2014 Morrison & Foerster LLP All Rights Reserved mofo.com The Federal Reserve Board s Final Dodd-Frank Systemic Prudential Regulations for Domestic Banks March 11, 2014 Presented By Henry M. Fields hfields@mofo.com Oliver I. Ireland oireland@mofo.com
Today s Discussion Topics Background Changes from the Proposals Coverage Capital Liquidity Risk Management Stress Testing Debt-to-Equity Limits This is MoFo. 2
Other Topics Deferred Rulemaking Single-Counterparty Credit Limits Early Remediation Standards Enhanced Prudential Standards for Non-Bank Financial Companies Stress testing rules previously adopted apply Other enhanced prudential standards to be addressed on a case-by-case basis This is MoFo. 3
Some Helpful Definitions Board Federal Reserve Board BHCA the U.S. Bank Holding Company Act BHC Bank holding company as defined under the BHCA and Regulation Y SLHC Savings and loan holding company as defined under Regulation LL DFA Dodd-Frank Wall Street Reform and Consumer Protection Act $10BB BHC a U.S. BHC with total consolidated assets of between $10BB and $50BB $50BB BHC a U.S. BHC with $50BB+ of total consolidated assets NBFC a nonbank financial company that the Financial Stability Oversight Council has determined under DFA Section 113 to be supervised by the Board and for which such determination is still in effect This is MoFo. 4
Background Proposed in December 2011 under DFA Sections 165 and 166 Section 165: Enhanced supervision and prudential standards for systemically important banks and nonbank financial companies Section 166: Early remediation requirements for systemically important banks and nonbank financial companies Designed to prevent or mitigate risks to U.S. financial stability that could arise from the material financial distress or failure, or ongoing activities of, large, interconnected financial institutions Enhanced prudential standards must increase in stringency based on the systemic footprint and risk characteristics of the financial institution This is MoFo. 5
Background Final Rule incorporates previously-issued capital plan and stress test requirements Capital plan rule adopted in 2011 imposes enhanced risk-based and leverage capital requirements on $50BB BHCs, and requires submission of an annual capital plan to the Board that demonstrates ability to maintain capital above minimum ratios under baseline and stressed conditions DFA Section 165(i)(1) rules adopted in 2012 require $50BB BHCs and NBFCs to conduct annual supervisory and semi-annual company-run stress tests DFA Section 165(i)(2) rules adopted in 2012 require $10BB BHCs and SLHCs and banks with more than $10BB in total consolidated assets to conduct annual company-run stress tests This is MoFo. 6
Changes from Proposals Final Rule defers action on single-counterparty credit limits and early remediation standards NBFCs Stress testing rules previously adopted apply Board intends separately to issue orders or rules imposing other enhanced prudential standards on NBFCs on a case-by-case basis This is MoFo. 7
Coverage Enhanced prudential standards generally apply to $50BB BHCs $10BB BHCs that are publicly traded are subject to risk committee requirements $10BB BHCs and SLHCs and banks with more than $10BB in total consolidated assets are subject to annual company-run stress test requirements NBFCs are subject to supervisory and company-run stress test requirements This is MoFo. 8
Summary Size Requirements Subpart of Final Rule $10BB BHCs and SLHCs and banks with more than $10BB in total consolidated assets Company-run stress tests Subpart B $10BB BHCs that are publicly traded Risk committee Subpart C $50BB BHCs NBFCs Risk-based and leverage capital Risk management Risk committee Liquidity risk-management, stresstesting and buffers Supervisory stress tests Company-run stress tests Debt-to-equity limits (upon grave threat determination Supervisory stress tests Company-run stress tests Subpart D Subpart E Subpart F Subpart U Subpart E Subpart F This is MoFo. 9
Capital: $50BB BHCs Must comply with, and hold capital commensurate with the requirements of, any regulations adopted by the Board relating to capital planning and stress tests Capital Plan Rule (issued Dec. 2011) Must submit annual capital plan to the Board that demonstrates ability to maintain capital above the minimum risk-based capital ratios under expected conditions and stressed scenarios over a minimum nine-quarter, forward-looking planning horizon Companies with unsatisfactory capital plans face limits on ability to make capital distributions Stress Test Rule (discussed later) Defines tier 1 common ratio by cross-reference to the capital plan rule Capital plans must reflect the results of company-run stress tests using the scenarios provided under the DFA stress test rules Supervisory and company-run stress test results alone will not sufficiently address all relevant outcomes that should be covered in a satisfactory capital plan (although such results will be considered in the Board s evaluation of the capital plan) This is MoFo. 10
Capital: $50BB BHCs Board issued Basel III-based revised regulatory capital framework in July 2013 New minimum common equity tier 1 capital ratio of 4.5% Raises minimum tier 1 ratio from 4% to 6% Minimum leverage ratio of 4% Implements strict eligibility criteria for regulatory capital instruments Introduces a standardized methodology for calculating risk-weighted assets Requires BHCs with total consolidated assets of $250BB+ or foreign exposures of $10BB+ to meet a supplementary leverage ratio of 3% BHCs subject to advanced approaches generally subject as of January 1, 2014 Other $50BB BHCs must comply by January 1, 2015 Board issued final rule in February 2014 incorporating the revised capital framework into the capital plan and stress test rules This is MoFo. 11
February 2014 final rule (cont.) Capital: $50BB BHCs $50BB BHCs must project regulatory capital ratios and meet the minimum capital requirements for each quarter of the planning horizon in accordance with the minimum capital requirements that are in effect for that company during that quarter BHCs using the advanced approaches framework must incorporate those changes into the capital planning and stress testing cycles that begin October 1, 2015 This is MoFo. 12
Risk Management $10BB BHCs that are publicly traded Must maintain a risk committee that: Approves and periodically reviews the risk-management policies (formerly practices ) of its global operations Oversees the operation of its global risk-management framework that is commensurate with the structure, risk profile, complexity, and size of the BHC Meets at least quarterly and fully documents and maintains records, including risk-management decisions The risk committee must have: At least one member with risk management experience (formerly expertise ), and at least one independent member A formal, written charter that is approved by the BHC s board of directors This is MoFo. 13
$50BB BHCs Risk Management The same risk committee requirements that apply to $10BB BHCs (regardless of whether stock is publicly traded) The BHC must appoint a chief risk officer, who must: Have risk management experience (formerly expertise ) Be independently compensated Report directly to both the risk committee and CEO Oversee the establishment of, and monitor compliance with, risk limits on an enterprise-wide basis Oversee the implementation of, and compliance with, risk management policies and procedures Oversee the management, monitoring and testing of risks and risk controls Report and resolve risk management deficiencies in a timely manner This is MoFo. 14
$50BB BHCs (cont.) Risk Management Risk committee s responsibilities include the liquidity riskmanagement responsibilities (discussed below) Must report directly to the BHC s board of directors Must receive and review reports on not less than a quarterly basis from the BHC s chief risk officer This is MoFo. 15
Liquidity: $50BB BHCs Final Rule builds on the Board s supervisory framework for liquidity adequacy and liquidity risk management Based substantially on the Basel Committee s Principles for Sound Liquidity Risk Management and Supervision Requires $50BB BHCs to: Establish and maintain a liquidity risk management review function independent of the management responsible for funding Regular (no less than annual) review of adequacy and effectiveness of liquidity risk management processes and compliance with law Report material liquidity risk management issues to board of directors or risk committee Produce comprehensive cash flow projections Monitor sources of liquidity risk and establish liquidity risk limits consistent with liquidity risk tolerance Establish and maintain procedures for collateral, legal entity, and intraday liquidity risk monitoring This is MoFo. 16
Liquidity: $50BB BHCs Establish and maintain a contingency funding plan Conduct monthly (or more frequently as the Board may require) liquidity stress tests Must include, at a minimum, scenarios reflecting: Adverse market conditions Idiosyncratic stress event Combined market and idiosyncratic stresses Must be tailored to, and provide sufficient detail to reflect, a BHC s capital structure, risk profile, complexity, activities and size Policies, procedures and controls (including management information systems) for liquidity stress testing are required Must maintain liquidity buffer of unencumbered highly liquid assets Must be sufficient to meet projected net stressed cash-flow need over 30- day planning horizon This is MoFo. 17
Liquidity: $50BB BHCs Senior management must: Establish and implement strategies, policies and procedures designed to effectively manage liquidity risk Establish liquidity risk limits Oversee the development and implementation of liquidity risk measurement and reporting systems Approve new products and business lines based on liquidity risk Periodically review the independent review function This is MoFo. 18
Liquidity: $50BB BHCs Senior management must, at least quarterly: Determine compliance with strategies, policies and procedures governing liquidity risk management and liquidity stress testing Determine compliance with liquidity risk limits Report the liquidity risk profile and liquidity risk tolerance to the board of directors or risk committee Review cash-flow projections and liquidity stress testing results Approve liquidity buffer And upon material revision, approve liquidity stress testing practices, methodologies and assumptions This is MoFo. 19
Liquidity: $50BB BHCs Board of directors must: Annually approve the BHC s liquidity risk tolerance, taking into account the capital structure, risk profile, complexity, activities and size of the BHC Review information provided by senior management at least semiannually to determine compliance with liquidity risk tolerance Approve and periodically review the liquidity risk-management strategies, policies and procedures established by senior management Risk committee (or a designated subcommittee thereof composed of members of the board of directors) must: Approve the contingency funding plan at least annually or upon revision This is MoFo. 20
Stress Testing A process to assess the potential impact of scenarios on the consolidated earnings, losses, and capital of a company over a nine-quarter planning horizon, taking into account the current condition of the company and its risks, exposures, strategies, and activities Scenarios are those sets of conditions that affect the U.S. economy or the financial condition of a company, including but not limited to baseline, adverse, and severely adverse scenarios For company-run stress tests, the Board may require a company to: Include a trading and counterparty component in its adverse and severely adverse scenarios (if engaged in significant trading activity) Include additional scenarios, or additional components in its adverse and severely adverse scenarios (based on the company s financial condition, size, complexity, risk profile, scope of operations, or activities, or risks to the U.S. economy) Final Rule incorporates stress test requirements issued in October 2012 This is MoFo. 21
Stress Testing $10BB BHCs and SLHCs and banks with more than $10BB in total consolidated assets Must conduct annual company-run stress tests using scenarios provided by the regulator SLHCs with total consolidated assets of $50BB+ and banks that are subsidiaries of $50BB BHCs: Must conduct stress test by January 5 of each calendar year based on data as of September 30 of the preceding calendar year, unless extended by the Board Must publicly disclose summary results between March 15 and March 31 Other SLHCs and banks and $10BB BHCs: Must conduct stress test by March 31 of each calendar year based on data as of September 30 of the preceding calendar year, unless extended by the Board Must publicly disclose summary results between June 15 and June 30 This is MoFo. 22
Stress Tests Guidance for $10BB Banks and BHCs Interagency Supervisory Guidance* Supervisory expectations regarding each requirement of the Dodd-Frank stress test rules and illustrative examples of satisfactory practices Stress test time-lines Stress test scenarios Stress test methodologies and practices Estimating the potential impact on regulatory capital levels and capital ratios Controls, oversight, and documentation Reports to supervisors Public disclosure of stress tests * OCC Bulletin 2014-5 (OCC, FRB, FDIC) This is MoFo. 23
Stress Testing: $50BB BHCs Must conduct annual and semi-annual company-run stress tests Annual company-run stress tests must: Be conducted by January 5 of each calendar year based on data as of September 30 of the preceding calendar year, unless extended by the Board Use scenarios provided by the Board Publicly disclose summary results between March 15 and March 31 Semi-annual company-run stress tests must: Be conducted by July 5 of each calendar year based on data as of March 31 of that calendar year, unless extended by the Board Use at least three company-developed scenarios Publicly disclose summary results between Sept 15 and Sept 30 This is MoFo. 24
Stress Testing: $50BB BHCs Also subject to annual supervisory stress test conducted by the Board The Board s stress test framework would rely on consolidated data and other information supplied by each BHC BHCs must submit regulatory reports and any other required information by mid-november Design focuses on the capital adequacy and does not focus on all aspects of financial condition Standardized tests are not adjusted for each BHC Scenarios for upcoming annual cycle published by Board no later than mid-november Board completes supervisory stress tests and compiles results by mid-february, and discloses results by March 31 This is MoFo. 25
Stress Testing: NBFCs NBFCs are subject to the same supervisory and company-run stress test requirements for $50BB BHCs This is MoFo. 26
Debt-to-Equity Limits All U.S. BHCs: A conditional debt-to-equity limit of not more than 15-to-1, upon a determination by the U.S. Financial Stability Oversight Council that a BHC poses a grave threat to U.S. financial stability, and that the debt-to-equity limit is necessary to mitigate that risk A company generally would be expected to make a good faith effort to increase equity capital through limits on distributions, share offerings, or other capital raising efforts prior to liquidating margined assets in order to achieve the required ratio This is MoFo. 27
Deferred Rulemaking Single-counterparty Credit Limits The Board is continuing to develop single-counterparty credit limits required under DFA Section 165 based on the results of a quantitative impact study conducted last summer and the Basel Committee s initiative to develop a regulatory framework governing large credit exposures that would apply to all global banks Early Remediation Requirements (DFA Section 166) The Board is continuing to review comments on early remediation requirements and is integrating the remediation levels with the Basel III capital rules adopted in July 2013 This is MoFo. 28
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