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4 Final Rule for Global Systemically Important BHCs (G-SIB)69

4 Final Rule for Global Systemically Important BHCs (G-SIB)69

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Board and which will be based on the firm’s business model, capital structure, and risk profile to determine whether enhanced prudential standards

should apply and tailor the requirements on the multitude of forms that

such company may assume. As stated by the Board’s Chairperson, Janet

L. Yellen:

The Final Rule before the Board today imposes a risk-based capital surcharge on the most systemically important U.S. bank holding companies.

A key purpose of the capital surcharge is to require the firms themselves to

bear the costs that their failure would impose on others. In practice, this

Final Rule will confront these firms with a choice: they must either hold substantially more capital, reducing the likelihood that they will fail, or else they

must shrink their systemic footprint, reducing the harm that their failure

would do to our financial system. Either outcome would enhance financial

stability. The Final Rule complements other aspects of the Board’s enhanced

prudential standards for the largest and most systemic U.S. banking firms.70

In order to determine whether a BHC is a G-SIB, the Final Rule discusses the methodology for making the determination and two methods

to calculate the G-SIB surcharge, the justification for using short-term

wholesale funding, and the justification for the G-SIB calibration. The

Final Rule also details the role of the surcharge in the capital framework

and its implementation and timing. Initially, the Final Rule concerned a

BHC with consolidated assets of $50 billion or more, but the Board raised

the threshold number to total consolidated assets of $250 billion or more

or $10 billion or more on-balance-sheet foreign exposures based on the

belief that a BHC with a lower level of consolidated assets is unlikely to

pose a systemic risk to the US economy.71

In order to determine whether a BHC is a G-SIB, the bank itself

(subject to the Board’s supervision) would have to annually compute its

Method 1 score. The score is based on five broad categories that may indicate systemic risk, each of which is give the same 20 % total weight divided

by an equal percentage weight for the subcategories, namely, (1) size; (2)

interconnectedness, which consists of intra-financial system assets, intrafinancial system liabilities, and securities outstanding; (3) substitutability,

which includes assets under custody and underwritten transactions in debt

and equity markets; (4) complexity with respect to notional amounts of

over-the-counter derivatives, trading and available-for-sale securities, and

level 3 assets; and (5) cross-jurisdictional activity with respect to crossjurisdictional claims and cross-jurisdictional liabilities. If the BHC exceeds



a designated Method 1 score, then it is deemed to be a G-SIB. The surcharge for the particular firm will vary from 0 % to 3.5 % for every 100

basis point increase in score.72

The FRB adopted a second method for making the G-SIB determination which would enable a BHC to better predict whether it will be

deemed to be a G-SIB and also enable the firm to take steps to reduce its

G-SIB surcharge. Method 2 is similar to Method 1 except that in the substitutability category a quantitative measure of the firm’s use of short-term

wholesale funding is used. The amount of the surcharge also ranges from

0 % for firms not meeting the threshold to gradual increases from 1.0 %

with increases to 5.5 % plus a 0.5 percentage point increase for every 100

basis point increase in the score. The table of Coefficients for Method 2

Systemic Indicators shows a greatly enhanced percentage for Level 3 assets

that is higher than all of the other systemic indicators combined.

Level 3 assets are short-term wholesale funding which if relied on by

a BHC may make it vulnerable in times of stress to runs that undermine

financial stability as illustrated during the past financial crisis. When shortterm creditors become concerned with a firm’s financial outlook, they have

strong incentives to withdraw funds before other creditors may become

aware, which in turn will lead to a drain of liquid assets. A downward spiral

may then take place, whereby the firm may have to engage in a fire sale of

its capital assets, which depletes its capital and drives down asset prices in

the financial marketplace.73

As stated above, the indicators of systemic risk include the following:

• Size. A banking organization that possess a large share of total financial activities is more likely to negatively impact the financial markets

and the overall financial markets because of its size, the volume of

transactions, and the counterparties affected. In the event of distress or failure it would be difficult to other firms to replace it. Size

would have been measured by total exposures, which was equal to

the BHC’s measure of total leverage exposure calculated pursuant to

the regulatory capital rule.

• Interconnectedness. The greater the interconnectedness of the

BHC with other financial institutions and intermediaries, the more

likely distress or failure of the institution would impact the overall

economy. Interconnectedness is measured by intra-financial system

assets, intra-financial system liabilities, and securities outstanding as

of December 31 of a given year. The financial institutions referred



to as depository institutions are BHCs, securities dealers, insurance

companies, mutual funds, hedge funds, pension funds, investment

banks, and central counterparties. Central banks and multilateral

development banks are excluded, but state-owned commercial banks

are included.

• Substitutability. The Final Rule indicated that substitutability is a

category of systemic importance. A firm’s potential adverse systemic

impact depends in part on the degree to which other banking organizations are able to serve as substitutes in the event that the banking organization is unable to perform its role. The rule states three

indicators to measure substitutability: (1) assets under custody as of

December 31 of a given year: (2) the total value of payments sent over

the calendar year; and (3) the total value of transactions in debt and

equity markets underwritten during the calendar year. The rule would

have a greater impact with respect to a finding of systemic importance

for certain banking organizations that are dominant in the provision

of asset custody, payment systems, and underwriting services.

The indicator of assets under custody refers to a banking organization

that manages or administers the custody or safekeeping of stocks, debt securities, or other assets for institutional and private investors. A collapse of such

a G-SIB firm could seriously disrupt financial markets and domestic and

global economies. A G-SIB firm that engages in substantial volume of payments will affect many customers in the event of a collapse, because customers would not be able to process payments and could experience liquidity

issues. The third factor of systemic importance is the total value of transactions in debt and equity, which in the event of a G-SIB failure could impede

new securities issuances and may increase the cost of debt and capital.

Complexity. Complexity is characterized under the Final Rule as a

category of systemic importance. In the event of failure or distress,

the more complex a banking organization is, the greater the

expense and time necessary to resolve it. Costly resolutions can

have negative cascading effects in the markets, including disorderly

unwinding of positions, fire sales of assets, disruption of services

to customers, and increased uncertainty in the markets. There are

three indicators of complexity (1) complexity notional amount of

over-the-counter (OTC) derivatives, (2) Level 3 assets, and (3)

trading and available-for-sale (AFS) securities as of December 31

of a given year.



OTC Derivatives Activity

According to the Final Rule, a BHC’s over-the-counter derivatives activity

will be the aggregate notional amount of the company’s transactions that

are cleared through a central counterparty or settled bilaterally. Level 3

assets will be equal to the value of the assets that the BHC measures at fair

value as required by regulation. They are generally illiquid assets with fair

values that cannot be determined by observable data, such as market price

signals or models. The value of the Level 3 assets will be based on internal

estimates or risk-adjusted value ranges by the banking organization. With

respect to trading and AFS securities, the Final Rule makes note that these

can cause a market disturbance through mark-to-market losses and fire

sales of assets in times of distress.

Cross-Jurisdictional Activity

The Board stated that the addition of other jurisdictions is a category of

systemic importance because of the difficulty and cost of resolution in the

event of distress of failure.

Use of Short-Term Wholesale Funding (Maturity of Less Than One Year)

The rule identified five categories of short-term wholesale funding sources:

(1) secured funding transactions; (2) unsecured wholesale funding; (3)

covered asset exchanges; (4) short positions; and (5) brokered deposits.

• Secured funding transactions include repos, securities lending transactions, secured funding from a Federal Reserve Bank or a foreign

central bank, Federal Home Loan Bank advances, secured deposits, loans of collateral to effect customer short positions, and other

secured wholesale funding arrangements of under one-year maturity. They are characterized as systemic because counterparties are

more likely to remove or roll-over the transactions than longer-term


• Unsecured wholesale funding. Unsecured wholesale funding includes

wholesale deposits; federal funds purchased; unsecured advances

from a public sector entity, sovereign entity, or US governmentsponsored enterprise; unsecured notes; bonds, or other unsecured

debt securities issued by a G-SIB (unless sold exclusively to retail

customers or counterparties); brokered deposits from non-retail customers; and any other transaction where an on-balance-sheet unsecured credit obligation has been contracted. It falls under this rubric



because, according to the Rule’s commentary, funding from wholesale counterparties presents greater run risk to banking organizations

during periods of stress as compared to the same type of funding

provided by retail counterparties, because wholesale counterparties facing financial distress are likely to withdraw large amounts of

wholesale funding in order to meet financial obligations.

Covered asset exchanges. Covered assets include the fair market value

of all assets that a G-SIB must return in connection with transactions

where it has provided a non-cash asset of a given liquidity category

to a counterparty in exchange for non-cash assets of a higher liquidity category, and the G-SIB and the counterparty agreed to return

the assets to each other at a future date. The systemic risk arises from

the possibility that the unwinding of such transactions could negatively impact a G-SIB’s funding profile in a period of stress because it

requires the G-SIB to obtain funding for a less liquid asset or security

if the counterparty is unwilling to roll over the transaction.

Short positions. Short positions are transactions where a BHC borrows a security from a counterparty to sell to a second counterparty,

and must return the security to the initial counterparty in the future.

A short position involving a certain security was assigned the same

weight as a secured short-term wholesale funding liability backed by

the same asset.

Broker deposits and brokered sweep deposits. Retail brokered deposits

and brokered sweep deposits are so characterized because of demonstrable volatility in times of stress, notwithstanding the presence of

deposit insurance. The deposits are readily movable from one firm to

another during times of stress, as customers and counterparties seek

higher interest rates or seek to use those funds for other purposes and

on account of the incentives that third-party brokers have to provide

the highest possible returns for their clients. Non-brokered deposits

or brokered sweep deposits are exempt because of the unlikelihood

that they would pose liquidity risks in times of stress.

Capital surcharge. The Final Rule proposes a G-SIB surcharge to

the regulatory capital rule’s capital conservation buffer.74 The Rule

states that a banking organization must maintain a minimum common equity tier 1 capital requirement of 4.5 %, a minimum tier 1

capital requirement of 6.0 %, and a minimum total capital requirement of 8.0 %. In addition to those minimums, in order to avoid limits on capital distributions and certain discretionary bonus payments,



a banking organization must hold a capital conservation buffer

composed of common equity tier 1 capital equal to more than 2.5

% of risk-weighted assets following a phase-in period. The capital

conservation buffer is divided into quartiles, each associated with

increasingly stringent limitations on capital distributions and certain discretionary bonus payments as the capital conservation buffer

approaches zero.


Enhanced Prudential Standards for Foreign Banking

Organizations (FBO)

The Final Rule, in addition to BHCs, also applied enhanced prudential

standards for foreign (non-US) banking organizations that were essentially

similar to the regulations applicable to BHCs. An FBO with total consolidated assets of more than $10 billion but less than $50 billion and a foreign savings and loan holding company consolidated assets of more than

$10 billion must be subject to capital stress testing regime by its home

country that meets US requirements; these include an annual supervisory

capital stress test conducted by the home-country supervisor; governance

and controls of stress-testing practices by the company’s management and

board; and, if the company does not meet the said standards, then it must

maintain eligible assets in its US branches of not less than 105 % of average

value daily of the total liabilities of all branches of the company and conduct an annual stress test of its US subsidiaries annually to verify that it

can meet losses as a result of adverse economic conditions. The FBO must

certify that it has established a risk committee for its global operations

to oversee risk-management policies of the company, and this committee

must include at least one member with experience in identifying, assessing,

and managing risk exposures of large, complex firms (Table 4.1).


FBO with $50 Billion or More of Total Consolidated Assets

but Under $50 Billion of Combined US Assets

A FBO meeting the asset requirement must certify to the FED that it

meets capital adequacy standards as set forth by its home country in accordance with the Basel Committee Capital Framework, or otherwise meet

the Basel standards if the home country does not adhere to the framework. It must also certify to the FED that it maintain a standalone committee on the global board of directors that oversees the risk-management



Table 4.1

Requirements for foreign banking organizations



Total consolidated assets of more than

$10 billion but less than $50 billion

Total consolidated assets equal to or

greater than $10 billion but less than

$50 billion (if publicly traded)

Total consolidated assets of $50

billion or more, but combined US

assets of less than $50 billion

Company-run stress tests

Total consolidated assets of $50

billion or more, and combined US

assets of $50 billion or more

Risk committee

Risk-based and leverage capital

Risk management

Risk committee


Capital stress testing

Debt to equity limits (upon grave threat


Risk-based and leverage capital

Risk management

Risk committee

Liquidity risk management, liquidity stress testing,

and buffer

Capital stress testing

US intermediate holding company requirement (if

the foreign banking organization has US

non-branch assets of $50 billion or more)

Debt-to-equity limits (upon grave threat


policies and has at least one member that has the relevant expertise. The

company must also meet liquidity risk-management requirements annually, and report to the FED the results of an internal liquidity stress-testing

accordance with the Basel Committee Principles. It must also certify that

its home country regime has capital stress-testing requirements that meet

Basel standards.


FBO with Total Consolidated Assets of $50 Billion or More

and Combined US Assets of $50 Billion or More

The regulations impose much more stringent standards than are applicable to a US intermediate holding company. The company must establish

a US intermediate holding company or comparable subsidiary organized

under US law; be governed by a board of directors pursuant to US law;

and report to the FED about the details of the company and certify that



it meets the Final Rule’s standards. The holding company must meet riskbased and leverage capital standards; risk management and risk committee

requirements; liquidity risk management, stress testing and buffers; capital

stress testing; and debt-to-equity limits, if it is determined that the company may pose a threat to US financial stability.

In accordance with the said requirements, the FBO is to submit an

implementation plan to the FED that includes a list of all US subsidiaries

setting forth ownership interest in each subsidiary; a projected timeline

for the transfer by the FBO of its ownership interest to the US intermediate holding company; a projected timeline of all planned capital action or

strategies of capital accretion; a description of its risk-management practices; a description of the current liquidity stress testing practices of its

US operations; and other requirements. The risk-management framework

must be commensurate with the structure, size, risk profile, activities, and

complexity of the company. There are to be processes in place establishing

risk-management governance, procedures, and risk-control infrastructure;

systems for implementation and monitoring compliance with the policies

and procedures; processes and systems for identifying and reporting risks

and risk-management deficiencies of the holding company; and management and employee responsibilities.

Corporate governance requirements include a risk-management committee similar to that stated above but also at least one member who is

not an officer or employee of the FBO and not a member of its immediate

family. The FBO must certify to the FED that it meets capital adequacy

standards of its home country, which are in compliance with Basel capital

standards. The risk-management committee, FBO, or holding company

must certify at least annually that it has met the acceptable level of liquidity risk given the unique structure, risk profile, size, activities, and capital

structure of the firm. The US chief risk officer of the holding company

must report to the firm’s risk committee on the liquidity risk profile of

the FBO’s combined US operations and approve new products and business lines after assessing their risks, liquidity costs, and benefits. There are

detailed requirements for liquidity and capital stress testing.75



The major complaint concerning the imposition of enhanced prudential standards on General Electric Capital Corporation Inc. (GECC) was

the requirement of additional independent directors to the Board to the



already existing independent directors. The meaning of director independence can be gauged from a number of sources. The ENRON debacle led

to the enactment of the Sarbanes-Oxley Act of 2002. §301amended the

Securities Exchange Act of 1934 regarding the responsibilities of the audit

committee of a publicly traded company with respect to registered public

accounting firms. Each member of the audit committee is to be a member

of the board of directors and shall be independent. The statute states that

in order to be considered independent a member of the audit committee

“may not other than in his or her capacity as a member of the audit committee, the board of directors, or any other board committee accept any

consulting, advisory, or other compensatory fee from the issuer; or be an

affiliated person of the issuer or any subsidiary thereof.”76

The New York Stock Exchange is much more explicit in defining the

meaning of director independence. In its Listed Company Manual defines

independent director as one where:

• The board of directors affirmatively determines that the director has

no material relationship with the listed company (either directly or as

a partner, shareholder, or officer of an organization that has a relationship with the company);

• In addition, in affirmatively determining the independence of any

director who will serve on the compensation committee of the listed

company’s board of directors, the board of directors must consider

all factors specifically relevant to determining whether a director has

a relationship to the listed company which is material to that director’s ability to be independent from management in connection with

the duties of a compensation committee member, including, but not

limited to:

– The source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the listed

company to such director; and

– Whether such director is affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the

listed company.77

In a commentary, the Manual states that it is not possible to anticipate

or explicitly provide for all circumstances that could signal a lack of independence; albeit ownership of shares in the company, even if significant,

is not a bar to independence. With respect to the sources of the directors’



compensation, the board should examine whether such compensation

would impair the director’s independent judgment concerning the company’s executive compensation. An “immediate family member” is anyone

sharing the person’s home, including in-laws. Other factors that may call

into question a director’s independence are:

• The director is, or has been within the last three years, an employee

of the company, or an immediate family member is or within the last

three years has been an executive officer of the company;

• The director has received, or has an immediate family member who

has received, during any twelve-month period within the last three

years, more than $120,000  in direct compensation from the listed

company, other than director and committee fees and pension or

other forms of deferred compensation for prior service (provided such

compensation is not contingent in any way on continued service);

• The director (A) is a current partner or employee of a firm that is the

listed company’s internal or external auditor; (B) the director has an

immediate family member who is a current partner of such a firm;

(C) the director has an immediate family member who is a current

employee of such a firm and personally works on the listed company’s audit; or (D) the director or an immediate family member was

within the last three years a partner or employee of such a firm and

personally worked on the listed company’s audit within that time;

• The director or an immediate family member is, or has been with

the last three years, employed as an executive officer of another company where any of the listed company’s present executive officers

at the same time serves or served on that company’s compensation


• The director is a current employee, or an immediate family member

is a current executive officer, of a company that has made payments

to, or received payments from, the listed company for property or

services in an amount which, in any of the last three fiscal years,

exceeds the greater of $1 million, or 2% of such other company’s

consolidated gross revenues.78

The National Association of Securities Dealers (NASD), which merged

with the regulatory committee of the New York Stock Exchange (NYSE)

to form the current Financial Industry Regulatory Authority (FINRA) in

2007, has similar rules defining director independence.



In Chaps. 5 and 6, we will examine four of the critical areas of processes

and types of financial intermediation, namely, securitization, repurchase

agreements, hedge funds, and mutual funds, particularly money market

mutual funds.



























Dodd-Frank Act, §165(a), (b)(1).

Id., §165(b)(2).

Dodd-Frank Act, §165(b).

Id., §165(b)(1)(A).

Id., §165(b)(1)(B).

Id., §165(b)(4).

Id., §165(b)(3).

Id., §165 (d)(1), www.federalreserve.gov/.../boardmeetings/memo.

Id., §165 (d)(2-5).

Id., §165(d)(5)(B).


Id., §165(d)(2).

Id., §165(d)(4-8).

Id., §165(e)(1-3).


§165 (h).

Id., §165 (j).

Id., §165(k).

, Federal Reserve System, Policy Statement on the Scenario Framework for

Stress Testing, (November 6, 2013), 12 CFR Part 252, http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20121115a4.pdf.

Id at 19.



Federal Deposit Insurance Corporation, Resolution of Systemically Important

Financial Institutions: The Single Point of Entry, Federal Register, Vol 78,

No. 243 (Dec. 18, 2013).

Enhanced Prudential Standards for Bank Holding Companies and for Foreign

Banking Organizations, 12 CFR Part 252, March 27, 2014, eff. June 1,


Noam Noked, Enhanced Prudential Standards, THE HARVARD LAW


FINANCIAL REGULAITONS (March 10, 2014), http://blogs.law.harvard.edu/corpgov/2014/03/10/enhanced-prudential-standards/.

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