Enhanced Prudential Standards for Large U.S.
Bank Holding Companies
March 24, 2014
The U.S. Federal Reserve Board recently issued final rules to implement certain “enhanced
prudential standards” for large U.S. bank holding companies with $50 billion or more in total
consolidated assets. Certain of these requirements—notably, risk committee and capital stresstesting requirements—also apply to certain bank holding companies with $10 billion or more in
total consolidated assets.
The final rules, which were issued on February 18, 2014, come two years after the Federal
Reserve issued proposed rules with respect to such domestic bank holding companies. 1 In
contrast to the proposed rules, the final rules implement only portions of Section 165 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) relating
to risk management, capital and leverage, liquidity, stress testing and debt-to-equity limits.
Other aspects of the proposed rules, such as single-counterparty credit limits and Section 166’s
early remediation framework, remain under development, according to the Federal Reserve.
Also, the final rules do not address short-term debt limits, which the Federal Reserve continues
to evaluate, or resolution planning requirements, which were adopted in separate rulemakings. 2
Enhanced prudential standards for nonbank financial companies that are designated by the
Financial Stability Oversight Council (“FSOC”) for Federal Reserve supervision due to theirsystemic importance (“nonbank SIFIs”) are not included in the final rules. Instead, the Federal
Reserve will apply standards to these institutions through a subsequently issued order or rule
following an evaluation of the business model, capital structure and risk profile of eachnonbank SIFI. In addition, savings and loan holding companies (“SLHCs”) are not covered by
the final rules (except that certain SLHCs may need to comply with capital stress testing
requirements).
According to Federal Reserve Governor Daniel K. Tarullo, the adoption of these rules is“another component” of an “ongoing effort under Section 165 of the Dodd-Frank Act to put inplace a set of prudential standards for large banking organizations that become progressively
more stringent as the systemic importance of the regulated entity increases.” A number of otherimportant rules—relating to capital surcharges, a supplemental leverage ratio, minimum levels

1

For a summary of the proposed rules, please see our memorandum titled, “Regulating Systemically
Important Financial Companies,“ dated January 10, 2012, available at http://www.stblaw.com/aboutus/news/details?id=9f945a72-f546-4ba5-ab5c-d19a47eeaec9.

2

Resolution planning, or “living will,” requirements were adopted by the Federal Reserve and theFederal Deposit Insurance Corporation in 2011 and 2012, respectively. See Regulation QQ (76 Fed.
Reg. 67323 (Nov. 1, 2011)) and 12 C.F.R. § 360.10 (77 Fed. Reg. 3075 (Jan. 23, 2012)).

Memorandum – March 24, 2014of long-term debt, and quantitative liquidity standards—are expected to be finalized or
proposed in the “coming months.”A.

SCOPE OF APPLICATION

The final rules impose the following requirements on U.S. bank holding companies, generally
depending on whether they have at least $10 billion in total consolidated assets or at least $50
billion in total consolidated assets.
Total
Consolidated
AssetsRequirements> $10 billion

Must:• Have a risk committee (if publicly traded and with at least $10
billion)• Perform annual company-run stress test (if over $10 billion)> $50 billion

B.

All of the above, plus:• Must have a risk committee (even if not publicly traded) andchief risk officer• Liquidity requirements, including:oLiquidity risk management requirementsoLiquidity stress testing requirementsoLiquidity buffer requirements• Potential additional risk-based capital and leverage
requirements (common equity capital surcharge, additional
leverage capital buffer, etc.)• Annual supervisory and annual/mid-cycle company-run stresstests• Potential debt-to-equity limits (upon “grave threat”
determination)

COMPLIANCE TIMINGFor U.S. bank holding companies (“BHCs”) that have a class of stock that is publicly traded andhave total consolidated assets of $10 billion or more as of June 30, 2014, risk management andliquidity requirements apply beginning on July 1, 2015. For publicly traded BHCs with $10
billion or more thereafter, compliance begins on the first day of the ninth quarter following thedate on which they met or exceeded this asset threshold.
For BHCs that have total consolidated assets of $50 billion or more as of June 30, 2014, risk
management and liquidity requirements apply beginning on January 1, 2015. For BHCs with$50 billion or more thereafter, compliance begins on the first day of the fifth quarter following
the date on which they met or exceeded this asset threshold.
For BHCs that meet or exceed the $50 billion threshold and are controlled by a foreign banking
organization (“FBO”), domestic risk management and liquidity requirements apply fromPage 2

Memorandum – March 24, 2014

January 1, 2015 to June 30, 2016. 3 Beginning on July 1, 2016, U.S. intermediate holding
companies established by FBOs must comply with the risk management and liquidity
requirements under the Federal Reserve’s rules applicable to FBOs. These rules were also
issued on February 18, 2014. 4
Other enhanced prudential requirements, such as those relating to capital stress testing andresolution planning, have detailed phase-in considerations, but are not the primary focus of thismemorandum.
C.

RISK MANAGEMENT REQUIREMENTS

Section 165(b) of Dodd-Frank requires the Federal Reserve to establish overall risk management
requirements for BHCs with total consolidated assets of $50 billion or more, while Section
165(h) requires the Federal Reserve to issue regulations requiring publicly traded BHCs withtotal consolidated assets of $10 billion or more to establish risk committees. Dodd-Frank also
authorizes, but does not require, the Federal Reserve to impose the risk committee requirementon all publicly traded BHCs, regardless of their asset size. Under Dodd-Frank, a risk committee
is responsible for the oversight of risk management practices on an enterprise-wide basis.
The final rules extend the risk committee requirement to all publicly traded BHCs with total
consolidated assets of $10 billion or more but less than $50 billion. Accordingly, the Federal
Reserve has not exercised its statutory authority to impose the risk committee requirement on
all publicly traded BHCs. As discussed below, the final rules also require large BHCs with $50
billion or more in total consolidated assets to have a stand-alone risk committee, as well as achief risk officer, regardless of whether such BHCs have a class of stock that is publicly traded.
In the preamble commentary accompanying the final rules, the Federal Reserve emphasizedthat the risk committee and overall risk management requirements in the final rules
supplement, but do not replace, existing risk management guidance and supervisory
expectations, including under the Federal Reserve’s Supervision and Regulation Letter SR 08-8.
1. Risk Committee
The final rules require (i) publicly traded BHCs with total consolidated assets of $10 billion ormore but less than $50 billion and (ii) BHCs with total consolidated assets of $50 billion or more
(publicly traded or not) to establish and maintain a risk committee that approves andperiodically reviews the risk management policies of the BHC’s global operations and oversees
3

Because certain FBOs are required to form a top-tier U.S. intermediate holding company for their U.S.
operations that complies with separate liquidity requirements beginning July 1, 2016, BHCs that are
subsidiaries of FBOs no longer need to comply independently with the domestic liquidity
requirements of the final rules after June 30, 2016.

4

For a summary of the enhanced prudential standards for FBOs, please see our memorandum titled,“Federal Reserve Issues Final Regulations on Enhanced Prudential Standards for Foreign Banking
Organizations,“ dated February 25, 2014, available at http://www.stblaw.com/aboutus/news/details?id=01e6b595-b636-4230-b7f4-b1f236e7d358.

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Memorandum – March 24, 2014

the operation of its “global risk management framework.” For a BHC with $50 billion or morein total consolidated assets, the risk committee’s responsibilities also include the requirement toapprove the BHC’s contingency funding plan (including any material revisions prior to
implementation), which is discussed in Section D.1 of this memorandum.
a. Governance and Composition Requirements
The risk committee must:
•
•
•

•

have a formal, written charter approved by the BHC’s board of directors;
meet at least quarterly (or more frequently if necessary) and fully document andmaintain records of such proceedings, including risk management decisions;have at least one member 5 who has “experience in identifying, assessing, andmanaging risk exposures” of large, complex firms (in the case of smaller, public
BHCs) or large, complex financial firms (in the case of large BHCs with at least$50 billion in assets); 6 andbe chaired by a director who meets certain independence requirements.

With regard to the independence of the risk committee’s chair, the final rules require that thedirector:•••

not be an officer or employee of the BHC and not have been an officer or
employee of the BHC during the previous three years;
not be a member of the “immediate family” (as defined in Section 225.41(b)(3) of
the Federal Reserve’s Regulation Y) of a person who is, or has been within thelast three years, an “executive officer” of the BHC (as defined in Section
215.2(e)(1) of the Federal Reserve’s Regulation O); andqualify as an “independent” director under Item 407 of the SEC’s Regulation S-K(if the BHC has an outstanding class of securities traded on a national securities
exchange) or be an individual who would qualify as an independent director
under the listing standards of a national securities exchange, as demonstrated tothe satisfaction of the Federal Reserve (if the BHC does not have an outstandingclass of securities traded on a national securities exchange).

Although only the chair of the risk committee is required to be independent, the Federal
Reserve “encourages” BHCs to consider having additional independent directors as members,
5

Even though only one member must have risk management-related expertise, the Federal Reserve
expects all risk committee members to have a general understanding of risk management principles
and practices relevant to the particular BHC. Also, the Federal Reserve expects a BHC that poses“more systemic risk” to have “more risk committee members with commensurately greater
understandings of risk management principles and practices.”

6

For smaller, publicly traded BHCs, an individual’s risk management experience in a nonbanking or
nonfinancial field may fulfill this requirement. For larger BHCs, the Federal Reserve has stated that afinancial firm may include a bank, securities broker dealer or insurance company, provided that theindividual’s experience at such firm is relevant to the particular risk facing the BHC.
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Memorandum – March 24, 2014

with the “appropriate proportion” determined by the BHC based on its size, scope andcomplexity. Also, the Federal Reserve acknowledged that the involvement of directors
affiliated with the BHC on the risk committee may complement the involvement of
independent directors.
For a large BHC with at least $50 billion in total consolidated assets, its risk committee must
also:
•
•

•

be a stand-alone, independent committee of the BHC’s board of directors (rather
than a joint risk/audit or risk/finance committee, for example);have as its “sole and exclusive function” the responsibility for the BHC’s risk
management policies and oversight of the operation of the BHC’s global risk
management framework; andreport directly to the BHC’s board of directors.

As such, while the risk committee would be prevented from having other substantive
responsibilities at the parent BHC-level, it would not be prevented from serving as the risk
committee for one or more subsidiaries of the BHC as long as the requirements of the final rules
are otherwise satisfied. Also, the Federal Reserve clarified, in its preamble commentary, thatthe risk committee may have members who are on other board committees and that other board
committees, such as audit or finance, may have some involvement in establishing a BHC’s risk
management framework.
b. Oversight of the Global Risk Management Framework
Each BHC must have a global risk management framework that is commensurate to its
structure, risk profile, complexity, activities and size. A BHC’s risk committee “oversees theoperation of” the framework, although the final rules do not specify whether such framework
must be established by the BHC’s board of directors or the risk committee. The final rules arelargely similar to the proposed rules on what the framework must address, except that the final
rules do not require specific risk limitations on each business line of the BHC.
Each BHC’s global risk management framework must include:
•

•
•

•

policies and procedures establishing risk management governance, risk
management procedures and a risk control infrastructure for the BHC’s global
operations;processes and systems for implementing and monitoring compliance with suchpolicies and procedures;processes and systems for identifying and reporting risks and risk management
deficiencies, including emerging risks, and ensuring effective and timely
implementation of actions to address emerging risks and risk management
deficiencies for its global operations;processes and systems for establishing managerial and employee responsibility
for risk management;

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Memorandum – March 24, 2014••

processes and systems for ensuring the independence of the risk management
function; andprocesses and systems to integrate risk management and associated controls withmanagement goals and the BHC’s compensation structure for its global
operations.
2. Chief Risk Officer

BHCs with total consolidated assets of $50 billion or more must appoint a chief risk officer(“CRO”) with experience in identifying, assessing and managing risk exposures of large,
complex financial firms. According to the preamble, the Federal Reserve expects a BHC to beable to demonstrate that the CRO’s experience is relevant to the particular risks facing the BHC
and commensurate with its structure, risk profile, complexity, activities and size.
The CRO is responsible for overseeing:•••

the establishment of risk limits on an enterprise-wide basis and the monitoring ofcompliance with such limits;
the implementation of and ongoing compliance with risk management policies
and procedures, as well as the development and implementation of related
processes and systems to monitor compliance; andthe management of risks and risk controls within the parameters of the BHC’s
risk control framework, including the monitoring and testing of such controls.

The CRO is to report directly to both the risk committee and the chief executive officer andprovide the risk committee with quarterly reports. The CRO must also be compensated andincentivized in a manner that will enable him or her to provide an “objective assessment” of therisks taken by the BHC. According to the preamble, the Federal Reserve does not regard thisrequirement as preventing a BHC from using discretion in adopting a compensation structure
for its CRO, whether through its compensation committee or otherwise, as long as the CRO’sability to provide an objective assessment is not compromised. Also, this requirement
supplements existing Federal Reserve guidance on sound incentive compensation, which
cautions that incentive compensation received by employees in risk management and control
functions should not be based substantially on the financial performance of the business units
they overview.
D.

LIQUIDITY REQUIREMENTS

Dodd-Frank directs the Federal Reserve to establish liquidity standards for BHCs with total
consolidated assets of $50 billion or more. The final rules subject these companies to a set ofenhanced liquidity risk management standards, liquidity stress testing requirements andliquidity buffer requirements, which build on guidance previously adopted by the Federal
Reserve and other U.S. federal banking agencies.
The Federal Reserve noted in the preamble that it intends to use the supervisory process to
supplement the final rules with horizontal reviews of the internal stress-testing methods,
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Memorandum – March 24, 2014

liquidity risk management, and liquidity adequacy of the largest, most complex BHCs. The
Federal Reserve also noted that it is considering adopting a short-term debt limit.
1. Enhanced Liquidity Risk Management Standards
BHCs with $50 billion or more of total consolidated assets are subject to enhanced liquidity risk
management standards that build on the Federal Reserve’s existing supervisory guidance.
These companies must take a number of prudential steps to manage liquidity risk:•

Cash-flow Projections—The BHC must produce comprehensive cash-flow
projections, using reasonable assumptions and detail sufficient to reflect thecapital structure, risk profile, size and complexity of the BHC, of cash flows
arising from assets, liabilities and off-balance sheet exposures over short-termtime horizons (updated daily) and long-term horizons (updated monthly). In thepreamble to the final rules, the Federal Reserve noted that more frequent cashflow reports may be appropriate for companies with more complex risk profiles
or for all companies in times of stress.

•

Contingency Funding Plan—The BHC must maintain, and at least annually
update, a contingency funding plan commensurate with the BHC’s capital
structure, risk profile, size and complexity, setting forth strategies for addressing
liquidity needs during stress events. Generally, the plan must identify potential
liquidity stress events and their impacts on the BHC, assess available funding
sources (including alternative funding sources) and funding needs during a
stress event, specify an “action plan” that clearly describes the strategies to be
employed to manage liquidity during a stress event, and include procedures formonitoring emerging stress events. The BHC must periodically test thecomponents of the contingency funding plan to ensure its reliability in a stressevent, including simulations to test communications and decision-making bymanagement, and tests of the methods the BHC will use to secure funding. In
the preamble to the final rules, the Federal Reserve stated that a BHC may
incorporate into its contingency funding plans as potential sources of credit: (i)lines of credit, including Federal Home Loan Bank advances, provided that theplan incorporates the characteristics of such credit in times of liquidity stress;and (ii) discount window credit, provided that the plan describes the actions thatwould be taken to replace such funding with more permanent funding.

•Liquidity Risk Limits—The BHC must establish appropriate limits on liquidity riskthat include (i) concentrations in various categories of funding sources, including
by instrument type or counterparty type, single counterparty, and secured andunsecured funding; (ii) the amount of liabilities that mature within various time
horizons; and (iii) off-balance sheet and other exposures that could create
funding needs during stress events.

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Memorandum – March 24, 2014•

Liquidity Risk Monitoring—The BHC must establish procedures for monitoring its
collateral positions (at least weekly), levels of unencumbered assets available tobe pledged and intraday liquidity risk exposure.

The final rules include a long list of affirmative steps that the board of directors andmanagement of a BHC must take to oversee these liquidity risk management programs:•

Role of Board of Directors and its Risk Committee—The board of directors must (i)approve, at least annually, the BHC’s acceptable liquidity risk tolerance, taking
into account the BHC’s capital structure, risk profile, complexity, activities, andsize; (ii) review, at least semi-annually, information provided by senior
management to assess whether the BHC is operating in accordance with its
liquidity risk tolerance; and (iii) approve and periodically review the liquidity
risk management strategies, policies and procedures established by senior
management. Additionally, the risk committee of the board of directors must
approve, at least annually, the contingency funding plan, which responsibility
had been the board’s under the proposed rules.

•

Role of Senior Management—Senior management of the BHC must (i) establish andimplement strategies, policies and procedures designed to effectively manage therisk that the BHC’s financial condition would be adversely affected by its
inability or the market’s perception of its inability to meet its cash and collateralobligations; (ii) oversee the development of liquidity risk management systems;(iii) determine, at least quarterly, whether the BHC is operating in accordancewith such procedures; (iv) report, at least quarterly, to the board of directors
regarding the BHC’s liquidity risk profile and liquidity risk tolerance; (v)approve new products and business lines and evaluate the liquidity costs,
benefits and risks of each new product and business line that could have asignificant effect on the BHC’s liquidity risk profile, in each case before the new
product or business line is offered; (vi) review, at least annually, significant
products and business lines to determine whether they have created any
unanticipated liquidity risk; (vii) review, at least quarterly, the BHC’s cash flow
projections for conformance with the BHC’s liquidity risk tolerance; (viii)
establish liquidity risk limits and review compliance with those limits at least
quarterly; and (ix) at least quarterly, approve liquidity stress testing practices,
review stress testing results, and approve the size and composition of theliquidity buffer, and periodically, review the independent review of the stresstests.

•

Independent Review Function—The BHC must have a review function,
independent of management functions that execute funding (i.e., independent of
its treasury operations), to evaluate liquidity risk management. This function
must meet regularly, but no less frequently than annually, to review theeffectiveness of the BHC’s liquidity risk management processes, including stresstesting, assess whether the BHC’s liquidity risk management function complies

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Memorandum – March 24, 2014

with applicable law and sound business practices, and report material liquidity
risk management issues to the board or its risk committee.
2. Liquidity Stress Testing
A BHC with $50 billion or more in total consolidated assets must conduct stress tests under anumber of stress scenarios and time horizons to assess the potential impact on the BHC’s cash
flows, liquidity position, profitability and solvency. Stress tests must be conducted at least
monthly and must be tailored to the BHC’s capital structure, risk profile, complexity, activities
and size. Each test must include scenarios reflecting: (i) adverse market conditions, (ii) an
idiosyncratic stress event for the BHC, (iii) a combination of market and idiosyncratic stresses,and (iv) any additional stress scenarios that would be appropriate based on the financial
condition and individual characteristics of the BHC. Each test must cover planning horizons(i.e., lengths of time over which the stress projection extends) of: (a) an overnight horizon, (b) 30
days, (c) 90 days, (d) one year, and (e) any other time period appropriate for the particular BHC.
Additionally, the BHC must establish a system of controls and oversight over stress testingprocesses to ensure that each stress test appropriately incorporates “conservative” assumptions,which must be approved by the BHC’s U.S. CRO.
The final rules provide some guidance about the assets and liabilities to be incorporated into
stress test results (and, by extension, liquidity management planning). Assets used as cash-flow
sources must be diversified by collateral, counterparty, borrowing capacity, and other factors
associated with an asset’s liquidity risk. To the extent an asset is used as a cash flow source inthe stress tests, it must be discounted to reflect any credit risk or market volatility. A line ofcredit does not qualify as a cash flow source for any stress test with a planning horizon of 30days or less, but may count as a cash flow source for any longer planning horizon. Noting thatsome banks provided unanticipated liquidity support to their sponsored funds and similar
conduits in the recent financial crisis, the Federal Reserve stated in the preamble that suchvehicles must be incorporated into stress test results.
3. Liquidity Buffers
A BHC with $50 billion or more in total consolidated assets must maintain a liquidity buffer
sufficient to meet its projected net stressed cash-flow need over the 30-day planning horizon
under each stress scenario identified above. 7 The buffer must consist of highly liquid,
unencumbered assets, discounted to fair market value.
Highly liquid assets include cash and securities issued or guaranteed by the United States, aU.S. government agency or a U.S. government-sponsored enterprise (“GSE”). Additionally, a
BHC may demonstrate to the Federal Reserve that any other asset is a highly liquid asset if it:••

7

has low credit risk and market risk;
is traded in an active secondary two-way market with committed market makers
and independent bona fide offers to buy and sell, such that a price reasonably
The net stressed cash-flow need is the difference between the amount of the BHC’s cash-flow
need and the amount of its cash flow sources over the 30-day horizon.
Page 9Memorandum – March 24, 2014•

related to the last sales price or current bona fide competitive bid and offer
quotations can be determined within one day and settled at that price within areasonable time period conforming with trade custom; andis a type of asset that investors historically have purchased in periods of financial
market distress with impaired market liquidity. 8

Unencumbered assets are those that (i) are free of legal, regulatory, contractual or otherrestrictions on the ability of the BHC to promptly sell or transfer them; and (ii) are not pledged
or used to secure or provide credit enhancement to any transaction, except for any pledge to acentral government or GSE to the extent potential credit secured by the asset is not currently
extended by such central bank or GSE. 9 The buffer may not contain a “significant
concentration” of any type of high-quality asset as measured by a number of characteristics,
except for cash and securities issued or guaranteed by the United States, a U.S. government
agency or GSE. The final rules do not define “significant concentration.”In the preamble to the final rules, the Federal Reserve stated that the BHC should periodicallymonetize a representative portion of its highly liquid assets, through repo or outright sale, inorder to test its access to the market. The Federal Reserve also noted that in circumstances thatwould be beneficial to the safety and soundness of the BHC, the BHC may, in consultation withsupervisors, temporarily reduce the amount of highly liquid unencumbered assets in its
liquidity buffer below the amount required to withstand the 30-day stress scenarios.
E.

CAPITAL AND LEVERAGE REQUIREMENTS

The final rules include a placeholder provision subjecting BHCs with total consolidated assets
of $50 billion or more to any applicable capital planning and stress testing regulations adopted
by the Federal Reserve.
In July 2013, the Federal Reserve released a final rule implementing capital standards under the
Basel III international framework that represented a significant re-working of existing U.S.
regulation of bank capital. 10 Also in July 2013, the Federal Reserve issued a proposal that would
8

In response to comments requesting clarification on the treatment of reverse repo transactions
secured by highly liquid assets, the Federal Reserve stated in the preamble that if a BHC is able torehypothecate collateral that it holds that has pledged to it to secure a loan, but has not done so, it
may count that collateral as a qualifying asset.

9

While the final rules do not make it explicit, the preamble clarifies that an asset used as a hedge
position may qualify as an unencumbered asset.

10

New Regulation Q (12 C.F.R. Part 217) sets forth the Federal Reserve’s revised capital framework,
as adopted in July 2013. See 78 Fed. Reg. 62157 and 62285 (Oct. 11, 2013). For a summary of therevised capital framework, please see our memorandum titled, “Federal Reserve Adopts Final
U.S. Bank Capital Standards Under Basel III,“ dated July 8, 2013, available at
http://www.stblaw.com/about-us/news/details?id=55abe6b4-d81a-4e3c-9cb4-7fd02835c9eb.
Among other things, the revised capital framework introduced a new minimum Common Equity
Tier 1 ratio of 4.5%, raised the minimum Tier 1 capital ratio from 4% to 6%, and will subject allbanking organizations to meet a 4% minimum leverage ratio. So-called “advanced approaches”
banking organizations (generally those with consolidated total assets of at least $250 billion orPage 10Memorandum – March 24, 2014

require U.S. top-tier BHCs with more than $700 billion in total consolidated assets or $10 trillion
in assets under custody to maintain a supplemental leverage buffer of at least 2% above theminimum supplementary leverage capital requirement of 3%. 11 Compliance would benecessary to avoid restrictions on capital distributions and discretionary bonus payments to
executive officers. Additionally, the Federal Reserve noted in the preamble to the final rulesthat it expects to propose additional prudential rules for large BHCs in the future, including aquantitative risk-based capital surcharge, for globally systemically important banks (“G-SIBs”)
identified by the Financial Stability Board. 12
F.

CAPITAL STRESS TESTING REQUIREMENTS

Section 165(i) of Dodd-Frank mandated that a set of forward-looking “stress tests” be conductedboth by the Federal Reserve and by financial companies regulated by the Federal Reserve,
including large BHCs with total consolidated assets of $50 billion or more, nonbank SIFIs, and
SLHCs and state member banks with total consolidated assets of more than $10 billion. Suchtests are intended to determine whether a particular institution has adequate capital to weather
a severe economic downturn.
In October 2012, the Federal Reserve finalized theimplementation of these Dodd-Frank stress testing requirements (“DFAST”). 13 Under theFederal Reserve’s DFAST rules, BHCs with total consolidated assets of $50 billion or more andnonbank SIFIs must undergo an annual supervisory stress test, as well as annual and mid-cycle
company-run stress tests. For BHCs with total consolidated assets between $10 billion and $50
billion and SLHCs and state member banks with total consolidated assets of more than $10
billion, only annual company-run stress tests are required. Compliance dates are not uniform,
as there are important phase-in considerations based on asset size, nonbank SIFI status, andwhether a U.S. BHC is currently relying on the Federal Reserve’s Supervision and Regulation
Letter SR 01-1.

consolidated total on-balance sheet foreign exposures of at least $10 billion) would need to meet a
supplementary leverage ratio of 3% (that is, on top of the 4% minimum leverage ratio).
11

See 78 Fed. Reg. 51101 (Aug. 20, 2013).

12

According to the preamble, the G-SIB capital surcharge would be based on the Basel Committeeon Banking Supervision’s approach and implementation timeframe. In July 2013, the BaselCommittee published its methodology for assessing and identifying G-SIBs, including the“additional loss absorbency requirements” that will eventually apply to such institutions and thatwill take the form of a common equity surcharge, ranging initially from 1% to 2.5% of a G-SIB’s
total risk-weighted assets. See “Global Systemically Important Banks: Updated Assessment
Methodology and the Higher Loss Absorbency Requirement” (July 2013), available at
http://www.bis.org/publ/bcbs255.pdf. Since November 2011, the Financial Stability Board has
annually published a list of G-SIBs, placing each in one of four common equity capital surcharge
buckets. In November 2013, the Financial Stability Board identified 29 G-SIBs on the basis of theBasel Committee’s July 2013 methodology, including eight U.S. bank holding companies.

13

77 Fed. Reg. 62378 & 62396 (Oct. 12, 2012). Concurrent with the release of the Federal Reserve’s
DFAST rules, the Federal Deposit Insurance Corporation and the Office of the Comptroller of theCurrency adopted similar rules for the insured depository institutions that they supervise. See 77
Fed. Reg. 61238 (Oct. 9, 2012); 77 Fed. Reg. 62417 (Oct. 15, 2012).
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Memorandum – March 24, 2014

Generally, for large banking organizations with total consolidated assets of $50 billion or more,scenarios for a given cycle’s supervisory and annual company-run stress tests are released by
November 15 of each year, with the filing of company-run regulatory reports by January 5. As
required by Dodd-Frank, the scenarios will describe hypothetical baseline, adverse and severely
adverse conditions, with projections for key macroeconomic and financial variables (such asreal GDP, the unemployment rate, and equity and property prices). These banking
organizations must disclose their results in the period between March 15 and March 31. For thesupervisory stress tests conducted by the Federal Reserve, results are communicated directly tothe banking organization by March 31, with summary results published by the Federal Reserveby March 31.
The final rules do not make any changes to the Federal Reserve’s previously issued DFAST
rules. The DFAST rules are simply re-codified within the Federal Reserve’s Regulation YY.
G.

DEBT-TO-EQUITY LIMITS

Under Section 165(j) of Dodd-Frank, if the FSOC determines that a BHC with total consolidated
assets of $50 billion or more (i) poses a “grave threat” to U.S. financial stability and (ii) the
imposition of a debt-to-equity limitation is “necessary to mitigate” that threat, then the Federal
Reserve must require the company to maintain a debt-to-equity ratio of no more than 15-to-1.
The final rules define “debt” and “equity” as having the same meaning as “total liabilities” and“total equity capital,” respectively, as calculated in a company’s reports of financial condition.
The 15-to-1 debt-to-equity ratio is calculated as the ratio of total liabilities to total equity capitalminus goodwill.
A BHC that is subject to a “grave threat” determination by the FSOC will receive written noticefrom the FSOC. After receiving such notice, the BHC will have 180 calendar days to come into
compliance with the prescribed debt-to-equity ratio requirement, although it may seek up to
two extensions of 90 days each. The debt-to-equity ratio requirement will remain in effect until
the FSOC determines that a particular BHC no longer poses a grave threat to U.S. financial
stability and that the imposition of the leverage limitation is no longer necessary.
H.

FUTURE ENHANCED PRUDENTIAL RULES

Sections 165 and 166 of Dodd-Frank require the Federal Reserve to issue regulations to
implement a number of enhanced prudential standards for BHCs with $50 billion or more in
total consolidated assets and for nonbank SIFIs. The final rules do not include enhanced
prudential standards for nonbank SIFIs or implement several key enhanced prudential
standards listed in the statute.
1. Application to Nonbank SIFIs
While the proposed rules would have generally subjected nonbank SIFIs to the same enhanced
prudential standards as those applicable to large BHCs, the final rules do not apply to nonbank
SIFIs. In the preamble, the Federal Reserve recognized that nonbank SIFIs may have a range ofbusinesses and structures and that the enhanced prudential standards applicable to large BHCs
may not be appropriate for all nonbank SIFIs. Instead, the Federal Reserve will thoroughly
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Memorandum – March 24, 2014assess the business, capital structure and risk profile of each nonbank SIFI to determine whether
and how enhanced prudential standards should apply, and will tailor the standards to eachnonbank SIFI or category of nonbank SIFI. However, for those nonbank SIFIs that are similar in
activities and risk profile to BHCs, the Federal Reserve expects to apply similar standards as
those that apply to large BHCs.
In particular, the application of capital requirements to insurance companies—whether they
have been designated as nonbank SIFIs or are SLHCs—raises significant policy issues in light ofthe distinctions in the business models and risk profiles of insurance companies and banking
organizations. Indeed, many prominent members of Congress, including Senator Susan
Collins—the sponsor of the so-called “Collins Amendment,” or Section 171 of Dodd-Frank,which generally mandates that risk-based capital and leverage requirements not be “less than”
the capital and leverage requirements applied to insured depository institutions—have urged
the Federal Reserve to give appropriate consideration to such distinctions when establishingcapital regulation for affected insurance companies. On March 11, 2014, a subcommittee of the
Senate Committee on Banking, Housing, and Urban Affairs heard testimony from Senator
Collins, as well as from industry, policy and academic witnesses, on the need to find the “right”
way to impose capital requirements on insurance companies. 14 It remains to be seen whatcourse the Federal Reserve will take in applying capital requirements to insurance companies
and whether concerns regarding the inappropriateness of “bank centric” capital regulation will
be sufficiently addressed.
2. Single Counterparty Credit Limits
Section 165(e) of Dodd-Frank directs the Federal Reserve to establish standards that prohibit alarge BHC or nonbank SIFI from having credit exposure to any unaffiliated company thatexceeds 25% of the BHC or nonbank SIFI’s capital stock and surplus (or such lower threshold ifnecessary to mitigate risks to U.S. financial stability). The proposed rules implemented thisrequirement with (i) a general limit on net credit exposures of a large BHC or nonbank SIFI to asingle unaffiliated counterparty, and (ii) a more stringent limit applicable to net credit
exposures between a BHCs or nonbank SIFI with over $500 billion in consolidated assets and acounterparty with over $500 billion in consolidated assets. The final rules do not finalize single
counterparty credit limits, and the Federal Reserve noted in the preamble that before it does so,it intends to take into account global single exposure standards that the Basel Committee on
Banking Supervision is currently developing.
3. Early Remediation Framework
To minimize the probability that a large BHC or nonbank SIFI will become insolvent and thepotential harm of such insolvency to U.S. financial stability, Section 166 of Dodd-Frank directs
the Federal Reserve to establish a framework for the early remediation of financial distress of
14

See “Finding the Right Capital Regulations for Insurance Companies,” Hearing Before theSubcomm. on Financial Institutions and Consumer Protection of the Senate Committee on
Banking, Housing, and Urban Affairs, 113th Congress (Mar. 11, 2014), available at
http://www.banking.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=9974bd4e-f8ab-4e9a-940e-bfa8def6e737.
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Memorandum – March 24, 2014

large BHCs and nonbank SIFIs. While the proposed rules included an early remediation
framework, the final rules do not finalize these requirements.
4. Short Term Debt
Section 165(b) of Dodd-Frank permits the Federal Reserve to establish short-term debt limits forlarge BHCs and nonbank SIFIs. In the preamble to the final rules, the Federal Reserve notedthat it is continuing to evaluate the benefits to systemic stability of imposing short-term debt
limits.
***For more information about the Federal Reserve’s enhanced prudential requirements for U.S.
bank holding companies, please contact any of the members of our Financial Institutions Group,
as listed below.
Lee Meyerson(212) 455-3675
lmeyerson@stblaw.com

Maripat Alpuche(212) 455-3971
malpuche@stblaw.com

Mark Chorazak(212) 455-7613
mchorazak@stblaw.com

Randy Benjenk(212) 455-2307
randy.benjenk@stblaw.com

This memorandum is for general information purposes and should not be regarded as legal advice. Pleasecontact your relationship partner if we can be of assistance regarding these important developments. The
names and office locations of all of our partners, as well as our recent memoranda, can be obtained fromour website, www.simpsonthacher.com.
The contents of this publication are for informational purposes only. Neither this publication nor the lawyers who authored it are
rendering legal or other professional advice or opinions on specific facts or matters, nor does the distribution of this publication to
any person constitute the establishment of an attorney-client relationship. Simpson Thacher & Bartlett LLP assumes no liability inconnection with the use of this publication.

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Memorandum – March 24, 2014

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