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

Federal RegisterJan 24, 2017

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FEDERAL RESERVE SYSTEM

12 CFR Part 252

[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

AGENCY:

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

ACTION:

Final rule.

SUMMARY:

The Board is adopting a final rule to require a U.S. top-tier bank holding company identified under the Board's rules as a global systemically important bank holding company (covered BHC) to maintain outstanding a minimum amount of loss-absorbing instruments, including a minimum amount of unsecured long-term debt. In addition, the final rule prescribes certain additional buffers, the breach of which would result in limitations on the capital distributions and discretionary bonus payments of a covered BHC. The final rule applies similar requirements to 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). The final rule also imposes restrictions on other liabilities that a covered BHC or covered IHC may have outstanding in order to improve their resolvability and resiliency; these restrictions are referred to in the final rule as “clean holding company requirements.”

DATES:

The final rule is effective on March 27, 2017.

FOR FURTHER INFORMATION CONTACT:

Sean Campbell, Associate Director, 202 452-3760, Thomas Boemio, Senior Project Manager, (202) 452-2982, or Anna Harrington, Senior Supervisory Financial Analyst, (202) 452-6406, Division of 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, Senior Counsel, (202) 452-3351, Greg Frischmann, Counsel, (202) 452-2803, or Mark Buresh, Senior Attorney, (202) 452-5270, 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. Background

B. Notice of Proposed Rulemaking and General Summary of Comments

C. Overview of the Final Rule

D. Consultation With the Federal Deposit Insurance Corporation, the Financial Stability Oversight Council, and Foreign Authorities

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. TLAC and LTD Requirements for U.S. Intermediate Holding Companies of Global Systemically Important Foreign Banking Organizations

A. Eligible External and Internal Issuance of TLAC and LTD by Covered IHCs

B. Scope of Application

C. Resolution and Non-Resolution IHCs

D. Calibration of the TLAC and LTD Requirements

E. Core Features of Eligible TLAC

F. TLAC Buffer for Covered IHCs

G. Core Features of Eligible Internal and External LTD for Covered IHCs

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 Certain Liabilities

F. Disclosure Requirements

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

VI. Transition Periods

VII. Consideration of Domestic Internal TLAC Requirements and Public Reporting Requirements for Eligible Internal TLAC and LTD

VIII. Regulatory Analysis

A. Paperwork Reduction Act

B. Regulatory Flexibility Act

C. Invitation for Comments on Use of Plain Language

I. Introduction

A. Background

In October 2015, the Board invited public comment on a notice of proposed rulemaking (proposal) to require the largest domestic and foreign banks operating in the United States to maintain a minimum amount of total loss-absorbing capacity (TLAC), consisting of a minimum amount of long-term debt (LTD) and tier 1 capital.

In addition, the proposed rule prescribed certain buffers, the breach of which would result in limitations on the capital distributions and discretionary bonus payments of the firm. The proposal also included a separate requirement that these companies maintain a minimum amount of LTD. The TLAC and LTD requirements in the proposal had two overall objectives: Improving the resiliency of these companies and improving their resolvability in the event of their failure or material financial distress. Both objectives help to reduce risks to financial stability, as provided in section 165 of the Dodd-Frank Act.

See

80 FR 74926 (November 30, 2015).

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111- 203, 124 Stat. 1376. (2010); 12 U.S.C. 5365.

Improving the resiliency of banking organizations, and in particular large banking organizations, has long been a goal of the Board. The Board has had a long-standing practice of requiring large bank holding companies to maintain minimum amounts of regulatory capital in order to absorb losses.

Banking organizations subject to the Board's regulatory capital rules (Regulation Q) must maintain a minimum amount of regulatory capital and maintain a capital buffer above the minimum capital requirements in order to avoid restrictions on capital distributions and discretionary bonus payments.

The largest and most complex banking organizations are subject to additional capital buffers because of their greater systemic risk.

See

12 CFR part 225, Appendix A (superseded as of January 1, 2015, by 12 CFR part 217).

12 CFR 217.11(a). The capital conservation buffer is composed entirely of common equity tier 1 capital.

These are the countercyclical capital buffer and the buffer in the Board's risk-based capital surcharge for global systemically important bank holding companies.

The minimum capital requirements in Regulation Q take the form of minimum ratios of different forms of regulatory capital to risk-based and total-leverage-based measures of assets.

The risk-based ratios are the common equity tier 1 ratio (common equity tier 1 capital to risk-weighted assets), the tier 1 risk-based capital ratio (tier 1 capital to risk-weighted assets), and the total risk-based capital ratio (tier 1 capital plus tier 2 capital to risk-weighted assets).

Regulation Q also includes a leverage ratio that relates a company's tier 1 capital to its total assets.

See

12 CFR 217.10.

See

12 CFR 217.10(a)(1) through (3).

See

12 CFR 217.10(a)(4). In addition, certain internationally active banking organizations are subject to a supplementary leverage ratio, which incorporates certain off-balance sheet exposures into the measure of total assets. 12 CFR 217.10(a)(5).

The TLAC and LTD requirements in the final rule build on, and serve as a complement to, the regulatory capital requirements in Regulation Q. While regulatory capital requirements are intended to ensure that a banking organization has sufficient capital to remain a going concern, the objective of the TLAC and LTD requirements in the final rule is to reduce the financial stability impact of a failure by requiring companies to have sufficient loss-absorbing capacity on both a going concern and a gone-concern basis.

A company's gone-concern loss-absorbing capacity is different from the company's going-concern capacity in a few fundamental respects. Although regulatory capital theoretically can absorb losses after a firm has entered resolution, the firm's regulatory capital, and especially its equity capital, is likely to be significantly or completely depleted in the lead up to a bankruptcy or resolution. Thus, if the ultimate goal is to have a failed firm re-emerge from resolution with sufficient capital to successfully operate as a going concern, there will need to be a new source of capital for the firm. In this regard, debt instruments, which count in regulatory capital in limited amounts and are subject to restrictions on their terms, are capable of absorbing losses in resolution. This is because the debt holders' claim on a company's assets may be reduced in a resolution or bankruptcy proceeding. This would increase the size of a company's assets relative to the size of its liabilities and thereby increase the company's equity. Certain debt instruments are better able to absorb losses in a resolution proceeding and only these eligible debt instruments count toward the TLAC and LTD requirement in the final rule.

As in the proposal, the TLAC and LTD requirements in the final rule focus on the largest and most systemic U.S. banking organizations and the U.S. operations of the largest and most systemic foreign banking organizations, because, as shown in the recent financial crisis, the failure or material financial distress of these companies has the greatest potential to disrupt U.S. financial stability.

The TLAC requirements in the final rule are based on many of the same measures as those that are in Regulation Q. For example, the TLAC requirements include both risk-based and leverage-based measures and include buffer requirements on top of the minimum TLAC requirements that function in a manner similar to the capital conversation buffer in Regulation Q. The risk-based measures of TLAC help to ensure that the amount of TLAC held by a company would be commensurate with its overall risks, while the leverage-based measures of TLAC act as a backstop to the risk-based measures. Companies that do not meet a TLAC buffer face limitations on capital distributions and discretionary bonus payments (in a manner similar to the restrictions in Regulation Q).

Improving resolvability was also an important goal of the proposal, and remains an important goal of the final rule. Efforts to ensure the orderly resolution of firms subject to the rule enhances financial stability. To further this objective, the largest domestic and foreign banks operating in the United States will be required to maintain a minimum amount of outstanding LTD instruments. This LTD also will count toward the TLAC requirements in the final rule. In the event that a company had significant losses such that it was experiencing significant financial distress or had depleted its equity capital, the LTD that the company had outstanding could be used to replenish the company's equity. This could occur in a resolution proceeding, or, in the case of the U.S. operations of certain foreign banks, by order of the Board.

Like the minimum TLAC requirements and for the same reasons as noted above, the minimum LTD requirements include both risk-based and leverage-based measures.

See, e.g.,

80 FR 74928-30 (November 30, 2015).

If a company subject to the final rule experiences losses, the losses would be passed on first to shareholders of the parent company and, if the losses exceed the parent company's equity, to the holders of the parent company's debt. In this way, the TLAC and LTD requirements would increase market discipline for banking organizations subject to the requirements by making them bear the costs of issuing a minimum amount of LTD instruments that are capable of absorbing losses in a manner that would enhance the resiliency and resolvability of the organization.

Foreign jurisdictions have been pursuing similar approaches to the approach adopted by the Board in the final rule since the 2007-2009 financial crisis.

In November 2015, the Financial Stability Board (FSB) finalized an internationally negotiated minimum standard for the total loss-absorbing capacity of global systemically important banks (GSIBs) (the FSB standard).

These efforts have been coordinated through the Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB), at the direction of the Heads of State of the Group of Twenty (G20 Leaders). Representatives of the United States have taken an active role in these efforts.

Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution, Total Loss-absorbing Capacity (TLAC) Term Sheet, November 9, 2015 (hereinafter “FSB Standard”),

available at http://www.fsb.org/wp-content/uploads/TLAC-Principles-and-Term-Sheet-for-publication-final.pdf.

The final rule also is generally consistent with the FSB standard, although the final rule adopts a minimum LTD requirement, unlike the FSB standard.

Several commenters noted that the proposed rule deviated from the FSB standard in various respects. These comments are addressed in greater detail below in the description of the requirements of the final rule, including those aspects of the final rule that were modified in response to issues raised by commenters. As described further below, the final rule requires full compliance by January 1, 2019.

Under the FSB standard, GSIBs would be subject to a minimum TLAC requirement equal to 16 percent of the banking organization's risk weighted assets (risk-weighted assets) as of January 1, 2019 and 18 percent as of January 1, 2022 plus any applicable regulatory capital (Basel III) buffers, which must be met in addition to the TLAC risk-weighted assets minimum. Minimum TLAC must also be at least 6 percent of the Basel III leverage ratio denominator as of January 1, 2019, and at least 6.75 percent as of January 1, 2022. The FSB standard also contains an expectation that a GSIB would meet at least one-third of its TLAC requirement with eligible LTD rather than equity.

The Board is issuing the final rule under section 165 of the Dodd-Frank Act. Section 165 authorizes 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.”

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

In addition, 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.

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

12 U.S.C. 5365(a)(1)(B), (b)(3).

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

In implementing other portions of the Dodd-Frank Act, the Board has taken important steps to protect U.S. financial stability by making major financial companies more resolvable—that is, to take measures so that a failed firm could be dealt with in an orderly manner, without the destructive effects on other

important financial firms that were caused by the failures and near-failures of major financial firms in 2008. These steps include heightened regulatory capital and capital planning requirements for large, systemically important banks holding companies and resolution planning requirements.

In addition, Title II of the Dodd-Frank Act established a new statutory resolution framework for major financial companies as an alternative to bankruptcy.

The enhanced prudential standards in the final rule 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 covered BHC or covered IHC. In particular, the final rule would improve the resolvability of a covered BHC under either the U.S. Bankruptcy Code or Title II of the Dodd-Frank Act and improve their resiliency.

See, e.g.,

12 CFR part 217, subpart H; 12 CFR 225.8; and 12 CFR part 243.

See

12 U.S.C. 5381-5394.

Similarly, the final rule would improve the resiliency of covered IHCs and their subsidiaries, and thereby increase the likelihood that a failed foreign bank with significant U.S. operations could be successfully resolved without the failure of the U.S. subsidiaries or, failing that, that the 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 authorizes the Board to establish “enhanced public disclosures” and “short-term debt limits.”

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

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

Finally, as noted, the Board has tailored the final rule to apply to companies that, if resolved in a disorderly manner, would likely pose the greatest risk to the financial stability of the United States.

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

B. Notice of Proposed Rulemaking and General Summary of Comments

As noted, the proposal contained requirements regarding LTD and TLAC for large, interconnected U.S. bank holding companies and the U.S. operations of large, interconnected foreign banking organizations.

The proposal included four interrelated requirements for these organizations.

80 FR 74926 (November 30, 2015).

First, the top-tier parent holding companies of U.S. GSIBs (covered BHCs) would be required to maintain outstanding minimum levels of total loss-absorbing capacity (external TLAC) and long-term unsecured debt (external LTD). In addition, the proposal included a related buffer on top of the risk-weighted asset component of external TLAC, the breach of which would result in limitations on a covered BHC's capital distributions and discretionary bonus payments. The proposal defined external LTD as unsecured debt that is issued directly by a covered BHC, is “plain vanilla” (that is, the debt instrument has no features that would interfere with a smooth resolution proceeding),

and is governed by U.S. law. External TLAC, under the proposal, was defined as the sum of the tier 1 regulatory capital issued directly by the covered BHC (excluding minority interests) and the external LTD of the covered BHC.

“Plain vanilla” is described in detail in section II.E.3 and generally excludes exotic features that could impact the loss absorbing capacity of the LTD and thereby diminish the prospects for an orderly resolution of a covered BHC, such as structured notes and most instruments that contain derivative-linked features.

Second, under the proposal, the top-tier U.S. intermediate holding companies of foreign GSIBs (covered IHCs) would have been required to maintain outstanding minimum levels of total loss-absorbing capacity (internal TLAC) and long-term unsecured debt instruments (internal LTD) issued to their foreign parent company. In addition, the proposal included a related buffer on top of the risk-weighted asset component of internal TLAC, the breach of which would result in limitations on a covered IHC's capital distributions and discretionary bonus payments. The proposal defined internal TLAC and LTD for covered IHCs similarly to external TLAC and LTD for covered BHCs, with a few key differences for internal LTD. These included the requirements that internal LTD had to be issued to a parent foreign entity that controls the covered IHC, be contractually subordinated to all third-party liabilities of the covered IHC, and contain a contractual conversion trigger pursuant to which the Board could require the covered IHC to cancel the eligible internal LTD or convert or exchange it into common equity tier 1 capital under certain circumstances. In addition, the minimum amount of internal TLAC required under the proposal varied based on whether the covered IHC was expected to adopt either an SPOE or MPOE resolution strategy, though both types of firms were required to issue the same amounts of internal LTD.

Third, the operations of the covered BHCs and covered IHCs would have been subject to “clean holding company” limitations to further improve their resolvability and the resiliency of their operating subsidiaries. In particular, the proposal would have prohibited covered BHCs 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 guarantee provided that the covered BHC's insolvency or entry into resolution was an event of default on the part of the subsidiary. The proposal applied a similar prohibition to covered IHCs. Additionally, the proposal capped the value of a covered BHC's liabilities (other than those related to external TLAC and external LTD) that can be pari passu with or junior to its external LTD at 5 percent of the value of its external TLAC. This cap on liabilities was not relevant to covered IHCs under the proposal because the proposal required that a covered IHC's eligible internal LTD be contractually subordinated to all of the covered IHC's third-party liabilities.

Fourth and finally, banking organizations subject to the Board's capital requirements would have been required to make certain deductions from capital for holding of unsecured debt issued by covered BHCs to limit the potential for financial sector contagion in the event of the failure of a covered BHC.

The Board received approximately 50 comments on the proposed rule from banking organizations, trade associations, public interest advocacy groups, members of Congress, and private individuals. Board staff also met with some commenters at their request to discuss their comments on the proposal and summaries of these meetings may be found on the Board's public Web site.

Commenters generally supported the proposal, including the proposed minimum TLAC and LTD requirements. Certain commenters, however, argued that the calibration of the proposed TLAC and LTD requirements under the proposal was too high for both covered BHCs and covered IHCs. A number of these commenters encouraged the Board to reduce or eliminate certain proposed requirements. In particular, a number of commenters urged the Board to eliminate the separate LTD requirement

and allow covered BHCs and covered IHCs the option to meet the proposed TLAC requirements with equity or debt.

Commenters also expressed concerns about the eligibility requirements for LTD. These commenters urged the Board to permit a broader set of instruments to qualify as eligible long-term debt, including debt with various types of acceleration clauses, debt issued under foreign law, principal-protected structured notes, and trust preferred securities (“TruPS”). In the alternative, to mitigate the impact of the requirements, commenters urged the Board to grandfather as eligible LTD existing outstanding long-term debt, which often contains features that would cause disqualification as eligible LTD under the proposal. The Board also received comment requesting that the leverage component of external TLAC be reduced and include a buffer similar to that placed on the risk-weighted asset component.

Foreign bank commenters raised a number of concerns related to the proposed internal TLAC and LTD requirements. These commenters expressed general concerns about national treatment and competitive equality.

In particular, some commenters argued that, given their relative size, covered IHCs should not be subject to TLAC and LTD requirements under the proposed rule considering that similarly-sized U.S. institutions would not be subject to these requirements. Commenters also urged the Board to permit covered IHCs to issue debt externally on the same terms as covered BHCs. Commenters expressed particular concerns about additional costs resulting from certain features of internal LTD that the proposal would not require for external LTD. According to the commenters, these features would make internal LTD relatively more costly than external LTD. In particular, foreign bank commenters requested the removal of the acceleration clause prohibition, the contractual subordination requirement, and the contractual conversion trigger requirement. Commenters argued that these requirements for internal LTD could cause eligible LTD to be characterized as equity, rather than debt, for U.S. income tax purposes.

The Board is required to give due regard to the principle of national treatment and equality of competitive opportunity in developing enhanced prudential standards under the Dodd-Frank Act. 12 U.S.C. 5365(b)(2).

While commenters generally supported the proposed clean holding company requirements, certain commenters urged the Board to modify the proposal to allow certain types of guarantees that are subject to cross-default rights. Commenters also requested that the Board include a market-making exception from the proposed capital deduction and provide additional time for companies to come into compliance with the requirements of the final rule. Comments on the proposal and the changes in the final rule are described in more detail throughout the remainder of this

SUPPLEMENTARY INFORMATION

C. Overview of the Final Rule

The Board is adopting this final rule to improve the resiliency and resolvability of GSIBs and thereby reduce threats to financial stability. The Board has made a number of changes to the proposal in response to concerns raised by commenters, as further described below.

The final rule is intended to improve the resolvability of the most systemically important banking firms—global systemically important banking organizations (GSIBs) without extraordinary government support or taxpayer assistance by establishing “total loss-absorbing capacity” standards for the GSIBs and requiring them to issue a minimum amount of LTD.

The final rule requires the top-tier holding companies of U.S. GSIBs to maintain outstanding minimum levels of TLAC and eligible LTD. In addition, the final rule establishes a buffer on top of both the risk-weighted asset and leverage components of the external TLAC requirements, the breach of which would result in limitations on a covered BHC's capital distributions and discretionary bonus payments.

Separately, the Board is continuing to work with the OCC and FDIC to mitigate the resolvability risks related to potential disorderly unwinds of financial contracts.

The final rule requires 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. In addition, the final rule establishes a buffer on top of the risk-weighted asset component of the internal TLAC requirements, the breach of which would result in limitations on a covered IHC's capital distributions and discretionary bonus payments.

The final rule applies “clean holding company” limitations to the operations of the top-tier holding companies of U.S. GSIBs and the top-tier U.S. intermediate holding companies of foreign GSIBs to further improve their resolvability and the resiliency of their operating subsidiaries. The Board has decided to defer adoption of capital deduction requirements for Board-regulation institutions that hold unsecured LTD. The Board will work with the other federal banking agencies to adopt the deduction requirements on a coordinated basis as further described below.

After analyzing the expected impact of the final rule with the modifications adopted to address concerns of commenters, the Board has determined to establish an effective date of January 1, 2019, for the rule. While this provides a shorter transition period than originally proposed, the changes adopted by the Board, including grandfathering outstanding LTD and other changes discussed below, mitigate the actions firms must take to comply with the final rule.

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

Under the final rule, a “covered BHC” is defined to mean a U.S. GSIB identified under the Board's rule establishing risk-based capital surcharges for global systemically important bank holding companies (GSIB surcharge rule).

A covered BHC will be required to maintain outstanding minimum levels of eligible TLAC and eligible external LTD beginning on January 1, 2019. Consistent with the proposal, a covered BHC's eligible external TLAC is defined to be the sum of the tier 1 regulatory capital issued directly by the covered BHC and the amount of the covered BHC's eligible external LTD that is due to be paid after one year or more.

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

The proposal was based on the “remaining maturity” of the debt, while the final rule is based on the unpaid principal amount “due to be paid” for reasons discussed below.

Also consistent with the proposal, eligible external LTD is defined under the final rule as debt that is issued directly by the covered BHC, is unsecured, is “plain vanilla,” and is governed by U.S. law. Only 50 percent of the amount of eligible external LTD that is due to be paid between one and two years can be used for purposes of the external LTD requirement (though such debt would count in full for purposes of the external TLAC requirement). The amount of eligible external LTD due to be paid in less than one year will not count toward the external TLAC requirement or the external LTD requirement.

In response to comments and to mitigate the impact of the requirements, the final rule differs from the proposal

by providing a grandfather for certain outstanding LTD of covered BHCs issued prior to December 31, 2016, to count towards the external LTD and external TLAC requirements in the final rule. The final rule also includes a provision that would allow the Board, after notice and an opportunity to respond, to order a global systemically important BHC to exclude from its outstanding eligible long-term debt amount any debt securities with features that would significantly impair the ability of such debt securities to take losses.

Under the external TLAC requirement of the final rule, a covered BHC is 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 7.5 percent of the covered BHC's total leverage exposure.

In addition, external TLAC buffers that are similar to the capital buffers in the Board's Regulation Q

will apply in addition to the risk-weighted asset component and leverage component of the external TLAC requirement. These requirements generally are the same as under the proposal, except the leverage component of the external TLAC requirement has been reduced from 9.5 percent under the proposal to 7.5 percent in the final rule, and the Board has adopted a 2 percent buffer on top of the leverage component of the external TLAC requirement to better align with the risk-weighted asset component and the Board's regulatory capital rules.

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

12 CFR part 217.

Under the external LTD requirement of the final rule, a covered BHC is 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. These requirements are the same as under the proposal. The external LTD requirement is calibrated by reference to a “capital refill” framework that helps to ensure that the covered BHC could be effectively recapitalized to the individual capital levels expected of each covered BHC to be sufficiently capitalized in the event that all or most of its capital were depleted. Because the capital requirements that apply to covered BHCs depend, in part, on idiosyncratic measures of a covered BHC's risks and, in part, on standardized measures of risk that are common across all bank holding companies, the LTD requirements that apply to a particular covered BHC will vary. To the extent that these capital requirements are updated over time, the Board would also expect to consider updating the associated external LTD requirement in an effort to preserve the general alignment between the Board's capital rules and the external LTD requirements.

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

The term “covered IHC” is defined in the final rule to include any U.S. IHC that (a) is required to be formed under the Board's enhanced prudential standards rule, and (b) is controlled by a foreign banking organization that has been designated as a GSIB or would be designated as a GSIB under the Board's capital rules.

Under the final rule, a “covered IHC” is required to maintain outstanding minimum levels of eligible total loss-absorbing capacity and eligible long-term debt beginning on January 1, 2019. A covered IHC's eligible TLAC generally is 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 LTD, as defined below.

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 final rule, the amount of eligible total loss-absorbing capacity (“eligible TLAC”) and long-term debt that a covered IHC is required to maintain outstanding, as well as whether the eligible long-term debt component may be issued externally, depends on whether the covered IHC (or any of its subsidiaries) is expected to enter resolution (resolution covered IHC) in a multiple-point-of-entry (MPOE) resolution strategy, or to continue to operate outside of resolution proceedings (non-resolution covered IHC) while a foreign parent entity is resolved under a single-point-of-entry (SPOE) resolution strategy.

A key modification to the proposal is that, under the final rule, a resolution covered IHC that adopts an MPOE resolution strategy would have the option to issue capital and LTD externally to third parties in a fashion similar to covered BHCs (and consistent with their resolution strategy) as described below. Non-resolution covered IHCs continue to be required under the final rule to issue LTD internally.

In developing the TLAC and LTD requirements in the proposal and final rule, the Board considered the two scenarios under which large financial firms are likely to be resolved following failure. In one scenario, an SPOE resolution, only the top-tier holding company would enter a resolution proceeding. An SPOE resolution thus would avoid the need for separate proceedings for separate legal entities run by separate authorities across multiple jurisdictions and the associated destabilizing complexity. The losses that caused the banking organization to fail would be passed up from the subsidiaries that incurred the losses using one of several potential mechanisms 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 fire sales) 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. Most of the U.S. GSIBs, as well as most foreign GSIBs, are developing plans that facilitate an SPOE approach, including in their most recent resolution plans.

The other likely resolution scenario is an MPOE resolution. An MPOE resolution involves separate resolutions of different legal entities within a financial firm and could potentially be executed by multiple resolution authorities across multiple jurisdictions. The final rule would improve the prospects for a successful MPOE resolution of a GSIB by requiring U.S. GSIBs and the intermediate holding company of a foreign GSIBs to maintain substantially more loss-absorbing capacity. The final rule also includes certain features that would facilitate the resolution of a foreign GSIB under an MPOE resolution. Moreover, an MPOE resolution strategy involving the resolution of a covered IHC may often effectively be an SPOE resolution strategy of their U.S. operations.

In particular, under the final rule, the capital and long-term debt of a non-resolution covered IHC will be required to be issued either to a foreign company that controls the covered IHC (a “foreign parent”) or to a directly or indirectly wholly-owned foreign subsidiary of the top-tier foreign parent (internal TLAC and LTD) consistent with the SPOE resolution strategy. The proposal, by contrast, required a foreign parent to hold internal TLAC and LTD issued by covered IHCs. In response to comments, the final rule was changed from the proposal to allow any directly or indirectly wholly owned subsidiary of the top-tier foreign parent to hold eligible internal TLAC and LTD issued by covered IHCs. This change is consistent with the overall objectives of the proposal that a non-resolution

covered IHC upstream any losses outside of the United States to a parent foreign banking organization. By contrast, under the final rule, a resolution covered IHC will have the option to issue its LTD internally to its foreign affiliates or externally to third-party investors consistent with an MPOE resolution strategy.

Under the final rule, beginning on January 1, 2019, non-resolution covered IHCs are 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; (b) 6 percent of the covered IHC's total leverage exposure (for covered IHCs that are subject to the supplementary leverage ratio);

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.

For all covered IHCs, a buffer that is similar to the capital conservation buffer in the Board's Regulation Q will apply in addition to the risk-weighted assets component of the TLAC requirement. These requirements for non-resolution covered IHCs are the same as under the proposal. In addition, under the final rule and as explained above, a non-resolution covered IHC is required to issue internal LTD to a foreign parent that controls the IHC as under the proposal, or to a directly or indirectly wholly owned foreign subsidiary of the top-tier foreign parent.

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).

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.

Under the final rule, beginning on January 1, 2019, resolution covered IHCs are required to maintain outstanding eligible TLAC in an amount not less than the greater of (a) 18 percent of the covered IHC's total risk-weighted assets; (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. As noted above, for all covered IHCs, a TLAC buffer that is similar to the capital conservation buffer in the Board's Regulation Q applies in addition to the risk-weighted assets component of the TLAC requirement. These requirements are generally the same as under the proposal.

In response to comments, the minimum eligible LTD requirements have been adjusted downward to reflect the same balance-sheet depletion assumption afforded to the calibration of the eligible external LTD requirements of U.S. bank holding companies. Accordingly, all covered IHCs (whether or not a resolution entity) will be required under the final rule to maintain outstanding eligible LTD in an amount not less than the greater of (a) 6 percent of total risk-weighted assets; (b) 2.5 percent of the total leverage exposure (if applicable); and (c) 3.5 percent of average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio. As discussed in more detail below, the final rule also includes a provision that would allow the Board, after notice and an opportunity to respond, to order a covered IHC to exclude from its outstanding long-term debt amount any debt securities with features that would significantly impair the ability of such debt securities to take losses.

A covered IHC's eligible LTD generally is subject to the same requirements as the requirements that apply to eligible external LTD for U.S. GSIBs: The eligible LTD must be issued directly from the covered IHC, be unsecured, have only “plain vanilla” features, and be governed by U.S. law. The amount of eligible LTD that is due to be paid between one and two years is subject to a 50 percent haircut for purposes of the LTD requirement, and eligible LTD amounts due to be paid in less than one year will not count toward the LTD requirement.

In addition, the final rule has been modified to allow eligible LTD issued by covered IHCs, whether external or internal LTD, to have the same acceleration clauses that are permitted for eligible external LTD issued by covered BHCs. Moreover, under the final rule, covered IHCs will have the option to adopt contractual subordination or structural subordination for their eligible long-term debt; under the proposal covered IHCs were required to contractually subordinate their long-term debt. These modifications will allow covered IHCs to issue eligible long-term debt, whether internal or external, on similar terms as covered BHCs under the final rule and therefore reduce burden on covered IHCs and help ensure national treatment and competitive equality. In response to comments and to mitigate the impact of the requirements, the final rule differs from the proposal by providing a grandfather for certain outstanding eligible external LTD of resolution covered IHCs issued prior to December 31, 2016.

However, one key feature will continue to distinguish eligible internal LTD from eligible external LTD for covered IHC's (both for non-resolution covered IHCs and for resolution covered IHCs that exercise their option to issue their LTD internally). Eligible internal LTD must include a contractual trigger pursuant to which the Board could require the covered IHC to convert or exchange the LTD into common equity tier 1 capital without the covered IHC's entry into a resolution proceeding in certain circumstances. These circumstances are (a) the Board determines that the covered IHC is “in default or in danger of default”; and (b) any of the following situations 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 conversion, or does not object to the conversion following 24 hours' notice, or (iii) the Board makes a written recommendation to the Secretary of the Treasury that the Federal Deposit Insurance Corporation (FDIC) should be appointed as receiver of the covered IHC.

In response to comments, the final rule includes certain changes to the requirement that the Board must be able to cause a covered IHC to convert its LTD to equity. Under the proposed rule, the contractual conversion trigger would have allowed the Board to cancel or convert the covered IHC's LTD. The final rule includes only the requirement that LTD be convertible into equity and does not include the requirement that LTD be subject to cancellation. Thus, under the final rule, a covered IHC must include a contractual conversion provision in its LTD that would allow the Board to order the conversion of the long-term debt into equity. In addition, the final rule has been modified to allow the Board to convert all or part of a covered IHC's LTD into equity. The intended purpose of these changes, along with allowing certain acceleration clauses and structural subordination, is to provide flexibility consistent with the purposes of the rule and to respond to concerns raised by commenters regarding the contractual conversion trigger as further discussed below. The Board believes that these changes respond to comments on the proposed rule and serve to mitigate the costs of the conversion feature on covered IHCs.

3. Clean Holding Company Requirements

The final rule prohibits or limits covered BHCs and covered IHCs from directly entering into certain financial arrangements that could impede an entity's orderly resolution. These prohibitions and limitations will enhance resiliency by reducing complexity and reliance on short-term funding and are intended to support the orderly resolution of a covered BHC and covered IHC.

Under the final rule, a covered BHC and covered IHC are 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 guaranteed by the covered BHC's subsidiaries or subject to contractual offset rights for its subsidiaries' creditors; or issuing certain guarantees of its subsidiaries' liabilities if the liability provides default rights based on the resolution of the covered BHC or covered IHC. This last prohibition has been revised from the proposal to exempt guarantees of liabilities that are subject to any future rule of the Board or another Federal banking agency restricting default rights.

Additionally, the final rule caps the amount of a covered BHC's third-party 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. The final rule includes a similar cap for covered IHCs that choose structural subordination of their long-term debt though with certain differences for non-resolution covered IHCs and resolution covered IHCs described further below. In each case, under the final rule, both covered BHCs and covered IHCs have the option under the final rule to contractually subordinate their eligible long-term debt to other third-party liabilities without the need for the 5 percent cap. Finally, the final rule requires covered BHCs and covered IHCs that issue long-term debt externally to make certain public disclosures.

4. Capital Deduction

The final rule does not adopt the requirement in the proposal that state member banks, bank holding companies, and savings and loan holding companies and IHCs formed to comply with the Board's enhanced prudential standards for foreign banking organizations deduct investments in the unsecured debt of covered BHCs that exceed certain thresholds from regulatory capital. The Board intends to address these elements of the proposal jointly with the Office of the Comptroller of the Currency (OCC) and FDIC at a later time, in order to apply these requirements consistently to all entities subject to the regulatory capital requirements of the federal banking agencies.

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

In developing this final rule, the Board consulted with the FDIC, the Financial Stability Oversight Council (Council), and other U.S. financial regulatory agencies. The final rule reflects input that the Board received during this consultation process. Furthermore, the Board has consulted with foreign financial regulatory authorities regarding this final rule and the establishment of other standards that would maximize the prospects for the cooperative and orderly cross-border resolution of failed GSIBs.

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

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

The final rule, like the proposal, applies to all “covered BHCs.” The term “covered BHC” is defined in the final rule in the same manner as the proposal to include any U.S. top-tier bank holding company identified as a global systemically important BHC under the Board's GSIB surcharge rule.

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 global systemically important BHC by applying a multifactor methodology established under the Board's regulatory capital rules.

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. Accordingly, the methodology provides a tool for identifying as global systemically important BHCs those banking organizations that pose elevated risks. The final rule's focus on global systemically important BHCs 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.

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

12 CFR part 217, subpart H.

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

Under the methodology in the GSIB surcharge rule, eight U.S. bank holding companies are currently identified as GSIBs. Those eight top-tier bank holding companies will therefore be covered BHCs subject to this final rule.

In addition, because the GSIB surcharge methodology is dynamic, other banking organizations could become subject to the final rule in the future. As under the proposal, a covered BHC will become subject to the requirements of the final rule on the later of January 1, 2019, or three years after the date on which the firm becomes a covered BHC.

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.

The Board did not receive any comments on the proposed methodology for identifying those U.S. BHCs subject to the rule. Accordingly, the Board is adopting this methodology in the final rule without modification.

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

Under the proposal, a covered BHC would have been required to maintain outstanding eligible external TLAC in an amount not less than the greater of 18 percent of its total risk-weighted assets and 9.5 percent of its total leverage exposure under the supplementary leverage ratio rule.

Under the final rule's external TLAC requirement, a covered BHC is 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

and

7.5 percent of the covered BHC's total leverage exposure.

See

12 CFR 217.10(c)(4)(ii). Under the proposal, the risk-weighted assets component of the external TLAC requirement would have been 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.

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.

As described below, the reduction of the leverage component of the external TLAC requirement is intended to account for revisions to the proposal. As revised, the final rule includes a buffer over the minimum external TLAC leverage exposure requirement that is being added in the final rule for parallelism with the buffer over the risk-weighted asset measure of external TLAC and with the Board's Regulation Q. As a result, two separate external TLAC buffers apply in addition to both the risk-weighted assets component and leverage component of the external TLAC requirement under the final rule.

Under the final rule's external LTD requirement, as under the proposal, a covered BHC is 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 are 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. A summary table of the final rule's calibrations for eligible external TLAC and LTD appears below.

Table 1—Eligible External TLAC and LTD Calibrations Under the Final Rule for Covered BHCs

Risk-weighted assets

Leverage

Covered BHCs:

External TLAC

18 percent plus buffer

7.5 percent plus buffer.

External LTD

6 percent plus GSIB surcharge

4.5 percent.

In developing the final rule, the Board considered comments on the calibration of the proposed external TLAC and LTD requirements. A number of commenters supported the external TLAC and LTD requirements in the proposed rule, and some commenters suggested that the requirements were appropriately calibrated to support U.S. financial stability. A few commenters, however, suggested that higher minimum TLAC requirements would provide additional financial stability benefits. Certain commenters argued that the external TLAC requirement should be calibrated using a more severe set of loss assumptions than the historical loss experience of major financial institutions during past financial crises, or set at a significantly higher percentage of a covered BHC's risk-weighted assets. For example, one commenter argued that the requirements should be well above a requirement informed by the most recent financial crisis and recommended a minimum TLAC requirement of 30 percent of risk-weighted assets.

A few commenters argued that the calibration of the external TLAC and external LTD requirements in the proposed rule was higher than necessary to support a successful resolution, did not take into account other regulatory efforts to address financial stability, and would impede economic growth and access to capital. These commenters generally supported adjusting the calibration of the external TLAC and LTD requirements by lowering the minimum external TLAC and LTD percentages levels. For example, certain commenters suggested reducing the risk-weighted asset component of the TLAC requirement from 18 percent to 14 percent and reducing the supplementary leverage ratio component of the TLAC requirement from 9.5 percent to 6.75, 7.5 or 8 percent. Similarly, one commenter suggested reducing the leverage component of LTD from 4.5 percent to 2.5 percent.

In addition, some commenters urged the Board to eliminate or significantly reduce the component of the external TLAC and external LTD requirement calculated as a percentage of the covered BHC's total leverage exposure in light of the lack of risk sensitivity of this measure. The commenters that objected to the calibrations as too high argued that superequivalent external TLAC and LTD requirements of the proposal relative to the FSB standard would put U.S. firms at a competitive disadvantage. Other commenters, however, expressed the view that superequivalence relative to the FSB requirements would enhance the competitive position of U.S. institutions and U.S. financial stability.

Certain commenters urged that the separate long-term debt requirement in the proposed rule be eliminated and that covered BHCs should be permitted to meet TLAC requirements with either equity or debt. These commenters argued that equity capital is the best way to ensure that firms are well capitalized and can absorb losses and that equity can act as a going-concern or gone-concern form of capital. These commenters further argued that if a separate LTD requirement were retained in the final rule, the final rule should include a one-year cure period for any breaches of the LTD requirement. Other commenters, however, including a member of Congress, expressed support for a separate long-term debt requirement to strengthen the resilience of covered firms and support recapitalization in a resolution, which would likely only occur after equity capital is depleted.

With regard to the calibration in the final rule, the Board balanced the need to help ensure the orderly resolution of a GSIB without imposing unduly high costs on the economy, against the need to ensure that firms can manage their overall liability structure in a cost effective manner that fits with their overall mix of business lines and funding needs. The final rule retains the overall calibration of the external TLAC and external LTD requirements set forth in the proposal but with certain modifications, discussed below, including a buffer for the leverage component of the external TLAC requirement.

As suggested by some commenters, the Board considered whether to structure the final rule solely around a minimum TLAC requirement—that is, as a single minimum requirement that could be satisfied by any mixture of capital and eligible LTD—without a specific minimum LTD requirement. In the absence of an LTD requirement, a TLAC requirement would permit each covered firm to reduce its expected systemic impact by striking its own balance between reducing its probability of default (by issuing additional going-concern equity capital above regulatory capital minimum requirements) or by reducing the harm it would cause if it were to fail (by issuing additional gone-concern LTD above regulatory capital minimum requirements).

See

“Calibrating the GSIB Surcharge” at 3 (July 20, 2015), available at

www.federalreserve.gov/aboutthefed/boardmeetings/gsib-methodology-paper-20150720.pdf.

The Board has determined that it is appropriate for the final rule to include both a minimum LTD requirement and a minimum TLAC requirement. Unlike existing equity, LTD can be “bailed-in” to create additional equity capital subsequent to a firm's failure. Imposing an LTD requirement would help to ensure that a covered firm would have a known and observable quantity of loss-absorbing capacity in excess of its going-concern equity capital. Unlike common equity, that loss-absorbing capacity would not be at substantial risk of volatility or depletion before the covered BHC fails or enters a resolution proceeding. Thus, the LTD requirements of the final rule would enhance the prospects for the successful resolution of a failed GSIB and thereby better address the too-big-to-fail problem, as compared with an approach that relied solely on a minimum TLAC requirement.

The availability of long-term debt that can serve as a fresh source of capital is vital to ensure a successful recapitalization of a failing firm experiencing stress without relying on government or taxpayer support to provide additional equity capital. The calibration of the TLAC and LTD requirements in the final rule takes into account the various statutory and regulatory requirements applicable to covered BHCs and other financial institutions, including those designed to enhance the stability of the United States financial system and support a successful resolution. In addition, the empirical analysis underlying the final rule's calibration described below suggests it would be sufficient to support the viability of a covered BHC during a period of severe economic stress.

The final rule also retains the proposed leverage-related TLAC and LTD requirements. Capital requirements based on simple measures of equity to total assets and capital requirements based on risk are complementary tools. Risk-based capital requirements reflect the different risk characteristics of different assets, while leverage capital requirements act as a backstop and act as a counterweight to potential arbitrage of risk-based capital requirements. For these reasons, the required TLAC and LTD requirements in the final rule include both risk-weighted and leverage-related components to ensure a robust set of requirements that are not overly dependent on a single risk measurement framework.

The calibration of the external TLAC requirement in the final rule 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).

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

and the government recapitalization support that they received. This provided an estimate of the level of losses that would 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 measure for the approximate level of TLAC necessary to achieve this purpose.

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.

See

“The Supervisory Capital Assessment Program: Overview of Results” (May 7, 2009), available at

http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf.

One commenter indicated that it conducted a similar internal analysis and determined that the calibration for external TLAC under the proposed rule is well-sized and would be more than sufficient to restore firms to solvency based on last financial crisis.

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 external TLAC requirement is consistent with this high-water mark from the global financial crisis. This historical analysis confirms the appropriateness of the calibration under the final rule.

Additionally, a separate 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 needs 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 calibration of the external TLAC requirement in the final rule is consistent with the findings of this historical survey. The risk-weighted assets component of the final rule exceeds a substantial majority of the loss-and-recapitalization experiences surveyed, while the total leverage exposure 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, and further supports the calibration of the final rule.

See

12 U.S.C. 5365.

The calibration of the external LTD requirement in the final rule 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 further into the loss tail of the income distribution.

Like the proposal, the final rule's 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. The amount of eligible external LTD required by the final rule is the amount estimated to be necessary for a covered BHC that has depleted all of its equity capital to return to a sufficient level of going concern capital level without any government assistance or outside investment. Thus, even if a covered BHC were unable to identify outside sources of funding, the company would be capitalized at a level sufficient

to support all of the operations that had been in place before resolution proceedings were initiated. This enhanced level of resiliency is appropriate because of the size, interconnectedness, and complexity of covered BHCs. Fulfilling this objective is vital to the use of eligible external LTD to facilitate the orderly resolution of a covered BHC, because an orderly SPOE resolution requires that a firm exiting from resolution have sufficient going-concern capital to maintain market confidence in its solvency so that other market participants will do business with it.

The external LTD requirement was calibrated in accordance with this framework. Under the Board's regulatory capital requirements, a covered BHC must maintain a minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent. In addition, a covered BHC is subject to a capital conservation buffer of 2.5 percent of risk-weighted assets plus a firm-specific surcharge determined under the GSIB surcharge rule (expressed as a percentage) of risk-weighted assets.

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

See

12 CFR 217.10(a)(1); 217.11. 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 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.

Since the calibration of the external LTD requirement is based on the capital refill framework, and the capital refill framework depends on the precise structure and calibration of bank capital requirements, the Board expects to consider updating the external LTD requirement in the event that the Board updates bank capital requirements in a way that materially changes their precise structure or calibration.

Under the final rule, a covered BHC is 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 the full amount of its minimum common equity tier 1 capital ratio plus buffer. 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 in light of the firm-specific GSIB surcharges applicable to the covered BHCs, the Board is applying 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 component of the external LTD requirement is analogous. The supplementary leverage ratio requires that bank holding companies maintain a ratio of tier 1 capital to total leverage exposure of at least 3 percent.

The enhanced supplementary leverage standards applicable to global systemically important BHCs add to a covered BHC's supplementary leverage ratio minimum a buffer of 2 percent of its total leverage exposure for a total tier 1 capital to total leverage exposure requirement plus buffer of 5 percent.

Under the final rule, a covered BHC is 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 percent, is appropriate to ensure that a covered BHC that has depleted its tier 1 capital and failed would be able to refill its capital to meet the minimum leverage ratio requirement and buffer through the exchange or conversion of its eligible external LTD into equity.

12 CFR 217.10(a)(5).

The supplementary leverage ratio requirement and buffer become effective January 1, 2018.

See

12 CFR 217.1(f)(1)(iii)(B).

The proposed rule would have prohibited a covered BHC from redeeming or repurchasing any outstanding eligible external LTD without the prior approval of the Board, if after the redemption the covered BHC would not meet its external LTD requirement or its external TLAC requirement. One commenter generally supported the proposed prior approval requirement, and, in particular, its limited application to cases where a BHC would fail to meet its external LTD requirement or its external TLAC requirement following redemption or repurchase.

The final rule adopts as proposed the prior approval requirement for redemptions and repurchases of a covered BHC's outstanding eligible external LTD. Allowing a covered BHC to redeem or repurchase its eligible external LTD without prior Board approval, where such redemption or repurchase would not result in the covered BHC failing to comply with the external TLAC and LTD requirements of the final rule, gives the covered BHC flexibility to manage its outstanding debt levels without interfering with the underlying purpose of the rule. In addition and as discussed below, the final rule includes a provision that would allow the Board, after notice and an opportunity to respond, to order a global systemically important BHC to exclude from its outstanding eligible long-term debt amount any debt securities with features that would significantly impair the ability of such debt securities to take losses.

Section 263.83 of the Board's rules of procedures describes the notice and response procedures that apply if the Board determines that a company's capital levels are not adequate.

See

12 CFR 263.83. The Board would follow the same procedures under the final rule to determine that a covered BHC must exclude from its eligible LTD amount securities with features that would significantly impair the ability of such debt securities to take losses. For example, the Board would provide notice to a company of its intention to require the company to exclude certain securities from its eligible LTD amount and up to 14 days to respond before the Board would issue a final notice requiring that company exclude the securities from its eligible LTD amount, unless the Board determines that a shorter period is necessary.

In addition, the final rule does not include a grace period during which a covered BHC that breaches its external LTD requirement could take voluntary actions to come into compliance with such requirement without being subject to any other regulatory consequences, such as an enforcement action, as suggested by certain commenters. The Board expects covered BHCs subject to the final rule to comply with applicable minimum external LTD requirements at all times. The key purpose of the eligible external LTD requirement is to have debt available to absorb losses; a one-year cure period would defeat this purpose by providing a period of time during which covered BHCs would not be required to meet the minimum requirements of the final rule.

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

The core features of eligible external TLAC under the final rule are the same as under the proposal. Under the final rule, 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) issued directly by the covered BHC (excluding any tier 1 minority interests), and (b) the covered BHC's eligible external LTD, as defined below.

Tier 2 capital that meets the definition of eligible external LTD would continue to count toward the external LTD and TLAC requirements.

Although eligible external LTD due to be paid 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 in the same manner as under the proposal. As discussed below, eligible external LTD due to be paid in less than one year would not count toward either the external TLAC requirement or the external LTD requirement.

Certain commenters urged the Board to harmonize the proposed TLAC requirement with the Basel III Capital framework by not disqualifying minority interests in consolidated subsidiaries from counting as TLAC. These commenters argued that the qualifying criteria imposed on minority interests in consolidated subsidiaries in the U.S. capital rules and Basel capital framework significantly haircut the amount of minority interest in a consolidated subsidiary that may be included in a parent organization's regulatory capital, thus mitigating any concern that the subsidiary's loss absorbing capacity would be unavailable to absorb losses anywhere in an banking organization.

Like the proposal, the final rule does not permit minority interests in consolidated subsidiaries to count as TLAC. 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).

D. External TLAC Buffers (Section 252.63(c) of the Final Rule)

The proposal would have imposed a buffer over the external TLAC requirement measured as a percentage of risk-weighted assets, but did not include a buffer over the external TLAC requirement measured as a percentage of total leverage exposure. The final rule retains the proposed buffer for the risk-weighted assets component of the external TLAC requirement and adds a buffer for the leverage component of the external TLAC requirement to address concerns raised by commenters regarding burden of the proposal's total leverage exposure requirement and for better parallelism with the regulatory capital framework in Regulation Q.

The Board received several comments on the proposed external TLAC buffer. The Board received comment arguing that the buffer should be broadened to apply to the leverage component of the external TLAC requirement, as well as the external LTD requirement, so that similar limitations on capital distributions and discretionary bonus payments would apply to each of the minimum requirements under the rule. A commenter also urged the Board to align the leverage component of the external TLAC requirement with the enhanced supplementary leverage ratio standard in Regulation Q by reducing the leverage component of the external TLAC requirement by 2 percent and adding a 2 percent buffer over this component. Commenters noted that, where the leverage component of the external TLAC requirement was binding, a buffer over this component of the external TLAC requirement would impose progressively more stringent limits on a firm's ability to make capital distribution and discretionary bonus payments as its capital was depleted, in parallel with the proposed buffer over the risk-weighted assets component of the external TLAC requirement. Another commenter suggested that breaches of the TLAC buffer should bar any capital distributions and discretionary bonus payments until the firm has refilled its TLAC buffer, rather than only resulting in the incremental limits to the firm's ability to make such payments. A commenter further urged the Board to study how the proposed TLAC buffer would interact with any incentive-based compensation rules issued by the Board and whether the rules were duplicative.

In response to comments received on the proposal, the final rule reduces the minimum amount of the leverage component of the external TLAC requirement and adds, in an equal amount, a TLAC buffer to the leverage component of the external TLAC requirement. Specifically, under the final rule, the leverage component of the external TLAC requirement has been reduced to 7.5 percent from 9.5 percent and a 2 percent buffer has been added over the leverage component of the external TLAC requirement. These changes should address the major concern raised by commenters to create a buffer for the leverage component of external TLAC to better parallel the buffer for the risk-weighted asset component of external TLAC and the Board's regulatory capital rules.

The purpose of the external TLAC buffers is to reduce the risk of insolvency by limiting the ability of a covered bank holding company to make capital distributions and discretionary bonus payments as its capital levels decline in the same manner as capital buffers in the Board's regulatory capital framework limits capital distributions and discretionary bonus payments. The buffer over the leverage component of the external TLAC requirement is designed to operate in a similar manner to the buffer in the enhanced supplementary leverage ratio standards, which functions similarly to the capital conservation buffer by limiting the ability of a company to make capital distributions and discretionary bonus payments as its capital levels decline.

Since the TLAC buffers are intended to be analogous to the capital buffers in Regulation Q, the final rule does not prohibit all discretionary bonus payments and dividends for breach of the applicable buffer, as suggested by one commenter, or include separate buffers on top of the long-term debt requirements. The Board notes that a covered BHC subject to this final rule may also be subject to future rules related to incentive compensation and that covered BHCs must comply with all applicable regulatory requirements.

See

12 U.S.C. 956; 81 FR 37670 (June 10, 2016).

A covered BHC's external TLAC buffer for the risk-weighted asset component (TLAC risk-weighted assets buffer) is 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

plus any applicable countercyclical capital buffer. The external TLAC risk-weighted assets buffer must be filled solely with common equity tier 1 capital, and a covered BHC's breach of its external TLAC risk-weighted assets buffer would subject it to limits on capital distributions and discretionary bonus payments in accordance with Table 1 to section 252.63 of the final rule. Thus, the external TLAC risk-weighted asset buffer is analogous to the capital conservation buffer applicable under the Board's Regulation Q, except that it applies in addition to the external TLAC requirement rather than in addition to

minimum risk-based capital requirements under Regulation Q and incorporates only the applicable GSIB surcharge amount required under method 1 of the GSIB surcharge rule (rather than the greater of the applicable GSIB surcharge under method 1 and method 2).

80 FR 49082 (Aug. 14, 2015); 12 CFR part 217, subpart H.

See

12 CFR 217, subpart H.

A covered BHC's external TLAC buffer for the total leverage exposure component of the external TLAC requirement (TLAC leverage buffer) is equal to 2 percent of total leverage exposure, the same as the buffer set by the enhanced supplementary leverage ratio standards. The TLAC leverage buffer must be filled solely with tier 1 capital, and a covered BHC's breach of its TLAC leverage buffer also subjects it to similar limits on capital distributions and discretionary bonus payments, as described in Table 2 to section 252.63 of the final rule. Accordingly, the TLAC leverage buffer is analogous to the buffer established under the enhanced supplementary leverage ratio standards except that it would apply in addition to the external TLAC requirement.

See

79 FR 24528 (May 1, 2014); 80 FR 49082 (August 14, 2015).

Finally, since under the final rule a covered BHC is subject to both the TLAC risk-weighted assets and TLAC leverage buffers, any limitations on distributions and discretionary bonus payments would be based on the more restrictive of the buffers. As an example, if a covered BHC had an amount of TLAC in excess of the TLAC risk-weighted asset requirement and in excess of the TLAC risk-weighted assets buffer but had an amount of TLAC in excess of the TLAC leverage requirement but less than the TLAC leverage buffer, the covered BHC's distributions and discretionary bonus payments would be limited by the level of its TLAC leverage buffer.

Table 2—Calculation of Maximum External TLAC Risk-Weighted Asset Payout Amount

External TLAC risk-weighted buffer level

Maximum external TLAC risk-weighted payout ratio

(as a percentage

of eligible

retained income)

Greater than the external TLAC risk-weighted buffer

No payout ratio limitation applies.

Less than or equal to the external TLAC risk-weighted buffer,

and

greater than 75 percent of the external TLAC risk-weighted buffer

60 percent.

Less than or equal to 75 percent of the external TLAC risk-weighted buffer,

and

greater than 50 percent of the external TLAC risk-weighted buffer

40 percent.

Less than or equal to 50 percent of the external TLAC risk-weighted buffer,

and

greater than 25 percent of the external TLAC risk-weighted buffer

20 percent.

Less than or equal to 25 percent of the external TLAC risk-weighted buffer

0 percent.

Table 3—Calculation of Maximum External TLAC Leverage Payout Amount

External TLAC leverage buffer level

Maximum external TLAC leverage payout ratio

(as a percentage of eligible

retained income)

Greater than 2.0 percent

No payout ratio limitation applies.

Less than or equal to 2.0 percent, and greater than 1.5 percent

60 percent.

Less than or equal to 1.5 percent, and greater than 1.0 percent

40 percent.

Less than or equal to 1.0 percent, and greater than 0.5 percent

20 percent.

Less than or equal to 0.5 percent

0 percent.

A covered BHC's external TLAC risk-weighted asset buffer level will be equal to 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 could be used to meet the risk-weighted assets component of the external TLAC requirement. To calculate its external TLAC risk-weighted assets buffer level, a covered BHC will 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 (excluding tier 1 minority interest) to its risk-weighted assets and minus the ratio of its outstanding eligible external LTD to its risk-weighted assets.

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, an outstanding eligible external LTD amount equal to 8 percent of its risk-weighted assets, and no tier 1 minority interest. Suppose further that BHC A is subject to an external risk-weighted asset TLAC requirement of 18 percent and an external risk-weighted assets TLAC buffer of 5 percent of risk-weighted assets. BHC A would meet its external risk-weighted asset 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 LTD to risk-weighted assets would be equal to 20, which is greater than 18. Moreover, BHC A would have an external TLAC risk-weighted assets buffer level equal to 10 − (18 − 2 − 8) = 2 percent. Because 2 percent 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 risk-weighted payout ratio of 20 percent of eligible retained income.

The covered BHC's external TLAC leverage buffer level would be equal to its supplementary leverage ratio minus that portion (if any) of its supplementary leverage ratio (expressed as a percentage) that is used to meet the leverage component of the external TLAC requirement. To calculate its external TLAC leverage buffer level, a

covered BHC would subtract from its supplementary leverage ratio the greater of 0 percent and the following figure: 7.5 percent (the leverage component of the covered BHC's external TLAC requirement) minus the ratio of its outstanding eligible external LTD amount to its total leverage exposure.

For example, suppose that a covered BHC called “BHC B” has a ratio of common equity tier 1 capital to total leverage exposure of 5 percent, a ratio of additional tier 1 capital to total leverage exposure of 1 percent, a ratio of outstanding eligible external LTD amount to total leverage exposure of 3 percent, and no tier 1 minority interest. BHC B will be subject to an external TLAC leverage requirement of 7.5 percent and a TLAC leverage buffer of 2 percent. BHC B would meet its external TLAC leverage requirement because the ratio of its common equity tier 1 capital and additional tier 1 capital plus outstanding eligible external LTD amount to total leverage exposure would be equal to 9 percent. Moreover, BHC B would have a TLAC leverage buffer level equal to 5 − (7.5 − 1 − 3) = 1.5 percent. Because 1.5 percent is less than or equal to 1.5 percent and greater than 1.0 percent, BHC B would be subject to a 40 percent maximum external TLAC leverage payout ratio for making distributions or discretionary bonus payments.

Finally, it is important to note that if the two examples provided above described a single BHC's TLAC risk-weighted assets buffer level and TLAC leverage buffer level then the BHC would be bound by the TLAC risk-weighted assets buffer because it would be more restrictive.

In order to comply with the external TLAC requirement and satisfy the TLAC risk-weighted assets buffer and TLAC leverage buffer, a covered BHC would need to have an outstanding TLAC amount sufficient to satisfy both the risk-weighted assets component and the total leverage exposure component of the TLAC requirement, as well as additional capital sufficient to satisfy both buffers. A covered BHC generally may use the same regulatory capital to satisfy its external TLAC requirement and the minimum ratios under Regulation Q. Therefore, a covered BHC that satisfies the minimum requirements and buffers under Regulation Q, and complies with the external LTD requirement, generally will satisfy the external TLAC requirement and the TLAC risk-weighted assets buffer and TLAC leverage buffer.

The rationale for the external TLAC buffers 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 buffers are 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 buffers 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.

E. Core Features of Eligible External LTD (section 252.61 of the final rule)

Under the final rule, a covered BHC's eligible external LTD is 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, has “plain vanilla” features, and is governed by U.S. law. While the core features of eligible external LTD are generally the same under the final rule as under the proposal, eligible external LTD under the final rule also includes certain debt instruments issued prior to December 31, 2016 that do not meet all the same requirements of eligible external LTD as described further below. Principal due to be paid on eligible external LTD in one year or more and less than two years is subject to a 50 percent haircut for purposes of the external LTD requirement, and principal due to be paid on eligible external LTD in less than one year would not count toward the external LTD requirement.

Commenters expressed general concerns about the criteria that long-term debt would be required to meet in order to count towards a firm's external long-term debt requirement. Some commenters suggested that the definition of eligible external LTD should be expanded to include a broader set of debt securities that may be available to absorb losses and recapitalize the covered BHC in a Title II resolution or bankruptcy. Several commenters suggested that the definition of eligible external LTD should include all capital structure liabilities, which would include all debt instruments available to absorb losses that have a reasonably determinable claim in bankruptcy, including instruments with standard acceleration clauses, instruments issued under foreign law, and principal-protected structured notes. Certain commenters, for example, urged the Board to permit all instruments that satisfy the Board's tier 2 regulatory capital requirements to qualify as eligible LTD, including preferred stock.

Commenters also noted that the criteria proposed for eligible external LTD would disqualify a significant amount of the existing, outstanding long-term debt issued by covered BHCs.

Commenters requested that preferred stock be allowed as eligible external LTD and eligible internal LTD. The Board is declining to allow preferred stock for either form of LTD for the same reasons as described below.

Several commenters suggested that the existing, outstanding long-term debt issued by covered BHCs should qualify as eligible external LTD, even if such debt does not meet all of the requirements for eligible external LTD. Some of these commenters noted that other actions covered BHCs would need to take to conform outstanding debt to the requirements for eligible external LTD in lieu of grandfathering—such as tendering and replacing outstanding debt, exchanging outstanding debt, or acquiring bondholder consent to amend the terms of outstanding debt—would impose significant costs on covered BHCs, costs that would be significantly reduced if the Board permitted such debt to qualify as eligible external LTD for even a short transitional period after the effective date of the final rule. Many of these commenters proposed that all external debt issued by covered BHCs before the effective date of the final rule should be permanently grandfathered to qualify as eligible external LTD. Other commenters proposed permitting outstanding long-term debt to qualify as eligible external LTD if such debt would be ineligible only due to one of the following features: The inclusion of otherwise impermissible acceleration clauses, such debt being subject to foreign law, or debt that was ineligible due to inclusion of a market-based redemption feature (

e.g.,

a security with a survivor put provision). Certain commenters noted that nearly all outstanding long-term debt issued by covered BHCs includes standard market acceleration clauses that would be impermissible under the proposal absent an explicit grandfathering provision in the final rule and that a significant fraction of currently outstanding long-term debt issued by covered IHCs has been issued under foreign law.

As discussed below, the general purpose of the proposed limitations on eligible long-term debt was to ensure the adequacy of the instruments to absorb losses in a resolution of the covered

BHC. As a consequence, the final rule largely retains the eligibility criteria for eligible external LTD set forth in the proposal, with important modifications to address concerns raised by commenters. The modifications provided in the final rule to the eligibility criteria for eligible external LTD should mitigate the impact on covered BHCs and preserve the marketability of such debt, without adversely impacting its loss-absorbing capacity in resolution.

In response to concerns raised by comments, and to mitigate the impact of the requirements, the final rule includes as eligible external LTD those long-term debt instruments that are issued by a covered BHC prior to December 31, 2016 even if these instruments contain otherwise impermissible acceleration clauses or are subject to foreign law as described below. This grandfathering provision would largely eliminate the costs of modifying the terms of existing, outstanding debt or issuing new debt to meet the minimum requirements as cited by commenters. Over time, debt that is grandfathered will mature and be replaced by long-term debt that meets the eligibility criteria of the final rule. As noted above, the final rule also contains a provision that would allow the Board, after notice and an opportunity to respond, to exclude from a covered BHC's outstanding long-term debt, the amount of any debt securities with features that would impair the ability of the debt to absorb losses.

1. Issuance by the Covered BHC and Prohibition on Own Holdings

Consistent with the proposal, 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 would qualify as regulatory capital.

Two commenters requested that the final rule make explicit whether TruPS would be classified as eligible external LTD in the final rule. In a typical TruPS structure, a trust holds assets consisting solely of junior subordinated notes issued by the bank holding company to the trust, and the trust issues the TruPS to investors. Therefore, TruPS, as typically structured, would not meet the requirement in the final rule that the debt be issued externally by the covered BHC. In addition, TruPS do not meet the criteria that such debt be “plain vanilla,” given the somewhat complex structure used to issue TruPS to the market, and the fact that TruPS are hybrid equity-debt instruments.

One commenter, who argued that TruPS should count as LTD, noted that its existing TruPS had impermissible acceleration clauses, another feature that would disqualify the securities from counting as eligible external LTD. In addition, information provided by commenters and the Board's review of available information regarding outstanding TruPS issued by U.S. covered BHCs suggests that the effect of not counting TruPS as eligible long-term debt would have a relatively minor impact on covered BHCs.

The requirement that eligible external LTD be issued by the covered BHC itself serves 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 requirement allows eligible external LTD to 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 a 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. Therefore, permitting debt issued by a subsidiary to qualify as eligible external LTD would be contrary to the SPOE approach and potentially would create risks to the orderly resolution of a covered BHC.

2. Unsecured

Eligible external LTD is 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). As no commenters raised issues regarding the requirement that eligible LTD must be unsecured, the final rule retains this requirement with no changes from the proposal.

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 fire sales that can occur when a financial institution fails and its secured creditors seize and liquidate collateral. Asset fire sales can drive down the value of the assets being sold, which can undermine financial stability by transmitting financial stress 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.

3. “Plain Vanilla”

As under the proposal, eligible external LTD instruments are required to be “plain-vanilla” instruments under the final rule. Exotic features could create complexity and thereby diminish the prospects for an orderly resolution of a covered BHC. These limitations 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 severing business relationships and

refusing to provide additional funding to such subsidiaries.

Under the final rule, eligible external LTD instruments are prohibited from (1) being structured notes; (2) having a credit-sensitive feature; (3) including a contractual provision for conversion into or exchange for equity in the covered BHC; or (4) 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 that continues for 30 days or more.

As under the proposal, 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 provisions discussed below regarding when the debt is due to be paid.

In response to comments requesting that the Board permit all tier 2 capital to count as eligible LTD, the Board has determined not to include as eligible LTD any instrument that qualifies as tier 2 capital. Certain of these instruments (

e.g.,

certain forms of preferred stock and convertible debt) would not meet the requirement to be “plain vanilla” or other aspects of the requirements of eligible LTD (

e.g.,

the prohibition on convertibility features described below). An instrument that qualifies as tier 2 capital will only qualify as eligible LTD under the final rule if it meets the applicable qualification requirements.

a. Structured Notes

The final rule retains the prohibition on counting structured notes, including principal-protected structured notes, as eligible external LTD. Structured notes contain features that could make their valuation uncertain, volatile, or unduly complex. In addition, they are often liabilities of retail customers (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.

For purposes of the final rule, a “structured note” is defined 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,

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 have a minimum principal amount that becomes due and payable upon acceleration or early termination; or (d) is not classified as debt under U.S. generally accepted accounting principles. The definition of a structured note does not include a non-dollar-denominated instrument or an instrument whose interest payments are based on an interest rate index (for example, a floating-rate note linked to the federal funds rate or to LIBOR) that satisfies the proposed requirements in all other respects.

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

One commenter recommended that the final rule clarify that instruments denominated in a currency other that U.S. dollars would not constitute “structured notes” and therefore may qualify as eligible external LTD. The same commenter noted that the final rule should clarify that an instrument whose interest payments are linked to an interest rate index would not be a structured note merely due to inclusion of this feature. The preamble to the proposed rule addressed these points and changes to provide further clarity are reflected in the final rule.

Several commenters proposed modifying the “plain vanilla” requirement for eligible external LTD to include a broader array of long-term debt securities issued by covered BHCs. In particular, certain commenters suggested that the final rule expand the definition of eligible external LTD to include structured notes that are principal-protected at par, as these notes by their terms require the issuer to pay 100 percent of the stated principal amount of the structured note upon early termination or acceleration and at maturity. As a result, these commenters argued that principal-protected structured notes do not present the same type of valuation issues as other structured notes whose value may be more volatile or uncertain since the minimum amount of any claim in a bankruptcy or Title II proceeding for a principal-protected structured note will always be the stated principal amount of the structured note.

Structured notes with principal protection often combine a zero-coupon bond, which pays no interest until the bond matures, with an option or other derivative product, whose payoff is linked to an underlying asset, index, or benchmark.

The derivative feature violates the intent of the clean holding company requirements (described below), which prohibits derivatives entered into by the covered bank holding company with third parties. Moreover, investors in structured notes tend to pay less attention to issuer credit risk than investors in other long-term debt, because structured note investors use structured notes to gain exposure unrelated to the covered BHC. As a result, these investors are less likely to contribute to the market discipline objective of the minimum LTD requirements.

https://www.sec.gov/investor/alerts/structurednotes.htm

For these same reasons, the final rule does not grandfather existing outstanding structured notes as eligible external TLAC. These products may not serve in a loss absorbing capacity consistent with the intended purposes of the final rule's long-term debt requirement. Moreover, based on figures provided by commenters and the Board's review of available information, the impact of not counting principal-protected structured notes as eligible external LTD is likely to be limited, especially in light of the grandfathering provided in the final rule for other outstanding long-term debt instruments.

b. Contractual Provision for Conversion Into or Exchange for Equity

Consistent with the proposal, the final rule retains the requirement that eligible external LTD be prohibited from including contractual provisions for conversion into or exchange for equity. Some commenters supported the requirement that the eligible external LTD not exclude debt that is convertible or exchangeable into equity of the covered BHC, arguing that such a conversion feature would reduce the financial stability benefits of the debt and increase risks to investors. By contrast, other commenters pointed out that tier 2 capital includes debt that may convert into tier 1 capital, but under the proposed rule would not count towards a firm's LTD or TLAC requirements even though such securities would be “loss-absorbing” either on an as-converted basis, or as outstanding debt. Consequently, these commenters contended that such securities should count as eligible external LTD (or, at a minimum, count towards a covered BHC's TLAC requirement). These commenters also stated that, while covered BHCs currently do not have long-term debt with such convertibility features outstanding, covered BHCs may wish to issue debt securities with such convertibility features in the future, particularly in times of stress when issuing other forms of capital could be difficult.

The fundamental objective of the external LTD requirement is to ensure that covered BHCs will have a 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. In addition, debt with features to allow conversion into equity are often complex and thus may not be characterized as “plain vanilla.” Convertible debt instruments may be viewed as debt instruments with an embedded stock call option. The embedded stock call option introduces a derivative-linked feature to the debt instrument that is inconsistent with the purpose of the clean holding company requirements (described below) and introduces uncertainty and complexity into the value of such securities. For these reasons, under the final rule, eligible external LTD may not include contractual provisions allowing for the conversion into or exchange for equity prior to the covered BHC's resolution. Moreover, in light of the fact that commenters indicate that existing outstanding debt generally does not contain such convertibility features, the impact of such a prohibition is likely to be immaterial.

c. Credit-Sensitive Features and Acceleration Clauses

Under the proposal, eligible external LTD was 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.

Several commenters expressed concerns with the proposed limitations on acceleration clauses. These commenters contended that the Board's final rule should permit more classes of acceleration clauses. In particular, these commenters argued that a covered BHC is unlikely to breach any traditional covenants that result in acceleration unless it were on the brink of insolvency. Traditional covenants range from covenants that are impossible to breach inadvertently, such as those not to enter a merger transaction or sell all or substantially all of their assets unless the successor assumes the debt securities subject to the covenant or to pledge the stock of material subsidiaries, to those that are administrative in nature and easy to comply with or cure breaches of, such as maintaining paying agents in certain locations. Commenters also argued that some classes of acceleration clauses that would be barred by the proposal would be unlikely to frustrate the purposes of the rule, and should therefore be permitted, including, for example, clauses permitting acceleration upon the event of non-payment of principal or interest (subject to a period during which the covered BHC could “cure” the failure to pay), restrictions on mergers or asset transfers, limits on the sale of principal subsidiaries, and other procedural covenants intended to facilitate payments on, and registration and transfer of, the debt securities. Moreover, commenters argued that these traditional covenants and related acceleration rights are important to investors and have traditionally been demanded and given in the markets for investment-grade senior long-term debt securities issued by covered BHCs.

Commenters contended that nearly all currently outstanding long-term debt of covered BHCs includes standard acceleration clauses, which would not qualify as eligible external LTD under the proposed rule, and that it would be impossible or very expensive to conform or redeem. For these reasons, commenters argued that the impact of this requirement was significant. The commenters asserted that, to the extent such debt is not grandfathered, covered BHCs would have a projected shortfall, as of January 1, 2019, of almost three times the estimated shortfall projected in the proposal. A number of commenters suggested that grandfathering outstanding debt would be helpful to mitigate the impact of the requirements.

A few commenters expressed the view that the final rule should prohibit all acceleration clauses in eligible external LTD, including the insolvency or payment default acceleration clauses permitted under the proposal. These commenters argued that because acceleration clauses related to payment default or insolvency are highly unlikely to protect creditors from losses upon insolvency of a covered BHC, their inclusion could be deceptive for investors.

Under the final rule, eligible external LTD is prohibited from having a credit-sensitive feature or an acceleration clause—a contractual right to the acceleration of payment of principal or interest at any time prior to the instrument's stated maturity, other than upon the occurrence of either an insolvency event or a payment default event that continues for 30 days or more—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 provisions discussed below related to when the debt is due to be paid.

This final rule's 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.

See

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

The final rule does not broaden the list of acceleration clauses that are permissible for long-term debt (and limits the permissibility of payment default acceleration clauses to those that include a cure period as described below). This restriction on acceleration clauses serves the same purpose as several of the other 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, could undermine an orderly resolution by forcing a covered BHC to make payment on the full value of the debt prior to the entry of the covered IHC 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.

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 not permitted in 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 final rule permits 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.

In addition, the final rule revises this aspect of the proposal to provide that an acceleration clause relating to a failure to pay principal or interest must include a “cure period” of at least 30 days. During this cure period, the covered BHC could make payment on the eligible external LTD before such debt could be accelerated and if the covered BHC satisfies its obligations on the eligible external LTD within the cure period, the instrument could not be accelerated. The purpose of this modification is to ensure that an accidental or temporary failure to pay principal or interest does not trigger immediate acceleration. Moreover, this cure period for interest payments is found in many existing debt instruments and is consistent with current market practice.

As discussed, the final rule's definition of “eligible debt security” has been modified to allow debt instruments issued prior to December 31, 2016 that contain otherwise impermissible acceleration clauses to count as eligible long-term debt. This change significantly mitigates the impact of the requirements, because, based on information provided by commenters, nearly all existing outstanding long-term debt issued by covered BHCs contains acceleration clauses that would otherwise be prohibited under the final rule.

Certain commenters argued that the inclusion of acceleration causes could be misleading to investors that hold long-term debt. The disclosure requirements (described below) require a covered BHC to publicly disclose a description of the financial consequences to unsecured debtholders of the covered IHC entering into a resolution proceeding. Accordingly, the disclosure requirements should address the concerns raised by commenters regarding transparency.

Commenters also noted that the proposal does not impose limits on the rights of holders of internal LTD to file suit in the event of non-payment or that such holders would have to waive those rights. However, because of the limitations on acceleration provisions, commenters requested that the Board clarify that the rule does not also limit such rights. The final rule does not require the holder of an eligible debt security to waive the holder's rights to file suit to enforce their ordinary creditor remedies. However, if a covenant involves a redemption or repurchase by the covered BHC (

e.g.,

upon sale of a principal subsidiary), any such covenant would be subject to the restrictions on repurchase described elsewhere in this

SUPPLEMENTARY INFORMATION

, including 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.

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

Under the proposal, 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.

Some commenters recommended that debt with a remaining maturity of at least one year, but less than two years, should not be subject to a haircut for purposes of the external LTD requirement. These commenters argued that this haircut incorrectly assumes that a covered BHC could be cut off from capital markets for a period of up to two years. One commenter noted, for example, that this proposed haircut would depart from the FSB standard, and would thus contribute to unequal treatment of covered BHCs subject to the U.S. requirements and foreign GSIBs subject to rules of foreign jurisdictions that adhere to the FSB standard. Another commenter, however, expressed the view that the proposed haircut is appropriately conservative, and would help to ensure that loss-absorbing resources will likely always exceed a covered BHC's total loss-absorbing capacity needs. One commenter urged the Board to require that LTD have a maturity of considerably longer than one year.

In addition, some commenters suggested that the Board should take into consideration maturity date concentrations in the issuances of covered BHCs. One commenter suggested that the Board should establish a mandatory minimum maturity to which all eligible external LTD would have to comply at issuance. Other commenters, however, urged the Board not to mandate a particular issuance schedule for external LTD of covered BHCs.

The final rule adopts the proposed amortization haircut requirements applicable to eligible external LTD. However, the final rule modifies the terminology from the remaining maturity of the unpaid principal amount to the amount due to be paid. The purpose of this intended change is to clarify that it is the amount of debt due to be paid that counts as eligible LTD under the final rule.

Under the final rule, the amount of eligible external LTD that is due to be paid between one and two years would be subject to a 50 percent haircut for purposes of the external LTD requirement, and the amount of eligible external LTD that is due to be paid in less than one year would not count toward the external LTD requirement. The amount of eligible external LTD that is due to be paid in more than two years would count at 100 percent of the unpaid principal amount.

The final rule makes clear that when principal payments are due, rather than the remaining maturity, governs the amount of LTD that counts toward the minimum requirements under the final rule. A covered BHC may only count the unpaid principal amount that is due to be paid as eligible external LTD. For amortizing debt, when the covered BHC pays back principal, that amount would not count toward the minimum LTD requirements in the final rule.

The purpose of these restrictions 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 that is due to be paid in 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 it is likely that the creditors would be unwilling to maintain their 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 a case where the covered BHC enters 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 being due to be paid in less than on year, 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.

This requirement also accords with market convention, which generally defines “long-term debt” as debt with maturity in excess of one year.

For the same reasons, eligible external LTD that is due to be paid in less than two years but greater than or equal to one year is subject to a 50 percent haircut under the final rule 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.

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 due to be paid in 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 that is due to be paid 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 that is due to be paid in less than two years by staggering its issuance, by issuing eligible external LTD that is due to be paid after a longer period, or by redeeming and replacing eligible external LTD once the amount due to be paid falls below two years.

As discussed above, the proposed amortization 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 final rule 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. As under the proposal, such an instrument would be treated as if it were due to be paid 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.

The date on which principal is due to be paid would be calculated from the date the put right would first be exercisable regardless of whether the put right would only be exercisable on that date if another event occurred (

e.g.,

a credit rating downgrade).

One commenter also recommended that the Board permit or grandfather long-term debt with a “survivor put” feature—that is, a provision that says that, on the death of the holder, the named holder's representative may require the issuer to repay the security within a designated period after the primary holder's death—to count as eligible external LTD. Under the final rule, the date on which debt is due to be paid of an outstanding eligible debt security is the date that the holder first has a contractual right to request or require payment of principal, provided that, with respect to a right that is exercisable on one or more dates that are specified in the instrument only on the occurrence of an event, the date will be calculated as if the event has occurred. Therefore, under the final rule, debt with a survivor put right would be treated as having matured on the first day it became subject to a put right, which would be the day of issuance. Because eligible external LTD must have a maturity of greater than one year, debt with a survivor put would therefore not qualify as eligible external LTD. For similar reasons, the final rule does not grandfather as eligible LTD outstanding long-term debt with such survivor put features.

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, the proposal would have required eligible external LTD to be governed by the laws of the United States or any State, which would include the U.S. Bankruptcy Code and Title II.

Several commenters argued that long-term debt subject to foreign law should not be excluded from the definition of eligible external LTD. These commenters contended that a significant fraction (over 10 percent) of existing, outstanding long-term debt securities would be ineligible due to the restriction on foreign governing law. These commenters expressed the view that there is no material risk that any actions taken in a U.S. bankruptcy or Title II proceeding to impose losses on long-term debt securities governed by foreign law would be subject to a successful legal challenge or not upheld by a court in foreign jurisdictions. These commenters pointed out that the United Kingdom, Japan and Australia, which commenters said account for 98 percent of the foreign-law governed LTD outstanding as of September 30, 2015, all have statutes that provide a judicial mechanism for recognizing and giving effect to actions taken in a U.S. bankruptcy or Title II proceeding. Certain commenters recommended that any material risk of a successful legal challenge could be eliminated by including clauses in eligible long-term debt securities that result in investors consenting to any actions taken in U.S. bankruptcy or Title II proceedings in the event of a covered BHC's failure as suggested by the FSB standard which provides that eligible external TLAC may be made subject to the laws of a foreign jurisdiction if the application of the home country's resolution tools is made “enforceable on the basis of binding statutory provisions or legally enforceable contractual provisions for recognition of resolution actions.”

FSB Standard at 17.

The final rule retains the requirement that long-term debt subject to foreign law does not qualify as eligible external LTD. Long-term debt that is subject to foreign law would potentially be subject to legal challenge in a foreign jurisdiction, which could jeopardize the orderly resolution of a covered BHC. Foreign courts might not defer to actions of U.S. courts or U.S. resolution authorities requiring the debt be converted into equity, for example, where the conversion negatively impacts foreign bondholders or foreign shareholders. While the presence of recognition regimes abroad does improve the likelihood that these actions would be enforced, it does not guarantee it.

However, to mitigate the impact of this requirement, the final rule's definition of “eligible debt security” has been modified to allow debt instruments issued prior to December 31, 2016 that are governed by foreign law to count as eligible long-term debt. Thus, long-term debt that is governed by foreign law and issued before December 31, 2016, may count toward the minimum LTD and TLAC requirements in the final rule.

6. Contractual Subordination

The final rule, like the proposal, does not include a requirement that eligible LTD instruments be contractually

subordinated. Covered BHCs would have the option of contractual subordination or structural subordination.

A number of commenters expressed support for the approach taken in the proposal to not require contractual subordination of eligible external LTD. Some commenters expressed concern that if the final rule required eligible external LTD to be either contractually or structurally subordinated to other liabilities of a covered BHC, long-term debt that failed to meet this criteria would not be available to absorb losses in the event of a resolution of a covered BHC. These commenters expressed the view that structural subordination would sufficiently ensure that eligible external LTD would absorb losses ahead of the liabilities of subsidiaries in an SPOE resolution. These commenters further argued that giving covered BHC's flexibility to comply with the external LTD requirement by either contractual or structural subordination allows for efficient compliance and adaptation to investor risk preferences, and limits the need to re-issue LTD that would otherwise be outstanding and available to absorb losses. By contrast, other comments expressed the view that the failure to include a contractual subordination provision might improve marketability but could be deceptive to investors. One commenter recommended that the Board should prohibit such debt from being called “senior debt,” which commenter argued was a title that could further mislead unsophisticated investors.

After reviewing the comments, the Board again 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 as suggested by certain commenters.

There continue to be several reasons to not require eligible LTD be contractually subordinated to the claims of third-party creditor. 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.

Second, the final rule includes clean holding company requirements that 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. In order to provide additional flexibility, the final rule provides that a covered BHC that chooses to issue all of its external LTD with a contractual subordination provision would not be subject to such a cap as described further below.

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 final rule, the final rule 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.

7. Explicit Bail-In Mechanisms

Several commenters recommended that the final rule include an express mechanism by which a covered BHC's eligible external LTD would be “bailed in” in the event of the covered BHC's bankruptcy or resolution. These commenters argued that additional detail would facilitate the orderly resolution of a covered BHC and reduce investor uncertainty. For example, such commenters sought clarification that the “bail in” of eligible external LTD would wipe out existing equity holders of a covered BHC in a resolution scenario. Other commenters encouraged the Board to mandate that a covered BHC's eligible external LTD could not be bailed in prior to the failure of the firm. One commenter suggested that a covered BHC emerging from bankruptcy or resolution should be required to be significantly simpler.

Under the final rule, eligible external LTD would be “bailed in” to absorb losses of the covered BHC only in bankruptcy or resolution proceedings of the firm. In contrast to the debt conversion mechanism that applies to the internal LTD of covered IHCs, as discussed below, the final rule does not require that a covered BHC's eligible external LTD include a specific conversion mechanism that could be triggered outside of bankruptcy or resolution. The requirements in the final rule are written under the assumptions that a covered BHC would recapitalize its subsidiaries in the event of distress so that the subsidiaries could remain operational outside of a bankruptcy or resolution proceedings and that losses the covered BHC sustained by such recapitalization could be imposed on holders of TLAC through a bankruptcy or resolution proceeding. However, the final rule does not prescribe any specific requirements for how a covered BHC would enter into bankruptcy or resolution, as any resolution would be dependent on the specific facts and circumstances of a covered BHC at the time of failure, and would be within the purview of the bankruptcy court (in a proceeding under the U.S. Bankruptcy Code) or the FDIC (in a Title II resolution).

8. Other Comments

Certain commenters argued that a covered BHC's eligible external LTD should be a required component of its executive compensation program. These commenters argued that requiring executives of a covered BHC to be compensated with such debt would help align the incentives of a covered BHC's management with the incentives of other holders of eligible external LTD.

The final rule does not include a requirement that a covered BHC compensate management with eligible external LTD. The intended purpose of this final rule is to improve the resolvability of covered BHCs by requiring them to issue long-term debt. Achieving this policy objective does not, as a general matter, require certain parties to hold the long-term debt of covered BHCs. Moreover, other rules may apply to the incentive compensation practices of covered BHCs.

Recently, the Board jointly issued with the OCC, the FDIC, the National Credit Union Administration, the Securities and Exchange Commission, and the Federal Housing Finance Agency, joint proposed rules that would implement the incentive compensation requirements of the Dodd-Frank Act.

See

12 U.S.C. 956; 81 FR 37670 (June 10, 2016).

F. Costs and Benefits

An analysis of the potential costs and benefits of the external TLAC and external LTD requirements was conducted at the time of the release of the proposal. To evaluate the costs attributable to the proposed requirements, this analysis estimated (a)

the extent by which each covered BHCs' required capital and currently outstanding long-term debt fell 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. In evaluating the costs and benefits of the final rule it is important to consider the state of covered BHC's at the time of the proposal. Importantly, while covered BHC's have closed some of the shortfall in their TLAC requirements since the time of the proposal, this activity does not reduce the costs of complying with the requirements. In particular, information reviewed by the Board suggests that covered BHC's aggregate TLAC shortfall has fallen from roughly $120 billion at the time of the proposal to roughly $70 billion as of the third quarter of 2016.

This reduction in shortfall, however, does not reduce the overall cost of the requirements but rather demonstrates that covered BHCs have already begun to bear the cost of the requirements of the final rule. Moreover, since the requirements of the final rule have been finalized largely as proposed, the overall estimated costs and benefits of the requirements as described in the final rule have not materially changed from the proposal. Several features of the final rule that differ from the proposal have impacted overall costs and we discuss these below.

The TLAC proposal reported a total shortfall of $120BN as of year-end 2014 that was based on different data and assumptions than the estimates presented above.

A few commenters suggested that the Board underestimated the cost of the rule in the proposal because the proposal's analysis assumed that covered firms' existing long-term debt is eligible under the rule even though much of the existing long-term debt would not have met the eligibility requirements under the proposal. Existing debt containing impermissible acceleration clauses was identified by certain commenters to be present in nearly all of the covered BHC's outstanding traditional long-term debt as of September 30, 2015. Similarly, commenters argued that a significant portion (over 10 percent) of the covered BHC's outstanding LTD would be ineligible under the proposal because it had been issued under foreign law. Commenters estimated that absent any grandfathering of this debt to satisfy the LTD requirements, the resulting shortfall would be in the range of $500 to $700 billion rather than the Board's estimated shortfall of $120 billion under the proposal. The Board believes that these comments on impact have been addressed and the costs of the final rule mitigated in large part by the fact that, as described above, eligible LTD in the final rule includes debt issued prior to December 31, 2016, that contains impermissible acceleration clauses or that is governed by foreign law. As a result the estimated shortfall of $120 billion that was reported in the original proposal is appropriate for considering the economic costs of the final rule.

1. Shortfall Analysis

An analysis of information collected and reviewed by the Board suggested that the total TLAC shortfall of U.S. GSIBs at the time of the proposal was roughly $120 billion.

This estimate includes debt with impermissible acceleration clauses and debt that is issued under foreign law but that is included in eligible LTD due to grandfathering of these features under the final rule. In addition, U.S. GSIBs have taken steps to reduce their overall shortfall since the release of the proposal. Information received and reviewed by the Board suggests that the aggregate TLAC shortfall has declined to roughly $70 billion as of the third quarter of 2016. This reduction in the shortfall indicates that the TLAC requirements are manageable as firms have made considerable progress in reducing their shortfalls in the relatively short period of time since the proposal. However, this also indicates that firms have already begun bearing the costs of the final rule by beginning to alter their capital structures after the proposal. The Board estimates that $120 billion is the relevant amount for purposes of considering the cost of the final rule because this is the shortfall that existed at the time of the proposal before covered entities had an opportunity to adjust their capital structure in response to the proposal.

See

80 FR 74926 at 74938.

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 have outstanding. For the same reasons that were discussed above, the estimated cost of filling the $120 billion shortfall that was described in the proposal is appropriate for estimating the costs of the final rule: It captures the cost that covered entities will bear to fill the shortfall that existed at the time the proposal was released and before covered entities made any changes to their capital structure in response to the proposal's requirements.

One reason that would cause the proposal's cost estimate to be inaccurate would be if the cost of long term debt relative to short term debt changed markedly between the time of the proposal and the final rule. Such a change would indicate that the current costs of filling the shortfall at the time of the release of the final rule would be significantly different from the costs that prevailed at the time of the proposal. One simple measure of the cost of long term versus short term financing is the spread between five-year and three-month U.S. Treasury debt. At the time of the proposal, this yield spread was roughly 1.45 percent and as of November 2016 this spread is roughly 1.1 percent. Accordingly, the cost of exchanging short term debt for long term debt has declined somewhat, which suggests that the estimates provided in the proposal represent a somewhat conservative estimate of filling the estimated shortfall. Accordingly, the estimated cost of filling the shortfall has not been decreased to reflect the modest narrowing in funding spreads.

Several additional assumptions were made to estimate the cost of filling the $120 billion shortfall. 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 would be the form of long-term bonds issued by the covered BHCs' bank subsidiaries.

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. Some commenters provided independent estimates of the cost of replacing this near-eligible debt with eligible debt. In particular, a group of commenters estimated that the cost of subordinating near-eligible debt would range from 25 to 100 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 would be 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. One commenter provided independent estimates of the cost of lengthening the duration of a bank's funding profile, but these estimates compared the costs of three to five year debt versus debt with a ten year maturity, rather than the relative costs of short term, deposit-like funding with longer-term debt.

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.

This particular estimate was provided by foreign bank commenters that were required under the proposal to contractually subordinate their debt. They indicated these costs reflected arm's length market terms for these transactions and, accordingly, the Board has considered these costs in evaluating the total cost of subordinating the debt.

The funding cost estimates at the low ends of the ranges described above—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 can be produced using figures at the high ends of these ranges and then further adjusting them upward to reflect a potential supply effect of 30 basis points.

Using the resulting, higher figures—130 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 $2.0 billion per year. The Board notes that this amount is roughly $500 million larger than the estimate that was provided in the proposal since the high estimate of the cost of replacing near-eligible debt with eligible debt has been taken from the higher estimate provided by one group of commenters which was 100 basis points rather than the 30 basis points that was cited in the proposal.

This accounts for an increase in the interest rate on eligible external LTD caused by the increase in the supply of eligible external LTD as a result of the 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.

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 $2.0 billion annually.

3. Increased Lending Rate Analysis

The Board conducted an analysis of increased lending rates using the updated values described previously that was similar to the analysis conducted under the proposal. To arrive at a conservative estimate of the effect of the final rule's 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 6.3 basis points as a result of the external TLAC and LTD requirements of the final rule. The total dollar value of this increase in funding rates is between $4.2 and $20.2 billion per year in increased lending costs across the entire U.S. economy.

4. Macroeconomic Costs Analysis

The Board also conducted the analysis of macroeconomic costs similar to that conducted for the proposal using the updated values described previously. 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 6.3 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 and consistent with the analysis in the proposal, it appears that the costs associated with the external TLAC and LTD requirements would be minimal.

5. Macroeconomic Benefits Analysis

To estimate the benefits of the final rule's 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).

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.

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 final rule will 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 a covered BHC's elig

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