Fed Rule Forcing Foreign Banks to Rethink U.S. Scope

WASHINGTON — A handful of large foreign banks are racing to try to wind down their U.S. assets below a $50 billion trigger to avoid new requirements the Federal Reserve Board plans to put in place next year.

Under rules issued last year, foreign banks above that threshold for U.S. assets not held in branches of the home office must align their U.S.-based bank and nonbank subsidiaries under a single "intermediate holding company," subject to strict capital rules and Fed-supervised stress tests by July 2016.

But if banks can get below the $50 billion trigger before July of this year, they would not have to form such a holding company. Their goal, if not to stay clear of the rule permanently, is to put off the requirement at least temporarily to provide some breathing room.

"Just like with any dollar threshold, some institutions are asking: 'Can we get under $50 billion in non-branch assets and therefore not have to comply with the IHC requirement, or can we get under it at least for a temporary time period because we want to build the IHC according to our own business schedule,'" said Sally Miller, the chief executive for the Institute of International Bankers.

At least one bank, Royal Bank of Scotland, which is in the process of divesting much of its U.S. holdings, appears on its way to avoiding the IHC requirement. Under a process whereby banks can request specific relief from the holding company requirement, the Fed granted RBS an extension that gives the bank until April of next year — instead of later this year — to fall below $50 billion. Another institution, Toronto-Dominion Bank, was not so lucky. The Fed denied the Canadian bank's request that it be allowed to hold a direct ownership interest in TD Ameritrade — a publicly traded U.S. broker-dealer — instead of transferring the interest to a new IHC.

One challenge in trying to reach the goal of avoiding an IHC designation is how liberal the Fed will be in including assets that count toward the threshold. The central bank is said to be counting certain relatively intangible assets such as financing structures and securitization vehicles.

"Since everything counts, people have been surprised by the things that can knock off your calculations," said Douglas Landy, a partner at Milbank, Tweed, Hadley & McCloy. "But there is some rationale to it in that those structures were a measure of instability in the last financial crisis once the markets dried up. People are concerned about how those things affect their calculations and are taking a good hard look at what they need to keep in the United States or not."

The Fed's rule imposed stepped up requirements on foreign firms with as little as $10 billion in consolidated assets. Those with at least $50 billion face tougher standards. An even stronger version was imposed on those with at least $50 billion in U.S. assets, including a liquidity buffer and the establishment of both a U.S. risk committee and a chief risk officer.

But much of the focus in implementing the rule has been on IHCs, which will be required for between 15 and 20 firms that exceed $50 billion of non-branch U.S. assets. The new holding company structure is meant to make the U.S. corporate entity more independent from its foreign parent and allow greater consolidated oversight of the U.S. bank and broker-dealer.

IHCs will follow the same Basel III capital requirements used for large U.S. banks, which are tougher than international standards. All IHCs will also be subject to the Fed's rigorous process of submitting capital plans to the central bank that are then tested under stressed scenarios. Their first capital plans will be due in January 2017, with their first stress tests coming in January 2018. Firms anticipating they will form IHCs were required to submit blueprints to the Fed at the beginning of this year on how the new companies would be structured, but are still awaiting feedback from the central bank.

"The Fed is requiring a layer of U.S. management, rather than running businesses in the U.S. simply as components of global businesses," said James Hilton, a managing director at Promontory Financial Group. "Transaction and accounting systems are often aligned on a global basis, not a geographic basis, and it's very hard to change that fundamental infrastructure."

The IHC requirement will be a change of pace particularly for firms with large broker-dealer subsidiaries in the U.S. Unlike domestic bank holding companies, which include the parent's investment units, foreign-owned broker-dealers have been able to report directly to the overseas parent where capital requirements are set by the home country regulator.

Observers said the new structure will force some firms to decide whether simply to comply with the rule or reduce the footprint of their U.S. broker-dealer, which could result in less onerous regulatory burden.

"They have to make significant decisions about what their investment banking business is going to look like — what businesses they are going to be in, what asset classes they will focus on, and what geographies they will cover," said Cyrus Amir-Mokri, a former assistant Treasury secretary for financial institutions and now a partner at Skadden, Arps, Slate, Meagher & Flom LLP.

Miller said firms with a large commercial banking footprint as part of their U.S. operation have had substantial experience with holding company oversight from the Fed. But for others, "their banking activities are done out of a branch of the parent and their capital markets activities are done out of a broker dealer," she said. "While subject to both SEC and FRB oversight and supervision, they have never had to put all their U.S activities into a holding company structure. For them, this is huge."

The run-up to the Fed's implementation deadlines has led to important decisions for big international banks. While firms within reach of falling below the $50 billion trigger are considering ways to reduce their U.S. footprint, companies that know for sure they will form IHCs are considering whether to move some operations out of the U.S. to ease the process.

"There is a real benefit to delaying this for a couple of years and some banks are trying to get there. But it's not a huge number of institutions," said Landy. For larger banks that want to reduce the regulatory impact of forming an IHC, he added, "repatriating" activities "to a jurisdiction with different capital rules makes all the sense in the world."

But others may consider whether to expand their operations here to rationalize the costs of higher regulatory burden.

"Foreign owned banks are at an inflection point. They're taking a look at what it costs to do business here and may decide that either they want to cut back enough to avoid" the requirement "or to go ahead with it but that as long as they're going to have to create the IHC they might as well really build their U.S. businesses," said Michael Wiseman, a partner at Sullivan & Cromwell.

On the flip side, Miller noted some firms not yet big enough in the U.S. to have to form IHCs may try to start the process anyway because they expect to expand their footprint in the coming years.

"There is a set of other banks saying, 'We know we're going to grow in the U.S., so should we be an early adopter of an IHC strategy so when we do tip over $50 billion through acquisition or internal growth, we're ready to comply?'" she said. "This … category wouldn't form an actual IHC right away, but maybe a virtual board of directors that starts to run the firm as if it were an IHC."

Amir-Mokri said many firms will likely conclude it is more vital to retain their place in the U.S. than transfer activities out of the country to reduce regulatory impact.

"If I had to guess, many foreign banks with major investment banking operations would likely continue to have a US presence with a balance sheet greater than $50 billion because they are committed to the US market," he said.