# 62 FR 68424: International Banking Operations; Rules Regarding Delegation of Authority > Federal · Regulations · In force URL: https://www.frixlaw.com/law-library/statutes/FR_PRORULE_97-33411 ## Section - **Citation:** 62 FR 68424 - **Heading:** International Banking Operations; Rules Regarding Delegation of Authority - **Jurisdiction:** Federal - **Kind:** Regulations - **Status:** In force - **Text as of:** August 14, 2026 - **Source:** Compiled text - **Location:** Federal Register / Vol. 62 / 62 FR 68424 ## Text Part IV Federal Reserve System _______________________________________________________________________ 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. ----------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------- 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. --------------------------------------------------------------------------- \6\ The Board proposes that existing dollar limits would be retained for companies that are not well-capitalized and well- managed. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- -------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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). --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \18\ Fifty-one countries reached debt relief agreements with commercial banks during the period January 1980-December 1995. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- 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 --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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 --------------------------------------------------------------------------- \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). --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \30\ See 12 CFR 265.11(d)(11). --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \30\ See 12 CFR 265.11(d)(11). --------------------------------------------------------------------------- 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 [Text truncated at 120,000 characters. 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Check the current official text before relying on it. Not legal advice.