International Banking Operations; Rules Regarding Delegation of Authority
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Federal Register › Vol. 62 › 62 FR 68424
Text
Part IV
Federal Reserve System
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12 CFR Parts 211 and 265
International Banking Operations; Rules Regarding Delegation of
Authority; Proposed Rule
Proposed Rules
FEDERAL RESERVE SYSTEM
12 CFR Parts 211 and 265
[Regulation K; Docket No. R-0994]
International Banking Operations; Rules Regarding Delegation of
Authority
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of proposed rulemaking.
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SUMMARY: Consistent with section 303 of the Riegle Community
Development and Regulatory Improvement Act of 1994 (the Regulatory
Improvement Act) and the International Banking Act of 1978 (the IBA),
the Board has reviewed Regulation K, which governs international
banking operations, and is proposing for comment a number of changes to
Subparts A, B and C of Regulation K.
Subpart A of Regulation K governs the foreign investments and
activities of all member banks (national banks as well as state member
banks), Edge and agreement corporations, and bank holding companies.
The proposed amendments would streamline foreign branching procedures
for U.S. banking organizations, authorize expanded activities in
foreign branches of U.S. banks, and implement recent statutory changes
authorizing a bank to invest up to 20 percent of capital in surplus in
Edge corporations. Changes also are proposed to the provisions
governing permissible foreign activities of U.S. banking organizations,
including securities activities, and investments by U.S. banking
organizations under the general consent procedures and portfolio
investments authority.
Subpart B of Regulation K (Foreign Banking Organizations) governs
the U.S. activities of foreign banking organizations
tions. Changes also are proposed to the provisions
governing permissible foreign activities of U.S. banking organizations,
including securities activities, and investments by U.S. banking
organizations under the general consent procedures and portfolio
investments authority.
Subpart B of Regulation K (Foreign Banking Organizations) governs
the U.S. activities of foreign banking organizations. The proposed
amendments include revisions aimed at streamlining the applications
procedures applicable to foreign banks seeking to expand operations in
the United States, changes to provisions regarding the qualification of
certain foreign banking organizations for exemption from the nonbanking
prohibitions of the section 4 of the Bank Holding Company Act (the BHC
Act), and implementation of provisions of the Reigle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the Interstate Act) that
affect foreign banks.
In addition, there are proposed a number of technical and
clarifying amendments for Subparts A and B, as well as Subpart C, which
deals with export trading companies, and certain amendments to the
Board's Rules Regarding Delegation of Authority.
DATES: Comments must be received by March 14, 1998.
ADDRESSES: Comments, which should refer to Docket No. R-0994, may be
mailed to William W. Wiles, Secretary, Board of Governors of the
Federal Reserve System, 20th and C Streets, NW., Washington, DC. 20551.
Comments addressed to Mr. Wiles also may be delivered to the Board's
mail room between 8:45 a.m. and 5:15 p.m., and to the security control
room outside of those hours. Both the mail room and the security
control room are accessible from the courtyard entrance on 20th Street
between Constitution Avenue and C Street, NW. Comments received will be
available for inspection in Room MP-500 of the Martin Building between
9:00 a.m. and 5:00 p.m. weekdays, except as provided in Sec. 261.14 of
the Board's Rules Regarding the Availability of Information, 12 CFR
261.14.
th the mail room and the security
control room are accessible from the courtyard entrance on 20th Street
between Constitution Avenue and C Street, NW. Comments received will be
available for inspection in Room MP-500 of the Martin Building between
9:00 a.m. and 5:00 p.m. weekdays, except as provided in Sec. 261.14 of
the Board's Rules Regarding the Availability of Information, 12 CFR
261.14.
FOR FURTHER INFORMATION CONTACT: Kathleen M. O'Day, Associate General
Counsel (202/452-3786); Sandra L. Richardson, Managing Senior Counsel
(202/452-6406), or Jon Stoloff, Senior Attorney (202/452-3269),
regarding Subpart A; Ann Misback, Managing Senior Counsel (202/452-
3788), or Janet Crossen, Senior Attorney (202/452-3281), regarding
Subparts B or C, Legal Division; or Michael G. Martinson, Associate
Director (202/452-2798), or Betsy Cross, Assistant Director (202/452-
2574), Division of Banking Supervision and Regulation. For the users of
Telecommunications Device for the Deaf (TDD) only, please contact Diane
Jenkins (202/452-3544).
SUPPLEMENTARY INFORMATION:
Subpart A: International Operations of U.S. Banking Organizations
Expansion of Permissible Foreign Activities
Statutory Framework
The proposed amendments to Regulation K, which are in part the
result of the Board's review of its regulations under section 303 of
the Regulatory Improvement Act, seek to eliminate unnecessary
regulatory burden, increase transparency, and streamline the approval
process for U.S. banking organizations seeking to expand their
operations abroad and foreign banks seeking to establish or expand
operations in the United States. The Federal Reserve Act, as amended by
the IBA, also requires the Board to review and revise its regulations
issued under section 25A of the Federal Reserve Act (the Edge Act) at
least once every five years to ensure that the purposes of the Edge Act
are being served in light of prevailing economic conditions and banking
practices
eking to establish or expand
operations in the United States. The Federal Reserve Act, as amended by
the IBA, also requires the Board to review and revise its regulations
issued under section 25A of the Federal Reserve Act (the Edge Act) at
least once every five years to ensure that the purposes of the Edge Act
are being served in light of prevailing economic conditions and banking
practices. The provisions of Subpart A, which govern the operations of
Edge corporations, also were reviewed with this statutory mandate in
mind.1
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\1\ The Board last revised Subpart A in December 1995, at which
time the general consent investment authority for strongly-
capitalized and well-managed U.S. banking organizations was expanded
significantly. A comprehensive review of Regulation K in its
entirety was completed in 1991.
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Edge corporations are international banking and financial vehicles
through which U.S. banking organizations offer international banking or
other foreign financial services and through which they compete with
similar foreign-owned institutions in the United States and abroad. The
purposes of the Edge Act, which amended the Federal Reserve Act in
1919, include enabling U.S. banking organizations to compete
effectively with foreign-owned institutions; providing the means to
finance international trade, especially U.S. exports; fostering the
participation of regional and smaller U.S. banks in providing
international banking and financing services to U.S. business and
agriculture; and stimulating competition in the provision of
international banking and financing services throughout the United
States. Congress, in enacting this legislation, recognized that U.S
to
finance international trade, especially U.S. exports; fostering the
participation of regional and smaller U.S. banks in providing
international banking and financing services to U.S. business and
agriculture; and stimulating competition in the provision of
international banking and financing services throughout the United
States. Congress, in enacting this legislation, recognized that U.S.
banks needed vehicles that could exercise wider financial powers abroad
than were permitted domestically in order to be competitive
internationally and to serve the international needs of U.S. firms. At
the same time, the Edge Act places limits on U.S. banks' exposure to
these broader foreign activities, by limiting the amount that U.S.
banks may invest in Edge corporations, establishing a number of
statutory safety and soundness constraints, and granting the Board wide
discretion in determining what activities should be permissible for
such entities. In exercising its authority in this area, the Board is
required by the IBA to implement the objectives of the Edge Act
consistent with supervisory standards relating to the safety and
soundness of U.S. banking organizations.
As a result of the current review, the Board has not identified any
changes that appear to be necessary with regard to the provisions
relating to the activities of Edge corporations in the United States.
Nevertheless, comment is sought on any changes to the permissible U.S.
activities of Edge corporations that are considered necessary or
appropriate to fulfill the purposes of the Edge Act.
.
As a result of the current review, the Board has not identified any
changes that appear to be necessary with regard to the provisions
relating to the activities of Edge corporations in the United States.
Nevertheless, comment is sought on any changes to the permissible U.S.
activities of Edge corporations that are considered necessary or
appropriate to fulfill the purposes of the Edge Act.
The Board, however, has determined that a number of the provisions
relating to foreign activities of U.S. banking organizations could be
revised. The Board proposes revisions to Subpart A that would: (1)
Expand permissible government bond trading by foreign branches of
member banks; (2) streamline procedures for establishment of foreign
branches by U.S. banking organizations; (3) expand permissible foreign
activities of U.S. banking organizations, including securities
activities; (4) expand general consent and portfolio investment
authority for U.S. banking organizations; (5) amend the debt/equity
swaps authority to reflect changes in circumstances of eligible
countries; (6) implement the new statutory provision allowing member
banks to invest, with the Board's approval, up to 20 percent of capital
and surplus in the stock of Edge and agreement corporations; and (7)
include additional technical and clarifying amendments. Each of these
proposed changes is discussed below.
Expansion of Government Bond Trading by Foreign Branches
mstances of eligible
countries; (6) implement the new statutory provision allowing member
banks to invest, with the Board's approval, up to 20 percent of capital
and surplus in the stock of Edge and agreement corporations; and (7)
include additional technical and clarifying amendments. Each of these
proposed changes is discussed below.
Expansion of Government Bond Trading by Foreign Branches
Section 25 of the Federal Reserve Act permits the Board to
authorize foreign branches of member banks to conduct abroad activities
that are not permitted domestically. However, the statute states that
the Board shall not ``except to such limited extent as the Board may
deem necessary with respect to securities issued by any `foreign state'
* * * authorize a foreign branch to engage or participate, directly or
indirectly, in the business of underwriting, selling, or distributing
securities.''
Given the statutory language, the Board, to date, has only
permitted foreign branches to underwrite and sell securities of the
government of the country in which the branch was located. This was
determined to be appropriate on the basis that it is often necessary in
the ordinary course of banking business for a branch to participate in
the selling of the bonds of the host country.
In recent years, U.S. banking organizations have become more active
in trading and underwriting foreign government securities.
Increasingly, such business, where possible, is being conducted in the
foreign branches of U.S. banks. Rather than distributing the securities
through their various branches, centralizing trading for all or for
certain groups of countries in a single branch can be desirable to
facilitate management and funding of this business. For example, a
banking organization might wish to centralize government securities
trading for all countries in the European Union in one European branch
of U.S. banks. Rather than distributing the securities
through their various branches, centralizing trading for all or for
certain groups of countries in a single branch can be desirable to
facilitate management and funding of this business. For example, a
banking organization might wish to centralize government securities
trading for all countries in the European Union in one European branch.
For these reasons, the Board proposes that banks be permitted to
underwrite and deal through their foreign branches in obligations of
governments other than the host government, provided that the
obligations are of investment grade and the business is otherwise
subject to sound banking practices and prudential regulations. The
Board considers the requirement that the obligations must be investment
grade would limit cross-border transfer risk to the bank because
trading of government securities giving rise to such risk would be
required to be conducted either directly through a local branch that is
funded locally or through a subsidiary instead of through the bank.
The Board believes that permitting branches to underwrite and sell
securities of governments other than the host government on this basis
is consistent with sound risk management and general business
practices, as well as with the Board's statutory authority. The Board
also proposes to retain the existing authority of foreign branches of
member banks to underwrite and deal in host government bonds regardless
of whether they are investment grade.
The Board seeks comment on these proposals, as well as on what
ratings should be considered to be investment grade for these purposes.
Foreign Branching
s, as well as with the Board's statutory authority. The Board
also proposes to retain the existing authority of foreign branches of
member banks to underwrite and deal in host government bonds regardless
of whether they are investment grade.
The Board seeks comment on these proposals, as well as on what
ratings should be considered to be investment grade for these purposes.
Foreign Branching
The Board's responsibilities as home country supervisor under the
Minimum Standards for the Supervision of International Banking Groups
and their Cross-border Establishments issued by the Basle Committee on
Banking Supervision (the Minimum Standards) call for its specific
authorization of a U.S. banking organization's outward expansion.
Outward expansion for these purposes means the initial establishment of
a banking presence in a country by the bank or any affiliate.
Regulation K currently requires the specific consent of the Board
for the establishment of branches by a member bank, an Edge or
agreement corporation, or a foreign bank subsidiary in its first two
foreign countries. The Board believes that 30 days' prior notice before
establishment of those initial foreign branches would be sufficient and
would be consistent with the Minimum Standards. The Board considers
that 30 days' prior notice also should be required consistent with the
Minimum Standards if the initial banking presence abroad is in the form
of a subsidiary bank; such notice would be required even if the amount
to be invested were below the general consent limits.
Under Regulation K at present, no prior Board approval is required
for a banking entity to establish additional branches in any foreign
country where it already operates one or more branches. However, a
banking entity must give the Board prior notice before establishing a
branch in a foreign country where it has no branches even though a
banking entity affiliate operates a branch in that country
er Regulation K at present, no prior Board approval is required
for a banking entity to establish additional branches in any foreign
country where it already operates one or more branches. However, a
banking entity must give the Board prior notice before establishing a
branch in a foreign country where it has no branches even though a
banking entity affiliate operates a branch in that country.
The Board proposes that Regulation K be liberalized such that if
any of the member bank, its Edge or agreement corporation subsidiaries,
or a foreign bank subsidiary (whether a subsidiary of the bank or of
the bank holding company) already has a branch in a particular foreign
country, a banking affiliate would be able to branch there without
prior notice to the Board. After-the-fact notice, however, would still
be required.
The Board also proposes that the 45 days' prior notice currently
required in order to branch into additional countries where there is no
affiliated banking presence (after the organization has branches
engaged in banking in two foreign countries) should be reduced to 12
business days. In taking this approach, the foreign branching
experience of the entire banking organization would be taken into
account in determining whether the banking entity would be subject to
the 30 day or 12 day prior notice procedure. Where a U.S. banking
organization as a whole already operates foreign branches of banking
entities in two countries, any banking affiliate would be able to open
a branch in a country where such organization has no banking presence
pursuant to the 12 days' prior notice procedure.
Finally, currently under Regulation K, nonbanking subsidiaries held
pursuant to Regulation K may branch into any country in which any
affiliate has a branch without prior notice, but a 45-day prior notice
must be submitted to establish a branch in a country where no affiliate
has a presence
untry where such organization has no banking presence
pursuant to the 12 days' prior notice procedure.
Finally, currently under Regulation K, nonbanking subsidiaries held
pursuant to Regulation K may branch into any country in which any
affiliate has a branch without prior notice, but a 45-day prior notice
must be submitted to establish a branch in a country where no affiliate
has a presence. The Board proposes permitting nonbanking subsidiaries
held pursuant to Regulation K to establish foreign branches without
prior review, subject only to an after-the-fact notice requirement.
The Board seeks comment on these proposed changes, including in
particular whether the proposed modified notice periods would
sufficiently accommodate foreign expansion plans.
Permissible Activities of Foreign Subsidiaries of U.S. Banking
Organizations
One aspect of bank regulation to which the Federal Reserve
subscribes is the fostering of a level competitive playing field for
financial intermediaries. Thus, in the United States, the Board has
advocated that expansion by banking organizations into nonbanking
activities should generally occur through the bank holding company and
not the bank. Banks in the United States benefit from the implicit
support of the national government and its sovereign credit rating
through federal deposit insurance, Federal Reserve discount window
access, and final riskless settlement of payment system transactions.
Extension of this system would make the existing playing field in the
United States unlevel for nonbank competitors and create unnecessary
distortions in competition.
The same principle applies to American banks abroad. Other nations
have chosen to allow their banks to engage in a broad array of
financial activities, especially investment banking activities, thereby
extending to these banks the implicit support of their governments. In
those markets, U.S
the
United States unlevel for nonbank competitors and create unnecessary
distortions in competition.
The same principle applies to American banks abroad. Other nations
have chosen to allow their banks to engage in a broad array of
financial activities, especially investment banking activities, thereby
extending to these banks the implicit support of their governments. In
those markets, U.S. banks would be at a disadvantage if unable to offer
their customers an equivalent range of key services with the
convenience and efficiency of their local bank competitors. Indeed, in
many of these markets, banks are the only significant providers of
capital markets services. Independent securities firms are not
generally substantial competitors in these markets, both for historical
reasons and because they may be unable to compete effectively with
banks that have the explicit and implicit support of their governments.
Congress has recognized the existence of the different competitive
environments faced by U.S. banks operating abroad and has legislated
specifically to deal with it. Under the Edge Act, the Board has been
granted broad authority to permit Edge corporations, which may be owned
by U.S. banks, to engage in a wider range of activities outside the
United States than has been permitted to U.S. banks domestically,
consistent with safety and soundness standards. As noted, the purposes
of the Edge Act include enabling U.S. banking organizations to compete
effectively with foreign-owned institutions. Congress, in enacting this
legislation, recognized that U.S. banks needed vehicles that could
exercise broader financial powers abroad in order to be able to be
competitive internationally and to serve the needs of U.S. firms.
Congress granted the Board similar broad discretion to allow bank
holding companies to engage in activities outside the United States.
In exercising its statutory authority, the Board has sought to
balance the need for U.S
U.S. banks needed vehicles that could
exercise broader financial powers abroad in order to be able to be
competitive internationally and to serve the needs of U.S. firms.
Congress granted the Board similar broad discretion to allow bank
holding companies to engage in activities outside the United States.
In exercising its statutory authority, the Board has sought to
balance the need for U.S. banks to be competitive abroad with the
public interest in assuring the safety and soundness of the banks,
protecting the deposit insurance fund, and limiting the extension of
the federal safety net. In proposing these revisions to Regulation K,
the Board has sought to give U.S. banks appropriate expansion of those
activities, such as investment banking, in which the competitive need
is the greatest. Liberalization in relation to other activities, such
as venture capital investments and insurance activities, has been
proposed only in relation to subsidiaries of the bank holding company.
These latter activities appear to be able to be conducted competitively
outside the bank chain of ownership.
Securities Activities
Current Restrictions on Securities Activities
Foreign subsidiaries of U.S. banking organizations have been
permitted broad authority to underwrite and deal in debt securities for
over 25 years, subject to the provision that the securities must be
included with loans for purposes of compliance with the parent bank's
lending limit. No separate dollar limits have been placed on
underwriting and dealing in debt securities.
Since 1979, Regulation K also has authorized foreign subsidiaries
of both U.S. banks and bank holding companies to underwrite and deal in
equity securities outside the United States, subject to certain
limitations and restrictions. These activities were determined to be
permissible, within the applicable limits, on two bases. First, it
became clear that it was necessary for U.S
t securities.
Since 1979, Regulation K also has authorized foreign subsidiaries
of both U.S. banks and bank holding companies to underwrite and deal in
equity securities outside the United States, subject to certain
limitations and restrictions. These activities were determined to be
permissible, within the applicable limits, on two bases. First, it
became clear that it was necessary for U.S. banking organizations to be
able to engage in these activities abroad, if they were to compete
successfully with foreign banks in the provision of services to foreign
customers. Indeed, for some time, virtually all the major foreign
competitors of U.S. banking organizations have been foreign banks that
conduct equity securities activities either directly in the bank or in
a subsidiary of the bank. Thus, consistent with the purposes underlying
the Edge Act and the BHC Act, there is clear statutory authority for
U.S. banking organizations to engage in these activities through
subsidiaries abroad. Second, in any event, the provisions of the Glass-
Steagall Act do not apply extra-territorially to the operations of
foreign subsidiaries of U.S. banking organizations.
While equity underwriting and dealing have been permissible
activities for U.S. banking organizations' foreign subsidiaries for
some time, as noted above, the level of such activity is subject to
limits under Regulation K. Prudential restrictions currently applied to
equity securities underwriting and dealing activities under Regulation
K include the following.
Underwriting limits--Through a foreign subsidiary, an investor
2 may underwrite equity securities in amounts up to the
lesser of $60 million or 25 percent of its tier 1 capital. These limits
do not include amounts covered by binding commitments from sub-
underwriters or other purchasers
applied to
equity securities underwriting and dealing activities under Regulation
K include the following.
Underwriting limits--Through a foreign subsidiary, an investor
2 may underwrite equity securities in amounts up to the
lesser of $60 million or 25 percent of its tier 1 capital. These limits
do not include amounts covered by binding commitments from sub-
underwriters or other purchasers. If the underwriting is done in a
subsidiary of the member bank, the amount of the uncovered underwriting
must be included in computing the bank's single borrower lending limit
with respect to the issuer.
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\2\ An investor for these purposes means an Edge corporation,
agreement corporation, bank holding company, member bank and any
foreign bank owned directly by a member bank.
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Dealing limits--Through a foreign subsidiary, an investor may hold
a dealing position in the equity securities of any one issuer in
amounts up to the lesser of $30 million or 10 percent of its tier 1
capital. An investor must include any shares of a company held in an
affiliate's dealing account in determining compliance with any
percentage limits placed on ownership of that company.
Aggregate limit--There is an aggregate limit on the total amount of
equity securities that may be held in investment and dealing accounts,
aggregating all shares held by subsidiaries: for a bank holding
company, the limit is 25 percent of tier 1 capital; for an Edge
corporation,3 the limit is 100 percent of the Edge's tier 1
capital.4
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There is an aggregate limit on the total amount of
equity securities that may be held in investment and dealing accounts,
aggregating all shares held by subsidiaries: for a bank holding
company, the limit is 25 percent of tier 1 capital; for an Edge
corporation,3 the limit is 100 percent of the Edge's tier 1
capital.4
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\3\ Any foreign bank directly owned by a U.S. bank is treated as
an Edge corporation for purposes of its limits.
\4\ Investments in companies must be added to any shares of such
companies held in the dealing account for purposes of this limit.
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Prior review--Banking organizations must submit to a review of
their foreign securities operations prior to engaging in foreign equity
securities activities to the extent of these limits. They may also seek
Board approval for higher underwriting limits, subject to certain
conditions.
Proposed Revisions
Determination of Applicable Limits
Although, as discussed above, the limits on underwriting and
dealing in equity securities in Regulation K are expressed both in
terms of percentages of tier 1 capital of the investor and absolute
dollar limits, as a practical matter it has been the dollar limits that
have constrained the ability of U.S. banking organizations to engage in
these activities through their foreign subsidiaries and, consequently,
have impeded their efforts to compete with foreign banks abroad. In
order to reduce further these constraints on competition, the Board
proposes to replace the dollar limits for underwriting or dealing
activity with limits based solely on percentages of the investor's tier
1 capital for well-capitalized and well-managed organizations
ities through their foreign subsidiaries and, consequently,
have impeded their efforts to compete with foreign banks abroad. In
order to reduce further these constraints on competition, the Board
proposes to replace the dollar limits for underwriting or dealing
activity with limits based solely on percentages of the investor's tier
1 capital for well-capitalized and well-managed organizations.
The Board considers that, if a banking organization is well-
capitalized and well-managed, tying the underwriting or dealing limits
solely to capital levels would have the benefit of more closely linking
the limits to the ability of the company to support the activity. It
would also provide U.S. banking organizations with greater flexibility
in responding to changing market conditions, because the amount of
capital devoted to an activity is, after meeting regulatory
constraints, determined by the firm.5
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\5\ Arguably, this flexibility could be enhanced further if
foreign subsidiaries of U.S. banking organizations were permitted to
exceed the individual and aggregate limits, subject to a requirement
that the amount in excess of the limits be deducted from capital
and, after such deduction, the institution would continue to be
well-capitalized.
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Accordingly, the Board proposes to amend Regulation K in relation
to those banking organizations that are well-capitalized and well-
managed by removing the existing dollar limits applicable to equity
securities activities, and instead providing that such activities would
be limited to percentages of the investor's tier 1 capital
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Accordingly, the Board proposes to amend Regulation K in relation
to those banking organizations that are well-capitalized and well-
managed by removing the existing dollar limits applicable to equity
securities activities, and instead providing that such activities would
be limited to percentages of the investor's tier 1 capital. For well-
capitalized and well-managed organizations, the Board proposes
applicable limits to be determined as follows.6 In relation
to securities activities of subsidiaries of bank holding companies,
their limits would be determined by reference to percentages of the
tier 1 capital of the holding company. The Board proposes, however,
that limits applicable to such activities undertaken by subsidiaries of
Edge and agreement corporations, as well as foreign banks that may be
direct subsidiaries of member banks, would be determined by reference,
at least in the first instance, to the tier 1 capital of the parent
bank.
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\6\ The Board proposes that existing dollar limits would be
retained for companies that are not well-capitalized and well-
managed.
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In the Board's view, tying applicable limits to the capital of the
parent bank is particularly important for subsidiaries of Edge
corporations. As previously noted, Congress has limited a member bank's
investment in Edge and agreement corporations to 20 percent of the
bank's capital.7 However, partly for tax reasons, Edge
corporations historically have tended to retain their earnings rather
than dividending them to the parent bank
mits to the capital of the
parent bank is particularly important for subsidiaries of Edge
corporations. As previously noted, Congress has limited a member bank's
investment in Edge and agreement corporations to 20 percent of the
bank's capital.7 However, partly for tax reasons, Edge
corporations historically have tended to retain their earnings rather
than dividending them to the parent bank. In some cases due to such
retained earnings, the capital of a bank's Edge and agreement
corporations may be in excess of 20 percent of the parent bank's
consolidated capital, even though its investment in the Edge subject to
the above-referenced statutory limit is below 20 percent.
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\7\ The Edge Act prohibited member banks from investing more
than 10 percent of their capital and surplus in the capital stock of
Edge and agreement corporations. In September 1996, Congress amended
this limit to permit investments in excess of 10 percent of capital
and surplus with the specific approval of the Board, provided the
amount invested shall not exceed 20 percent of capital and surplus
of the bank.
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In these circumstances, the Board considers that the capital of an
Edge corporation that is in excess of 20 percent of the parent bank's
consolidated capital, when retained earnings are counted, should be
excluded for purposes of determining applicable limits for activities
of the Edge and its subsidiaries. The Board proposes to accomplish this
by setting limits for Edge corporations tied both to percentages of the
Edge's and parent bank's capital, respectively.8 Limits tied
to the parent bank's capital would be 20 percent of the limits
otherwise applicable to Edge corporations. The lower limit would be the
binding limit
rmining applicable limits for activities
of the Edge and its subsidiaries. The Board proposes to accomplish this
by setting limits for Edge corporations tied both to percentages of the
Edge's and parent bank's capital, respectively.8 Limits tied
to the parent bank's capital would be 20 percent of the limits
otherwise applicable to Edge corporations. The lower limit would be the
binding limit. For example, if a limit proposed for a given activity of
an Edge corporation is 10 percent of capital but the Edge's capital is
in excess of 20 percent of the bank's total capital, the binding limit
for the Edge would be two percent of the parent bank's tier 1 capital.
For those U.S. banks that do not have significant levels of retained
earnings at the Edge, the binding limit more than likely would be the
separate limit tied to the Edge's capital.
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\8\ As noted above, Regulation K currently treats any foreign
bank owned directly by a member bank as an Edge corporation for
purposes of its limits. The Board proposes that this treatment would
be continued under the revised Regulation K limits.
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The Board considers that this approach would be consistent with the
intent underlying the provisions of the Edge Act limiting the total
amount of capital a bank may invest in Edge corporations. This approach
effectively would place a cap on the percentage of total bank capital
that could be placed at risk through activities or investments not
otherwise permitted to the bank directly, regardless of the capital
level of the Edge corporation. This approach also would remove any
regulatory incentive to retain earnings at the Edge because any
regulatory benefit from such retained earnings, in terms of expanded
limits on activities abroad, would be denied
l bank capital
that could be placed at risk through activities or investments not
otherwise permitted to the bank directly, regardless of the capital
level of the Edge corporation. This approach also would remove any
regulatory incentive to retain earnings at the Edge because any
regulatory benefit from such retained earnings, in terms of expanded
limits on activities abroad, would be denied.
The Board proposes that all limits applicable to well-capitalized
and well-managed Edge corporations under the amended Regulation K would
proceed on this basis. Comment is requested on these proposals and
whether any other approach might achieve similar objectives.
Equity Underwriting
The $60 million limit on underwriting equity securities
significantly impedes the ability of U.S. banking organizations to
compete for this business in foreign markets, where securities
underwriting is increasingly a service offered by local banks. At the
same time, the risks associated with the activity suggest that such a
stringent limit is not required for safety and soundness purposes for
well-capitalized and well-managed banking organizations. While initial
underwriting commitments may involve large sums, in most cases by the
time the underwriting goes to market, large portions of the exposure
have been passed on sub-underwriters or presold. Thus, in most cases,
the initial underwriting commitment overstates the risk being assumed.
The Board proposes to remove the absolute dollar limits on
underwriting exposure for well-capitalized and well-managed banking
organizations, but retain a limit based on a percentage of the
investor's capital. More specifically, limits for underwriting exposure
to a single company would be established at 15 percent of the bank
holding company's tier 1 capital for its subsidiaries and, for
subsidiaries of Edge corporations, the lesser of three percent of tier
1 capital of the bank or 15 percent of the tier 1 capital of the Edge
ons, but retain a limit based on a percentage of the
investor's capital. More specifically, limits for underwriting exposure
to a single company would be established at 15 percent of the bank
holding company's tier 1 capital for its subsidiaries and, for
subsidiaries of Edge corporations, the lesser of three percent of tier
1 capital of the bank or 15 percent of the tier 1 capital of the Edge.
These limits on underwriting exposure to a single company would be
applied on an aggregate basis. A bank holding company's limit would
include all underwriting exposure to one issuer by all of the holding
company's direct and indirect subsidiaries, including exposures held
through its bank subsidiaries. The bank's and Edge's
limits would include all exposures held by their respective
subsidiaries. The Board proposes, however, that this expanded
underwriting authority would be available to U.S. banking organizations
only if each of the bank holding company, bank and Edge or agreement
corporation qualify as well-capitalized and well-managed.9
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\9\ The Board proposes that what, if any, action should be taken
in relation to banking organizations' limits and dealing positions
if they cease to be well-capitalized and well-managed would be
addressed on a case-by-case basis through supervisory action.
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--------------------------------------------------------------
\9\ The Board proposes that what, if any, action should be taken
in relation to banking organizations' limits and dealing positions
if they cease to be well-capitalized and well-managed would be
addressed on a case-by-case basis through supervisory action.
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For organizations that fail to meet the well-capitalized and well-
managed criteria, the Board proposes that the existing dollar limits
(i.e., $60 million) on commitments by an investor and its affiliates
for the shares of an organization would be retained.
The Board proposes that, in order to engage in such activities, all
banking organizations would be required to implement internal systems
and controls adequate to ensure proper risk management. Controls would
have to be in place to assure that underwriting positions do not result
in violations of limits on securities held in the trading account or
exceed the parent bank's lending limits when the underwriting positions
are combined with other credit exposures. Sanctions (such as temporary
suspension of underwriting authority) may be imposed for violations of
such limits.
Dealing in Equity Securities
The Board also proposes for comment liberalization of dealing
activities for well-capitalized and well-managed banking organizations.
As with underwriting limits, the proposed dealing limits would be based
on percentages of capital of the organization and, thus, on the ability
of the organization to accommodate risk. This change would permit U.S.
banking organizations to compete more effectively with foreign banks in
providing equity dealing and underwriting services to customers abroad,
where such activities are generally permissible to banking
organizations
osed dealing limits would be based
on percentages of capital of the organization and, thus, on the ability
of the organization to accommodate risk. This change would permit U.S.
banking organizations to compete more effectively with foreign banks in
providing equity dealing and underwriting services to customers abroad,
where such activities are generally permissible to banking
organizations. Nevertheless, in the Board's view, dealing activities
appear to present somewhat greater risk of loss than underwriting,
which suggests somewhat more restrictive limits are needed for dealing
activities relative to underwriting activities.
For well-capitalized and well-managed organizations, the Board,
therefore, proposes to remove the current dollar limits and revise the
existing percentage of capital limits as follows. First, in order to
provide diversification in the trading account, the Board proposes a
limit on holdings of any one stock in the trading account of 10 percent
of the tier 1 capital of the bank holding company for its subsidiaries
and, for subsidiaries of an Edge corporation, the lesser of two percent
of the bank's tier 1 capital or 10 percent of the Edge's tier 1
capital.
Second, the Board proposes an aggregate limit applicable to all
holdings of equities in the trading accounts of all direct and indirect
subsidiaries authorized pursuant to Subpart A.10 Without
such an aggregate ceiling, the Board is concerned that a banking
organization could have excessive exposure to movements in equity
markets. The Board proposes aggregate limits of 50 percent of the bank
holding company's tier 1 capital for its subsidiaries and, in the case
of an Edge's subsidiaries, the lesser of 10 percent of the tier 1
capital of the bank or 50 percent of the Edge's tier 1 capital.
---------------------------------------------------------------------------
d have excessive exposure to movements in equity
markets. The Board proposes aggregate limits of 50 percent of the bank
holding company's tier 1 capital for its subsidiaries and, in the case
of an Edge's subsidiaries, the lesser of 10 percent of the tier 1
capital of the bank or 50 percent of the Edge's tier 1 capital.
---------------------------------------------------------------------------
\10\ As at present, shares held as an investment pursuant to
Subpart A also would be included in calculating the applicable
aggregate limits.
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The Board proposes that the limits on equity trading and dealing
would apply to net positions across legal vehicles held, directly or
indirectly, by the regulated entity to which the limit is applicable
(that is, the bank holding company, the bank or the Edge
corporation).11 Long equity positions in a single stock
could be netted against short positions in the same stock and against
derivatives referenced to the same stock.12 For purposes of
the aggregate limits, all physical and derivative long positions could
be netted against physical and derivative short positions. It is
further proposed that, for purposes of measuring compliance with these
investment limits, banks would be permitted to use internal models to
calculate the value of derivative positions used to offset exposures
and net dealing positions in individual stocks, as well as the value of
total net equity holdings in the trading account.13 The
Board considers that the adequacy of such models is subject to review
during the exam process, and proposes that no special review would be
required for their use in connection with the proposed limits on
securities activities. 14
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stocks, as well as the value of
total net equity holdings in the trading account.13 The
Board considers that the adequacy of such models is subject to review
during the exam process, and proposes that no special review would be
required for their use in connection with the proposed limits on
securities activities. 14
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\11\ Currently these limits are normally applied on a gross
basis.
\12\ The Board also proposes that a basket of stocks,
specifically segregated by the banking organization as an offset to
a position in a stock index derivative product, as computed by the
bank's internal model, may be netted as a whole against the stock
index.
\13\ Currently, the use of internal models in computing net
positions in stocks is subject to prior Board review and the
limitation that any position in a security shall not be deemed to
have been reduced through netting by more than 75 percent.
\14\ The Board also seeks comment on allowing netting of
underwriting exposures.
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For organizations that fail to satisfy the well-capitalized and
well-managed criteria, the Board proposes to retain the existing dollar
limit on individual shares held in the trading account (i.e., $30
million), which would be calculated in the same manner as at present.
With regard to an aggregate limit on shares held in the trading
account, the Board considers that a reasonable limit for all equity
positions of such organizations, aggregating all positions and
investments held pursuant to Subpart A, would be 25 percent of the
holding company's capital for its subsidiaries and, for subsidiaries of
Edges and any foreign bank held directly by a member bank, the lesser
of 5 percent of the bank's tier 1 capital or 25 percent of the Edge's
tier 1 capital
hat a reasonable limit for all equity
positions of such organizations, aggregating all positions and
investments held pursuant to Subpart A, would be 25 percent of the
holding company's capital for its subsidiaries and, for subsidiaries of
Edges and any foreign bank held directly by a member bank, the lesser
of 5 percent of the bank's tier 1 capital or 25 percent of the Edge's
tier 1 capital. These limits would be half of those applicable to
organizations that are well-capitalized and well-managed as proposed
above.
These proposed percentage limits may appear lower than the existing
limits (which are 25 percent of tier 1 for subsidiaries of bank holding
companies and 100 percent of tier 1 for any other investor). In this
regard, however, the Board also proposes that an organizations'
aggregate position in stocks also could be calculated on the net basis
described above in determining compliance with these limits, rather
than on the gross basis presently required by Regulation K. This
netting authority in most cases would allow organizations to continue
to conduct their current levels of activities, even under the proposed
new limits. In these circumstances, the Board considers that the
aggregate limits should be reduced. In particular, the Board is
concerned that permitting an organization that is not well capitalized
or well managed to maintain what would be essentially an open exposure
to the stock markets in excess of 25 percent of the tier 1 capital of
the holding company or the Edge or five percent of the tier 1 capital
of the bank simply would not be consistent with safety and soundness
considerations.
The Board seeks comment generally on the proposed limits and
netting authority. Commenters' views in particular are solicited on
whether:
e essentially an open exposure
to the stock markets in excess of 25 percent of the tier 1 capital of
the holding company or the Edge or five percent of the tier 1 capital
of the bank simply would not be consistent with safety and soundness
considerations.
The Board seeks comment generally on the proposed limits and
netting authority. Commenters' views in particular are solicited on
whether:
--The revised limits, when taken together with the netting authority,
would enable U.S. banking organizations to compete with foreign banks
in these activities abroad;
--Appropriate distinctions have been drawn, in terms of dealing
authority,
between organizations that are well-capitalized and those that are not;
--The proposed netting authority should be available to organizations
that are not well-capitalized or well-managed;
--Even with the proposed netting authority, the reduction in percentage
limits for organizations that are not well-capitalized or well-managed
would give rise to a need for grandfathering of, e.g., existing
portfolio investments;
--It would be appropriate to include underwriting commitments in the
aggregate limits for dealing activities and portfolio investments; and
--Provision should be made for higher dealing limits for banking
organizations on a case-by-case basis.
For organizations that are not well capitalized and well managed,
the Board proposes to retain the existing dollar limits applicable to
underwriting and dealing positions (that is, $60 million on and $30
million, respectively), without regard to limits on percentage of
capital. As noted, it is generally the dollar limits that currently
constrain organizations in their ability to conduct these activities.
This is because, at present, only the largest banking organizations are
engaged in these activities. The Board notes, however, that in the
future a relatively small organization may seek to enter these lines of
business and, for it, exposures of $30 or $60 million may be large
relative to its capital
limits that currently
constrain organizations in their ability to conduct these activities.
This is because, at present, only the largest banking organizations are
engaged in these activities. The Board notes, however, that in the
future a relatively small organization may seek to enter these lines of
business and, for it, exposures of $30 or $60 million may be large
relative to its capital. The Board seeks comments on whether, in
addition to dollar limits, limits based on percentage of capital also
should be adopted for organizations that are not well capitalized and
well managed in order to address the relative exposure of such
organizations to these activities.
Additional Option
The Board also seeks comment on whether, instead of imposing the
limits discussed above in relation to equity underwriting and dealing
activities by subsidiaries of well-capitalized and well-managed bank
holding companies, it would be appropriate to lift all limits on these
activities for such entities except for the limits on individual stocks
held in the trading account discussed above (i.e., 10 percent of the
holding company's tier 1 capital). The Board considers that, at a
minimum, this limit should be imposed on holding companies in order to
assure diversification in individual stock holdings. Under this
alternative, banking organizations also would be required to implement
internal systems and controls adequate to ensure proper risk management
and that underwriting positions do not result in violations of limits
on investments in any one company.
Authority to Engage in Equity Securities Activity
on holding companies in order to
assure diversification in individual stock holdings. Under this
alternative, banking organizations also would be required to implement
internal systems and controls adequate to ensure proper risk management
and that underwriting positions do not result in violations of limits
on investments in any one company.
Authority to Engage in Equity Securities Activity
Board approval currently is required to engage in underwriting and
dealing in equity securities pursuant to Regulation K. Because of the
increased supervisory focus on risk management procedures, the Board
seeks comment on whether banking organizations that are well
capitalized and well managed should be allowed to engage in the
expanded equity securities activities without seeking prior Board
approval provided that they already have experience in equity
securities activities under either Regulation K or Regulation Y.
As discussed above, the Board proposes that other banking
organizations would be authorized to take positions in individual
stocks only to the extent currently permissible (i.e., subject to the
existing dollar limitations on equity underwriting and dealing). In
view of these lower limits, the Board proposes that these banking
organizations would not be required to obtain prior Board approval to
engage in equity securities activities to this limited extent, provided
that these organizations satisfy minimum capital and managerial
criteria.
Venture Capital Activities Through Portfolio Investments
Current Restrictions
ity underwriting and dealing). In
view of these lower limits, the Board proposes that these banking
organizations would not be required to obtain prior Board approval to
engage in equity securities activities to this limited extent, provided
that these organizations satisfy minimum capital and managerial
criteria.
Venture Capital Activities Through Portfolio Investments
Current Restrictions
Regulation K currently allows U.S. banking organizations to make
portfolio investments, that is, limited, noncontrolling investments in
foreign commercial and industrial companies. This authority is intended
to enhance the competitiveness of U.S. banking organizations by
increasing the range of financial services they may provide abroad.
Many foreign financial institutions, including foreign banks, engage in
venture capital activities, at times in connection with the provision
of other financial services to the company.
At present, in order for a portfolio investment to be a permissible
investment, an investor must hold less than 20 percent of the voting
stock of the company, and no more than 40 percent of the company's
total equity. Additionally, bank holding companies are subject to an
aggregate limit on such investments in non-financial firms of 25
percent of tier 1 capital, and Edge corporations are subject to an
aggregate limit of 100 percent of tier 1 capital. 15 These
limits are designed to ensure that U.S. banking organizations do not
control commercial and industrial companies and that their overall risk
exposure to nonfinancial investments is limited.
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\15\ In determining compliance with both the individual and
aggregate limits, shares in such companies held in the dealing or
trading account by the investor and any of its affiliates must be
included.
---------------------------------------------------------------------------
e to nonfinancial investments is limited.
---------------------------------------------------------------------------
\15\ In determining compliance with both the individual and
aggregate limits, shares in such companies held in the dealing or
trading account by the investor and any of its affiliates must be
included.
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As a practical matter, however, venture capital, or portfolio,
investments presently are made almost exclusively under general consent
procedures and consequently also have been subject to a dollar limit of
$25 million in a single company (the same limit currently applied to
most other investments for purposes of general consent). Such
investments are generally made in companies engaged in activities
unrelated to banking or finance. The $25 million limit has had the
effect of focusing banking organizations primarily on the small company
end of the venture capital business.
Proposed Investment Limits
The Board believes that removing the practical constraint of the
dollar limit on such investments by keying the limits solely to a
percentage of the investor's tier 1 capital may be appropriate for
well-capitalized and well-managed bank holding companies. The Board
proposes to limit any liberalization in this area to subsidiaries of
holding companies because it is concerned that, in view of the risk of
loss inherent in venture capital investments and their low liquidity,
these activities may be more appropriately conducted outside the bank
ownership chain. In proposing this approach, the Board is aware that,
even in the existing regulatory environment, much of the current
venture capital activity abroad is conducted through subsidiaries of
the holding company. Thus, there appear to be no major operational or
competitive considerations that would weigh in favor of expanding the
authority of Edge subsidiaries to engage in this activity
hip chain. In proposing this approach, the Board is aware that,
even in the existing regulatory environment, much of the current
venture capital activity abroad is conducted through subsidiaries of
the holding company. Thus, there appear to be no major operational or
competitive considerations that would weigh in favor of expanding the
authority of Edge subsidiaries to engage in this activity. However, if
appropriate diversification and aggregate limits were established, the
Board considers that some expansion of the ability of holding company
subsidiaries to engage in this activity, using shareholder funds, would
not present undue risks to the affiliated U.S. bank and would enhance
the ability of U.S. banking organizations to compete in the provision
of banking and financial services abroad.
For these reasons, the Board proposes to establish limits for
portfolio investments made by subsidiaries of well-capitalized and
well-managed bank holding companies of 2 percent of the holding
company's tier 1 capital for an individual investment (in order to
assure diversification of these potentially volatile and illiquid
investments), and an aggregate limit of 25 percent of the holding
company's tier 1 capital for all such investments. In determining
compliance with the individual limit, shares in such companies held in
the trading account by the investor and any of its affiliates would be
included.
For all other investors (i.e., Edge corporation and foreign bank
subsidiaries of member banks, and subsidiaries of bank holding
companies that are adequately capitalized but fail to meet the well-
capitalized and well-managed standards), the Board proposes limits on
investments in any one organization of $25 million; larger investments
would continue to be eligible for approval on a case-by-case basis
other investors (i.e., Edge corporation and foreign bank
subsidiaries of member banks, and subsidiaries of bank holding
companies that are adequately capitalized but fail to meet the well-
capitalized and well-managed standards), the Board proposes limits on
investments in any one organization of $25 million; larger investments
would continue to be eligible for approval on a case-by-case basis. An
aggregate limit on such investments, when taken together with other
positions in equity securities held in the dealing account, also would
be imposed consistent with the aggregate dealing limits discussed
above, namely, 25 percent of tier 1 capital for subsidiaries of holding
companies and, for Edge or foreign bank subsidiaries, the lesser of 5
percent of the parent bank's tier 1 capital or 25 percent of the Edge's
tier 1 capital.
The Board seeks comment on these proposals, including regarding the
relative risk of portfolio investments and whether there is a need for
competitive reasons for foreign subsidiaries of banks also to have
expanded authority in relation to such investments.
Limits on Voting Shares in Target Company
At present, portfolio investments are limited to less than 20
percent of a company's voting shares. At the time this limit was
adopted by the Board, the equity method of accounting was used for
investments of 20 percent or more of a company's voting shares and the
cost method of accounting was used for investments under this level.
Venture capital investments, however, now may be reported at fair value
irrespective of the percentage of ownership, with changes in fair value
recognized in income and correspondingly in tier 1 capital. In light of
these developments, the Board considers that the current limit of less
than 20 percent of voting shares has lost its original purpose.
In these circumstances, the Board proposes permitting investors to
make noncontrolling venture capital investments in up to 24.9 percent
of a company's voting shares in recognition of this fact
nized in income and correspondingly in tier 1 capital. In light of
these developments, the Board considers that the current limit of less
than 20 percent of voting shares has lost its original purpose.
In these circumstances, the Board proposes permitting investors to
make noncontrolling venture capital investments in up to 24.9 percent
of a company's voting shares in recognition of this fact. The proposed
limit on voting shares would be set at less than 25 percent in order to
provide further assurance of the noncontrolling nature of the
investment. The Board is concerned that at levels above 25 percent of
voting shares, both other investors and foreign authorities may view
the bank holding company as a controlling investor, with implicit
responsibilities to support the company or with liability for
industrial accidents. As at present, these investments also would be
permissible only if the investor in fact does not control the company
in which the investment is made. Thus, the investor may not control a
majority of the board of directors or have a disproportionate
representation on the board; it may not have a management contract with
the company or exercise veto power over its actions; nor may the
investor use other means to control the operations of the company.
``Incidental'' Activities in the United States
As a result of limitations in the Federal Reserve Act and the BHC
Act, U.S. banking organizations are prohibited from investing in more
than 5 percent of the voting shares of foreign companies that engage in
impermissible activities in the United States other than those
activities that are an incident to their international or foreign
business.16 The Board previously has taken the view that
such permissible incidental activities in the United States are limited
to those activities that the Board has determined are permissible for
Edge corporations to conduct in the United States.17
---------------------------------------------------------------------------
e
activities that are an incident to their international or foreign
business.16 The Board previously has taken the view that
such permissible incidental activities in the United States are limited
to those activities that the Board has determined are permissible for
Edge corporations to conduct in the United States.17
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\16\ In particular, the FRA prohibits investments in companies
engaging in ``the general business of buying or selling goods,
wares, merchandise or commodities in the United States.'' 12 U.S.C.
section 615. Section 4(c)(13) investments under the BHC Act are
limited only by a requirement that the company do ``no business in
the United States except as incident to its international or foreign
business.''
\17\ See 12 CFR 211.4(e).
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However, as noted above, companies in which portfolio investments
are made generally are engaged in industrial or commercial activities,
which are not permissible activities for Edge corporations.
Consequently, under Regulation K at present, if a portfolio investment
company decides to engage in activities in the United States, the U.S.
banking organization is forced to sell the portfolio investment even if
market considerations would not warrant selling the shares at that
time. This is despite the fact that the U.S. banking organization, by
reason of the mandatory noncontrolling nature of portfolio investments,
is unlikely to be in a position to influence any decision regarding
entry into the U.S. market. The Board is aware that, with the
increasing globalization of economies around the world, this situation
may become more common in the future
shares at that
time. This is despite the fact that the U.S. banking organization, by
reason of the mandatory noncontrolling nature of portfolio investments,
is unlikely to be in a position to influence any decision regarding
entry into the U.S. market. The Board is aware that, with the
increasing globalization of economies around the world, this situation
may become more common in the future.
The Board considers that these changes in circumstance may warrant
a limited change in the interpretation of what constitutes activities
in the United States that are ``incidental'' to international or
foreign activities in order to provide some relief for U.S. banking
organizations making portfolio investments abroad. Given the minority
nature of the portfolio investments and the significant changes in
international markets, the Board considers that, consistent with the
Federal Reserve Act and the BHC Act, portfolio investment companies
that derive no more than 10 percent of their total revenue in the
United States may be considered to be engaged only in business that is
an incident to their international or foreign business and therefore
may be held for an appropriate investment period consistent with the
nature of venture capital activities. In reaching this view, the Board
has taken into account the particular nature of portfolio investments.
Most portfolio investments are venture capital investments that are
intended to be sold after a period of time. They are not intended to be
permanent holdings of the banking organization. In addition, the
preponderance of the value of the portfolio investment is derived from
its foreign business.
The Board seeks comment on this proposed change. The Board also
seeks comment regarding what an appropriate period for divestiture
would be for investments that exceed the proposed U.S. revenue limits,
as well as whether a time limit should be placed on the period for
holding these types of portfolio investments in view of their
supposedly medium-term nature
rived from
its foreign business.
The Board seeks comment on this proposed change. The Board also
seeks comment regarding what an appropriate period for divestiture
would be for investments that exceed the proposed U.S. revenue limits,
as well as whether a time limit should be placed on the period for
holding these types of portfolio investments in view of their
supposedly medium-term nature.
Insurance Activities
Regulation K currently permits bank holding companies to own
foreign companies that underwrite and reinsure life and related types
of insurance outside the United States. The Board requests comment on
whether the reinsuring by a foreign subsidiary of a bank holding
company of annuities or life insurance policies sold to U.S. persons is
an activity that should be considered to fall within this authority.
This issue has been raised recently by several bank holding companies.
Under one proposal, an offshore insurance subsidiary, which has no U.S.
office, would reinsure certain annuities sold in the United States to
U.S. residents. These annuities would be underwritten by a U.S.
insurance company unaffiliated with the bank holding company, and sold
by various insurance agencies, including those affiliated with the bank
holding company. The U.S. insurance company would cede a portion of the
portfolio of annuities sold to the bank holding company's customers to
the insurance company's foreign affiliate and the offshore insurance
subsidiary of the bank holding company would enter into a retrocession
agreement with that foreign company to reinsure no more than 50 percent
of the portfolio of annuities sold to the bank holding company's
customers. The offshore insurance subsidiary of the bank holding
company would not have any contact with the annuity purchasers and
would assume no liability to them. Moreover, the offshore insurance
subsidiary would have no reinsurance liability to the U.S. insurance
company, but only to the foreign affiliate of the U.S. insurance
company
olio of annuities sold to the bank holding company's
customers. The offshore insurance subsidiary of the bank holding
company would not have any contact with the annuity purchasers and
would assume no liability to them. Moreover, the offshore insurance
subsidiary would have no reinsurance liability to the U.S. insurance
company, but only to the foreign affiliate of the U.S. insurance
company.
The Board does not consider that an offshore insurance subsidiary
of a bank holding company under Regulation K may sell policies directly
into the United States. It appears, however, that the relevant statutes
could permit a bank holding company, through its Regulation K
subsidiary, to reinsure all or a portion of the risk of policies or
annuities sold in the United States by U.S. affiliates of the bank
holding company or unrelated parties. A question is presented, however,
regarding whether the fact that the reinsurance takes place offshore is
sufficient evidence that the activity is conducted outside the United
States. On this view, any U.S. aspects of the activity would be
considered merely an incident to the permissible offshore reinsurance
activity. Alternatively, the fact that the risk to be reinsured is in
the United States could cause the activity to be considered located in
the United States, particularly given the significant involvement of
the bank holding company's U.S. affiliates. In view of what appears to
be increasing interest in this activity, the Board requests comment on
these matters.
Debt/Equity Swaps
nsurance
activity. Alternatively, the fact that the risk to be reinsured is in
the United States could cause the activity to be considered located in
the United States, particularly given the significant involvement of
the bank holding company's U.S. affiliates. In view of what appears to
be increasing interest in this activity, the Board requests comment on
these matters.
Debt/Equity Swaps
Regulation K currently permits banking organizations to swap
certain developing country debt for equity interests in companies of
any type. The debt/equity swap authority was established in 1987. Under
this authority, the Board granted its general consent for investors to
invest up to one percent of their tier 1 capital in up to 40 percent of
the shares, including voting shares, of private sector companies in
eligible countries. These foreign investment provisions are more
liberal than provided elsewhere in Regulation K. Eligible countries
were defined as countries that have rescheduled their debt since 1980,
or any country the Board deemed to be eligible.18
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\18\ Fifty-one countries reached debt relief agreements with
commercial banks during the period January 1980-December 1995.
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The debt/equity swap authority was viewed by the Board at that time
as adding to the menu of options available to banking organizations for
managing large amounts of sovereign developing country debt that was
nonperforming and illiquid.19 In considering ways in which
banking organizations could deal with these debt problems, the Board
adopted an approach analogous to foreclosure on debts previously
contracted (``DPC'') by private parties and extended the DPC concept to
permit an exchange of sovereign debt for any equity assets, private or
public, in the country
gn developing country debt that was
nonperforming and illiquid.19 In considering ways in which
banking organizations could deal with these debt problems, the Board
adopted an approach analogous to foreclosure on debts previously
contracted (``DPC'') by private parties and extended the DPC concept to
permit an exchange of sovereign debt for any equity assets, private or
public, in the country. Such an investment had to be held through the
bank holding company, unless the Board specifically permitted it to be
held through the bank or a bank subsidiary.
---------------------------------------------------------------------------
\19\ The only significant alternatives at that time were
establishing provisions for the bad debts or writing the debts off
and accepting the losses.
---------------------------------------------------------------------------
There is now a well developed secondary market in developing
country debt. The vast bulk of developing country problem debt has been
repackaged in the form of long-term Brady bonds, mostly denominated in
U.S. dollars and fully collateralized as to principal by U.S.
government bonds. Many banking organizations actively trade these
instruments in the secondary market.
Due to the development of the secondary markets for emerging market
debt, U.S. banks now have the same options with regard to many of these
assets as they have with other bank assets--namely, they can hold the
asset with a view toward collecting at maturity or sell the asset for
cash to invest in other bank eligible assets. Indeed, the sovereign
debt of most of the historically ``eligible countries'' is no longer
illiquid, and those eligible countries that account for the vast share
of rescheduled debt have largely regularized their relations with
commercial banks
assets--namely, they can hold the
asset with a view toward collecting at maturity or sell the asset for
cash to invest in other bank eligible assets. Indeed, the sovereign
debt of most of the historically ``eligible countries'' is no longer
illiquid, and those eligible countries that account for the vast share
of rescheduled debt have largely regularized their relations with
commercial banks.
Accordingly, the Board proposes that the term ``eligible country''
be redefined so that only countries with currently impaired sovereign
debt (i.e., debt for which an allocated transfer risk reserve would be
required under the International Lending Supervision Act and for which
there is no liquid market) would be eligible for investments through
debt/equity swaps under Regulation K. This proposal would redirect this
special authority to the asset quality problem it was originally
intended to help resolve. In connection with this change, the Board
also proposes that existing holdings of such investments would be
grandfathered, subject to the existing time period for divestiture of
such investments (i.e., generally 10 years from the date of
acquisition).
Comment is requested regarding these proposed changes. The Board
also seeks comment on whether, alternatively, this exception to the
limitations on investments by banking organizations in non-financial
fitness is no longer needed and should be deleted in its entirety.
Streamlining Application Procedures
General Consent Limits
estments (i.e., generally 10 years from the date of
acquisition).
Comment is requested regarding these proposed changes. The Board
also seeks comment on whether, alternatively, this exception to the
limitations on investments by banking organizations in non-financial
fitness is no longer needed and should be deleted in its entirety.
Streamlining Application Procedures
General Consent Limits
While existing Regulation K procedures have proved effective in
maintaining the safety and soundness of U.S. banks' international
operations, they have become increasingly complex over the years. For
example, under prior notice procedures, the Board has reviewed all
foreign investments made by banking organizations above a de minimis
level as a principal mechanism for overseeing the safety and soundness
of the investing organization. In view of relatively recent shift in
emphasis to supervision based upon risk management capabilities, the
Board believes that prior review of relatively small investments is no
longer useful as a fundamental supervisory tool, especially where the
investor is well capitalized and well managed. Accordingly, the Board
proposes that only significant investments, as determined solely on the
basis of the investor's capital, would be subject to prior review by
the Board, provided that the investors are well capitalized
20 and
well managed.21 The proposed changes to the general consent
procedures attempt to balance safety and soundness considerations with
the objective of enhancing the ability of U.S. banking organizations to
compete with foreign banks overseas.
---------------------------------------------------------------------------
r review by
the Board, provided that the investors are well capitalized
20 and
well managed.21 The proposed changes to the general consent
procedures attempt to balance safety and soundness considerations with
the objective of enhancing the ability of U.S. banking organizations to
compete with foreign banks overseas.
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\20\ A bank holding company is considered well capitalized if,
on a consolidated basis, it maintains total and tier 1 risk-based
capital ratios of at least 10 percent and 6 percent, respectively.
Further, the bank holding company may not be subject to any written
agreement, order, capital directive, or prompt corrective action
directive. In the case of an insured depository institution, well
capitalized means that the institution maintains at least the
capital levels required to be well capitalized under the capital
adequacy regulations or guidelines applicable to the institution
that have been adopted under section 38 of the Federal Deposit
Insurance Act (12 U.S.C. 1831o). The Board proposes that an Edge or
agreement corporation would be considered well capitalized if it
maintains total and tier 1 capital ratios of 10 and 6 percent,
respectively.
\21\ A bank holding company or insured depository institution is
considered well managed if, at it most recent inspection or
examination or subsequent review, the holding company or institution
received at least a satisfactory composite rating and at least a
satisfactory rating for management and for compliance, if such a
rating is given. Under the standards adopted by the Board in
connection with the December 1995 expansion of general consent
authority in Regulation K, an Edge or agreement corporation will be
considered to be well managed for these purposes if it has received
a composite rating of 1 or 2 at its most recent examination or
review and it is not subject to any supervisory enforcement action
ch a
rating is given. Under the standards adopted by the Board in
connection with the December 1995 expansion of general consent
authority in Regulation K, an Edge or agreement corporation will be
considered to be well managed for these purposes if it has received
a composite rating of 1 or 2 at its most recent examination or
review and it is not subject to any supervisory enforcement action.
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Limits on Investments in One Company
Historically, all general consent investments under Regulation K
were subject to absolute dollar limits. Currently, the general consent
limit for most investments is $25 million. However, as a result of
amendments to Regulation K implemented in December 1995, certain
investments by strongly capitalized and well-managed banks are subject
to Board review only to the extent they exceed a percentage of the
investor's capital.
The Board proposes expanding upon this approach by eliminating the
absolute dollar limits on foreign investments permissible under general
consent authority for well-capitalized and well-managed investors (with
the exception of those on venture capital investments made by the
bank). Under the proposal, general consent limits for all investors
(bank holding companies, banks, and Edge corporations) would be based
solely on a percentage of their tier 1 capital.22
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\22\ If the Edge corporation were making the investment, then
the Edge corporation, the member bank, and the bank holding company
would be required to meet the well-capitalized and well-managed
tests. If the member bank were making the investment, then the bank
and the bank holding company would be required to meet the tests.
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the Edge corporation were making the investment, then
the Edge corporation, the member bank, and the bank holding company
would be required to meet the well-capitalized and well-managed
tests. If the member bank were making the investment, then the bank
and the bank holding company would be required to meet the tests.
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The limits on individual investments made under general consent
authority would vary according to the investor (bank holding company,
bank, or Edge corporation) and the type of entity in which the
investment is made. For well-capitalized and well-managed investors,
the Board proposes the following percentage limits.
General Consent Limits on Investment in a Subsidiary
------------------------------------------------------------------------
------------------------------------------------------------------------
Bank holding company 10 percent of tier 1 capital of the bank
subsidiaries. holding company.
Bank subsidiaries............ The lesser of 2 percent of tier 1 capital
of the bank or 10 percent of tier 1
capital of the bank subsidiary.
------------------------------------------------------------------------
General Consent Limits on Investment in a Joint Venture
------------------------------------------------------------------------
------------------------------------------------------------------------
Bank holding company 5 percent of tier 1 capital of the bank
subsidiaries. holding company.
Bank subsidiaries............ The lesser of 1 percent of tier 1 capital
of the Bank or 5 percent of tier 1
capital of the Bank subsidiary.
------------------------------------------------------------------------
--------------
------------------------------------------------------------------------
Bank holding company 5 percent of tier 1 capital of the bank
subsidiaries. holding company.
Bank subsidiaries............ The lesser of 1 percent of tier 1 capital
of the Bank or 5 percent of tier 1
capital of the Bank subsidiary.
------------------------------------------------------------------------
The proposed limits are intended to reflect the risk involved in
the type of investment. A higher percentage of capital would be
permitted in the case of an investment in a subsidiary as opposed to an
investment in a joint venture because the latter is considered to carry
a greater risk of loss. Thus, with joint ventures, investors acquire
less than full control, and the record on such investments has shown
that they experience a higher rate of loss. As a result, most U.S.
banks do not now make sizeable joint venture investments. In light of
these considerations, the Board believes that lower general consent
limits may be appropriate for joint venture investments.
For investors that fail to meet the well-capitalized or well-
managed standards, the Board proposes the following limits. Individual
investments under general consent authority would be limited to the
lesser of $25 million or 5 percent of tier 1 capital in the case of an
investor that is a bank holding company, or 1 percent of tier 1 capital
if the investor is a member bank. Limits on individual investments for
an Edge corporation would be $25 million or the lesser of 1 percent of
the parent bank's tier 1 capital or 5 percent of the Edge's tier 1
capital. The Board proposes, however, that authority would be delegated
to the Director of Banking Supervision and Regulation to approve higher
investment limits on a case-by-case basis or as part of an investment
program as described above
investments for
an Edge corporation would be $25 million or the lesser of 1 percent of
the parent bank's tier 1 capital or 5 percent of the Edge's tier 1
capital. The Board proposes, however, that authority would be delegated
to the Director of Banking Supervision and Regulation to approve higher
investment limits on a case-by-case basis or as part of an investment
program as described above.
The Board seeks comment on these proposed limits, as well as
whether general consent limits should be established for investments in
joint ventures that are lower than the limits on investments in
subsidiaries. The Board notes that these limits reflect only the
investments that may be made under general consent authority; larger
investments may continue to be made with 30 days' prior notice.
Aggregate Limits
The above limits are intended to address the fact that individual
foreign investments above a certain size may be a source of potential
concern, and therefore prior review of such investments should be
required. In addition, the Board is also concerned with any rapid
increase in an organization's foreign investments overall, made without
prior review. Accordingly, it is proposed that when the cumulative
investments made under general consent reach a certain amount over a
given period, new or additional investments would become subject to
prior review. Investments by all affiliates of a bank holding company
would be taken into account in determining compliance of the holding
company with the aggregate limits; investments of subsidiaries of a
bank or of an Edge, respectively, would be aggregated in determining
compliance with their limits. Under the proposed liberalized general
consent procedures, the new aggregate limit for all investments during
any 12-month period for investors meeting the well-capitalized and
well-managed tests would be:
Bank holding companies....... 20 percent of tier 1 capital.
consent in any 12-month
period would be half that applicable to well-capitalized and well-
managed organizations (i.e., 10 percent of tier 1 capital for bank
holding companies, 5 percent of tier 1 capital for banks, and, for Edge
corporations, the lesser of 5 percent of the parent bank's tier 1
capital or 10 percent of the Edge's tier 1 capital).
Application of Limits to the Edge Corporation
The Board notes that an argument can be made that, in cases where
the investment is made by the Edge corporation, the well-capitalized
and well-managed tests should be based on a review of the parent bank,
not the Edge corporation. In considering these proposals, the Board
believes that the well-capitalized and well-managed tests for the Edge
corporation itself should be retained as one of the bases for
determining limits applicable to general consent investments. This
approach would help to ensure the safety and soundness of the Edge
corporation in its own right and is consistent with the statutory (and
supervisory) rationale underlying Edge corporations. As discussed
above, Congress limited the amount of capital that banks could invest
in Edge corporations, which in turn could invest in activities
otherwise prohibited to banks that were perceived to be higher risk.
Congress also subjected Edge corporations to regulation and examination
by the Federal Reserve. For these reasons, the Board considers that
Edge corporations should themselves be operating satisfactorily and not
be a source of potential weakness to the U.S. parent bank. The Board
therefore is proposing limits that are tied to the condition of the
Edge. The Board seeks comment on this approach generally.
Preclearance of Investment Program
gulation and examination
by the Federal Reserve. For these reasons, the Board considers that
Edge corporations should themselves be operating satisfactorily and not
be a source of potential weakness to the U.S. parent bank. The Board
therefore is proposing limits that are tied to the condition of the
Edge. The Board seeks comment on this approach generally.
Preclearance of Investment Program
The Board proposes to establish a procedure that would permit U.S.
banking organizations to obtain preclearance of an investment program
even though one or more of the investments would be in excess of the
individual or aggregate general consent investment limits and would be
made over a period of time longer than one year. The Board believes
such a procedure would be useful to banking organizations that may wish
to engage in a specific investment program with respect to an
individual company, a market segment, a region, or worldwide. Providing
a preclearance mechanism would serve to ensure that the regulatory
process would not impede the organization's ability to pursue its
business plans.
For example, an organization that is well managed and well
capitalized might contemplate bidding on a large privatization that
would require the organization to commit in advance to making an
investment in excess of the general consent limit if selected.
Obtaining preclearance would enable the organization to make such a
commitment. The Board proposes that the preclearance authority would be
delegated to the Director of the Division of Banking Supervision and
Regulation.
Comment is requested on whether such a preclearance program would
be useful to U.S. banking organizations and whether it should be
available to all banking organizations.
Authorization to Invest More Than Ten Percent of a Bank's Capital in
its Edge and Agreement Corporation Subsidiaries
rance authority would be
delegated to the Director of the Division of Banking Supervision and
Regulation.
Comment is requested on whether such a preclearance program would
be useful to U.S. banking organizations and whether it should be
available to all banking organizations.
Authorization to Invest More Than Ten Percent of a Bank's Capital in
its Edge and Agreement Corporation Subsidiaries
Prior to September 30, 1996, section 25A of the Federal Reserve Act
prohibited member banks from investing more than 10 percent of capital
and surplus in the stock of Edge and agreement corporation
subsidiaries. With the enactment of the Economic Growth and Regulatory
Paperwork Reduction Act of 1996 on September 30, 1996, member banks may
now invest, with the Board's prior approval, up to 20 percent of
capital and surplus in the stock of such subsidiaries.
The Board may not approve the investment of more than 10 percent of
capital and surplus in the stock of Edge and agreement corporation
subsidiaries unless the Board determines that the investment of an
additional amount by the bank would not be unsafe or unsound. As
discussed above, due to the accumulation of retained earnings in Edge
corporations, some U.S. banking organizations now have over 20 percent
of the member bank's consolidated capital resident in Edge corporation
subsidiaries.
Accordingly, the Board proposes to implement the new statutory
provision by adding to Regulation K an application requirement to
obtain the Board's approval of an increase in invested capital in the
stock of Edge and agreement corporations above 10 percent of the parent
bank's capital, as well as a general description of the types of
considerations that would be taken into account in reaching a decision
on such an application
implement the new statutory
provision by adding to Regulation K an application requirement to
obtain the Board's approval of an increase in invested capital in the
stock of Edge and agreement corporations above 10 percent of the parent
bank's capital, as well as a general description of the types of
considerations that would be taken into account in reaching a decision
on such an application. Criteria that the Board considers would be
appropriate to take into account would include: the composition of the
assets of the bank's Edge and agreement corporations; the total capital
invested by the bank in its Edge and agreement corporations when
combined with retained earnings of the Edge and agreement corporations,
as a percentage of the bank's capital; whether the bank, bank holding
company, and Edge and agreement corporations are well capitalized and
well managed; and whether the bank is adequately capitalized after
deconsolidating and deducting the aggregate investment in and assets of
all Edge or agreement corporations and all foreign bank subsidiaries.
The Board seeks comment on whether the above criteria are
appropriate in determining whether investments of up to 20 percent of
the parent bank's capital and surplus in Edge and agreement corporation
subsidiaries would not be unsafe or unsound. Additionally, the Board
seeks comment on whether only the well-capitalized and well-managed
criteria should apply where the total Edge and agreement corporation
capital (including retained earnings) on a pro forma basis would not
exceed 20 percent of the bank's capital.
Other Revisions to Subpart A
Harmonization of Regulation K With Other Regulatory Changes
As a result of the substantial liberalizations made in the recent
revisions to other Board regulations, particularly Regulation Y,
certain activities on the laundry list of
greement corporation
capital (including retained earnings) on a pro forma basis would not
exceed 20 percent of the bank's capital.
Other Revisions to Subpart A
Harmonization of Regulation K With Other Regulatory Changes
As a result of the substantial liberalizations made in the recent
revisions to other Board regulations, particularly Regulation Y,
certain activities on the laundry list of
permissible activities in Regulation K are now more restrictive than
those authorized domestically. As noted above, Regulation K
traditionally has permitted U.S. banking organizations to conduct a
wider range of financial activities abroad than may be permitted
domestically in order to compete more effectively abroad. Accordingly,
in addition to the expanded activities discussed above, the Board
proposes removing certain restrictions on the laundry list of
permissible activities to reflect recent liberalizations in other
regulations.
Leasing Activities
Regulation K currently requires that leasing activities conducted
under authority of Regulation K serve as the functional equivalent of
an extension of credit to the lessee. The Regulation Y revisions
removed that limitation with respect to high residual value leasing.
Accordingly, Regulation K would be interpreted consistent with this
authority.
Swaps Activities
The Regulation K proposal would also remove the requirement that
commodity-related swaps must provide an option for cash settlement that
must be exercised upon settlement. Regulation Y now authorizes
investment as principal in commodity derivatives where the contract
either: (i) Requires cash settlement, or (ii) allows for assignment,
termination or offset prior to expiration and reasonable efforts are
made to avoid delivery. The Regulation K restriction would be relaxed
to the same extent.
Data Processing
sh settlement that
must be exercised upon settlement. Regulation Y now authorizes
investment as principal in commodity derivatives where the contract
either: (i) Requires cash settlement, or (ii) allows for assignment,
termination or offset prior to expiration and reasonable efforts are
made to avoid delivery. The Regulation K restriction would be relaxed
to the same extent.
Data Processing
No changes are proposed to the provision authorizing data
processing. The Board notes, however, that this authority extends only
to the processing of information and does not authorize general
manufacture of hardware for such services.
Loans to Officers at Foreign Branches
Regulation K currently places certain restrictions on mortgage
loans to officers of foreign branches. However, the Board has
liberalized its Regulation O, which governs loans to executive
officers, such that the provisions in Regulation K now are more
restrictive. The more restrictive provision in Regulation K would be
eliminated.
Changes With Respect to Edge and Agreement Corporations
The Board proposes adding provisions to Regulation K that would
outline procedures under which Edge and agreement corporations could be
liquidated on a voluntary basis.
Liquidation Procedures
The Board is proposing to provide procedures for the liquidation of
Edge corporations and to clarify certain matters regarding the
appointment of receivers for Edge corporations. Under paragraph 17 of
the Edge Act (12 U.S.C. 623), an Edge corporation may go into voluntary
liquidation by a vote of its shareholders owning two-thirds of its
stock. Staff proposes to add a new Sec. 211.13 to Regulation K that
would provide for 45 day's prior notice to the Board of an Edge
corporation's intent to dissolve. This notice would create greater
certainty as to the date that the Edge corporation would cease business
and permit the Board to take any necessary supervisory actions. Under
paragraph 18 of the Edge Act (12 U.S.C
-thirds of its
stock. Staff proposes to add a new Sec. 211.13 to Regulation K that
would provide for 45 day's prior notice to the Board of an Edge
corporation's intent to dissolve. This notice would create greater
certainty as to the date that the Edge corporation would cease business
and permit the Board to take any necessary supervisory actions. Under
paragraph 18 of the Edge Act (12 U.S.C. 624), the Board is authorized
to appoint a receiver for an Edge corporation if it determines that the
corporation is insolvent. The proposal would specify the grounds for
determining that an Edge corporation is insolvent and clarify the
powers of the receiver.
Additional Areas of Liberalization
The Board believes there are other areas that should be liberalized
in order to reduce regulatory burden and enable U.S. banking
organizations to compete more effectively with foreign banks.
Authorizing Foreign Branches of Operating Subsidiaries of Member Banks
The Board proposes clarifying that a member bank may establish
foreign branches through its operating subsidiaries with the Board's
approval, provided that the foreign branches of the operating
subsidiary would engage only in activities that are permissible
directly for the member bank parent. 23
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\23\ The establishment of foreign branches of operating
subsidiaries would be subject to the prior notice and general
consent provisions of Regulation K.
---------------------------------------------------------------------------
ld engage only in activities that are permissible
directly for the member bank parent. 23
---------------------------------------------------------------------------
\23\ The establishment of foreign branches of operating
subsidiaries would be subject to the prior notice and general
consent provisions of Regulation K.
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The Board has previously approved the establishment of foreign
branches by an operating subsidiary of a member bank. The Board
determined that the ability of an operating subsidiary to establish
foreign branches is incidental to the member bank's authority to
establish such branches, subject to the condition stated above.
Accordingly, this proposed addition would codify the Board's
determination and allow other member banks to establish foreign
branches of operating subsidiaries on the same basis as outlined above.
FCM Activities
Regulation K currently states that investors must seek prior Board
approval for futures commission merchant (FCM) activities conducted on
any exchange or clearing house that requires members to guarantee or
otherwise contract to cover losses suffered by other members (a mutual
exchange). This requirement has been eliminated for subsidiaries of
bank holding companies, due to the revision of Regulation Y. The Board
also seeks comment on whether to eliminate the requirement for prior
notice where: (i) the activity is conducted through a separately
incorporated subsidiary of the bank;24 and (ii) the parent
bank does not provide a guarantee or otherwise become liable to the
exchange or clearing house for an amount in excess of the applicable
general consent limits.25 The Board believes that in these
circumstances the potential exposure of the parent bank to a mutual
exchange or clearing house would be sufficiently limited, such that
prior approval would no longer be necessary
nd (ii) the parent
bank does not provide a guarantee or otherwise become liable to the
exchange or clearing house for an amount in excess of the applicable
general consent limits.25 The Board believes that in these
circumstances the potential exposure of the parent bank to a mutual
exchange or clearing house would be sufficiently limited, such that
prior approval would no longer be necessary. Eliminating the
requirement for prior review of these activities would reduce the prior
notice and application requirements associated with FCM activities.
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\24\ If the investment is made through an Edge corporation, the
investment in the subsidiary would be limited to no more than 2
percent of the parent bank's tier 1 capital.
\25\ This proposal is generally consistent with the FCM
requirements under Regulation Y, except that it would place a limit
on the amount of exposure to the exchange or clearing house, tied to
the bank's tier 1 capital.
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Additional Delegation of Authority
The Board proposes delegating additional authority to the Director
of the Division of Banking Supervision and Regulation in order to
decrease processing periods in appropriate circumstances. Under the
proposal, authority would be delegated in the areas of: (1) Indicating
no objection to the establishment of foreign branches by prior notice;
--------------
Additional Delegation of Authority
The Board proposes delegating additional authority to the Director
of the Division of Banking Supervision and Regulation in order to
decrease processing periods in appropriate circumstances. Under the
proposal, authority would be delegated in the areas of: (1) Indicating
no objection to the establishment of foreign branches by prior notice;
(2) authorizing a banking organization to exceed its aggregate general
consent investment limits based upon the financial and managerial
strength of the organization and the soundness of its investment
strategy and future plans; and (3) allowing organizations that are not
well-capitalized and well-managed to invest under a reduced general
consent limit in appropriate circumstances.
Subpart B: Foreign Banking Organizations
Subpart B of Regulation K governs the U.S. activities of foreign
banking
organizations. It implements the IBA and provisions of the BHC Act that
affect foreign banks.
This proposed revision of Subpart B seeks to eliminate unnecessary
regulatory burden, increase transparency, and streamline the
application/notice process for foreign banks operating in the United
States based on the Board's recent experience with foreign bank
applications. In addition, the proposal implements certain application
related provisions of the Economic Growth and Regulatory Paperwork
Reduction Act of 1996 (the 1996 Act).
If adopted, the proposal would liberalize the standards under which
certain foreign banking organizations qualify for exemptions from the
nonbanking prohibitions of section 4 of the BHC Act. Comment is also
being requested on a change in the scope of an existing exemption that
would better conform the exemption to the policy of national treatment.
The proposal also implements several provisions of the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the Interstate
Act) that affect foreign banks
ons from the
nonbanking prohibitions of section 4 of the BHC Act. Comment is also
being requested on a change in the scope of an existing exemption that
would better conform the exemption to the policy of national treatment.
The proposal also implements several provisions of the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the Interstate
Act) that affect foreign banks. Finally, several technical changes to
various other provisions in Subpart B are being proposed.
Streamlining the Regulatory Process
The Board is required to approve the establishment by foreign banks
of branches, agencies, commercial lending companies, and representative
offices in the United States. This authority is contained in the
Foreign Bank Supervision Enhancement Act of 1991 (FBSEA), which amended
the IBA, and was intended to close perceived gaps in the supervision
and regulation of foreign banks. Prior to FBSEA, there was no federal
approval required for the establishment of most types of direct U.S.
offices of foreign banks nor were uniform standards applicable to these
offices.
In the six years since the enactment of FBSEA, the Board has gained
substantial experience with the issues presented by applications by
foreign banks to establish direct offices. The proposed revisions would
streamline the applications process based on experience gained over
this period. In addition, the proposal implements new discretionary
authority and time limits contained in the 1996 Act.
Adoption of Single Supervision Standard for Approval of Representative
Offices
xperience with the issues presented by applications by
foreign banks to establish direct offices. The proposed revisions would
streamline the applications process based on experience gained over
this period. In addition, the proposal implements new discretionary
authority and time limits contained in the 1996 Act.
Adoption of Single Supervision Standard for Approval of Representative
Offices
Under FBSEA, in order to approve an application by a foreign bank
to establish a branch, agency, or commercial lending company, the Board
generally is required to determine, among other things, that the
applicant bank, and any parent bank, are subject to comprehensive
supervision or regulation on a consolidated basis by their home country
authorities (the consolidated comprehensive supervision or CCS
determination 26). A lesser supervision standard, however,
applies under FBSEA to representative office applications. While the
Board is required to ``take into account'' home country supervision in
evaluating an application by a foreign bank to establish a
representative office, a CCS determination is not required to approve
such an application. The law simply requires the Board to consider the
extent to which applicant bank is subject to CCS. A lesser standard
applies because representative offices do not conduct a banking
business, such as taking deposits or making loans, and therefore
present less risk to U.S. customers and markets than do branches or
agencies.
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\26\ As discussed later in the summary, the 1996 Act amended
FBSEA to allow the Board, under certain conditions, to approve an
application if the bank is not subject to CCS.
---------------------------------------------------------------------------
less risk to U.S. customers and markets than do branches or
agencies.
---------------------------------------------------------------------------
\26\ As discussed later in the summary, the 1996 Act amended
FBSEA to allow the Board, under certain conditions, to approve an
application if the bank is not subject to CCS.
---------------------------------------------------------------------------
Regulation K currently restates the statutory ``take into account''
standard but does not define a minimum supervision standard that a
foreign bank must meet in order to establish a representative office.
Instead, the Board has developed standards in the context of specific
cases. To date, the Board has used two different supervision standards
in approving applications by foreign banks to establish representative
offices.27 Under the first standard, the Board has permitted
a foreign bank to establish a representative office able to exercise
all powers available under applicable law and regulation on the basis
of a finding that the home country supervisors exercise a significant
degree of supervision over the bank.28 The second standard
is more flexible. In cases in which a foreign bank has committed to
limit the scope of activities of its proposed representative office to
those posing only the most minimal risk to U.S. customers and markets
(such as by agreeing not to solicit deposits from retail customers or
possibly any customers), the Board has approved the establishment of
the office on the basis of a finding that the foreign bank is subject
to a supervisory framework that is consistent with approval of the
application, taking into account the limited activities of the proposed
office and the operating record of the bank.29
---------------------------------------------------------------------------
ibly any customers), the Board has approved the establishment of
the office on the basis of a finding that the foreign bank is subject
to a supervisory framework that is consistent with approval of the
application, taking into account the limited activities of the proposed
office and the operating record of the bank.29
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\27\ Wherever the record submitted by an applicant in a
representative office case is sufficient to support a CCS finding,
the Board generally has do so. See, e.g., Caisse Nationale de Credit
Agricole, 81 Fed. Res. Bull. 1055 (1995). The two representative
office standards have been applied in those cases where the record
is not sufficient to support a CCS finding.
\28\ See, e.g., Citizens National Bank, 79 Fed. Res. Bull. 805
(1993).
\29\ See, e.g., Promstroybank of Russia, 82 Fed. Res. Bull. 599
(1996).
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Based on experience in dealing with representative office
applications, the Board believes that the existence of two standards
can be confusing and is unnecessary, particularly in light of the
generally minimal risk presented to U.S. customers or markets by
representative offices. Consequently, the Board is proposing that
Sec. 211.24(d)(2) of Regulation K be amended to establish only one
flexible standard. Under the proposal, assuming all other factors were
consistent with approval, the Board could approve an application to
establish a representative office if it were able to make a finding
that the applicant bank was subject to a supervisory framework that is
consistent with the activities of the proposed office, taking into
account the nature of such activities and the operating record of the
applicant.
The record necessary to support the required finding would depend
on the nature of the activities the applicant proposed to conduct in
the representative office
ake a finding
that the applicant bank was subject to a supervisory framework that is
consistent with the activities of the proposed office, taking into
account the nature of such activities and the operating record of the
applicant.
The record necessary to support the required finding would depend
on the nature of the activities the applicant proposed to conduct in
the representative office. Approval of a representative office that
could conduct all permissible activities would require a record
demonstrating that the applicable supervisory framework was consistent
with level of risk presented by such activities. If the proposal is
adopted, the Board expects that most applicants would be able to
conduct all permissible activities. In those instances in which the
Board had particular concerns regarding the consistency of the
applicant's home country supervision with the proposed activities of
the office, however, the applicant could commit to restrict the
activities. A less comprehensive record would be required where the
applicant has committed to limit the activities of the office to those
posing minimal risk to U.S. customers.
The Board intends that the publishing of a single flexible standard
will, in most cases, simplify the application process. The Board
requests comment on the elimination of the significant degree of
supervision standard and adoption of the proposed single standard.
Reduced Filing Requirements for the Establishment of U.S. Offices
A major thrust of the proposed revisions is reduction of burden in
the
d intends that the publishing of a single flexible standard
will, in most cases, simplify the application process. The Board
requests comment on the elimination of the significant degree of
supervision standard and adoption of the proposed single standard.
Reduced Filing Requirements for the Establishment of U.S. Offices
A major thrust of the proposed revisions is reduction of burden in
the
application process by streamlining existing application procedures for
the establishment of new U.S. offices of foreign banks. Under the
current Subpart B, the establishment by a foreign bank of a U.S.
branch, agency, commercial lending company subsidiary, or
representative office generally requires the Board's specific approval.
Once the Board has approved the establishment of a foreign bank's first
office under the standards set out in FBSEA, additional offices with
the same or lesser powers may be approved by the Reserve Banks under
delegated authority.30 Prior notice and general consent
procedures are currently available for the establishment of certain
kinds of representative offices. The Board is now proposing that
additional types of applications be processed under prior notice and
general consent procedures.
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\30\ See 12 CFR 265.11(d)(11).
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Prior Notice Available After First CCS Determination
nds of representative offices. The Board is now proposing that
additional types of applications be processed under prior notice and
general consent procedures.
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\30\ See 12 CFR 265.11(d)(11).
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Prior Notice Available After First CCS Determination
The proposal would amend Sec. 211.24(a) to provide that any foreign
bank which the Board has determined to be subject to CCS in a prior
application under FBSEA may establish additional branches, agencies,
commercial lending company subsidiaries, and representative offices
pursuant to a 45 day prior notice procedure. This time frame would
allow for review of whether any material changes had occurred with
respect to home country supervision, a determination of whether the
bank continues to meet capital requirements, and a review of any other
relevant factors. If this proposal is adopted, the current delegation
to the Reserve Banks for such applications would be deleted as no
longer necessary. This procedure would also be available even if the
CCS determination had been made in connection with an application for
an office with lesser powers than the office the foreign bank seeks to
establish.
Prior Notice Available for Representative Offices Established by
Foreign Banks Subject to the BHC Act or Previously Approved to
Establish a Representative Office Under FBSEA
longer necessary. This procedure would also be available even if the
CCS determination had been made in connection with an application for
an office with lesser powers than the office the foreign bank seeks to
establish.
Prior Notice Available for Representative Offices Established by
Foreign Banks Subject to the BHC Act or Previously Approved to
Establish a Representative Office Under FBSEA
Many foreign banks have a U.S. banking presence and therefore are
subject to the provisions of the BHC Act, but have not received a CCS
determination under FBSEA. The proposal also seeks to reduce the burden
on such banks applying to establish representative offices. If a
foreign bank is subject to the provisions of the BHC Act through
ownership of a bank or commercial lending company or operation of a
branch or agency, it is already subject to supervision and oversight
through the Board's Foreign Banking Organization (FBO) program. Through
the FBO program, the Board gains knowledge of the bank, its policies
and procedures, and a general view on home country supervision. In
these instances, the Board believes that an expedited procedure may be
adopted for the establishment of representative offices by these banks,
even where the foreign bank had not previously been reviewed under the
standards of FBSEA.
In addition, the proposal would permit the establishment by prior
notice of additional representative offices by any foreign bank not
subject to the BHC Act but previously approved by the Board to
establish a representative office, regardless of the type of
supervision finding made by the Board in the prior case. Such
applications are currently delegated to the Reserve Banks. The Board
sees no reason to continue to require full application from such banks.
The Board is proposing that Sec. 211.24(a) be amended to permit banks
in these two categories to use the 45-day prior notice procedure for
opening a representative office, rather than requiring them to use the
application procedure.
the prior case. Such
applications are currently delegated to the Reserve Banks. The Board
sees no reason to continue to require full application from such banks.
The Board is proposing that Sec. 211.24(a) be amended to permit banks
in these two categories to use the 45-day prior notice procedure for
opening a representative office, rather than requiring them to use the
application procedure.
New General Consent Authority
The proposal would permit the establishment by general consent of a
representative office by a foreign bank that is both subject to the BHC
Act and has been previously determined by the Board to be subject to
CCS. Establishment of a representative office by such a foreign bank is
currently subject to the prior notice procedure. The proposal is based
on an assessment that a foreign bank that is subject to supervision
under the FBO program and has been judged subject to CCS should
generally qualify to establish a representative office.
Finally, the Board is proposing that a foreign bank that is subject
to the BHC Act could establish a regional administrative office by
general consent, whether or not the Board had determined the bank to be
subject to CCS. Regional administrative offices currently can be
established using the prior notice procedure.
Suspension of Prior Notice and General Consent Procedures
The proposal also provides that the Board, upon notice, may modify
or suspend the prior notice and general consent procedures described
above for any foreign bank. For example, modification or suspension of
these procedures might be appropriate if the composite rating of the
foreign bank's combined U.S. operations was less than satisfactory
31 or if the foreign bank were subject to supervisory
action. In general, the Board envisions that these procedures would be
available for the establishment of offices by foreign banks only where
the establishment does not present material issues.
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the
foreign bank's combined U.S. operations was less than satisfactory
31 or if the foreign bank were subject to supervisory
action. In general, the Board envisions that these procedures would be
available for the establishment of offices by foreign banks only where
the establishment does not present material issues.
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\31\ See 12 CFR 225.2(s) (definition of ``well-managed'' foreign
banking organization).
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These proposals should reduce the burden and delay associated with
the establishment of new U.S. offices by certain categories of foreign
banks without compromising the Board's ability to make the
determinations necessary in connection with the establishment of such
offices.
After-the-Fact Approvals
In implementing FBSEA in 1993, the Board recognized that it would
be impractical to require prior approval for the establishment of
foreign bank offices acquired in certain types of overseas
transactions, such as a merger of two foreign banks, and provided for
an after-the-fact approval in such cases. The regulation currently
requires the foreign banks involved to commit to file an application to
retain the acquired U.S. office as soon as possible after the
occurrence of such transactions.
Since the enactment of FBSEA, a number of applicants using the
after-the-fact procedure have chosen to wind down and close acquired
offices or consolidate them with existing offices, in each case within
a reasonable time frame. In most instances, no regulatory purpose was
served by requiring the filing of an application. The regulation
currently does not address this possibility. The proposal would amend
the rules to contemplate both after-the-fact applications to retain, as
well as decisions to wind-down and close, U.S. offices acquired in a
transaction eligible for the after-the fact approval process
e time frame. In most instances, no regulatory purpose was
served by requiring the filing of an application. The regulation
currently does not address this possibility. The proposal would amend
the rules to contemplate both after-the-fact applications to retain, as
well as decisions to wind-down and close, U.S. offices acquired in a
transaction eligible for the after-the fact approval process. Where the
foreign bank chooses to close the acquired U.S. office, the Board could
impose appropriate conditions on the U.S. operations until the winding-
down is completed.
Implementation of the 1996 Act
As noted above, FBSEA generally requires the Board to determine
that a foreign bank applicant is subject to CCS in order to approve the
establishment of a branch, agency, or commercial lending company. The
1996 Act gave the Board discretion to approve the establishment of such
offices by a foreign bank where the application record is insufficient
to support a finding that the bank is
subject to CCS, provided the Board finds that the home country
supervisor is actively working to establish arrangements for the
consolidated supervision of the bank, and all other factors are
consistent with approval. This discretion gives the Board flexibility
to approve applications on an exceptional basis where the home country
authorities are making progress in upgrading the bank supervisory
regime but the record may not yet be sufficient to support a full CCS
finding. The Board has stated that this authority should be viewed as a
limited exception to the general requirement relating to
CCS.32 The statutory standards are included in the proposed
revision.
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making progress in upgrading the bank supervisory
regime but the record may not yet be sufficient to support a full CCS
finding. The Board has stated that this authority should be viewed as a
limited exception to the general requirement relating to
CCS.32 The statutory standards are included in the proposed
revision.
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\32\ The Board first exercised its discretion under the 1996 Act
when it approved an application by a Korean bank to establish a
state-licensed branch in New York City. See Housing & Commercial
Bank, 83 Fed. Res. Bull. 935 (1997).
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The proposal also would incorporate into Regulation K the statutory
time limits in the 1996 Act for Board action on applications for
branches, agencies, and commercial lending companies. The 1996 Act
provided that the Board must act on such an application within 180 days
of its receipt. The time period may be extended once for an additional
180 days, provided notice of the extension and the reasons for it are
provided to the applicant and the licensing authority; the applicant
may also waive the time periods. Although the regulation will reflect
these statutory time periods, the Board proposes to maintain existing
internal time schedules that would require faster processing where
possible.
New Discretionary Factor
n additional
180 days, provided notice of the extension and the reasons for it are
provided to the applicant and the licensing authority; the applicant
may also waive the time periods. Although the regulation will reflect
these statutory time periods, the Board proposes to maintain existing
internal time schedules that would require faster processing where
possible.
New Discretionary Factor
In light of the increasing attention being paid to the problem of
money laundering, the Board currently requests that foreign banks
applying to establish U.S. offices provide information on the measures
taken to prevent the bank from being used to launder money, the legal
regime to prevent money laundering in the home country, and the extent
of the home country's participation in multilateral efforts to combat
money laundering. The Board considers this information in reaching its
decision on applications. In light of this practice, the proposed
revision includes as a new discretionary standard for the establishment
of U.S. offices by foreign banks that the Board may consider the
adequacy of measures for the prevention of money laundering.
Qualifications of Foreign Banks for Nonbank Exemptions
Changes to the QFBO Test
Regulation K implements statutory exemptions from the BHC Act for
certain activities of foreign banks. These exemptions are available to
qualifying foreign banking organizations (QFBOs) and are found in
sections 2(h) and 4(c)(9) of the BHC Act. Section 2(h) allows a foreign
company principally engaged in banking business outside the United
States to own foreign affiliates that engage in impermissible
nonfinancial activities in the United States, subject to certain
requirements. These include that the foreign affiliate must derive most
of its business from outside the United States and it may engage in the
United States only in the same lines of business it conducts outside
the United States
banking business outside the United
States to own foreign affiliates that engage in impermissible
nonfinancial activities in the United States, subject to certain
requirements. These include that the foreign affiliate must derive most
of its business from outside the United States and it may engage in the
United States only in the same lines of business it conducts outside
the United States. Section 4(c)(9) allows the Board to grant foreign
companies an exemption from the nonbank activity restrictions of the
BHC Act where the exemption would not be substantially at variance with
the BHC Act and would be in the public interest. Under this exemption,
the Board has exempted, among other things, all foreign activities of
QFBOs from the nonbanking prohibitions of the BHC Act.
In order to qualify as a QFBO, a foreign banking organization must
demonstrate that more than half of its business is banking and more
than half of its banking business is outside the United States. Banking
business is defined to include the activities permissible for a U.S.
banking organization to conduct, directly or indirectly, outside of the
United States.33 Under the current regulations, however,
such activities can be counted as banking business for the purposes of
the QFBO test only if they are conducted in the foreign bank ownership
chain; that is, by the foreign bank or a subsidiary of the foreign
bank. Activities conducted by a parent holding company or sister
affiliate do not count toward qualification.
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such activities can be counted as banking business for the purposes of
the QFBO test only if they are conducted in the foreign bank ownership
chain; that is, by the foreign bank or a subsidiary of the foreign
bank. Activities conducted by a parent holding company or sister
affiliate do not count toward qualification.
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\33\ These activities include, in addition to traditional
banking activities, underwriting various types of insurance (credit
life, life, annuity, pension fund-related, and other types of
insurance where the associated risks are actuarially predictable);
underwriting, distributing, and dealing in debt and equity
securities outside the United States; providing data processing,
investment advisory, and management consulting services; and
organizing, sponsoring, and managing a mutual fund.
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Removal of the Banking Chain Requirement From One Prong of the QFBO
Test
In connection with the 1991 revisions to Regulation K, a number of
commenters suggested that the Board eliminate the requirement that
banking activities be conducted in the bank ownership chain. The Board
did not adopt this suggestion in 1991 because it was concerned that to
do so could have allowed a foreign financial conglomerate with no
substantial commercial bank to conduct full-scope banking operations in
the United States. The Board determined that the intent of the BHC Act
was to grant exemptions only to those foreign organizations that were
substantially engaged in commercial banking.
The Board has reconsidered the QFBO test in light of this
background and believes that the test can be liberalized without
extending the BHC Act exemptions to foreign firms that are not engaged
substantially in commercial banking
e Board determined that the intent of the BHC Act
was to grant exemptions only to those foreign organizations that were
substantially engaged in commercial banking.
The Board has reconsidered the QFBO test in light of this
background and believes that the test can be liberalized without
extending the BHC Act exemptions to foreign firms that are not engaged
substantially in commercial banking. As noted above, the QFBO test has
two prongs: first, more than half of the organization's activities must
be banking, and second, more than half its banking business must be
outside the United States. Under the proposed revision, the requirement
that all activities must be conducted under the bank ownership chain to
count as ``banking'' would be eliminated from the first prong. By
eliminating the banking chain requirement for this prong of the test, a
foreign banking organization that has substantial life insurance
activities outside of the banking chain would be able to count such
activities toward meeting this prong of the QFBO test. The Board
understands that, in at least some recent instances where foreign
banking organizations failed the current QFBO test, these organizations
would have been able to pass the test under the proposed re-
formulation.
The banking chain requirement has not been eliminated, however, for
purposes of determining whether a foreign banking organization's
banking operations outside of the United States are larger than those
in the United States. Eliminating the banking chain requirement for
this part of the test would enable a foreign organization engaged
primarily in certain financial activities, such as life insurance,
outside of the United States to meet the QFBO test even if its U.S.
commercial banking operations were larger than the commercial banking
operations of its foreign bank or banks. The exemptions under sections
2(h) and 4(c)(9) of the BHC Act, which this section of
his part of the test would enable a foreign organization engaged
primarily in certain financial activities, such as life insurance,
outside of the United States to meet the QFBO test even if its U.S.
commercial banking operations were larger than the commercial banking
operations of its foreign bank or banks. The exemptions under sections
2(h) and 4(c)(9) of the BHC Act, which this section of
Regulation K implements, are intended to limit the extraterritorial
effect of the BHC Act on foreign banks and to prevent foreign financial
companies that own U.S. banks from obtaining competitive advantages.
Accordingly, the proposal retains the banking chain requirement for
this prong of the QFBO test. The Board believes that this approach
would give appropriate flexibility to foreign banking organizations
that operate under different economic and regulatory environments while
still addressing the intent of the BHC Act to give exemptions only to
true foreign banks that conduct more banking business outside the
United States than in the United States.
Request for Comments With Respect to the Expansion of the Activities
That May be Counted as Banking
The QFBO test in Regulation K permits foreign banking organizations
to count only those assets, revenues, or net income related to
activities which are permissible for a U.S. banking organization to
conduct outside of the United States. Under the current test, a
predominantly financial organization that engages to a significant
extent in activities not permissible for a U.S. bank abroad--for
example, property and casualty insurance--could fail to meet the QFBO
test.
In formulating the QFBO test, the Board has sought to balance the
potentially competing goals of avoiding the extraterritorial
application of U.S. law on the one hand and ensuring competitive
equality with U.S. banking organizations on the other
ficant
extent in activities not permissible for a U.S. bank abroad--for
example, property and casualty insurance--could fail to meet the QFBO
test.
In formulating the QFBO test, the Board has sought to balance the
potentially competing goals of avoiding the extraterritorial
application of U.S. law on the one hand and ensuring competitive
equality with U.S. banking organizations on the other. In this regard,
the Board does not intend the QFBO exemptions to permit foreign
commercial and industrial firms to conduct a commercial banking
business in the United States. This view, however, is not necessarily
inconsistent with granting the QFBO exemptions to a foreign banking
organization that is engaged to a significant extent in financial
activities not permissible for a U.S. bank abroad. For this reason, the
Board is requesting comment with respect to whether and how to expand
the list of activities that would be considered banking for purposes of
the QFBO test.
Comment is requested on both of these proposals and on any other
issues arising under the QFBO rules.
Applications for Special Determination of Eligibility for QFBO
Treatment
Regulation K permits a foreign banking organization that ceases to
qualify as a QFBO to request a special determination of eligibility.
The proposal would permit a foreign banking organization that has
applied for a specific determination of eligibility to continue to
conduct its business as if it were a QFBO, except with respect to
making investments in U.S. companies under section 2(h) of the BHC Act
for which Board consent would be required. The proposal reflects the
approach taken in a prior case considered by the Board.
Comment Requested on Limiting the Ability of Foreign Banks to Conduct
Unregulated Activities Abroad Through U.S. Companies in the Interests
of National Treatment
were a QFBO, except with respect to
making investments in U.S. companies under section 2(h) of the BHC Act
for which Board consent would be required. The proposal reflects the
approach taken in a prior case considered by the Board.
Comment Requested on Limiting the Ability of Foreign Banks to Conduct
Unregulated Activities Abroad Through U.S. Companies in the Interests
of National Treatment
Regulation K currently exempts from the BHC Act any activity
conducted by a QFBO outside the United States. There appears to be a
growing trend by foreign banks under this exemption toward using U.S.
companies operating under section 4(c)(8) of the BHC Act to hold
foreign subsidiaries that such foreign banks regard as unrestricted in
their activities.
Under the BHC Act, a U.S. bank holding company may own foreign
subsidiaries only under the authority of Regulation K, which sets
limits on the activities that can be conducted in such subsidiaries. In
the past, in response to inquiries, Board staff has provided advice
that the activities of foreign subsidiaries of section 4(c)(8)
companies owned by foreign banking organizations should be operated
subject to these same limitations. Nonetheless, it appears that some
foreign banking organizations have interpreted the general exemption in
Regulation K for all non-U.S. activities of foreign banking
organizations as also extending to the foreign subsidiaries of section
4(c)(8) companies. The question is raised of whether this provides an
unfair competitive advantage to foreign banks in using and marketing
the name and operations of the regulated U.S. company.
Given the fact that the foreign activities of a QFBO are exempt
under Regulation K, the Board recognizes the ability to own a foreign
subsidiary through a section 4(c)(8) company may not be viewed as a
material competitive advantage for foreign banks
er this provides an
unfair competitive advantage to foreign banks in using and marketing
the name and operations of the regulated U.S. company.
Given the fact that the foreign activities of a QFBO are exempt
under Regulation K, the Board recognizes the ability to own a foreign
subsidiary through a section 4(c)(8) company may not be viewed as a
material competitive advantage for foreign banks. Even if the ownership
of impermissible foreign subsidiaries through section 4(c)(8) companies
were to be prohibited, a foreign bank could comply simply by moving the
ownership from the U.S. company to a true foreign subsidiary.
The purpose of the exemption in Regulation K, however, was to
permit foreign banking organizations to conduct their non-U.S.
activities outside the scope of U.S. regulation because there was no
U.S. interest served by regulating such activities. The Board, however,
does have a regulatory interest in section 4(c)(8) companies. The
exemption was not intended to allow U.S. companies regulated under
section 4(c)(8) of the BHC Act and owned by foreign banking
organizations to engage in unrestricted foreign activities.
Accordingly, the Board is requesting comment on limiting the
availability of the exemption in Regulation K to activities conducted
by true foreign subsidiaries of foreign banks, and preventing the use
of such exemption by foreign-owned but U.S.-regulated companies such as
those operating under section 4(c)(8).
Implementation of New Interstate Rules
engage in unrestricted foreign activities.
Accordingly, the Board is requesting comment on limiting the
availability of the exemption in Regulation K to activities conducted
by true foreign subsidiaries of foreign banks, and preventing the use
of such exemption by foreign-owned but U.S.-regulated companies such as
those operating under section 4(c)(8).
Implementation of New Interstate Rules
In addition to application procedures and rules on nonbanking
activities, Regulation K implements the restrictions on interstate
operations of foreign banks provided in the IBA and the BHC Act. The
Interstate Act amended the IBA and the BHC Act to remove geographic
restrictions on interstate acquisitions of banks by foreign banks,
permitted foreign banks to branch interstate by merger and de novo on
the same basis as domestic banks with the same home state as the
foreign bank, and modified the definition of a foreign bank's home
state for purposes of interstate branching. The Interstate Act became
fully effective in June 1997.
In May 1996, the Board published a final rule to implement certain
of the changes made by the Interstate Act. The rule required certain
foreign banks to select a home state for the first time, or have a home
state designated by the Board, removed obsolete provisions of
Regulation K that restricted the ability of a foreign bank to effect
major bank mergers through U.S. subsidiary banks located outside the
foreign bank's home state, and deleted certain other obsolete rules
governing home state selection.
This proposal would implement and interpret certain other changes
made by the Interstate Act. The proposal would permit foreign banks to
make additional changes in home state under certain circumstances and
clarify the extent to which a foreign bank changing its home state is
required to conform its existing network of bank subsidiaries and
banking offices
es
governing home state selection.
This proposal would implement and interpret certain other changes
made by the Interstate Act. The proposal would permit foreign banks to
make additional changes in home state under certain circumstances and
clarify the extent to which a foreign bank changing its home state is
required to conform its existing network of bank subsidiaries and
banking offices. In addition, the proposal sets forth the additional
standards for approval of applications by foreign banks to establish
interstate branches. It also would clarify that the ``upgrade'' of
agencies and limited branches to full branches requires Board approval
and that the Board will approve such upgrades (absent a merger
transaction) only if the host state has enacted laws permitting de novo
interstate branching. Finally, the proposal deletes the Board's home
state attribution rule, which provides that a foreign bank (or other
company) and all other foreign banks which it controls must have the
same home state.
Changes of Home State
In 1980, the Board allowed foreign banks a single change of home
state as a compromise between the need for comparable treatment with
domestic banks and Congress' intent, in adopting the IBA, that foreign
banks be allowed some flexibility to change home state. The basic
framework for interstate banking, however, has changed substantially
since 1980, when domestic banks generally could not branch interstate
and rarely, if ever, could change home states. Domestic and foreign
banks may now branch into other states either de novo or by merger in
certain circumstances; interstate branching by merger between banks is
now possible in all states other than Montana and Texas, and de novo
interstate branching is permitted in 13 states. As a result, many
domestic banks with interstate branches now have significant
opportunities to change home state, although these opportunities are
not available to all banks under all circumstances
rger in
certain circumstances; interstate branching by merger between banks is
now possible in all states other than Montana and Texas, and de novo
interstate branching is permitted in 13 states. As a result, many
domestic banks with interstate branches now have significant
opportunities to change home state, although these opportunities are
not available to all banks under all circumstances.
In light of these changes, the proposal gives foreign banks
additional opportunities to change home state in a way that affords
comparable treatment to foreign and domestic banks. The proposal would
retain the ability of foreign banks under current rules to change their
home state once by filing a notice with the Board. Changes made by
foreign banks prior to the entry into effect of the proposed amendments
would count toward this one-time limit. The proposal would also
establish a new procedure for foreign banks to change home state an
unlimited number of times, by applying for the prior approval of the
Board for each such change. A foreign bank applying to change its home
state under the new procedure would be required to show that a domestic
bank with the same home state would be able to make the same change.
The new procedure advances the policy of national treatment
underlying the IBA by allowing foreign banks to take advantage of
changes in laws concerning interstate branching in order to change home
state, when and to the extent those laws make it possible for domestic
banks to change home state as well. The new procedure also seeks to
prevent foreign banks from gaining an unfair competitive advantage over
domestic banks by changing home state in circumstances where a domestic
bank would be unable to do so. Although the Interstate Act made it
possible for domestic banks to change home state in some cases, there
are other cases where such changes in home state may be difficult or
impossible
. The new procedure also seeks to
prevent foreign banks from gaining an unfair competitive advantage over
domestic banks by changing home state in circumstances where a domestic
bank would be unable to do so. Although the Interstate Act made it
possible for domestic banks to change home state in some cases, there
are other cases where such changes in home state may be difficult or
impossible. Accordingly, the new procedure would allow foreign banks to
change home state only in cases where a domestic bank could effect the
same change.
The Board would have discretion to grant the request of a foreign
bank to change home state under the new proposed procedure. In
evaluating these applications, the Board would consider whether the
proposed change of home state would be consistent with competitive
equity between foreign and domestic banks. Relevant factors in this
regard include the degree to which a national or state bank would be
able to make the same change of home state while retaining its existing
operations outside the new home state.
Changes in home state would generally have no impact on which
Reserve Bank will supervise the operations of a foreign bank nor on
which Reserve Bank will receive a foreign bank's reports and
applications.
Conforming U.S. Operations Upon Change in Home State
Regulation K currently requires a foreign bank that changes its
home state to conform its banking operations outside the new home state
to what would have been permissible at the time of the bank's original
home state selection. The requirement, adopted in 1980, implemented
section 5 of the IBA which sought to prevent foreign banks from using a
home state change to acquire and maintain subsidiary banks or branches
in more than one state in circumstances where a domestic bank or bank
holding company would be unable to do so
e
to what would have been permissible at the time of the bank's original
home state selection. The requirement, adopted in 1980, implemented
section 5 of the IBA which sought to prevent foreign banks from using a
home state change to acquire and maintain subsidiary banks or branches
in more than one state in circumstances where a domestic bank or bank
holding company would be unable to do so.
The Interstate Act liberalized the rules on interstate branches and
eliminated the geographic restrictions on the purchases of banks by
domestic bank holding companies and foreign banks under the BHC Act and
the IBA. Consequently, the Board is proposing that the provisions on
conforming operations upon a foreign bank's change of home state be
revised to reflect changes made by the Interstate Act. For example,
with respect to subsidiary banks, a foreign bank would no longer be
required to divest a subsidiary bank outside its new home state; the
Interstate Act authorizes interstate acquisitions of bank subsidiaries.
With respect to conforming branches outside the foreign bank's new
home state, the proposed amendment would reflect the liberalized
interstate branching rules applicable to foreign and domestic banks as
a result of the Interstate Act. A foreign bank changing its home state
would be permitted to retain all branches which the foreign bank could
establish (under current law) if it already had its new home state.
This relaxation is appropriate given that domestic, as well as foreign
banks, now have significant opportunities to establish and retain
interstate branches.
The proposal would not change the current rule which allows a
foreign bank to retain branches grandfathered under the IBA, and
limited branches (that is, branches that ``limit'' their deposit-taking
to only those deposits that an Edge corporation may accept).
Additional Standards for Interstate Offices
gn
banks, now have significant opportunities to establish and retain
interstate branches.
The proposal would not change the current rule which allows a
foreign bank to retain branches grandfathered under the IBA, and
limited branches (that is, branches that ``limit'' their deposit-taking
to only those deposits that an Edge corporation may accept).
Additional Standards for Interstate Offices
The proposal also contains the additional standards required by the
Interstate Act for approval by the Board of the establishment by a
foreign bank of branches located outside of the bank's home state.
These standards are designed to insure that foreign banks seeking to
establish interstate branches meet requirements comparable to those
imposed on domestic banks seeking to operate interstate.
Upgrading of Agencies and Limited Branches to Full Branches
Section 5 of the IBA, as amended by the Interstate Act, allows a
foreign bank to establish full branches outside its home state only if
a domestic bank with the same home state could establish branches in
the same host state under the Interstate Act. The Interstate Act allows
interstate branching by merger with an existing bank or branch (the
merger provisions) or through de novo branching (the de novo
provisions). The merger provisions further distinguish between
interstate mergers of entire banks and interstate acquisition of
individual branches.
Some foreign bank trade groups have argued that a foreign bank with
interstate offices, including agencies and limited branches, should be
permitted to convert such agencies and limited branches outside the
home state into full-service branches. The argument is based on the
fact that domestic banking organizations can consolidate their existing
interstate subsidiary banks and establish interstate branches through
the merger provisions. Accordingly, the argument goes, in order to
provide national treatment, foreign banks should be able to
to convert such agencies and limited branches outside the
home state into full-service branches. The argument is based on the
fact that domestic banking organizations can consolidate their existing
interstate subsidiary banks and establish interstate branches through
the merger provisions. Accordingly, the argument goes, in order to
provide national treatment, foreign banks should be able to
``consolidate'' their own existing interstate operations into full-
service branches.
The Board has several concerns with this argument. In an interstate
merger of bank subsidiaries, different legal entities are merged into
one; operations are retained as branches of the surviving bank. In the
case of a foreign bank's interstate network of offices, each office is
already part of one legal entity; there is no merger. Moreover, in an
interstate merger transaction, all existing subsidiary banks would
generally have full deposit-taking authority; the merger does not
increase the ability of the merged entities to take deposits. In the
case of foreign banks, however, many of the interstate offices do not
have full deposit powers 34 and granting the request would
allow foreign banks substantially to increase their deposit powers.
Finally, unlike foreign banks, domestic banks did not have the
opportunity to establish agencies and limited branches outside their
home states prior to enactment of the Interstate Act. One possible
issue is whether the existing networks of such interstate offices of
foreign banks, established at a time when such interstate offices were
unavailable to domestic banks, would give foreign banks an unfair
advantage over domestic banks if the Board decides that such offices
can be upgraded to full branches under the merger
provisions.35
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e existing networks of such interstate offices of
foreign banks, established at a time when such interstate offices were
unavailable to domestic banks, would give foreign banks an unfair
advantage over domestic banks if the Board decides that such offices
can be upgraded to full branches under the merger
provisions.35
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\34\ Limited branches may take only Edge-type deposits; agencies
may accept only foreign-source deposits.
\35\ It could be argued that the ability of foreign banks to
maintain agency, limited branch, and representative office networks
outside their home states since 1978 gave foreign banks a slight
competitive advantage, and that foreign banks wishing to upgrade
their out-of-home-state offices should be allowed to do so only if a
domestic bank could open a de novo branch under the Interstate Act.
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On balance, the Board believes it should approve upgrades of
agencies and limited branches to full branches only if the host state
permits de novo interstate branching. Comment is being requested on
whether foreign banks wishing to upgrade their out-of-home-state
offices should be permitted to do so only if a domestic bank with the
same home state as the foreign bank could open a de novo branch, or
whether there are other circumstances in which a foreign bank should be
permitted to upgrade its offices.
In connection with this issue, the Board is proposing a change in
the current definition of ``change in status'' in Regulation K.
Regulation K requires the prior approval of the Board under the FBSEA
for any ``change in the status'' of a U.S. office
n bank could open a de novo branch, or
whether there are other circumstances in which a foreign bank should be
permitted to upgrade its offices.
In connection with this issue, the Board is proposing a change in
the current definition of ``change in status'' in Regulation K.
Regulation K requires the prior approval of the Board under the FBSEA
for any ``change in the status'' of a U.S. office. The current
definition of change in status in Regulation K does not expressly
include upgrades from limited to full branches because foreign banks
generally were unable to effect such upgrades without changing home
state until the Interstate Act gave foreign banks the ability to
establish full branches on an interstate basis.
As discussed above, upgrading a limited branch of a foreign bank to
a full branch implicates policy concerns similar to those raised by
changes in the status of an office requiring prior Board approval under
FBSEA. Thus, the Board proposes to expand the definition of ``change in
status'' to include upgrades from a limited branch to a full branch,
such that prior approval of the Board under FBSEA would be necessary
for such upgrades. Where a foreign bank proposes to upgrade a limited
branch to a full branch outside its home state, the prior approval of
the Board under the interstate branching provisions of section 5 of the
IBA also would be required as a result of this rule change.
Home State Attribution Rule Deleted
to a full branch,
such that prior approval of the Board under FBSEA would be necessary
for such upgrades. Where a foreign bank proposes to upgrade a limited
branch to a full branch outside its home state, the prior approval of
the Board under the interstate branching provisions of section 5 of the
IBA also would be required as a result of this rule change.
Home State Attribution Rule Deleted
Regulation K currently provides that a foreign banking organization
and all its affiliates are entitled to only one home state. Thi
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