Coverage – Holding Company and Subsidiaries

OLA Designation of Failed CounterpartyScope and Coverage

U.S. FI Corp*(BHC, NonbankSIFI, 85% FI)

Bank(FDIA)

Insurance(state)

Broker(SIPA) except

* = Covered by OLAQFC = Qualified Financial Contract (e.g., Securities Finance)

OLA Designation of Failed Counterparty The Emerging Paradigm – Conversion

Holdco

Equity Debt

BD �

Bridge

Debt Equity

Bank BD ☺

*** FDIC (5/2/13) – Possible “Presumptive Path” guidance due out this Summer.

• “Single Point of Entry” Approach

– Holdco fails, others saved

• FDIC – 3/28/13 – Preferred Approach

– Only not used if insufficient bail-in debt @ Holdco

• International Acceptance to avoid local failure

– UK – 70% of U.S. offshore assets – December MOU

– Engaged with Switzerland – positive

– EU resolution strategy due this summer

– Japan - staff level discussions

• Hope for principles later this year

• Tarullo (5/3/13)

– “Clear need” for a req’mt that large FIs have minimum amounts of long-term unsecured debt

OLA Designation of Failed Counterparty The Emerging Paradigm – Coordination

• “QFC” includes many counterparty-based arrangements:

– E.g., securities finance arrangements/swaps

• Timing (unlike bankruptcy)

– Stayed for 1 business day (till 5pm Eastern Time Monday) if default based on:

A) Insolvency, OR

B) (According to FDIC) failed funding performance

– Note: May be better than SIPA timing

• FDIC must

– Repudiate (or not) all QFCs to a “counterparty”

– Transfer to a bridge (or not) all QFCs to a “counterparty”

• FDIC – “Virtually all” QFCs in Bridge

– Who is “counterparty” in securities finance?

• Damages – Calculated as of date of repudiation, and may include cost of cover

OLA Designation of Failed CounterpartySpecial Case – Qualified Financial Contracts (“QFCs”)

Gregory J. Lyons

Ph# - 212-909-6566

Email - gjlyons@debevoise.com

Emilie T. Hsu

Ph# - 212-909-6884

Email - ehsu@debevoise.com

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