# Total Loss-Absorbing Capacity, Long-Term Debt, and Clean Holding Company Requirements for Systemically Important U.S. Bank Holding Companies and Intermediate Holding Companies of Systemically Important Foreign Banking Organizations; Regulatory Capital Deduction for Investments in Certain Unsecured Debt of Systemically Important U.S. Bank Holding Companies

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2015-29740

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** November 30, 2015
- **Citation:** 80 FR 74926

## Text

FEDERAL RESERVE SYSTEM
12 CFR Parts 217 and 252
[Regulations Q and YY; Docket No. R-1523]
RIN 7100-AE37
Total Loss-Absorbing Capacity, Long-Term Debt, and Clean Holding Company Requirements for Systemically Important U.S. Bank Holding Companies and Intermediate Holding Companies of Systemically Important Foreign Banking Organizations; Regulatory Capital Deduction for Investments in Certain Unsecured Debt of Systemically Important U.S. Bank Holding Companies

AGENCY:

Board of Governors of the Federal Reserve System (Board).

ACTION:

Notice of proposed rulemaking.

SUMMARY:

The Board is inviting comment on a proposed rule to promote financial stability by improving the resolvability and resiliency of large, interconnected U.S. bank holding companies and the U.S. operations of large, interconnected foreign banking organizations pursuant to section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and related deduction requirements for all banking organizations subject to the Board's capital rules. Under the proposed rule, a U.S. top-tier bank holding company identified by the Board as a global systemically important banking organization (covered BHC) would be required to maintain outstanding a minimum amount of loss-absorbing instruments, including a minimum amount of unsecured long-term debt, and related buffer. Similarly, the proposed rule would require the top-tier U.S. intermediate holding company of a global systemically important foreign banking organization with $50 billion or more in U.S. non-branch assets (covered IHC) to maintain outstanding a minimum amount of intra-group loss-absorbing instruments, including a minimum amount of unsecured long-term debt, and related buffer. The proposed rule would also impose restrictions on the other liabilities that a covered BHC or covered IHC may have outstanding. Finally, the proposed rule would require state member banks, bank holding companies, and savings and loan holding companies that are subject to the Board's capital rules to apply a regulatory capital deduction treatment to their investments in unsecured debt issued by covered BHCs.

DATES:

Comments should be received by February 1, 2016.

ADDRESSES:

You may submit comments, identified by Docket No. R-1523 and RIN 7100 AE-37, by any of the following methods:

•
Agency Web site:

http://www.federalreserve.gov
. Follow the instructions for submitting comments at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm
.

•
Federal eRulemaking Portal:

http://www.regulations.gov
. Follow the instructions for submitting comments.

•
Email:

regs.comments@federalreserve.gov
. Include the docket number in the subject line of the message.

•
Fax:
(202) 452-3819 or (202) 452-3102.

•
Mail:
Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW., Washington, DC 20551.

All public comments will be made available on the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm
as submitted, unless modified for technical reasons. Accordingly, your comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper form in Room 3515, 1801 K Street (between 18th and 19th Streets NW.) Washington, DC 20006 between 9:00 a.m. and 5:00 p.m. on weekdays.

FOR FURTHER INFORMATION CONTACT:

Constance M. Horsley, Assistant Director, (202) 452-5239, Thomas Boemio, Senior Project Manager, (202) 452-2982, Juan C. Climent, Manager, (202) 872-7526, Felton Booker, Senior Supervisory Financial Analyst, (202) 912-4651, Sean Healey, Senior Financial Analyst, (202) 912-4611, or Mark Savignac, Senior Financial Analyst, (202) 475-7606, Division of Banking Supervision and Regulation; or Laurie Schaffer, Associate General Counsel, (202) 452-2272, Benjamin McDonough, Special Counsel, (202) 452-2036, Jay Schwarz, Senior Counsel, (202) 452-2970, Will Giles, Counsel, (202) 452-3351, Mark Buresh, Senior Attorney, (202) 452-5270, or Greg Frischmann, Senior Attorney, (202) 452-2803, Legal Division, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. For the hearing impaired only, Telecommunications Device for the Deaf (TDD) users may contact (202) 263-4869.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

A. Addressing Too-Big-to-Fail

B. Approaches to Resolution

C. Overview of the Proposal

D. Consultation with the FDIC, the Council, and Foreign Authorities

E. The FSB's Proposal on Total Loss-Absorbing Capacity for GSIBs

F. Overview of Statutory Authority

II. External TLAC and LTD Requirements for U.S. GSIBs

A. Scope of Application

B. Calibration of the External TLAC and LTD Requirements

C. Core Features of Eligible External TLAC

D. External TLAC Buffer

E. Core Features of Eligible External LTD

F. Costs and Benefits

III. Internal TLAC and LTD Requirements for U.S. Intermediate Holding Companies of Foreign Banking Organizations

A. Scope of Application

B. Calibration of the Internal TLAC and LTD Requirements

C. Core Features of Eligible Internal TLAC

D. Internal TLAC Buffer

E. Core Features of Eligible Internal LTD

IV. Clean Holding Company Requirements

A. Third-Party Short-Term Debt Instruments

B. Qualified Financial Contracts with Third Parties

C. Guarantees that Are Subject to Cross-Defaults

D. Upstream Guarantees and Offset Rights

E. Cap on Other Third-Party Liabilities

F. Disclosure Requirements

V. Consideration of Reporting Requirements for Eligible External and Internal TLAC and LTD

VI. Consideration of Domestic Internal TLAC Requirement

VII. Regulatory Capital Deduction for Investments in the Unsecured Debt of Covered BHCs

VIII. Transition Periods

IX. Regulatory Analysis

A. Paperwork Reduction Act

B. Regulatory Flexibility Act

C. Riegle Community Development and Regulatory Improvement Act of 1994

D. Solicitation of Comments on the Use of Plain Language

I. Introduction

A. Addressing Too-Big-to-Fail

An important objective of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)
1

is to mitigate risks to the financial stability of the United States that could arise from the material financial distress or failure of large, interconnected financial companies, including by ending market perceptions that certain financial companies are “too big to fail” and would therefore receive extraordinary government support to prevent their failure. Such perceptions reduce the

incentives of the shareholders, creditors, and counterparties of such a company to discipline excessive risk-taking by the company. Such perceptions also tend to fuel further growth by the largest financial companies, making them even more systemically important and leading to more financial sector concentration than would exist in the absence of market expectations of government support. Finally, such perceptions can produce competitive distortions by allowing the largest, most interconnected financial companies to fund themselves more cheaply than their smaller competitors can. These distortions are unfair to smaller companies and detrimental to competition.

1
The Dodd-Frank Act was enacted on July 21, 2010 (Pub. L. 111- 203).

The Dodd-Frank Act establishes a framework to address the financial stability risks associated with major financial companies. The Act seeks to enhance financial stability through two approaches. First, the Act seeks to reduce major financial companies' probability of failure by requiring the Board to subject them to enhanced capital, liquidity, and other prudential requirements and to heightened supervision.
2

Second, the Act seeks to reduce the risk that such a company's failure, were it to occur, would pose to the financial stability of the United States through resolution-planning requirements and a new statutory resolution framework for major financial companies.
3

These approaches have also been followed in international regulatory reform efforts since the 2007-2009 financial crisis, which have been coordinated through the Basel Committee on Banking Supervision (BCBS)
4

and the Financial Stability Board (FSB),
5

at the direction of the Heads of State of the Group of Twenty (G20 Leaders).
6

2

See
12 U.S.C. 5365(a)(1)(A).

3

See
12 U.S.C. 5381-5394.

4
The BCBS is a committee of banking supervisory authorities established by the central bank governors of the Group of Ten countries in 1975. The committee's membership consists of senior representatives of bank supervisory authorities and central banks from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States. The BCBS usually meets at the Bank for International Settlements (BIS) in Basel, Switzerland, where its permanent Secretariat is located.

5
The FSB was established in 2009 to coordinate at the international level the work of national financial authorities and international standard-setting bodies and to develop and promote the implementation of effective regulatory, supervisory, and other financial sector policies in the interest of financial stability. The FSB brings together national authorities responsible for financial stability in 24 countries and jurisdictions, as well as international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts.
See generally
Financial Stability Board, available at
http://www.financialstabilityboard.org.

6
The Group of Twenty was established in 1999 to bring together industrialized and developing economies to discuss key issues in the global economy. Members include finance ministers and central bank governors from Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, Republic of Korea, Turkey, the United Kingdom, and the United States and the European Union.

The Board has made considerable progress in implementing the first approach by reducing the probability that a major financial company will fail. Along with the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), the Board has implemented stronger capital standards
7

and a new liquidity standard called the liquidity coverage ratio.
8

The Board also has adopted leverage and risk-based capital surcharges for U.S. global systemically important banking organizations (GSIBs),
9

established a robust stress testing framework for large banking organizations,
10

and created a Large Institution Supervision Coordinating Committee to strengthen the supervision of the most systemically important financial institutions operating in the United States.
11

7
The Board and the OCC issued a joint final rule on October 11, 2013 (78 FR 62018) and the FDIC issued a substantially identical interim final rule on September 10, 2013 (78 FR 55340). The FDIC adopted the interim final rule as a final rule with no substantive changes on April 14, 2014. 79 FR 20754.

8
79 FR 61440 (October 10, 2014).

9

See
80 FR 49082 (Aug. 14, 2015) (GSIB risk-based capital surcharge); 79 FR 24528 (May 1, 2014) (enhanced supplementary leverage ratio). The eight firms currently identified as U.S. GSIBs are Bank of America Corporation, The Bank of New York Mellon Corporation, Citigroup Inc., Goldman Sachs Group, Inc., JP Morgan Chase & Co., Morgan Stanley, State Street Corporation, and Wells Fargo & Company.

10
12 CFR 252.32 and 252.35.

11

See
Large Institution Supervision Coordinating Committee, available at
http://www.federalreserve.gov/bankinforeg/large-institution-supervision.htm.

To further enhance firm-specific resiliency during periods of severe stress, the Board has also issued guidance on recovery planning to the most systemically important U.S. banking organizations.
12

In addition, the Board has implemented a broad set of other enhanced prudential standards for bank holding companies and foreign banking organizations with total consolidated assets of $50 billion or more.
13

Internationally, the BCBS has adopted a substantial set of post-crisis reforms, developed with significant participation from the Board and other U.S. bank regulatory agencies, which align well with the bank regulatory reforms implemented in the United States.

12

See
Supervision and Regulation Letter 14-8, “Consolidated Recovery Planning for Certain Large Domestic Bank Holding Companies” (September 25, 2014).

13
79 FR 17240 (March 27, 2014).

U.S. regulators have also made substantial progress with respect to the second approach by implementing the Dodd-Frank Act's framework for resolution-planning for major financial companies. The Dodd-Frank Act provides significant new authorities to the FDIC and the Board to address the failure of large, interconnected financial companies.
14

First, Section 165(d) of the Dodd-Frank Act requires bank holding companies with total consolidated assets of at least $50 billion and nonbank financial companies designated for supervision by the Board to prepare resolution plans, also known as “living wills,” that describe how they could be resolved in an orderly manner under the U.S. Bankruptcy Code if they were to fail.
15

The Board and the FDIC have established resolution-planning requirements to implement section 165(d).
16

14
12 U.S.C. 5365, 5384, and 5385.

15
12 U.S.C. 5365(d).

16
76 FR 67323 (November 1, 2011).

Second, Title II of the Dodd-Frank Act (Title II) establishes an alternative resolution framework for the largest financial companies, the Orderly Liquidation Authority. In general, if a major U.S. bank holding company or non-bank financial company were to fail, it would be resolved under the U.S. Bankruptcy Code.
17

Congress recognized, however, that such a company might fail under extraordinary circumstances that would prevent it from being resolved in bankruptcy without serious adverse effects on the financial stability of the United States.
18

Title II therefore provides the Secretary of the Treasury, upon recommendation from other government agencies, with the authority to place a major financial company into an FDIC receivership, rather than bankruptcy.
19

The set of resolution powers created by Title II form a critical post-crisis toolkit for mitigating the negative effects that could follow from the failure of a systemically important financial institution.

17

See, e.g.,
12 U.S.C. 5382(c), 5383(a)(2)(F) and (b)(4). Insurance companies, depository institutions, and broker dealers are resolved under different resolution mechanisms.

18

See
12 U.S.C. 5384.

19

See
12 U.S.C. 5383(b).

Since 2012, the largest bank holding companies and foreign banking organizations with U.S. operations have submitted annual resolution plans to the

Board and the FDIC as required by section 165(d). The Board and the FDIC review the resolution plans, provide feedback on their shortcomings, and set expectations for subsequent iterations of the plans that are intended to improve the organizations' resolvability. Each annual plan review cycle has yielded valuable information that is being used to assess and mitigate potential obstacles to orderly resolution under the U.S. Bankruptcy Code and to plan for the contingency of a resolution under Title II. The Board and the FDIC also consult regularly on regulatory actions intended to improve GSIB resolvability, including this proposed rule.

B. Approaches to Resolution

Resolution of large financial firms will involve either a single-point-of-entry (SPOE) resolution strategy or a multiple-point-of-entry (MPOE) resolution strategy.
20

Most of the U.S. GSIBs are developing plans that facilitate an SPOE approach, including in their 2015 resolution plans.

20

See
FDIC, “Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy” (6741-01-P) (December 10, 2013), available at
http://www.fdic.gov/news/board/2013/2013-12-10_notice_dis-b_fr.pdf
.

In an SPOE resolution of a banking organization, only the top-tier bank holding company would enter a resolution proceeding. The losses that caused the banking organization to fail would be passed up from the subsidiaries that incurred the losses and would then be imposed on the equity holders and unsecured creditors of the holding company, which would have the effect of recapitalizing the subsidiaries of the banking organization. An SPOE resolution could avoid losses to the third-party creditors of the subsidiaries and could thereby allow the subsidiaries to continue normal operations, without entering resolution or taking actions (such as asset firesales) that could pose a risk to the financial stability of the United States. The expectation that the holding company's equity holders and unsecured creditors would absorb the banking organization's losses in the event of its failure would also help to maintain the confidence of the operating subsidiaries' creditors and counterparties, reducing their incentive to engage in potentially destabilizing funding runs. An SPOE resolution would avoid the need for separate proceedings for separate legal entities run by separate authorities across multiple jurisdictions and the associated destabilizing complexity.
21

21

See
78 FR 76614 (December 18, 2013).

Certain structural features of the U.S. GSIBs facilitate SPOE resolution. In the United States, the top-tier parent company of a large banking organization generally does not itself engage in material operations. Rather, it generally acts primarily as a holding company, by, for example, measuring and managing the consolidated risks of the organization, undertaking capital and liquidity planning, coordinating the operations of its subsidiaries, and raising equity capital and long-term debt to fund those operations. Its assets therefore consist largely of cash, liquid securities, and equity and debt investments in its subsidiaries. As a result of this organizational structure, in the context of SPOE resolution the liabilities of the parent holding company are generally “structurally subordinated” to the liabilities of the operating subsidiaries.
22

Strengthening the loss-absorbing capacity of the parent holding company therefore improves the resiliency of the banking organization as a whole.

22
Generally, in an insolvency proceeding, direct third-party claims on a parent holding company's subsidiaries would be superior to the parent holding company's equity claims on the subsidiaries.

The alternative to an SPOE resolution is a multiple-point-of-entry (MPOE) resolution. An MPOE resolution would entail separate resolutions of different legal entities within the financial firm and could potentially be executed by multiple resolution authorities across multiple jurisdictions. The SPOE approach to resolution appears to offer substantial advantages, because it facilitates the continued operations of subsidiaries of a GSIB, reducing the material risk that the failure of the organization could have on U.S. financial stability. U.S. regulators nevertheless are cognizant of the need to prepare for other plausible contingencies, including the MPOE resolution of a GSIB. While this proposal is primarily focused on implementing the SPOE resolution strategy, it would also substantially improve the prospects for a successful MPOE resolution of a GSIB by requiring U.S. GSIBs and the IHCs of foreign GSIBs to maintain substantially more loss-absorbing capacity.

C. Overview of the Proposal

The Board is inviting comment on this notice of proposed rulemaking to improve the resolvability and resiliency of U.S. banking organizations. The proposal would require the parent holding companies of U.S. GSIBs to maintain outstanding minimum levels of total loss-absorbing capacity and long-term unsecured debt, and a related buffer. The proposal would also require the top-tier U.S. intermediate holding companies of foreign GSIBs to maintain outstanding minimum levels of total loss-absorbing capacity and long-term unsecured debt instruments issued to their foreign parent company, and related buffer. The proposal would subject the operations of the parent holding companies of U.S. GSIBs and the top-tier U.S. intermediate holding companies of foreign GSIBs to “clean holding company” limitations to further improve their resolvability and the resiliency of their operating subsidiaries. Finally, the proposal would require banking organizations subject to the Board's capital requirements to make certain deductions from capital.

This proposal would further the goals of improving the resiliency and resolvability of GSIBs. Separately, the Board and the FDIC are continuing to work to mitigate the resolvability risks related to potential disorderly unwinds of financial contracts. Other actions for consideration include ensuring the adequacy of “internal bail-in” mechanisms through which operating subsidiaries can pass losses up to their parent holding company and the holding company can recapitalize the subsidiaries.

1. External Total Loss-Absorbing Capacity and Long-Term Debt Requirements for Covered U.S. Bank Holding Companies

Under this proposal, a “covered BHC” would be required to maintain outstanding minimum levels of eligible external total loss-absorbing capacity (external TLAC requirement) and eligible external long-term debt (external LTD requirement). The term “external” refers to the fact that the requirement would apply to loss-absorbing instruments issued by the covered BHC to third-party investors, and the instrument would be used to pass losses from the banking organization to those investors in case of failure. This is in contrast to “internal” loss-absorbing capacity, which could be used to transfer losses among legal entities within a banking organization (for instance, from the operating subsidiaries to the parent holding company).

The term “covered BHC” would be defined to include any U.S. top-tier bank holding company identified as a GSIB under the Board's rule establishing risk-based capital surcharges for GSIBs (“GSIB surcharge rule”).
23

Under the external TLAC requirement, a covered

BHC would be required to maintain outstanding eligible external total loss-absorbing capacity (“eligible external TLAC”) in an amount not less than the greater of 18 percent of the covered BHC's total risk-weighted assets and 9.5 percent of the covered BHC's total leverage exposure.
24

An external TLAC buffer that is similar to the capital conservation buffer in the Board's Regulation Q would apply in addition to the risk-weighted assets component of the external TLAC requirement.

23
12 CFR 217.402; 80 FR 49106 (August 14, 2015).

24
The risk-weighted assets component of the external TLAC requirement would be phased in as follows: It would be equal to 16 percent of the covered BHC's risk-weighted assets beginning on January 1, 2019, and would be equal to 18 percent of the covered BHC's risk-weighted assets beginning on January 1, 2022.

Under the external LTD requirement, a covered BHC would be required to maintain outstanding eligible external long-term debt instruments (“eligible external LTD”) in an amount not less than the greater of 6 percent plus the surcharge applicable under the GSIB surcharge rule (expressed as a percentage) of total risk-weighted assets and 4.5 percent of total leverage exposure.
25

25
Total leverage exposure is defined in 12 CFR 217.10(c)(4)(ii).

A covered BHC's eligible external TLAC would be defined to be the sum of (a) the tier 1 regulatory capital of the covered BHC issued directly by the covered BHC and (b) the covered BHC's eligible external LTD, as defined below.

A covered BHC's eligible external LTD would generally be defined to be debt that is issued directly by the covered BHC, is unsecured, is “plain vanilla,”
26

and is governed by U.S. law. Eligible external LTD with a remaining maturity of between one and two years would be subject to a 50 percent haircut for purposes of the external LTD requirement, and eligible external LTD with a remaining maturity of less than one year would not count toward the external LTD requirement.

26
The term “plain vanilla” is defined in detail in section II.E.3 and excludes structured notes and most instruments that contain derivative-linked features.

2. Internal Total Loss-Absorbing Capacity and Long-Term Debt Requirements for Covered U.S. Intermediate Holding Companies

Under this proposal, a “covered IHC” would be required to maintain outstanding minimum levels of eligible internal total loss-absorbing capacity (“internal TLAC requirement”) and eligible internal long-term debt (“internal LTD requirement”). The term “internal” refers to the fact that these instruments would be required to be issued internally within the foreign banking organization, from the covered IHC to a foreign parent entity. The term “covered IHC” would be defined to include any U.S. intermediate holding company that (a) is required to be formed under the Board's enhanced prudential standards rule
27

and (b) is controlled by a foreign banking organization that would be designated as a GSIB under the Board's capital rules if it were subject to the Board's GSIB surcharge on a consolidated basis (“foreign GSIB”).

27
The Board's enhanced prudential standards rule generally requires any foreign banking organization with total consolidated non-branch U.S. assets of $50 billion or more to form a single U.S. intermediate holding company over its U.S. subsidiaries. 12 CFR 252.153; 79 FR 17329 (May 27, 2014).

Under the internal TLAC requirement, the amount of eligible internal total loss-absorbing capacity (“eligible internal TLAC”) that a covered IHC would be required to maintain outstanding would depend on whether the covered IHC (or any of its subsidiaries) is expected to go into resolution in a failure scenario, rather than being maintained as a going concern while a foreign parent entity is instead resolved. In general, this means that the stringency of the internal TLAC and LTD requirements for a given covered IHC would be a function of whether the foreign GSIB parent of the covered IHC has an SPOE or an MPOE resolution strategy.

Covered IHCs that are not expected to enter resolution themselves would be required to maintain eligible internal TLAC in an amount not less than the greater of: (a) 16 percent of the covered IHC's total risk-weighted assets;
28

(b) for covered IHCs that are subject to the supplementary leverage ratio,
29

6 percent of the covered IHC's total leverage exposure; and (c) 8 percent of the covered IHC's average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio.
30

28
The risk-weighted assets component of the internal TLAC requirement would be phased in as follows: It would be equal to 14 percent of the covered IHC's risk-weighted assets beginning on January 1, 2019, and would be equal to 16 percent of the covered IHC's risk-weighted assets beginning on January 1, 2022.

29
Under the IHC rule, U.S. intermediate holding companies with total consolidated assets of $250 billion or more or on-balance sheet foreign exposure equal to $10 billion or more are required to meet a minimum supplementary leverage ratio of 3 percent. 12 CFR 252.153(e)(2); 79 FR 17329 (March 27, 2014).

30
The final rule imposes the same leverage capital requirements on U.S. intermediate holding companies as it does on U.S. bank holding companies. 12 CFR 252.153(e)(2); 79 FR 17329 (March 27, 2014). These leverage capital requirements include the generally-applicable leverage ratio and the supplementary leverage ratio for U.S. intermediate holding companies that meet the scope of application for that ratio.

Covered IHCs that are expected to enter resolution themselves would be required to maintain outstanding eligible internal TLAC in an amount not less than the greater of: (a) 18 percent of the covered IHC's total risk-weighted assets;
31

(b) 6.75 percent of the covered IHC's total leverage exposure (if applicable); and (c) 9 percent of the covered IHC's average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio.

31
The risk-weighted assets component of the internal TLAC requirement for covered IHCs of MPOE firms would be phased in as follows: It would be equal to 16 percent of the covered IHC's risk-weighted assets beginning on January 1, 2019, and would be equal to 18 percent of the covered IHC's risk-weighted assets beginning on January 1, 2022.

For all covered IHCs, an internal TLAC buffer that is similar to the capital conservation buffer in the Board's Regulation Q would apply in addition to the risk-weighted assets component of the internal TLAC requirement.

Under the internal LTD requirement, a covered IHC would be required to maintain outstanding eligible internal long-term debt instruments (“eligible internal LTD”) in an amount not less than the greater of: (a) 7 percent of total risk-weighted assets; (b) 3 percent of the total leverage exposure (if applicable); and (c) 4 percent of average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio.

A covered IHC's eligible internal TLAC would generally be defined to be the sum of (a) the tier 1 regulatory capital issued from the covered IHC to a foreign parent entity that controls the covered IHC and (b) the covered IHC's eligible internal LTD, as defined below.

A covered IHC's eligible internal LTD would generally be subject to the same requirements as would apply to eligible external LTD: It would be required to be debt that is issued directly from the covered IHC, is unsecured, is plain vanilla, and is governed by U.S. law. Eligible internal LTD with a remaining maturity of between one and two years would be subject to a 50 percent haircut for purposes of the internal LTD requirement, and eligible internal LTD with a remaining maturity of less than one year would not count toward the internal LTD requirement.

However, several features distinguish eligible internal LTD from eligible external LTD: It would be required to be issued to a parent foreign entity that controls the covered IHC, to be contractually subordinated to all third-party liabilities of the covered IHC, and to include a contractual trigger pursuant

to which the Board could require the covered IHC to cancel the eligible internal LTD or convert or exchange it into tier 1 common equity on a going-concern basis (that is, without the covered IHC's entry into a resolution proceeding) if: (a) The Board determines that the covered IHC is “in default or in danger of default”; and (b) any of the following circumstances apply (i) the top-tier foreign banking organization or any subsidiary outside the United States is placed into resolution proceedings, (ii) the home country supervisory authority consents to the cancellation, exchange, or conversion, or does not object to the cancellation, exchange, or conversion following 48 hours' notice, or (iii) the Board has made a written recommendation to the Secretary of the Treasury that the FDIC should be appointed as receiver of the covered IHC.

3. Clean Holding Company Requirements

The Board is proposing to prohibit or limit covered BHCs from directly entering into certain financial arrangements that could impede an entity's orderly resolution. In an SPOE resolution of a U.S. GSIB, the covered BHC will go into a resolution proceeding while its subsidiaries continue their normal operations. These prohibitions and limitations would support the orderly resolution of a covered BHC, whether in an SPOE resolution or in an MPOE resolution involving the resolution of the covered BHC. The proposed requirements would also enhance the resiliency of the U.S. GSIB by reducing the covered BHC's complexity and reliance on short-term funding.

Under the Board's clean holding company proposal, a covered BHC would be prohibited from issuing short-term debt instruments to third parties (including deposits); entering into “qualified financial contracts” (QFCs) with third parties; having liabilities that are subject to “upstream guarantees” from the covered BHC's subsidiaries or that are subject to contractual offset rights for its subsidiaries' creditors; or issuing guarantees of its subsidiaries' liabilities, if the issuance of the guarantee would result in the covered BHC's insolvency or entry into resolution operating as a default event on the part of the subsidiary. Additionally, the proposal would cap the value of a covered BHC's liabilities (other than those related to eligible external TLAC and eligible external LTD) that can be pari passu with or junior to its eligible external LTD at 5 percent of the value of its eligible external TLAC. Finally, the proposal would require covered BHCs to make certain public disclosures of the fact that their unsecured debt would be expected to absorb losses ahead of other liabilities, including the liabilities of the covered BHC's subsidiaries, in a failure scenario.

An SPOE resolution of a foreign GSIB in its home jurisdiction would allow the GSIB's covered IHC to continue operating without itself entering into a resolution proceeding. However, to prepare for a scenario in which a covered IHC would enter U.S. resolution proceedings, the Board is proposing to prohibit covered IHCs from entering into certain financial arrangements that can impede such a resolution.

4. Consideration of Domestic Internal TLAC Requirement

The SPOE resolution strategy assumes (a) that losses will be passed up from the subsidiaries that initially incur them to the covered BHC or covered IHC and (b) that they then will be passed on to either the external TLAC holders (in the case of a covered BHC) or a foreign parent entity (in the case of a covered IHC). This proposal would work to satisfy the second of these assumptions, but it does not address the first. As discussed further below, however, the Board is seeking comment on whether, and if so how, the Board should regulate the mechanisms used by a covered BHC or covered IHC to transfer losses up from the operating subsidiaries that incur them to the covered BHC or covered IHC.

5. Regulatory Capital Deduction for Investments in the Unsecured Debt of Covered BHCs

To limit the potential for financial sector contagion in the event of the failure of a covered BHC, state member banks, certain bank holding companies and savings and loan holding companies with total consolidated assets of at least $1 billion, and intermediate holding companies formed pursuant to the Board's enhanced prudential standards for foreign banking organizations would be required to apply a regulatory capital deduction treatment to any investments in unsecured debt instruments issued by covered BHCs (including unsecured debt instruments that do not qualify as eligible external LTD).

D. Consultation With the FDIC, the Council, and Foreign Authorities

In developing this proposal, the Board consulted with the FDIC, the Financial Stability Oversight Council (Council), and other U.S. financial regulatory agencies. The proposal reflects input that the Board received during this consultation process. The Board also intends to consult with the FDIC, the Council, and other financial regulatory agencies after it reviews comments on the proposal. Furthermore, the Board has consulted with, and expects to continue to consult with, foreign financial regulatory authorities regarding this proposal and the establishment of other standards that would maximize the prospects for the cooperative and orderly cross-border resolution of failed GSIBs.

E. The FSB's Proposal on Total Loss-Absorbing Capacity for GSIBs

In 2013, the G20 Leaders called on the FSB to develop proposals on the adequacy of the loss-absorbing capacity of global systemically important financial institutions (“SIFIs”).
32

In November 2014, the FSB published for consultation a set of principles and a term sheet to implement those principles in the form of an internationally negotiated minimum standard for the total loss-absorbing capacity (“TLAC”) of GSIBs.
33

Under the FSB's proposed standard, GSIBs would be subject to a TLAC requirement equal to the greater of (a) a figure between 16 percent and 20 percent of a banking organization's risk-weighted assets (with the specific figure within that range to be agreed upon later) and (b) twice the Basel III tier 1 leverage ratio requirement. The FSB's proposed standard also contains an expectation that a GSIB would meet at least one-third of its TLAC requirement with eligible long-term debt (“LTD”) rather than equity.

32
The Group of 20, “G20 Leaders' Declaration” (September 2013), available at
https://g20.org/wp-content/uploads/2014/12/Saint_Petersburg_Declaration_ENG_0.pdf
.

33

See
“Adequacy of loss-absorbing capacity of global systemically important banks in resolution” (November 10, 2014), available at
http://www.financialstabilityboard.org/wp-content/uploads/TLAC-Condoc-6-Nov-2014-FINAL.pdf
.

This proposal is generally consistent with the FSB's proposed standard, although it includes a required LTD component that is more stringent than the expectation in the FSB's proposed standard.

The Board considered whether to structure this proposal solely as a TLAC requirement—that is, as a single minimum requirement that could be satisfied by any mixture of capital and eligible LTD—without a specific LTD requirement. In the absence of an LTD requirement, a TLAC requirement would permit each covered firm to reduce its expected systemic impact

either by reducing its probability of default through increased going-concern capital or by reducing the harm it would cause if it were to fail through increased gone-concern LTD.
34

34

See
“Calibrating the GSIB Surcharge” at 3 (July 20, 2015), available at
www.federalreserve.gov/aboutthefed/boardmeetings/gsib-methodology-paper-20150720.pdf
.

This proposal includes a separate LTD requirement in order to address the too-big-to-fail problem. Unlike existing equity, LTD can be used as a fresh source of capital subsequent to failure. Imposing an LTD requirement would help to ensure that a covered firm would have a known and observable quantity of loss-absorbing capacity at the point of failure. Unlike common equity, that loss-absorbing capacity would not be at substantial risk of volatility or depletion before the covered BHC is placed into a resolution proceeding. Thus, the proposed LTD requirements would more assuredly enhance the prospects for the successful resolution of a failed GSIB and thereby better address the too-big-to-fail problem than would TLAC requirements alone.

F. Overview of Statutory Authority

The Board is issuing this proposal under the authority provided by section 165 of the Dodd-Frank Act.
35

Section 165 instructs the Board to impose enhanced prudential standards on bank holding companies with total consolidated assets of $50 billion or more “[i]n order to prevent or mitigate risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected financial institutions.”
36

These enhanced prudential standards must increase in stringency based on the systemic footprint and risk characteristics of individual covered firms.
37

In addition to requiring the Board to impose enhanced prudential standards of several specified types, section 165 authorizes the Board to establish “such other prudential standards as the Board of Governors, on its own or pursuant to a recommendation made by the Council, determines are appropriate.”
38

35
12 U.S.C. 5365.

36
12 U.S.C. 5365(a)(1).

37
12 U.S.C. 5365(a)(1)(B), (b)(3)(A)-(D).

38
12 U.S.C. 5365(b)(1)(B)(iv).

The enhanced prudential standards in this proposal are appropriate because they are intended to prevent or mitigate risks to the financial stability of the United States that could arise from the material financial distress, failure, or ongoing activities of a GSIB. In particular, the proposed requirements would improve the resolvability of U.S. GSIBs under either the U.S. Bankruptcy Code or Title II and improve their resiliency. The proposed requirements would also improve the resiliency of covered IHCs and their subsidiaries, and thereby increase the likelihood that a failed foreign GSIB with significant U.S. operations would be successfully resolved under an SPOE approach without the failure of the U.S. subsidiaries or, failing that, that the foreign GSIB's U.S. operations could be separately resolved in an orderly manner.

In addition to the authority identified above, section 165 of the Dodd-Frank Act also authorizes the Board to establish “enhanced public disclosures” and “short-term debt limits.”
39

The proposal includes disclosure requirements and limits on the ability of covered BHCs and covered IHCs to issue short-term debt.

39
12 U.S.C. 5365(b)(1)(B)(ii) and (iii).

Finally, the Board has tailored this proposal to apply only to those companies whose disorderly resolution would likely pose the greatest risk to the financial stability of the United States: The U.S. GSIBs and the U.S. intermediate holding companies of foreign GSIBs.
40

40
12 U.S.C. 5365(a)(1)(B).

Question 1: The Board invites comment on all aspects of this section.

II. External TLAC and LTD Requirements for U.S. GSIBs

A. Scope of Application (Section 252.60 of the Proposed Rule)

The proposed rule would apply to all “covered BHCs.” The term “covered BHC” would be defined to include any U.S. top-tier bank holding company identified as a GSIB under the Board's GSIB surcharge rule.
41

Under the GSIB surcharge rule, a U.S. top-tier bank holding company subject to the advanced approaches rule must determine whether it is a GSIB by applying a multifactor methodology established by the Board.
42

This methodology evaluates a banking organization's systemic importance on the basis of its attributes in five broad categories: Size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity.

41
12 CFR 217.402; 80 FR 49106 (August 14, 2015).

42
12 CFR part 217, subpart E.

Accordingly, the methodology provides a tool for identifying as GSIBs those banking organizations that pose elevated risks. The proposal's focus on GSIBs is in keeping with the Dodd-Frank Act's mandate that more stringent prudential standards be applied to the most systemically important bank holding companies.
43

43
12 U.S.C. 5365(a)(1)(B).

Under the GSIB surcharge rule's methodology, eight U.S. bank holding companies would currently be identified as GSIBs. Those eight top-tier bank holding companies would therefore be covered BHCs under this proposal.
44

In addition, because the GSIB surcharge methodology is dynamic, other banking organizations could become subject to the proposed rule in the future.

44
The eight firms currently identified as U.S. GSIBs are Bank of America Corporation, The Bank of New York Mellon Corporation, Citigroup Inc., Goldman Sachs Group, Inc., JP Morgan Chase & Co., Morgan Stanley, State Street Corporation, and Wells Fargo & Company.

Question 2: The Board invites comment on alternative approaches for determining the scope of application of the proposed external TLAC and LTD requirements.

B. Calibration of the External TLAC and LTD Requirements (Sections 252.62 and 252.63 of the Proposed Rule)

Under the proposal's external TLAC requirement, a covered BHC would be required to maintain outstanding eligible external TLAC in an amount not less than the greater of 18 percent of the covered BHC's total risk-weighted assets
45

and 9.5 percent of the covered BHC's total leverage exposure under the supplementary leverage ratio rule. As described below, an external TLAC buffer would apply in addition to the risk-weighted assets component of the external TLAC requirement.

45
A covered BHC would calculate risk-weighted assets for purposes of the external TLAC requirement using the same methodology it uses to calculate risk-weighted assets under the Board's regulatory capital rules. See 12 CFR part 217, subparts D and E. The Board's regulatory capital rules require an advanced approaches banking organization (generally, a banking organization with $250 billion or more in total consolidated assets or $10 billion or more in total on-balance sheet foreign exposure) that has successfully completed its parallel run to calculate each of its risk-based capital ratios using the standardized approach and the advanced approaches, and directs the banking organization to use the lower of each ratio as its governing ratio.
See
12 CFR 217.10.

The risk-weighted assets component of the external TLAC requirement would be phased in as follows: It would be equal to 16 percent of the covered BHC's risk-weighted assets beginning on January 1, 2019, and would be equal to 18 percent of the covered BHC's risk-weighted assets beginning on January 1, 2022.

Under the proposal's external LTD requirement, a covered BHC would be required to maintain outstanding eligible external LTD in an amount not less than the greater of 6 percent plus the surcharge applicable under the GSIB

surcharge rule (expressed as a percentage) of total risk-weighted assets and 4.5 percent of total leverage exposure. Covered BHCs would be prohibited from redeeming or repurchasing eligible external LTD prior to its stated maturity date without obtaining prior approval from the Board where the redemption or repurchase would cause the covered BHC's eligible external LTD to fall below its external LTD requirement.

The calibration of the proposed external TLAC requirement is based in part on an analysis of the historical loss experience of major financial institutions during financial crises. First, a targeted analysis of losses of U.S. financial firms during the 2007-2009 financial crisis was performed. The analysis considered the loss experiences of the 19 bank holding companies that participated in the Supervisory Capital Assessment Program (SCAP).
46

This analysis combined the losses actually sustained by those firms during the 2007-2008 period with their 2009 SCAP loss projections
47

and the government recapitalization support that they received in order to estimate the level of losses that would likely have been sustained in the absence of extraordinary government intervention in the financial system, which likely prevented substantial losses that each firm would otherwise have incurred as a result of the material financial distress or failure of major counterparties. The purpose of a TLAC requirement is to ensure that GSIBs have sufficient loss-absorbing capacity to absorb significant losses and then be recapitalized to the level necessary for them to face the market on a going-concern basis without public-sector support. Therefore, the sum of losses and public-sector recapitalization provides a good comparator for a TLAC requirement.

46

See
Press Release, “Federal Reserve, OCC, and FDIC release results of the Supervisory Capital Assessment Program” (May 7, 2009), available at
http://www.federalreserve.gov/newsevents/press/bcreg/20090507a.htm
.

47

See
“The Supervisory Capital Assessment Program: Overview of Results” (May 7, 2009), available at
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf
.

The analysis found that the bank holding company with the most severe loss experience incurred estimated losses and recapitalization needs of roughly 19 percent of risk-weighted assets. The risk-weighted assets component of the proposed external TLAC requirement is consistent with this high-water mark from the global financial crisis. This historical analysis provides further confirmation of the appropriateness of the proposed calibration.

Additionally, a quantitative study of the experiences of 13 U.S. and foreign GSIBs and other major financial firms that incurred substantial losses during the 2007-2009 financial crisis and the Japanese financial crisis of the 1990s was conducted. With respect to each firm, the study considered both the peak losses incurred by the firm (measured in terms of total comprehensive income) over the loss period and public-sector capital support, incorporating both direct capital injections and asset relief transactions.

The study examined losses and recapitalization in terms of both risk-weighted assets and total assets, which is relevant to the total leverage exposure component of the external TLAC requirement. The proposed calibration of the external TLAC requirement is consistent with the findings of this historical survey. The risk-weighted assets component of the proposed requirement exceeds a substantial majority of the loss-and-recapitalization experiences surveyed, while the total leverage exposure component of the proposed requirement is slightly higher than the most severe experience surveyed. These are appropriate results in light of the Dodd-Frank Act's focus on the mitigation of risks that could arise from the material financial distress or failure of the largest, most systemic financial institutions.

The proposed external LTD requirement was calibrated primarily on the basis of a “capital refill” framework. According to the capital refill framework, the objective of the external LTD requirement is to ensure that each covered BHC has a minimum amount of eligible external LTD such that, if the covered BHC's going-concern capital is depleted and the covered BHC fails and enters resolution, the eligible external LTD will be sufficient to absorb losses and fully recapitalize the covered BHC by replenishing its going-concern capital. Fulfilling this objective is vital to the use of eligible external LTD to facilitate the orderly resolution of a covered BHC, because it is a prerequisite to an orderly SPOE resolution that the resolved firm have sufficient going-concern capital post-resolution to maintain market confidence in its solvency so that other market participants continue to do business with it.

The proposed external LTD requirement was calibrated in accordance with this framework. In terms of risk-weighted assets, a covered BHC's common equity tier 1 capital level is an amount equal to a minimum requirement of 4.5 percent of risk-weighted assets plus a capital conservation buffer, which is itself equal to 2.5 percent plus a firm-specific surcharge determined under the GSIB surcharge rule (expressed as a percentage) of risk-weighted assets.
48

Thus, a covered BHC with a GSIB surcharge of 2 percent would have a common equity tier 1 capital minimum plus buffers of 9 percent.

48
Under the Board's capital rules, the capital conservation buffer can be increased by an additional 2.5 percent of risk-weighted assets through the activation of a countercyclical capital buffer. The proposed external LTD requirement does not incorporate any countercyclical capital buffer because it is likely that no such buffer would be active under the economic circumstances most likely to be associated with the failure and resolution of a covered BHC.

Under the proposal, a covered BHC would be subject to an external LTD requirement equal to 7 percent of risk-weighted assets plus the applicable GSIB surcharge minus a 1 percentage point allowance for balance-sheet depletion. This results in a requirement of 6 percent plus the applicable GSIB surcharge (expressed as a percentage) of risk-weighted assets. Without the 1 percentage point allowance for balance-sheet depletion, the risk-weighted assets component of a covered BHC's external LTD requirement would require it to maintain outstanding an amount of eligible external LTD equal to its common equity tier 1 capital minimum requirement plus buffers. The 1 percentage point allowance for balance-sheet depletion is appropriate under the capital refill theory because the losses that the covered BHC incurs leading to its failure will deplete its risk-weighted assets as well as its capital. Accordingly, the pre-failure losses would result in a smaller balance sheet for the covered BHC at the point of failure, meaning that a smaller dollar amount of capital would be required to restore the covered BHC's pre-stress capital level. Although the specific amount of eligible external LTD necessary to restore a covered BHC's pre-stress capital level in light of the diminished size of its post-failure balance sheet will vary slightly in light of the varying GSIB surcharges applicable to the covered BHCs, the Board is proposing to apply a uniform 1 percentage point allowance for balance-sheet depletion so as to avoid undue regulatory complexity.

The application of the capital refill framework to the leverage ratio component of the external LTD requirement is analogous. Under the enhanced supplementary leverage ratio applicable to U.S. GSIBs, a covered BHC's tier 1 leverage ratio minimum plus buffer is 5 percent of its total

leverage exposure. Under the proposal, a covered BHC would be subject to an external LTD requirement equal to 4.5 percent of its total leverage exposure. This requirement, which incorporates a balance-sheet depletion allowance of 0.5 percentage points, is appropriate to ensure that a covered BHC that has depleted its tier 1 capital and failed will be able to refill its leverage ratio minimum requirement and buffer through the cancellation or the exchange or conversion into equity of its eligible external LTD.

The proposed calibration of the external LTD requirement was also informed by an analysis of the extreme loss tail of the distribution of income for large U.S. bank holding companies over the past several decades. This analysis closely resembled the analysis that informed the calibration of the minimum risk-based capital requirements in the revised capital framework, but it involved looking farther into the tail of the income distribution.

Question 3: The Board invites comment on all aspects of the calibration of the proposed external TLAC and LTD requirements. In particular, the Board invites comment on the probable impact of the proposed requirements on covered BHCs and on markets for senior unsecured debt instruments.

C. Core Features of Eligible External TLAC (Section 252.63(b) of the Proposed Rule)

Under the proposal, a covered BHC's eligible external TLAC would be defined to be the sum of (a) the tier 1 regulatory capital (common equity tier 1 capital and additional tier 1 capital, excluding any tier 1 minority interests) issued directly by the covered BHC and (b) the covered BHC's eligible external LTD, as defined below.
49

Tier 2 capital that meets the definition of eligible external LTD would count toward the external TLAC requirement.

49
Although eligible external LTD with a remaining maturity between one and two years would be subject to a 50 percent haircut for purposes of the external LTD requirement, such eligible external LTD would continue to count at full value for purposes of the external TLAC requirement. As discussed below, eligible external LTD with a remaining maturity of less than one year would not count toward either the external TLAC requirement or the external LTD requirement.

The requirement that regulatory capital be issued out of the covered BHC itself (rather than by a subsidiary) is intended to ensure that the total required amount of loss-absorbing capacity would be available to absorb losses incurred anywhere in the banking organization (through downstreaming of resources from the BHC to the subsidiary that has incurred the losses, if necessary). Regulatory capital that is issued by a subsidiary lacks this key feature of being available to flexibly absorb losses incurred by other subsidiaries.

Question 4: The Board invites comment on all aspects of the proposed definition of eligible external TLAC.

Question 5: In particular, the Board invites comment on the proposed requirement that regulatory capital be issued directly by the covered BHC in order to count as eligible external TLAC. Should the definition of eligible external TLAC be broadened to include minority interests?

Question 6: Should eligible external LTD with a remaining maturity between one and two years be subject to a 50 percent haircut for purposes of the external TLAC requirement, by analogy to the treatment of such eligible external LTD for purposes of the external LTD requirement?

Question 7: Do covered BHCs have outstanding tier 2 capital instruments that would not count as eligible external LTD? What features of such tier 2 capital instruments are inconsistent with the definition of eligible external LTD? Should such tier 2 capital instruments count as eligible external TLAC?

D. External TLAC Buffer (Section 252.63(c) of the Proposed Rule)

An external TLAC buffer would apply in addition to the risk-weighted assets component of the external TLAC requirement. A covered BHC's external TLAC buffer would be equal to the sum of 2.5 percent plus the GSIB surcharge applicable to the covered BHC under method 1 of the GSIB surcharge rule
50

plus any applicable countercyclical capital buffer. The external TLAC buffer would be required to be filled solely with common equity tier 1 capital, and a covered BHC's breach of its external TLAC buffer would subject it to limits on capital distributions and discretionary bonus payments in accordance with Table 1. Thus, the external TLAC buffer would be analogous to the capital conservation buffer applicable under the Board's Regulation Q, except that it would apply in addition to the external TLAC requirement rather than in addition to minimum risk-based capital requirements under Regulation Q and would incorporate only the applicable method 1 GSIB surcharge (rather than the greater of the applicable method 1 GSIB surcharge and the applicable method 2 GSIB surcharge).

50
80 FR 49082 (Aug. 14, 2015).

Table 1—Calculation of Maximum External TLAC Payout Amount

External TLAC buffer level
Maximum external TLAC payout ratio (as a percentage of eligible retained income)

Greater than the external TLAC buffer
No payout ratio limitation applies.

Less than or equal to the external TLAC buffer,
and
greater than 75 percent of the external TLAC buffer

60 percent.

Less than or equal to 75 percent of the external TLAC buffer,
and
greater than 50 percent of the external TLAC buffer

40 percent.

Less than or equal to 50 percent of the external TLAC buffer,
and
greater 25 percent of the external TLAC buffer

20 percent.

Less than or equal to 25 percent of the external TLAC buffer
0 percent.

In order to determine whether it has met the external TLAC requirement and the external TLAC buffer, a covered BHC would calculate an outstanding TLAC amount and an external TLAC buffer level. In keeping with the definition of eligible external TLAC, a covered BHC's outstanding TLAC amount would be equal to the sum of its common equity tier 1 capital, its additional tier 1 capital, and its eligible external LTD. The covered BHC's external TLAC buffer level would be equal to the sum of its common equity tier 1 capital ratio minus that portion (if any) of its common equity tier 1 capital ratio (expressed as a percentage) that is used to meet the risk-weighted assets

component of the external TLAC requirement. To calculate its external TLAC buffer level, a covered BHC would subtract from its common equity tier 1 capital ratio the greater of 0 percent and the following figure: The risk-weighted assets component of the covered BHC's external TLAC requirement minus the ratio of its additional tier 1 capital to its risk-weighted assets (additional tier 1 capital ratio) and minus its eligible external LTD.

In order to comply with the external TLAC requirement, the covered BHC would need to have an outstanding TLAC amount sufficient to meet both the risk-weighted assets component and the total leverage exposure component. In order to avoid limitations on capital distributions and discretionary bonus payments pursuant to Table 1, the covered BHC would also have to have an external TLAC buffer level in excess of its external TLAC buffer.

For example, suppose that a covered BHC called “BHC A” has a common equity tier 1 capital ratio of 10 percent, an additional tier 1 capital ratio of 2 percent, and an eligible external LTD amount equal to 8 percent of its risk-weighted assets. Suppose further that BHC A is subject to an external TLAC requirement of 18 percent and an external TLAC buffer of 5 percent of risk-weighted assets. BHC A would meet its external TLAC requirement because the sum of its common equity tier 1 capital ratio, its additional tier 1 capital ratio, and the ratio of its eligible external TLAC to risk-weighted assets would be equal to 20, which is greater than 18. Moreover, BHC A would have an external TLAC buffer level equal to 10 − (18 − 2 − 8) = 2. Because 2 is less than 50 percent and more than 25 percent of the applicable 5 percent external TLAC buffer, BHC A would be subject to a maximum external TLAC payout ratio of 20 percent of eligible retained income.

Although the proposed external TLAC buffer must be met only with common equity tier 1 capital, under the proposal, any covered BHC that meets existing capital requirements and the existing capital conservation buffer would not need to increase its common equity tier 1 capital to meet its external TLAC requirement and its external TLAC buffer. This is because (a) a covered BHC could meet its external TLAC requirement solely through the issuance of eligible external LTD, (b) a covered BHC could use the same common equity tier 1 capital that it uses to meet existing minimum capital requirements and the existing capital conservation buffer to meet the proposed external TLAC requirement and external TLAC buffer, and (c) a covered BHC's external TLAC buffer would always be less than or equal to its existing capital conservation buffer.
51

A covered BHC could thus use its existing common equity tier 1 capital to meet the external TLAC buffer while issuing eligible external LTD as necessary to meet its external TLAC requirement.

51
This is because, as discussed above, the external TLAC buffer and the existing capital conservation buffer would have the same components except that the external TLAC buffer would include only the applicable method 1 GSIB surcharge, while the existing capital conservation buffer includes the greater of the applicable method 1 GSIB surcharge and the applicable method 2 GSIB surcharge.

The rationale for the external TLAC buffer is similar to the rationale for the capital conservation buffer established by the Board's Regulation Q. During the 2007-2009 financial crisis, some banking organizations continued to pay dividends and substantial discretionary bonuses even as their financial condition weakened. These capital distributions weakened the financial system and exacerbated the crisis. The external TLAC buffer would be intended to encourage covered BHCs to practice sound capital conservation and thus to enhance the resilience of covered BHCs and of the financial system as a whole. The external TLAC buffer would pursue this goal by providing covered BHCs with incentives to hold sufficient capital to reduce the risk that their eligible external TLAC would fall below the minimum external TLAC requirement during a period of financial stress.

Question 8: The Board invites comment on the organization and placement of the external TLAC buffer. For example, would the external TLAC buffer be easier to understand if it were incorporated directly into the Board's regulatory capital rules (Regulation Q)?

Question 9: The Board invites comment on an alternative calibration of the total leverage exposure component of the proposed external TLAC requirement pursuant to which covered BHCs would be subject to an external TLAC requirement equal to 7.5 percent of
total leverage exposure and a capital conservation buffer equal to 2 percent of total leverage exposure would apply in addition to that external TLAC requirement, by analogy to the enhanced supplementary leverage ratio.

E. Core Features of Eligible External LTD (Section 252.61 of the Proposed Rule)

Under the proposal, a covered BHC's eligible external LTD would be defined to be debt that is paid in and issued directly by the covered BHC, is unsecured, has a maturity of greater than one year from the date of issuance, is “plain vanilla,” and is governed by U.S. law. Eligible external LTD with a remaining maturity of between one and two years would be subject to a 50 percent haircut for purposes of the external LTD requirement, and eligible external LTD with a remaining maturity of less than one year would not count toward the external LTD requirement.

As discussed below, the general purpose of these requirements is to ensure the adequacy of eligible external LTD instruments to absorb losses in a resolution of the covered BHC.

1. Issuance by the Covered BHC

Eligible external LTD would be required to be paid in and issued directly by the covered BHC itself—that is, by the banking organization's top-tier holding company. Thus, debt instruments issued by a subsidiary would not qualify as eligible external LTD, even if they do qualify as regulatory capital.

This restriction would serve two purposes. First, as with the requirement that regulatory capital be issued directly by the covered BHC in order to count as eligible external TLAC, this restriction helps to ensure that eligible external LTD can be used to absorb losses incurred anywhere in the banking organization. By contrast, loss-absorbing debt issued by a subsidiary would lack this flexibility and would generally be available only to absorb losses incurred by that particular subsidiary.

Second, issuance directly from the covered BHC would enable the use of the eligible external LTD in an SPOE resolution of the covered BHC. Under the SPOE approach, only the covered BHC itself would enter resolution. The covered BHC's eligible external LTD would be used to absorb losses incurred throughout the banking organization, enabling the recapitalization of operating subsidiaries that had incurred losses and enabling those subsidiaries to continue operating on a going-concern basis. For this approach to be implemented successfully, the eligible external LTD must be issued directly by the covered BHC. Debt issued by a subsidiary generally cannot be used to absorb losses even at the issuing subsidiary itself unless that subsidiary enters a resolution proceeding, which would be contrary to the SPOE approach and, in the case of a material operating subsidiary of a covered BHC, would likely present risks to financial stability.

Question 10: The Board invites comment on the benefits or drawbacks

of permitting long-term debt issued by a subsidiary of a covered BHC to count as eligible external LTD and on whether there are other means to ensure that the debt be available to absorb losses incurred anywhere within the banking organization.

2. Unsecured

Eligible external LTD would be required to be unsecured, not guaranteed by the covered BHC or a subsidiary of the covered BHC, and not subject to any other arrangement that legally or economically enhances the seniority of the instrument (such as a credit enhancement provided by an affiliate). The primary rationale for this restriction is to ensure that eligible external LTD can serve its intended purpose of absorbing losses incurred by the banking organization in resolution. To the extent that a creditor is secured, it can avoid suffering losses by seizing the collateral that secures the debt. This would thwart the purpose of eligible external LTD by leaving losses with the covered BHC (which would lose the collateral) rather than imposing them on the eligible external LTD creditor (which could take the collateral).

A secondary purpose of the restriction is to prevent eligible external LTD from contributing to the asset firesales that can occur when a financial institution fails and its secured creditors seize and liquidate collateral. Asset firesales can drive down the value of the assets being sold, which can undermine financial stability by transmitting contagion from the failed firm to other entities that hold similar assets.

Finally, the requirement that eligible external LTD be unsecured ensures that losses can be imposed on that debt in resolution in accordance with the standard creditor hierarchy in bankruptcy, under which secured creditors are paid ahead of unsecured creditors.

Question 11: The Board invites comment on whether eligible external LTD should be required to be contractually subordinated to the general unsecured liabilities of the covered BHC (such as senior unsecured debt). If so, should the subordination requirement apply to all or only to some portion of the debt used to satisfy the external LTD requirement?

3. “Plain Vanilla”

Eligible external LTD instruments would be required to be “plain-vanilla” instruments. The purpose of this requirement is to ensure that eligible external LTD can be effectively used to absorb losses in resolution by prohibiting exotic features that could create complexity and thereby diminish the prospects for an orderly resolution.

These prohibitions would help to ensure that a covered BHC's eligible external LTD represents loss-absorbing capacity with a definite value that can be quickly determined in resolution. In a resolution proceeding, claims represented by such plain-vanilla debt instruments are more easily ascertainable and relatively certain compared to more complex and volatile instruments. Permitting these features could engender uncertainty as to the level of the covered BHC's loss-absorbing capacity and could increase the complexity of the resolution proceeding, both of which could undermine market participants' confidence in an SPOE resolution and potentially result in a disorderly resolution. This could occur, for instance, if creditors and counterparties of the covered BHC's subsidiaries decided to reduce their exposures to the subsidiaries of the failed covered BHC by engaging in a funding run.

Eligible external LTD instruments also would be prohibited from: (a) Being structured notes; (b) having a credit-sensitive feature; (c) including a contractual provision for conversion into or exchange for equity in the covered BHC; or (d) including a provision that gives the holder a contractual right to accelerate payment (including automatic acceleration), other than a right that is exercisable on a one or more dates specified in the instrument, in the event of the insolvency of the covered BHC, or the covered BHC's failure to make a payment on the instrument when due.
52

52
This restriction would be subject to an exception that would permit eligible external LTD instruments to give the holder a future put right as of a date certain, subject to the remaining maturity provisions discussed below.

For purposes of this proposal, a “structured note” is a debt instrument that (a) has a principal amount, redemption amount, or stated maturity that is subject to reduction based on the performance of any asset,
53

entity, index, or embedded derivative or similar embedded feature; (b) has an embedded derivative or similar embedded feature that is linked to one or more equity securities, commodities, assets, or entities; (c) does not specify a minimum principal amount due upon acceleration or early termination; or (d) is not classified as debt under U.S. generally accepted accounting principles. The proposed definition of a structured note is not intended to include non-dollar-denominated instruments or instruments whose interest payments are linked to an interest rate index (for example, a floating-rate note linked to the federal funds rate or to LIBOR) that satisfy the proposed requirements in all other respects.

53
Assets would include loans, debt securities, and other financial instruments.

Structured notes would not count as eligible external LTD because they contain features that could make their valuation uncertain, volatile, or unduly complex, and because they are typically customer liabilities (as opposed to investor liabilities). To promote resiliency and market discipline, it is important that covered BHCs have a minimum amount of loss-absorbing capacity whose value is easily ascertainable at any given time. Moreover, in an orderly resolution of a covered BHC, debt instruments that will be subjected to losses must be able to be valued accurately and with minimal risk of dispute. The requirement that eligible external LTD not contain the features associated with structured notes advances these goals.

Eligible external LTD would be prohibited from including contractual provisions for conversion into or exchange for equity prior to the covered BHC's resolution because the fundamental objective of the external LTD requirement is to ensure that covered BHCs will have at least a fixed minimum amount of loss-absorbing capacity available to absorb losses upon the covered BHC's entry into resolution. Debt instruments that could convert into equity prior to resolution may not serve this goal, since by doing so they would reduce the amount of debt that will be available to absorb losses in resolution.

Finally, eligible external LTD would be prohibited from having a credit-sensitive feature or giving the holder of the instrument a contractual right to the acceleration of payment of principal or interest at any time prior to the instrument's stated maturity (an “acceleration clause”), other than upon the occurrence of either an insolvency event or a payment default event, except that eligible external LTD instruments would be permitted to give the holder a put right as of a future date certain, subject to the remaining maturity provisions discussed below. This proposed prohibition is similar to but moderately less stringent than the analogous restriction on tier 2 regulatory capital. The main difference between eligible external LTD and tier 2 capital in this regard is that tier 2 capital is also prohibited from containing payment default event acceleration clauses.
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However, the Board is considering whether to instead impose a restriction on eligible external LTD that is identical to the one applicable to tier 2 capital by also prohibiting eligible external LTD from containing payment default event clauses.

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See
12 CFR 217.20(d)(1)(vi).

This proposed restriction serves the same purpose as several of the other proposed restrictions discussed above: to ensure that the required amount of loss-absorbing capacity will indeed be available to absorb losses in resolution if the covered BHC fails. Early acceleration clauses, including cross-acceleration clauses, may undermine this prerequisite to orderly resolution by triggering and forcing the covered BHC to make payments prior to its entry into resolution, potentially depleting the covered BHC's eligible external LTD immediately prior to resolution. This concern does not apply to acceleration clauses that are triggered by an insolvency event, however, because the insolvency that triggers the clause would generally occur concurrently with the covered BHC's entry into a resolution proceeding, in which case the payment obligations would generally be stayed and the debt would remain available to absorb losses.

Senior debt instruments issued by covered BHCs commonly also include payment default event clauses. These clauses provide the holder with a contractual right to accelerate payment upon the occurrence of a “payment default event”—that is, a failure by the covered BHC to make a required payment when due. Payment default event clauses, which are prohibited from tier 2 regulatory capital, raise more concerns than insolvency event clauses because a payment default event may occur (triggering acceleration) before the institution has entered a resolution proceeding and a stay has been imposed. Such a pre-resolution payment default event could cause a decline in the covered BHC's loss-absorbing capacity.

Nonetheless, the proposal would permit eligible external LTD to be subject to payment default event acceleration rights for two reasons. First, default or acceleration rights upon a borrower's default on its direct payment obligations are a standard feature of senior debt instruments, such that a prohibition on such rights could be unduly disruptive to the potential market for eligible external LTD. Second, the payment default of a covered BHC on an eligible external LTD instrument would likely be a credit event of such significance that whatever diminished capacity led to the payment default event would also be a sufficient trigger for an insolvency event acceleration clause, in which case a prohibition on payment default event acceleration clauses would have little or no practical effect.

Question 12: The Board invites comment on the proposed definition of eligible external LTD, including whether such debt securities should be allowed to include any of the features discussed above. The Board also invites comment as to the impact that the proposed restrictions would have on the bindingness of the proposal for covered BHCs or on the markets for senior unsecured debt instruments of covered BHCs. Please provide data supporting your answer.

Question 13: The Board invites comment on whether its proposed definition of eligible external LTD should exclude debt that is subject to a guarantee from any affiliate of the global systemically important BHC.

Question 14: The Board invites comment on whether additional restrictions should be imposed on instruments that qualify as eligible external LTD in order to enhance the usefulness of eligible external LTD in an orderly resolution of the covered BHC.

Question 15: Would an orderly resolution of a covered BHC be facilitated by additional requirements intended to facilitate the process of imposing losses on the claims of holders of eligible external LTD? If so, what additional requirements (e.g., requiring eligible external LTD to be held through a securities settlement system, requiring internal data systems to facilitate the claims process) are appropriate?

Question 16: The Board invites comment on whether currently outstanding instruments that meet all other requirements should be allowed to count as eligible external LTD despite containing features that would be prohibited under the proposal. What is the amount of debt instruments now outstanding that would fall into this category, and what is the remaining maturity of those debt instruments? How burdensome would it be for covered BHCs to modify the terms of any such instruments to eliminate features that would be prohibited under the proposal?

Question 17: The Board invites comment on whether eligible external LTD should be permitted to include acceleration clauses that relate to payment default events. The Board also invites comment on the impact of excluding instruments with such acceleration clauses from the definition of eligible external LTD, including any impact on debt markets for senior unsecured debt instruments.

Question 18: The Board invites comment on whether debt instruments that are convertible into equity (with or without a regulatory conversion triggers) should be permitted to count as eligible external TLAC even if they are excluded from eligible external LTD and on whether such instruments would advance the objectives of an orderly resolution of a covered BHC.

4. Minimum Remaining Maturity and Amortization (Section 252.62(b) of the Proposed Rule)

Eligible external LTD with a remaining maturity of between one and two years would be subject to a 50 percent haircut for purposes of the external LTD requirement, and eligible external LTD with a remaining maturity of less than one year would not count toward the external LTD requirement.

The purpose of this restriction is to limit the debt that would fill the external LTD requirement to debt that will be reliably available to absorb losses in the event that the covered BHC fails and enters resolution. Debt with a remaining maturity of less than one year does not adequately serve this purpose because of the relatively high likelihood that the debt will mature during the period between the time when the covered BHC begins to experience extreme stress and the time when it enters a resolution proceeding. If the debt matures during that period, then the creditor will likely be unwilling to maintain its exposure to the covered BHC and will therefore refuse to roll over the debt or extend new credit and the distressed covered BHC will likely be unable to replace the debt with new long-term debt that would be available to absorb losses in resolution. This run-off dynamic could result in the covered BHC's entering resolution with materially less loss-absorbing capacity than would be required to recapitalize its subsidiaries, potentially resulting in a disorderly resolution. To protect against this outcome, eligible external LTD would cease to count toward the external LTD requirement upon falling below one year of remaining maturity so that the full required amount of loss-absorbing capacity would be available in resolution even if the resolution period were preceded by a year-long stress period.
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This requirement also accords with market convention, which generally defines “long-term debt” as debt with maturity in excess of one year.

For analogous reasons, eligible external LTD with a remaining maturity of less than two years would be subject to a 50 percent haircut for purposes of the external LTD requirement, meaning

that only 50 percent of the value of its principal amount would count toward the external LTD requirement.
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This amortization provision is intended to protect a covered BHC's loss-absorbing capacity against a run-off period in excess of one year (as might occur during a financial crisis or other protracted stress period) in two ways. First, it requires covered BHCs that rely on eligible external LTD that is vulnerable to such a run-off period (because it has a remaining maturity of less than two years) to maintain additional loss-absorbing capacity. Second, it incentivizes covered BHCs to reduce or eliminate their reliance on loss-absorbing capacity with a remaining maturity of less than two years, since by doing so they avoid being required to issue additional eligible external LTD in order to account for the haircut. A covered BHC could reduce its reliance on eligible external LTD with a remaining maturity of less than two years by staggering its issuance, by issuing eligible external LTD with a relatively long initial maturity, or by redeeming and replacing eligible external LTD once its remaining maturity falls below two years.

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As discussed above, the proposed amoritization would apply only to eligible external LTD, not to eligible external TLAC. Thus, an eligible external LTD instrument that counts for only half value toward the external LTD requirement because of the 50 percent amortization provision would continue to count for full value toward the external TLAC requirement, although debt with a remaining maturity of less than one year would not count toward either requirement.

The proposal also provides similar treatment for eligible external LTD that could become subject to a “put” right—that is, a right of the holder to require the issuer to redeem the debt on demand—prior to reaching its stated maturity. Such an instrument would be treated as if it were going to mature on the day on which it first became subject to the put right, since on that day the creditor would be capable of demanding payment and thereby subtracting the value of the instrument from the covered BHC's loss-absorbing capacity.
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The remaining maturity would be calculated from the date the put right would first be exerciseable regardless of whether the put right would only be exerciseable on that date if another event occurred (
e.g.,
a credit rating downgrade).

Question 19:

The Board invites comment on whether the proposed treatment of eligible external LTD with a remaining maturity of less than two years is appropriate. How would a different remaining maturity requirement or amortization schedule better achieve the objectives of the proposal?

Question 20:

The Board invites comment on whether a specific eligible external LTD issuance schedule or similar requirement should be imposed on covered BHCs by regulation. If so, how should the requirement be structured to maximize benefits and minimize costs?

Question 21: The Board invites comment on the proposed treatment of debt instruments that could become subject to put rights in the future. Should such instruments
be excluded entirely from the definition of eligible external LTD? If so, what impact would such a prohibition have on markets for senior unsecured debt of covered BHCs?

5. Governing Law

Eligible long-term debt instruments should consist only of liabilities that can be effectively used to absorb losses during the resolution of a covered BHC under the U.S. Bankruptcy Code or Title II without giving rise to material risk of successful legal challenge. To this end, eligible external LTD must be governed by U.S. law, including the U.S. Bankruptcy Code and Title II.

Question 22: The Board invites comment on the proposed governing law requirement, including whether such a requirement is necessary or appropriate. Should the proposed definition of eligible external LTD permit instruments to be governed by or subject to non-U.S. law in any respects? If so, how would that be consistent the purposes of the proposed rule?

6. Contractual Subordination

The Board considered whether to require eligible external LTD instruments to be contractually subordinated to the claims of general creditors of a covered BHC. A contractual subordination requirement could improve the market discipline imposed on a covered BHC by increasing the clarity of treatment for eligible external LTD holders relative to other creditors.

The proposal does not include a contractual subordination requirement for several reasons. First, as discussed above, the structural subordination of a covered BHC's creditors to the creditors and counterparties of the covered BHC's subsidiaries already generally ensures that the covered BHC's creditors would absorb losses ahead of the creditors of the covered BHC's subsidiaries in an SPOE resolution of the covered BHC.
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Second, the Board is proposing to subject covered BHCs to clean holding company provisions that would limit the amount of non- TLAC instruments that could be pari passu with or junior to eligible external LTD, which will further address any concerns with covered BHCs' unsecured creditor hierarchies.

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As discussed above, in an insolvency proceeding, direct third-party claims on a parent holding company's subsidiaries would be superior to the parent holding company's equity claims on the subsidiaries.

By limiting the criteria for eligible external LTD to those necessary to achieve the objectives of the proposal, the proposal seeks to retain the broadest possible market for eligible external LTD instruments. Allowing covered BHCs to retain the flexibility to satisfy the external LTD requirement with either senior or subordinated debt instruments should allow covered BHCs to comply with the requirement efficiently, to adapt to debt investors' risk preferences, and to avoid re-issuances of outstanding long-term senior debt instruments that would otherwise meet the criteria for eligible external LTD.

Question 23: Should the Board require that eligible external LTD be contractually subordinated to the general unsecured liabilities of the covered BHC.

F. Costs and Benefits

An analysis of the potential costs and benefits of the external TLAC and LTD requirements was conducted. To evaluate the costs attributable to the proposed requirements, this analysis estimated (a) the extent by which the covered BHCs' required capital and currently outstanding long-term debt fall short of the proposed requirements, (b) the increase in each U.S. GSIB's ongoing cost of funding that would result from meeting the proposed requirements, (c) the expected increase in the interest rates that the U.S. GSIBs would charge to borrowers to make up for their higher funding costs, and (d) any decline in the gross domestic product (GDP) of the United States that would result from these increased lending rates.

The following components relevant to the benefits of the proposed requirements were evaluated: (a) The probability of a financial crisis occurring in a given year, (b) the cumulative economic cost that a financial crisis would impose if it were to occur, and (c) the extent to which the proposed requirements would decrease the likelihood and cost of a financial crisis.

The analysis concluded that the estimated benefits would outweigh the estimated costs and that the proposed external TLAC and LTD requirements would yield a substantial net benefit for the U.S. economy.

1. Shortfall Analysis

To evaluate the U.S. GSIBs' shortfalls relative to the proposed external TLAC and LTD requirements, information was collected on the long-term debt that covered BHCs had outstanding as of year-end 2014.

Several assumptions were made for purposes of the shortfall analysis. First, to provide an accurate estimate of shortfalls relative to the proposed requirements using 2014 data, it was assumed that the covered BHCs were already compliant with the other capital requirements (including capital conservation buffers) that will be in effect as of 2019, when the proposed external TLAC and LTD requirements would begin to take effect. This assumption was necessary to ensure that the analysis would attribute to the proposed external TLAC and LTD requirements only those costs that would result from those requirements, as distinct from other requirements that the Board has imposed but that were not fully phased in as of year-end 2014. As a result of this assumption, a certain amount of “capital catch-up” was allocated to five of the U.S. GSIBs to bring their capital levels into alignment with the rules that will be in effect as of 2019.

Second, for purposes of this analysis, all of the U.S. GSIB debt that met the primary attributes of eligible external LTD was treated as eligible LTD, including issuance directly from the covered BHC, remaining maturity of at least one year, and the absence of derivative-linked features. Although these instruments may not meet every one of the other proposed elements of eligible external LTD, it appears that the cost of meeting any remaining elements would be relatively minor.

Under the proposal, covered BHCs would have an aggregate external LTD requirement of approximately $680 billion. This amounts to approximately 9.6 percent of aggregate risk-weighted assets and 4.9 percent of aggregate total leverage exposure for the covered BHCs. The covered BHCs' aggregate shortfall relative to the proposed external TLAC requirement was approximately $100 billion. The covered BHCs' aggregate shortfall relative to the proposed external LTD requirement was approximately $90 billion. For four of the covered BHCs, the risk-weighted assets component of the external LTD requirement was binding; for the other four covered BHCs, the supplementary leverage exposure component was binding.

The covered BHCs' overall aggregate shortfall from the two proposed requirements was approximately $120 billion, or 1.7 percent of aggregate risk-weighted assets.
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The proposed external TLAC requirement was the binding requirement for three of the covered BHCs, while the proposed external LTD requirement was the binding requirement for the other five covered BHCs. Two of the covered BHCs had no shortfall under either requirement, while the largest overall shortfall for any covered BHC amounted to 3.2 percent of its risk-weighted assets.

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This figure is less than the sum of the separate aggregate shortfalls for the external TLAC requirement and the external LTD requirement because of substantial overlap between the two requirements (that is, because eligible external LTD would also count toward the external TLAC requirement).

2. Cost-of-Funding Analysis

The analysis also considered the effect that filling the $120 billion shortfall through the issuance of additional eligible external LTD would have on the covered BHCs' cost of funding. This analysis relied on additional information about the amounts and costs of funding of the debt that the covered BHCs and their subsidiaries currently have outstanding.

Several additional assumptions were made at this stage of the analysis. First, it was assumed that covered BHCs would fill their shortfalls by replacing existing, ineligible debt with eligible external LTD during the period prior to the effective date of the proposed requirements, rather than by expanding their balance sheets by issuing the new debt while maintaining existing liabilities outstanding. Second, it was assumed that covered BHCs would minimize the cost associated with meeting the proposed external TLAC and LTD requirements by first replacing with eligible external LTD their “near-eligible debt”—that is, their outstanding debt that comes closest to meeting all requirements for eligible external LTD (and that therefore entails a cost of funding almost as high as that associated with eligible external LTD)—and by proceeding in this cost-minimizing fashion until the proposed requirements were met. Thus, the marginal cost of each additional dollar of eligible external LTD was assumed to be the surplus of the funding cost associated with eligible external LTD over the funding cost of the covered BHC's highest-cost remaining ineligible debt. Finally, if total near-eligible liabilities were insufficient to fill the shortfall, it was assumed that the covered BHC proceeded to replace more senior, short-term liabilities, such as deposits, with eligible external LTD.

Roughly $65 billion of the aggregate $120 billion shortfall could be filled through the issuance of eligible external LTD in the place of existing near-eligible debt, most of which takes the form of long-term bonds issued by the covered BHCs' bank subsidiaries.
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Based on market data, it was estimated that the spread between this near-eligible debt and eligible external LTD is between 20 and 30 basis points. The remaining $55 billion shortfall could then be filled through the issuance of eligible external LTD in the place of existing deposits or other lower-cost liabilities. It was estimated that the spread between these liabilities and eligible external LTD is approximately equal to the spread between the risk-free interest rate and the eligible external LTD rate, which is estimated to be between 100 and 150 basis points.

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For purposes of this analysis, structured notes were not treated as near-eligible debt. Structured notes could be viewed as near-eligible debt, but in many cases structured notes serve different purposes than debt that was treated as near-eligible (such as plain-vanilla bonds issued by covered BHCs' bank subsidiaries). As a result, the analysis assumed that covered BHCs would not replace their outstanding structured notes with eligible external LTD. On the assumption that covered BHCs would indeed replace their outstanding structured notes with eligible external LTD, covered BHCs would be able to meet roughly $100 billion of the aggregate $120 billion shortfall by replacing near-eligible debt with eligible external LTD, which would result in a lower estimated cost impact from the proposed requirements.

The figures at the low ends of these ranges—20 basis points for replacing near-eligible debt and 100 basis points for replacing lower-cost liabilities such as deposits—result in an aggregate increased cost of funding for the covered BHCs of $680 million per year.

A more conservative estimate was produced using figures at the high ends of these ranges and then further adjusted them upward to reflect a potential supply effect of 30 basis points (that is, an increase in the interest rate on eligible external LTD caused by the increase in the supply of eligible external LT as a result of the proposed external LTD requirement). The aggregate shortfall in eligible LTD amounts to approximately 20 percent of the covered BHCs' current eligible LTD, implying that the covered BHCs in the aggregate would need to increase their outstanding eligible external LTD by 3 to 4 percent each year through 2022, when the proposed requirements would be fully phased in. On the basis of both internal analysis and an international survey of market participants in which Board staff participated, it is estimated that this increase in supply would increase spreads of covered BHCs'

eligible external LTD by approximately 30 basis points.

Using the resulting, higher figures—60 basis points for replacing near-eligible debt and 200 basis points for replacing lower-cost liabilities—resulted in an estimated aggregate increased cost of funding for the covered BHCs of approximately $1.5 billion per year.

Thus, the aggregate increased cost of funding attributable to the proposed external TLAC and LTD requirement are estimated to be in the range of $680 million to $1.5 billion annually.

3. Increased Lending Rate Analysis

To arrive at a conservative estimate of the effect of the proposed external TLAC and LTD requirements on lending rates, it was next assumed that the U.S. GSIBs would maintain their current return-on-equity levels by passing all of their increased funding costs on to borrowers, holding constant their level of lending activity. The increased lending rates that the U.S. GSIBs would charge to borrowers were calculated by dividing both the low-end and the high-end estimated cost-of-funding increases by the U.S. GSIBs' aggregate outstanding loans of roughly $3.2 trillion. Under this analysis, covered BHCs would employ an increased lending rate of 1.3 to 3.1 basis points as a result of the proposed external TLAC and LTD requirements.

4. Macroeconomic Costs Analysis

In prior assessments of the economic impact of regulations on banking organizations, increases in lending rates have been assumed to produce a drag on GDP growth. However, the very modest lending rate increases estimated above—from 1.3 to 3.1 basis points—do not rise to the level of increase that could be expected to meaningfully affect GDP. Thus, from the standpoint of the economy as a whole, it appears that the costs associated with the proposed external TLAC and LTD requirements would be minimal.

5. Macroeconomic Benefits Analysis

To estimate the benefits of the proposed requirements, the analysis built on the framework considered in a recent study titled “An assessment of the long-term economic impact of stronger capital and liquidity requirements” (“LEI report”).
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The LEI report estimated that, prior to the regulatory reforms undertaken since 2009, the probability of a financial crisis occurring in a given year was between 3.5 percent and 5.2 percent and the cumulative cost was between 20 percent and 100 percent of annual economic output. Even assuming that the lower ends of these ranges are accurate, these estimates reflect the well-understood fact that financial crises impose very substantial costs on the real economy. And the disorderly failures of major financial institutions play a major role in causing and deepening financial crises, as Congress recognized in enacting section 165 of the Dodd-Frank Act.

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Basel Committee on Banking Supervision, “An assessment of the long-term economic impact of stronger capital and liquidity requirements” (August 2010), available at
http://www.bis.org/publ/bcbs173.pdf
.

This proposal would materially reduce the risk that the failure of a covered BHC would pose to the financial stability of the United States by enhancing the prospects for the orderly resolution of such a firm. Moreover, by ensuring that the losses caused by the failure of such a firm are borne by private-sector investors and creditors (the holders of the covered BHC's eligible external TLAC), this proposal would materially reduce the probability that a covered BHC would fail in the first place by giving the firm's shareholders and creditors stronger incentives to discipline its excessive risk-taking. Both of these reductions would promote financial stability and concomitantly materially reduce the probability that a financial crisis would occur in any given year. The proposed rule would therefore advance a key objective of the Dodd-Frank Act and help protect the American economy from the substantial potential losses associated with a higher probability of financial crises.

Question 24: The Board invites comment on all aspects of the foregoing evaluation of costs and benefits.

III. Internal TLAC and LTD Requirements for U.S. Intermediate Holding Companies of Foreign Banking Organizations

A. Scope of Application (Section 252.160 of the Proposed Rule)

The proposed rule would apply to all “covered IHCs.” The term “covered IHC” would be defined to include any U.S. intermediate holding company that (a) is required to be formed under the Board's enhanced prudential standards rule (IHC rule) and (b) is controlled by a foreign banking organization that would be designated as a GSIB under either the Board's capital rules if it were subject to the Board's GSIB surcharge on a consolidated basis or the BCBS assessment methodology (foreign GSIB).

The purpose of these criteria is to identify those foreign banking organizations that are global systemically important banking organizations and that have substantial operations in the United States. The Board's IHC rule identifies foreign banking organizations with a substantial U.S. presence and requires them to form a single U.S. intermediate holding company over their U.S. subsidiaries.
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Thus, the fact that a foreign banking organization is required to form a U.S. intermediate holding company is an indicator of whether its U.S. presence is substantial.

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The IHC rule generally requires any foreign banking organization with total consolidated non-branch U.S. assets of $50 billion or more to form a single U.S. intermediate holding company over its U.S. subsidiaries. 12 CFR 252.153; 79 FR 17329 (May 27, 2014).

The Board's GSIB surcharge rule identifies the most systemically important banking organizations. As discussed above with respect to covered BHCs, its methodology evaluates a banking organization's systemic importance on the basis of its size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity. The firms that score the highest on these attributes are classified as GSIBs. While the GSIB surcharge rule itself applies only to U.S. BHCs, its methodology is equally well-suited to evaluating the systemic importance of foreign banking organizations. The Board's methodology for identifying GSIBs is aligned with that of the assessment methodology for the GSIB surcharge framework developed by the BCBS. Moreover, foreign jurisdictions collect information from banking organizations in connection with that framework that parallels the information collected by the Board for purposes of the Board's GSIB surcharge rule.

Under the proposal, a foreign banking organization that controls a U.S. intermediate holding company would be required to determine whether it is a GSIB under that BCBS assessment methodology if the foreign banking organization already prepares or reports, for any purpose, the information necessary to determine whether it is a GSIB under the BCBS assessment methodology. A foreign banking organization that determines under this requirement that it is a GSIB would be a foreign GSIB under the proposal.

A foreign banking organization that controls a U.S. intermediate holding company also would be a foreign GSIB under the proposal if the Board determines that the foreign banking organization has the characteristics of a GSIB under the BCBS assessment methodology or the Board's methodology for determining whether U.S. bank holding companies are GSIBs for purposes of the Board's capital rules,

or if the Board determines that the U.S. intermediate holding company would itself be a GSIB under the Board's methodology. The proposal would therefore require each top-tier foreign banking organization that controls an U.S. intermediate holding company to notify the Board by January first of each year whether its home country supervisor (or other appropriate home country regulatory authority) has adopted standards consistent with the BCBS assessment methodology, whether the organization prepares or reports the indicators used by the BCBS assessment methodology, and if it does prepare or report such indicators, whether the organization has determined that it has the characteristics of a global systemically important banking organization under the BCBS assessment methodology.
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Under the proposal, these notice and determination requirements would apply to the “top-tier foreign banking organization.” The proposal defines top-tier foreign banking organization, with respect to a foreign bank, as the top-tier entity that controls the foreign bank (if any) unless the Board specifies a subsidiary of such entity as the “top-tier foreign banking organization.” Thus, the definition would include the top-tier entity that controls a foreign bank, which would be the foreign bank if no entity controls the foreign bank, or the entity specified by the Board that is a subsidiary of the top-tier entity.

As with covered BHCs, the proposal's focus on GSIBs is in keeping with the Dodd-Frank Act's mandate that more stringent prudential standards be applied to the most systemically important bank holding companies.
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Furthermore, the use of the GSIB surcharge rule to identify foreign GSIBs as well as U.S. GSIBs (and thus to identify both covered BHCs and covered IHCs) promotes a level playing field between U.S. and foreign banking organizations.

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12 U.S.C. 5365(a)(1)(B).

Question 25: The Board invites comment on alternative approaches for determining the scope of application of the proposed internal TLAC and LTD requirements. Should the Board apply the proposed internal TLAC and LTD requirements to all U.S. intermediate holding companies required to be formed under the IHC rule rather than limiting it to U.S. intermediate holding companies that are controlled by foreign GSIBs?

Question 26: Is the proposed method for determining whether a foreign banking organization is a foreign GSIB—application of the relevant portion of the Board's GSIB surcharge rule to the foreign banking organization's balance sheet—an appropriate method for making that determination? Would an alternative method for identifying foreign GSIBs—such as looking to whether the foreign banking organization has been classified as a GSIB by its home supervisory authority or by the FSB—be more appropriate?

Question 27: What additional modifications, if any, would be appropriate to the definition “top-tier foreign banking organization” to sufficiently explain the types of entities that may be considered top-tier foreign banking organizations under the proposal?

B. Calibration of the Internal TLAC and LTD Requirements (Sections 252.162 and 252.164 of the Proposed Rule)

Under the internal TLAC requirement, the amount of eligible internal total loss-absorbing capacity (“eligible internal TLAC”) that a covered IHC would be required to maintain outstanding would depend on whether the covered IHC (or any of its subsidiaries) is expected to enter resolution if a foreign parent entity fails, rather than being maintained as a going concern while a foreign parent entity is resolved. If the home country resolution authority for the parent foreign banking organization of the covered IHC provides a certification to the Board indicating that the authority's planned resolution strategy for the foreign banking organization does not involve the covered IHC or any subsidiary of the covered IHC entering a resolution proceeding in the United States, then the covered IHC would be considered a “non-resolution entity.”
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If the home country resolution authority for the foreign banking organization that controls the covered IHC subsequently indicates that its planned resolution strategy for the foreign banking organization does involve the covered IHC or its subsidiaries being separately resolved in the United States, the covered IHC would cease to be a non-resolution entity one year after the Board provides the covered IHC with notice of the change.

Covered IHCs that are non-resolution entities would be required to maintain outstanding eligible internal TLAC in an amount not less than the greater of: (a) 16 percent of the covered IHC's total risk-weighted assets;
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(b) for covered IHCs that are subject to the supplementary leverage ratio,
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6 percent of the covered IHC's total leverage exposure; and (c) 8 percent of the covered IHC's average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio.
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All other covered IHCs would be required to maintain outstanding eligible internal TLAC in an amount not less than the greater of: (a) 18 percent of the covered IHC's total risk-weighted assets;
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(b) 6.75 percent of the covered IHC's total leverage exposure (if applicable); and (c) 9 percent of the covered IHC's average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio.

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The risk-weighted assets component of the internal TLAC requirement would be phased in as follows: It would be equal to 14 percent of the covered IHC's risk-weighted assets beginning on January 1, 2019, and would be equal to 16 percent of the covered IHC's risk-weighted assets beginning on January 1, 2022.

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Under the IHC rule, U.S. intermediate holding companies with total consolidated assets of $250 billion or more or on-balance sheet foreign exposure equal to $10 billion or more are required to meet a minimum supplementary leverage ratio of 3 percent. 12 CFR 252.153(e)(2); 79 FR 17329 (March 27, 2014).

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The final rule imposes the same leverage capital requirements on U.S. intermediate holding companies as it does on U.S. bank holding companies. 12 CFR 252.153(e)(2); 79 FR 17329 (March 27, 2014). These leverage capital requirements include the generally-applicable leverage ratio and the supplementary leverage ratio for U.S. intermediate holding companies that meet the scope of application for that ratio.

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The risk-weighted assets component of the internal TLAC requirement for covered IHCs of MPOE firms would be phased in as follows: It would be equal to 16 percent of the covered IHC's risk-weighted assets beginning on January 1, 2019, and would be equal to 18 percent of the covered IHC's risk-weighted assets beginning on January 1, 2022.

As described below, an internal TLAC buffer would apply to all covered IHCs in addition to the applicable risk-weighted assets component of the internal TLAC requirement.

Under the internal LTD requirement, a covered IHC would be required to maintain outstanding eligible internal long-term debt instruments (“eligible internal LTD”) in an amount not less than the greater of: (a) 7 percent of total risk-weighted assets; (b) 3 percent of the total leverage exposure (if applicable); and (c) 4 percent of average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio. Covered IHCs would be prohibited from redeeming eligible internal LTD prior to its stated maturity date without obtaining prior approval from the Board where such redemption would cause the covered IHC's eligible internal LTD to fall below its internal LTD requirement.

The rationale for the proposed internal TLAC and LTD requirements is generally parallel to the rationale for the proposed external TLAC and LTD requirements, which is discussed above. Covered IHCs, other than those that are non-resolution entities, would be subject to an internal TLAC requirement with a risk-weighted assets component identical to the risk-weighted assets component of the proposed external TLAC requirement. They would be subject to a supplementary leverage ratio component (if applicable) that is lower than the supplementary leverage ratio component of the proposed

external TLAC requirement in recognition of the fact that covered IHCs are not U.S. GSIBs and so would not be subject to the enhanced supplementary leverage ratio that applies to U.S. GSIBs. Finally, because some covered IHCs may not be subject to the supplementary leverage ratio, a third component based on the U.S. tier 1 leverage ratio was added to the internal LTD requirement. The proposed calibration of this component is consistent with the proposed calibration of the supplementary leverage ratio component.
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Generally, a bank holding company is subject to a 4 percent on-balance sheet leverage ratio requirement and a 3 percent supplementary leverage ratio requirement (if the supplementary leverage ratio applies to the bank holding company). The proposed calibration of the on-balance sheet leverage ratio component of the proposed internal TLAC requirement, 8 percent, is twice the 4 percent requirement because the proposed calibration of the supplementary leverage ratio requirement, 6 percent, is twice the 3 percent requirement. The aim was to ensure that covered IHCs that are not subject to the supplementary leverage ratio would be subject to a roughly analogous component under the internal TLAC requirement.

Covered IHCs that are non-resolution entities would be subject to a slightly lower internal TLAC requirement. Most foreign GSIBs are expected to be resolved by their home jurisdiction resolution authorities through an SPOE resolution and are therefore expected to be non-resolution entities under the proposal. Were such an SPOE resolution to succeed, the covered IHC would avoid entering resolution and would continue as a going concern, with its eligible internal TLAC and eligible internal LTD used to pass up the covered IHC's going-concern losses to the parent foreign GSIB, to the extent necessary. However, the Board also recognizes the need to plan for the contingency in which the covered IHC enters a U.S. resolution proceeding. The proposed calibration for such a covered IHC is based on the desirability of providing support for the preferred SPOE resolution of the foreign GSIB, which requires that the foreign GSIB be allowed to have some internal loss-absorbing capacity at the parent level that can be freely allocated to whichever subsidiaries have incurred the greatest losses (including non-U.S. subsidiaries), balanced with the need to ensure that sufficient loss-absorbing capacity is prepositioned with the covered IHC to ensure that it can be kept operating as a going concern or subjected to an orderly resolution in the United States if the foreign GSIB is not subjected to an SPOE resolution.

By contrast, covered IHCs that are not designated as non-resolution entities are more analogous to covered BHCs, which are themselves resolution entities. For these covered IHCs, there is no need to apply a diminished eligible internal TLAC requirement in order to support an SPOE resolution of the parent foreign GSIB. These covered IHCs would therefore be subject to eligible internal TLAC requirements in line with the eligible external TLAC requirements that would apply to covered BHCs, as discussed above.

The proposed internal LTD requirements are based on the capital refill framework discussed above with respect to the proposed external LTD requirements. Because covered IHCs are not U.S. GSIBs and are therefore not subject to a GSIB surcharge or to the enhanced supplementary leverage ratio, a covered IHC is subject to a common equity tier 1 capital level of 7 percent of risk-weighted assets (4.5 percent plus a 2.5 percent capital conservation buffer) and, if the supplementary leverage ratio applies to the covered IHC, to a tier 1 capital supplementary leverage ratio requirement of 3 percent of total leverage exposure. Because some covered IHCs may not be subject to the supplementary leverage ratio, a third component based on the U.S. tier 1 leverage ratio was added to the internal LTD requirement. The applicable requirement under that leverage ratio is 4 percent of on-balance sheet assets. The calibration of the proposed internal LTD requirements derives from the application of the capital refill framework described above to these requirements.

Question 28: The Board invites comment on all aspects of the proposed calibration of the internal TLAC and LTD requirements, including any impact on the internal funding structures of the covered IHC's parent foreign bank.

Question 29: The Board invites comment on its proposed method for identifying covered IHCs that are non-resolution entities.

Question 30: The Board invites comment on whether, instead of being subject to differing internal TLAC requirements on the basis of whether or not they are non-resolution entities, all covered IHCs should be subject to either the lower proposed internal TLAC requirement or to the higher proposed internal TLAC requirement.

Question 31: The Board invites comment on whether to eliminate the proposed internal TLAC requirement and subject covered IHCs to the proposed internal LTD requirement only.

C. Core Features of Eligible Internal TLAC (Section 252.164 of the Proposed Rule)

The definition of eligible internal TLAC is similar to the definition of eligible external TLAC. A covered IHC's eligible internal TLAC would be defined to be the sum of (a) the tier 1 regulatory capital (common equity tier 1 capital and additional tier 1 capital) issued from the covered IHC to a foreign entity that directly or indirectly controls the covered IHC (“foreign parent entity”) and (b) the covered IHC's eligible internal LTD, as defined below.
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Similar to the definition of eligible external TLAC, tier 2 capital that meets the definition of eligible internal LTD would count toward the internal TLAC requirement.

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Although eligible internal LTD with a remaining maturity between one and two years would be subject to a 50 percent haircut for purposes of the internal LTD requirement, such eligible internal LTD would continue to count at full value for purposes of the internal TLAC requirement. As discussed below, eligible internal LTD with a remaining maturity of less than one year would not count toward either the internal TLAC requirement or the internal LTD requirement.

The rationale for the requirement that regulatory capital be issued directly by the covered IHC, rather than by a subsidiary of the IHC, in order to count as eligible internal TLAC is identical to the rationale for the analogous requirement for eligible external TLAC: To ensure that the required quantity of loss-absorbing capacity will be available to absorb losses incurred anywhere by any subsidiary of the IHC. Regulatory capital that is issued by one subsidiary of the covered IHC would not necessarily be available to absorb losses incurred by another subsidiary.

Regulatory capital must meet one additional requirements in order to count as eligible internal TLAC: It must be issued to a foreign parent entity

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2015-29740. Public record. Not legal advice.