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1.2 The Fed’s New Authority In Regard to Financial Stability

<< Title I Overview

1.2 The Fed's New Authority In Regard to Financial Stability

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1.2.       The Fed's New Authority In Regard to Financial Stability       

1.2.1.      Fed Required to Adopt Enhanced Supervision and Prudential Standards for Large BHCs and Significant Nonbanks.   

The Fed is given a broad mandate to establish prudential standards and reporting and disclosure requirements for Large BHCs and Significant Nonbanks.  For purposes of this section 1.2., Large BHCs and Significant Nonbanks are referred to as a "Company" or "Companies."   These standards may be based on recommendations made by the Oversight Council or based on the Fed's own determination.

Any standards adopted by the Fed must be more stringent than the corresponding standards applicable to BHCs in general and to nonbanks that are not designated as Significant Nonbanks.  The standards must become increasingly stringent based on (i) the presence of the same factors used by the Oversight Council to make a determination that a nonbank should be treated as Significant Nonbank; (ii) whether the Company owns an insured depository institution; (iii) the Company's nonfinancial activities and affiliations; and (iv) any other factors the Fed deems appropriate.  The Fed is authorized to differentiate among Companies on an individual basis or by category, taking into account, among other things, their capital structure, riskiness and other risk-related factors.  For Large BHCs, the Fed may use a higher dollar threshold for applying most of the heightened standards. [§ 165(a)]

            The Fed is required to establish standards by regulation or order in particular specified areas.  It is also permitted, but not required, to establish standards in other areas, including in several specified areas.  When establishing standards applicable to foreign BHCs and foreign Significant Nonbank, the Fed must give due regard to the principle of national treatment and equality of competitive opportunity and take into account the extent to which those companies are subject to comparable home country standards applied on a consolidated basis. [§ 165(b)]

1.2.1.1. Required Standards.  The Fed must adopt standards for Companies, by regulation or order, in the following areas.

1.2.1.1.1.          Capital.  The Fed must adopt standards for risk-based capital and leverage limits.  In the case of an individual Company, the Fed, in consultation with the Oversight Council, may determine that stricter capital standards are not required and may instead apply other standards that result in similarly stringent risk controls.

1.2.1.1.2.          Liquidity Requirements.  The Fed must adopt standards for liquidity requirements.

1.2.1.1.3.         Resolution Plan.  The Fed must require periodic reports to the Fed, the Oversight Council and the FDIC on Company plans for rapid and orderly resolution in the event of material financial distress or failure.  The plan must provide information regarding (i) how any affiliated depository institution is adequately protected from the activities of the nonbank subsidiaries of the Company; (ii) a full description of the ownership structure, assets, liabilities, and contractual obligations of the Company; (iii) an identification of the cross-guaranties tied to different securities, major counterparties, and a process for determining to whom the collateral of the company is pledged; and (iv) any other information the Fed and FDIC jointly require by regulation or order.   

If the Fed and the FDIC determine that a resolution plan is not credible or would not facilitate an orderly resolution of the Company under Chapter 11 of the Bankruptcy Code, they are to notify the Company of the deficiencies.  The Company must within a specified time resubmit a credible plan that would result in an orderly resolution under Chapter 11, which must include any proposed changes in business operations or corporate structure to facilitate implementation of the plan. 

If a Company does not resubmit a credible revised plan on a timely basis, the Fed and the FDIC may jointly impose more stringent capital, leverage or liquidity requirements, or restrictions on growth, activities or operations of the company, or any of its subsidiaries, until the company resubmits an acceptable plan.  In the case of a Company that becomes subject to such additional requirements, if it fails to resubmit a credible plan within two years of the imposition of the requirements, the Fed and FDIC in consultation with the Oversight Council may direct the company to divest certain assets or operations identified by the Fed and the FDIC to facilitate an orderly resolution of the Company under Chapter 11. [§ 165(d)]  

A resolution plan will not be binding on a bankruptcy court, a receiver appointed under Title II of the Act, or any other authority authorized to resolve the Company.  Moreover, no private right of action may be based on any resolution plan submitted under this provision of the Act.       

The Fed and FDIC are required no later than 18 months after enactment of the Act to jointly issue regulations implementing the provisions regarding resolution plans and credit exposure reports.

 

   1.2.1.1.4.          Credit Exposure Report.  The Fed must require Companies to submit periodic reports to the Fed and the FDIC regarding the nature and extent of the company's credit exposure to Large BHCs and Significant Nonbanks and the nature and extent to which Large BHCs and Significant Nonbanks have credit exposure to the Company. [§ 165(d)]    

1.2.1.1.5.          Concentration Limits.  The Fed is required to issue regulations to limit the risks that the failure of any Company could pose to Large BHCs and Significant Nonbanks.    The Fed's regulations must prohibit Companies from having credit exposure to any unaffiliated company that exceeds 25% of the capital stock and surplus (or a lower amount designated by the Fed) of the company. [§ 165(e)]   

Credit exposure is defined to mean: (i) all extensions of credit to a company; (ii) repurchase and reverse repurchase agreements with a company, and securities lending and securities borrowing transactions with a company to the extent that they create credit risk for the Company; (iii) all guarantees and letters of credit issued on behalf of a company; (iv) all purchases of or investments in securities issued by a company; (v) counterparty credit exposure to the company in connection with derivatives transactions between the Company and the Large BHC or Significant Nonbank; and (vi) any other similar transactions that the Fed determines by regulation to be a credit exposure.  For purposes of this provision, any transaction by a Company with a person will be deemed to be a transaction with a company to the extent that the proceeds of the transaction are used for the benefit of, or transferred to, that company. 

The Federal Home Loan Banks are exempted from any concentration limits.  The Fed also has general authority, by regulation or order, to exempt transactions, in whole or in part, from the definition of credit exposure if it finds that the exemption is in the public interest and is consistent with the purpose of the concentration limits provision.   

 

The credit limits provision of the Act and the Fed's regulations and orders under the provision will not become effective until 3 years after the enactment of Act, subject to an extension of up to an additional 2 years by the Fed.

 

1.2.1.1.6.          Risk Management.  In a departure from the general $50 billion threshold for BHCs, the Fed is required to issue regulations requiring each publicly traded BHC with consolidated assets of not less than $10 billion to establish a risk committee.  A risk committee is to be responsible for oversight of a company's enterprise-wide risk management practices.  The Fed may require each BHC that is a publicly traded company that has consolidated assets of less than $10 billion to establish a risk committee. 

 

The Fed is required to issue final regulations regarding risk committees not later than 1 year after the transfer date (which is generally to be 1 year after the date of enactment of the Act), which regulations shall take effect not less than 15 months after the transfer date.

         

1.2.1.1.7.          Stress Tests  

The Fed, in coordination with the appropriate primary financial regulatory agencies and the Federal Insurance Office is required to conduct annual stress tests of Companies to evaluate whether they have the capital necessary to absorb losses as a result of adverse economic conditions.  The Act establishes certain requirements for the stress tests.  Based on the results of its analysis, the Fed may require a Company to update its resolution plan.  The Fed is also required to publish a summary of the stress tests it conducts. [§ 165(i)]

Each Company is required to conduct its own stress test on a semiannual basis.  All other financial companies that are regulated by primary Federal financial regulatory agency that have assets of more than $10 billion in assets are required to conduct annual stress tests.  All entities required to conduct a stress test must submit a report regarding the test to the Fed and its primary financial regulatory agency in the form specified by the primary financial regulatory agency. 

Each Federal primary financial regulatory authority, in coordination with the Fed and the Federal Insurance Office, is required to issue consistent regulations regarding the conduct and reporting of stress tests and requiring companies to publish the results of their stress tests. 

 

1.2.1.1.8.    Leverage Limitation in Urgent Circumstances. 

The Fed shall require a Company to maintain a debt to equity ratio of no more than 15 to 1 if the Oversight Council determines that it poses a grave threat to the financial stability of the U.S. and the imposition of such a requirement is necessary to mitigate the risks posed by the Company.  The Federal Home Loan Banks are exempted from the application of this provision. [§ 165(j)]

 

The Fed is required to issue regulations to establish procedures and timelines for complying with the leverage limitation.

 


                        1.2.1.1.9.          Inclusion of Off-Balance-Sheet Activities in Computing Capital Requirements. 

Under this provision, the calculation of a Company's capital for purposes of meeting capital requirements shall take into account any off-balance-sheet activities of the company.  Off-sheet-balance activities are defined as an existing liability of a company that is not currently a balance sheet liability, but may become one upon the happening of some future event, including: (i) standby letters of credit, (ii) sale and repurchase agreements, (iii) asset sales with recourse against the seller, and (iv) interest rate swaps.  If the appropriate Federal banking agencies determine that an exemption from this requirement is appropriate, the Federal banking agencies may exempt a Company or any transaction from this requirement.      

1.2.1.2. Discretionary Standards.

The Fed is also given the discretion to implement, by regulation or order, certain additional requirements in regard to Companies.

1.2.1.2.1.          Contingent Capital.  After the Oversight Council submits its report on contingent capital to Congress, the Fed may issue regulations that require Companies to maintain a minimum amount of long-term hybrid debt convertible to equity in times of financial distress – contingent capital.  In making any determination regarding contingent capital, the Fed is directed to consider, among other things, the Oversight Council's study and its recommendations regarding contingent capital and an appropriate transition period for the implementation of a conversion. [§ 165(c)] 

1.2.1.2.2.           Enhanced Public Disclosures.  The Fed may issue regulations which require periodic public disclosures by Companies in order to support market evaluation of their risk profile, capital adequacy, and risk management. [§ 165(f)]

1.2.1.2.3.          Limiting Short-term Debt.  The Fed is authorized to issue a regulation limiting the amount of short-term debt, including off-balance sheet exposures that a Company may accumulate.  Short-term debt shall be defined by the Fed by regulation, but shall exclude insured deposits.   The Fed is authorized to grant Companies that do not control an insured depository institution an exemption from, or adjustment to, any short-term debt limits. [§ 165(g)]

1.2.2.                Early Remediation Requirements for Companies. 

The Fed, in consultation with the Oversight Council and the FDIC, is required to issue regulations establishing requirements to provide for the early remediation of financial distress of a Company.  The Act states that nothing in this provision authorizes the provision of financial assistance from the Federal Government. [§ 166]   This provision is similar in concept to the Prompt Corrective Action provisions of the Federal Deposit Insurance Act ("FDI Act") that apply to insured depository institutions.

The Fed's regulations are to establish a series of specific remedial actions to be taken by a Company that is experiencing financial distress with the intention of minimizing the probability that the Company will become insolvent and the potential harm of such insolvency to the financial stability of the U.S.  The regulations are required to establish measures of the financial condition of a Company, including regulatory capital and liquidity.  The regulations must impose increasing restrictions as a Company's financial decline becomes more severe.  In the initial stages of financial decline, the regulations are to include limits on capital distributions, acquisitions and asset growth.  In the later stages of financial decline, the regulations are to include a requirement for a capital restoration plan, limits on transactions with affiliates, management changes and asset sales.

1.2.3.    How Can A "Grave Threat" to U.S. Financial Stability Posed by a Company be Addressed? 

If the Fed determines that a Company poses a "grave threat" to U.S. financial stability, the Fed, with the approval of the members of Oversight Council, must limit the Company's ability to merge with or acquire another company, restrict its ability to offer a financial product or products, impose conditions on the Company's conducting one or more activities, require the Company to terminate one or more activities, or, if the Fed determines such actions to be inadequate to mitigate the threat, require the Company to transfer assets or off-balance-sheet items to an unaffiliated third party. 

A Company subject to any such proposed action may request a hearing.  In making its decision, the Fed must take into account the factors that are considered in a determination to designate a company as a Significant Nonbank.  The Fed may adopt regulations regarding the application of this provision to foreign Significant Nonbanks and foreign BHCs, giving due regard to the principle of national treatment and equality of competitive opportunity and taking into account the extent to which the affected companies are subject to comparable home country standards applied on a consolidated basis. [§ 121]

1.2.4.    New Requirements Regarding Acquisitions. 

A Company may not acquire direct or indirect ownership or control of any voting shares of any company (other than an insured depository institution) that is engaged in financial activities under Section 4(k) of the BHC Act that has consolidated assets of $10 billion or more without prior notice to the Fed. [§ 163(b)]

A Company will be required to provide prior notice to the Fed in connection with certain nonbank acquisitions that would otherwise not require prior notice.  In reviewing a nonbank acquisition the Fed is directed to consider the extent to which the proposed acquisition would result in greater or more concentrated risks to global or U.S. financial stability or the U.S. economy.          

1.2.5.    Expanded Application of Interlocks Prohibitions.  A Significant Nonbank will be treated as a BHC for purposes of the Depository Institutions Management Interlocks Act.  Under this provision the Fed is prohibited from exercising its authority to permit service by a management official of a Significant Nonbank as a management official of a Large BHC or a Significant Nonbank (other than for a temporary exemption for interlocks resulting from a merger, acquisition, or consolidation). [§ 164]

1.2.6.      Expanded Examination Authority for the FDIC.  The FDIC is given the authority to examine any Company when it determines that a special examination is necessary to determine the condition of the Company for the purpose of implementing its authority to provide for orderly liquidation of such a Company under Title II of the Act. [§ 172]    The FDIC is prohibited from exercising such authority with respect to a Company that is in a generally sound condition. 

1.2.6.1.     FDIC Backup Enforcement Authority.  The Act amends the FDIC's backup enforcement authority to provide that the FDIC may take backup enforcement action if the conduct or threatened conduct of a depository institution holding company poses a risk to the Deposit Insurance Fund.  This authority is subject to the limitation that such authority may not be used with respect to a depository institution holding company that is in generally sound condition and whose conduct does not pose a foreseeable and material risk of loss to the Deposit Insurance Fund.    

1.2.7.     Timing of Issuance of Final Regulations.  The Act provides that the Fed shall have the authority to issue regulations to implement the subtitles of the Title I other than the subtitle related to the OFR.  It further provides that except as otherwise specified, the Fed shall issue final regulations not later than 18 months after the effective date of the Act. [§ 168]