INSTITUTE OF INTERNATIONAL BANKERS

Transcription

1 October 17, 2013 REGULATION AND SUPERVISION OF U.S. BRANCHES AND AGENCIES OF FOREIGN BANKS BY U.S. BANKING AUTHORITIES AND THE TREATMENT OF CLAIMS OF THEIR THIRD-PARTY DEPOSITORS IN LIQUIDATION The Institute of International Bankers ( IIB ) has prepared this memorandum for use in connection with individual requests to the Securities and Exchange Commission ( SEC ) submitted by banking organizations headquartered outside the United States ( foreign banks ) for approval to maintain and operate through their U.S. branches Special Reserve Bank Accounts for broker-dealers pursuant to the SEC s Rule 15c3-3(e). The discussion below commences with a summary of the standards foreign banks must satisfy to be eligible to establish a U.S. branch, together with a general overview of how U.S. branches of foreign banks are regulated and supervised in the United States as separately licensed offices of the banks and how the Federal Reserve assesses foreign banks capital adequacy for U.S. regulatory purposes. This discussion of the extensive regulation and supervision of U.S. branches by U.S. banking authorities provides the background for the principal focus of the analysis: the legal regime for liquidating the operations of a U.S. branch under federal or state law and the treatment of claims of third-party depositors of the U.S. branch in connection therewith. In brief, regardless of whether a U.S. branch of a foreign bank is licensed under federal or state law, as supervisory concerns with respect to the financial condition of the branch increase the appropriate supervisory authority has considerable discretion to require the branch to take actions to strengthen its ability to satisfy its obligations to third-party depositors and other creditors. Where those actions prove insufficient and the branch is placed in liquidation, the liquidation process is undertaken in accordance with a legal ring-fence regime which (i) maximizes the assets that are available to satisfy the claims of third-party depositors and other creditors arising out of their transactions with the branch and (ii) provides legal certainty regarding the priority status of those claims vis-à-vis claims of the foreign bank s head office, other offices and affiliates. Under the ring-fence regime, any excess amount remaining after payment of third-party claims is distributed to the appropriate authority in the foreign bank s home country. I. Standards Governing the Establishment of U.S. Branches of Foreign Banks Foreign banks conduct a substantial portion of their commercial banking activities in the United States through offices of the bank that are licensed as a branch or an agency 1 by either 1 The principal difference between a branch and agency of a foreign bank is that only branches are authorized to accept deposits from U.S. persons. Compare 12 U.S.C. 3101(3) (definition of branch ) with 12 U.S.C. 3101(1) (definition of agency ). However, OCC-licensed agencies are prohibited outright from accepting deposits from any person (12 U.S.C. 3102(d)). Foreign banks conduct principally wholesale banking activities through their branches and agencies. The deposits of U.S. branches are not insured by the FDIC, with the exception of 8 foreign banks that are permitted, pursuant to grandfather authority granted under Section 214 of the Foreign Bank Supervision

2 a state banking authority or the Office of the Comptroller of the Currency ( OCC ). 2 In the aggregate, U.S. branches and agencies of foreign banks hold over $2 trillion of assets, accounting for approximately 14% of total banking assets in the United States. 3 Foreign banks seeking to enter the U.S. market through a branch are required to obtain the prior approval of both the Federal Reserve and either the OCC (in the case of federal branches) or the appropriate state banking authority such as the NYDFS (in the case of state-licensed branches). In reviewing an application to establish a branch, the Federal Reserve takes into account, among other considerations, the financial and managerial resources of the foreign bank, and it may impose such conditions on its approval as it deems necessary. 4 The relevant state authority or, as the case may be, the OCC makes an independent determination of the foreign bank s fitness to establish and maintain a branch. For the Federal Reserve, a key consideration in acting on an application to establish a U.S. branch is whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by the appropriate authorities in its home country (referred to as the comprehensive consolidated supervision ( CCS ) requirement ). 5 In addition, in the case of an Enhancement Act of 1991 (codified at 12 U.S.C. 3104), to maintain branches whose deposits are insured by the FDIC subject to the same $250,000 limit on deposit insurance coverage applicable to all other FDIC-insured depository institutions (as indicated in Appendix 1 hereto, these grandfathered insured branches have approximately $66 billion in total assets in the aggregate, representing approximately 3% of the more than $2 trillion of total assets held by U.S. branches and agencies in the aggregate). The discussion in this memorandum focuses on the uninsured U.S. branches of foreign banks, but the same requirements are in general equally applicable to their U.S. agencies. It is our understanding that none of the grandfathered U.S. insured branches seek to maintain and operate Special Reserve Accounts under Rule 15c3-3(e), and the discussion in this memorandum therefore does not address the extent to and manner in which these branches are subject to the FDIC s oversight or the provisions of the Federal Deposit Insurance Act that would apply in the event of their liquidation. 2 According to the most recently available structure data published by the Federal Reserve (reported as of March 31, 2013), there are 187 state-licensed foreign bank branches and agencies, 106 of which are licensed by the New York Department of Financial Services (the NYDFS ), and 48 OCC-licensed branches, of which 32 are located in New York. The structure data is available at: Further analysis of the composition of foreign banks U.S. branch and agency operations is provided in Appendix 1 hereto. Not every state permits foreign banks to establish branches or agencies. Foreign banks branch offices outside New York are located principally in Illinois, Texas, Connecticut, California and Florida, listed in descending order of total assets held by branches in the state (see Appendix 2 hereto). We limit our analysis of applicable state law in this memorandum to the laws of New York and Connecticut with the understanding that the provisions of Texas law and the laws of any other state that may be relevant to a foreign bank s request under Section 15c3-3(e) will be addressed in connection with the particular bank s request for exemptive relief. 3 See the Federal Reserve share data as of March 31, 2013, which also indicate that their U.S. branches account for approximately 66% of foreign banks total commercial banking assets in the United States (available at: 4 See generally, 12 U.S.C. 3105(d). 5 See 12 U.S.C. 3105(d)(2)(A). 2

3 application by a foreign bank that presents a risk to the stability of the United States financial system, the Federal Reserve may consider whether the home country of the foreign bank has adopted, or is making demonstrable progress toward adopting, an appropriate system of financial regulation for the financial system of such home country to mitigate such risk. 6 The Federal Reserve considers a variety of factors in determining whether a foreign bank satisfies the CCS requirement. 7 In the event the Federal Reserve is unable to find that a foreign bank meets the CCS requirement, it nevertheless may permit the bank to establish a U.S. branch if it determines that the appropriate authorities in the home country of the foreign bank are actively working to establish arrangements for the consolidated supervision of such bank. 8 II. The U.S. Bank Regulatory Approach to U.S. Branches as Separately Licensed Offices of Foreign Banks Examination and Supervision. U.S. branches are not separately capitalized entities, but their operations are subject to comprehensive regulation and supervision by U.S. federal and state banking authorities. As part of the overall supervision and regulation process, they are periodically examined by the appropriate licensing authority a state banking authority (such as the NYDFS or the Connecticut Department of Banking) or the OCC as well as by the Federal Reserve 9 and assigned supervisory ROCA ratings. 10 In addition, the Federal Reserve assigns a 6 This factor was added by Section 173(a) of the Dodd-Frank Act, codified at 12 U.S.C. 3105(d)(3)(E). 7 The relevant provisions of the Federal Reserve s Regulation K (12 C.F.R (c)(1)(ii)) state that in making a CCS determination, the Federal Reserve shall assess, among other factors, the extent to which the foreign bank s home country supervisor: (A) ensures that the foreign bank has adequate procedures for monitoring and controlling its activities worldwide; (B) obtains information on the condition of the foreign bank and its subsidiaries and offices outside the home country through regular reports of examination, audit reports, or otherwise; (C) obtains information on the dealings and relationship between the foreign bank and its affiliates, both foreign and domestic; (D) receives from the foreign bank financial reports that are consolidated on a worldwide basis, or comparable information that permits analysis of the foreign bank's financial condition on a worldwide, consolidated basis; and (E) evaluates prudential standards, such as capital adequacy and risk asset exposure, on a worldwide basis. 8 See 12 U.S.C. 3105(d)(6)(A)(i)). 9 The Federal Reserve s examination authority derives from Section 7(c) of the International Banking Act of 1978 (the IBA ), and in exercising this authority the Federal Reserve seeks to coordinate with the appropriate licensing authority to the extent possible to reduce burden and avoid unnecessary duplication of examinations and it may request 3

4 rating based on its assessment of the foreign bank s ability to support its branch and other U.S. operations (the Strength of Support Assessment ( SOSA ) rating). In practice, U.S. branches are subject to on-site safety and soundness examinations on an annual basis, except those with total assets of less than a specified amount and that meet certain other criteria, which instead may be examined on an 18-month cycle. 11 U.S. branches also are subject to targeted examinations, which focus on particular aspects of their operations (e.g., compliance with the requirements of the Bank Secrecy Act). However, the authorities have broad authority to conduct additional examinations when and for whatever purpose they see fit. For example, the New York Superintendent of Financial Services (the Superintendent ) has the power under Section 36.4 of the New York Banking Law at any time to examine any New York-licensed branch for the purpose of ascertaining whether it has violated any law and for any other purpose. Likewise, Section 36a-428l(a) of the Connecticut Banking Law provides that the Banking Commissioner (the Commissioner ) may make such public or private investigations or examinations within or outside this state, concerning any foreign bank licensed to maintain a state branch...in this state, as the commissioner deems necessary to carry out the duties of the commissioner relating to such branch. Reporting. U.S. branches are required to maintain separate books and records in accordance with U.S. regulatory requirements and file with the Federal Reserve and the appropriate licensing authority quarterly reports of their assets and liabilities ( Call Reports ). 12 In addition, the appropriate supervisory authority can require a branch within its oversight to provide such additional information and reports with respect to such matters, in such form and with such frequency as it may require in its discretion. For example, Section 37.1 of the New York Banking Law authorizes the Superintendent to require any foreign bank with a New York-licensed branch that its examination be conducted simultaneously with that of the other appropriate examining authority. See 12 U.S.C. 3105(c)(1). 10 The ROCA rating system consists of separate assessments of a branch s risk management, operations, compliance and asset quality, as well as an overall composite assessment of the branch. The ROCA rating assists in determining any remedial action that a U.S. branch may be required to undertake and whether an enforcement action would be appropriate to address the situation. 11 At the federal level, branches with total assets of less than $500 million are eligible for an 18-month examination cycle. See 12 C.F.R. 4.7(b) (OCC examinations) and (c)(2) (Federal Reserve examinations). Section 36.2(b) of the New York Banking Law prescribes a $250 million asset limit for 18-month examinations. 12 For U.S. branches and agencies, the relevant Call Report is the Report of Assets and Liabilities of U.S. Branches and Agencies of Foreign Banks (FFIEC Form 002). FFIEC Form 002 and the instructions thereto are available on the web site of Federal Financial Institutions Examination Council at: The branch Call Reports have specific line items and schedules for reporting details of the assets and liabilities reflected in the reporting branch s books and records, but there is no line item for reporting any capital because, of course, the branch itself is not a separately capitalized entity. The public portions of the quarterly Call Reports filed by individual U.S. branches and agencies may be accessed through the Federal Reserve s National Information Center at: 4

5 to make special reports to him at such times a he may prescribe. Similarly, Section 36a-428h (b) of the Connecticut Banking Law provides that the Commissioner may require Connecticutlicensed branches to submit such regular or special reports as the commissioner deems necessary for the proper supervision of licensees. Activity Limitations. In general, U.S. branches are limited to the same types of activities as are permissible for their U.S. domestic bank counterparts. Inasmuch as foreign banks U.S. branches do not have their own capital, restrictions on such activities that are based on capital (for example, lending limits) are applied to branches by reference to the foreign bank s consolidated capital, as calculated under its home country standards. Proposed Dodd-Frank Enhanced Liquidity Requirements. 13 U.S. branches of foreign banks will be subject to additional regulatory requirements should the Federal Reserve adopt as proposed rules implementing the enhanced capital, liquidity and other requirements of Section 165 of the Dodd-Frank Act for large foreign banks (defined as those with worldwide total consolidated assets of $50 billion or more). 14 The impact of the proposed enhanced liquidity requirements would be especially significant for U.S. branches of those foreign banks whose U.S. bank and nonbank operations, including those of their U.S. branches, have total combined assets of $50 billion or more. These requirements are intended to strengthen those branches safety and soundness and the protection of their third-party depositors and other creditors and would apply in addition to whatever enhanced liquidity requirements the appropriate primary supervisory authority (e.g., the NYDFS or the OCC) might require (see the discussion below in Part IV.A). It is our understanding that each foreign bank that would request approval under SEC Rule 15c3-3(e) meets the $50 billion combined U.S. asset threshold. The Section 165 FBO Proposal would require the U.S. branches of foreign banks whose combined U.S. operations have total assets of $50 billion or more to establish separate U.S. liquidity buffers comprised of unencumbered highly liquid assets based on the liquidity needs 13 The discussion of the proposed Dodd-Frank enhanced liquidity requirements in this memorandum is limited to a description of how they would apply to U.S. branches of covered foreign banks. In its April 30, 2013 comment letter on the Federal Reserve s proposed rules, the IIB has raised concerns with certain aspects of the proposal as a whole, including in particular the trapping of liquidity and the requirement to consolidate U.S. operations conducted outside a branch/agency network under a U.S. intermediate holding company ( IHC ), and has proposed an alternative approach to address the policy issues underlying Section 165 (the IIB comment letter can be accessed at the following link: Discussion of these considerations is beyond the scope and purpose of this memorandum. 14 See Enhanced Prudential Standards and Early Remediation Requirements for Foreign Banking Organizations and Foreign Nonbank Financial Companies, 77 Fed. Reg (Dec. 28, 2012) (the Section 165 FBO Proposal ). Section 165 directs the Federal Reserve to prescribe enhanced prudential standards for banking organizations, including foreign banks with U.S. banking operations, with $50 billion or more of total consolidated assets. These enhanced requirements include risk-based capital requirements and leverage limits, liquidity requirements, overall risk management requirements, resolution plans, and concentration limits. 5

6 derived from monthly, internally run liquidity stress tests conducted according to principles and guidelines set forth in the Proposal. 15 This liquidity buffer would have to be sufficient to meet the branch s net stressed cash flow needs for a period of 30 days, but only the first 14 days of that buffer would be required to be held inside the United States; the remainder (days 15 through 30) could be held at its head office, provided that the Federal Reserve is satisfied that the head office (or a non-u.s. affiliate) has and is prepared to provide highly liquid assets to the U.S. branch sufficient to meet the branch s liquidity needs during days 15 through The overall effect of the liquidity buffer would be to trap liquidity at the branch and prohibit the branch from relying on liquidity available anywhere else in the foreign bank s consolidated group (i.e., head office and any other non-u.s. office, as well as any U.S. or non-u.s. affiliate) to meet expected short-term external cash flow needs under stressed conditions. Finally, under the proposed early remediation requirements (pursuant to Section166 of the Dodd-Frank Act), a determination by the Federal Reserve that any part of such a foreign bank s combined U.S. operations is in substantial noncompliance with the enhanced liquidity management requirements would automatically trigger the following limitations on the bank s U.S. branch: (i) it must remain in a net due to position to its head office and rest of the group outside the United States, and (ii) it becomes subject to a minimum 108% asset maintenance requirement. 17 III. The Federal Reserve s Assessment of a Foreign Bank s Capital Adequacy on a Consolidated Basis A foreign bank that owns or controls a U.S. bank subsidiary is itself a bank holding company and, as such, is subject to the requirements of the Bank Holding Company Act (the 15 See proposed Section of Regulation YY, 77 Fed. Reg. at For foreign banks whose combined U.S.non-branch operations, including those of registered broker-dealer and investment adviser subsidiaries, have total assets of $50 billion or more in the aggregate, the Section 165 FBO Proposal calls for the consolidation of those operations under an IHC, which would be subject on a consolidated basis to its own 30-day liquidity buffer requirement (all of which would have to be held in the U.S.), as well as to the risk-based capital requirements and leverage limits applicable to U.S.-headquartered bank holding companies. In addition, the foreign bank s combined U.S. operations (IHC and branch) would be subject to liquidity risk management and governance standards and contingency funding planning requirements, and would be required to establish and maintain procedures for monitoring the intra-day liquidity risk exposure of the combined U.S. operations. Foreign banks whose combined U.S. operations have total assets of less than $50 billion would not be subject to a separate liquidity buffer (whether at the branch or IHC level), but would be required to report to the Federal Reserve on the results of internal liquidity stress tests conducted in a manner consistent with the Basel Committee s principles for liquidity risk management. See proposed Section of Regulation YY, 77 Fed. Reg. at See proposed Section (f)(2) of Regulation YY, 77 Fed. Reg. at See proposed Section (c)(7) of Regulation YY, 77 Fed. Reg. at The net due to and asset maintenance limitations prescribed by the Section 165 Large FBO Proposal would be imposed independently of any similar such limitations that might be imposed by the branch s primary supervisory authority (these other requirements are discussed below in Part IV.A). 6

7 BHC Act ), including those relating to capital adequacy. By virtue of Section 8(a) of the IBA (12 U.S.C. 3106(a)), a foreign bank whose banking operations in the United States are limited to maintaining a branch or agency is treated as a bank holding company and therefore subject to the BHC Act s requirements in the same manner and to the same extent that bank holding companies are subject to such provisions. The Federal Reserve conducts its assessment of foreign banks capital for these and other regulatory purposes in accordance with the principle of national treatment. This longstanding U.S. policy is embedded in the IBA and calls for parity of treatment between [foreign and U.S. banks] in like circumstances, 18 but it is recognized that parity of treatment does not mean identical treatment. Instead, national treatment is accomplished by applying the requirements applicable to U.S. banking organizations in a manner that appropriately takes into account the differences resulting from foreign banks operating in the United States through U.S. branches. In the context of assessing a foreign bank s capital adequacy on a consolidated basis, this approach recognizes that (i) a U.S. branch does not maintain its own capital and (ii) the foreign bank itself is subject to capital requirements prescribed by its home country authority. In the case of a foreign bank whose home country applies capital standards consistent with those adopted by the Basel Committee, 19 the bank s consolidated capital as calculated under those standards is accepted as the starting point for the U.S. regulatory assessment. 20 This approach neither gives complete deference to home country capital requirements nor requires a foreign bank strictly to abide by each of the U.S. requirements or to calculate its capital pursuant to U.S. rules. 21 Thus, for example, to qualify as a financial holding company ( FHC ) under the BHC Act, a foreign bank with a U.S. branch must meet the well capitalized standard applicable to U.S.-headquartered FHCs but compliance with those standards minimum risk-based tier 1 and total capital ratios of 6% and 10%, respectively are determined by reference to the foreign bank s 18 See S. Rep. No. 1073, 95 th Cong. 2d Sess. 2, reprinted in 1978 U.S. Code Cong. and Admin. News 1421, It is our understanding each foreign bank that would seek approval for its U.S. branch to maintain Special Reserve Bank Accounts pursuant to SEC Rule 15c3-3(e) is subject on a consolidated basis to home country capital requirements consistent with those adopted by the Basel Committee. 20 See, e.g., 12 C.F.R (r)(3)(i)(A). 21 In this memorandum, we focus only on assessments of the foreign bank s capital adequacy, as opposed to the capital adequacy of any of its U.S. bank holding company or bank subsidiaries. For example, the Section 165 FBO Proposal would require foreign banks U.S. IHCs to comply with the capital requirements applicable to U.S.- headquartered bank holding companies as prescribed by the Federal Reserve. Similarly, a U.S. IHC would have to comply with the minimum capital standards required under Section 171 of the Dodd-Frank Act, (the Collins Amendment ), but the Collins Amendment does not apply to foreign banks themselves. See Section 171(a)(3) of the Dodd-Frank Act. Assessment of a foreign bank s capital adequacy under the Section 165 proposal is discussed in the text accompanying footnote 24 below. 7

8 consolidated capital as measured under its home country Basel standards. 22 For purposes of assessing comparability to the requirements applicable to U.S.-headquartered FHCs, the Federal Reserve may consider additional factors, including the composition of the foreign bank s capital, the ratio of the foreign bank s tier 1 capital leverage ratio, home country accounting standards, the foreign bank s long-term debt ratings, its reliance on government support to meet capital requirements and whether it satisfies the CCS standard. 23 Similarly, the Section 165 FBO Proposal would require a foreign bank to meet capital adequacy standards at the parent consolidated level that are consistent with the Basel capital framework and to provide certain information to the Federal Reserve on a consolidated basis. The Federal Reserve would look to the foreign bank s home country capital regulation to determine whether this regulation is consistent with the Basel capital framework and whether the foreign bank meets these home country capital adequacy standards at the consolidated level. 24 IV. Treatment of the Claims of Third-Party Depositors in connection with the Involuntary Liquidation of A U.S. Branch 25 As is the case with U.S.-chartered banks, U.S. supervisory authorities have considerable discretionary authority over the operations of U.S. branches of foreign banks. 26 This authority enables them to impose increasingly severe measures of a formal (e.g., administrative enforcement actions and directives) and informal nature in order to maintain the safety and soundness of the branch as a going concern under stressful conditions. 27 These measures may be applied separately or in combination as the supervisory authority sees fit depending on the circumstances, and they provide the supervisor considerable flexibility in addressing a branch s deteriorating financial condition. In the event these measures fail and the supervisory authority determines that the branch should be closed, applicable federal and state banking law empowers the supervisory authority to 22 See 12 C.F.R (b)(1)(i) and (ii). 23 See 12 C.F.R (e). 24 See proposed Section (c) of Regulation YY, 77 Fed. Reg. at As the term indicates, voluntary liquidation is undertaken at the decision of the foreign bank. Where voluntary liquidation is elected, it must be undertaken in accordance with legal requirements that protect the interests of depositors and other creditors. See, e.g., 12 C.F.R (federal branches); Section of the New York Banking Law (New York-licensed branches); and Section 36a-428k of the Connecticut Banking Law (Connecticutlicensed branches). 26 At the federal level, see 12 U.S.C (federal branches) and, 3105(c) (Federal Reserve examination authority). 27 See, e.g., 12 U.S.C. 1818(b)(4) (federal enforcement powers that are exercisable against insured depository institutions are equally exercisable against foreign banks and their U.S. branches and agencies). 8

9 seize the business and operations of the branch, undertake its liquidation and, in connection therewith, apply the branch s assets to satisfy the claims of third parties arising from transactions with the branch. 28 This specialized regime for the liquidation of OCC- and state-licensed U.S. branches of foreign banks is the exclusive means for resolving the claims of depositors and other creditors of a U.S. branch; the Bankruptcy Code prohibits an administrator or receiver of the foreign bank outside the United States from initiating any action thereunder to reach the assets of a U.S. branch of the bank. 29 To date, there have been very few instances in which a U.S. branch has been involuntarily liquidated. We are not aware of the involuntary liquidation of any OCC-licensed branch, and the only instances of the involuntary liquidation of a state-licensed of which we are aware are those very few occasions only 5 times since the end of the Second World War in which the Superintendent has taken possession of a New York-licensed branch and the one occasion in which a California-licensed agency was liquidated. 30 Importantly, in each of these instances, the claims of third-party depositors and other creditors have been satisfied in full from the assets at the disposal of the Superintendent under New York law. A. Supervisory Measures in Advance of Involuntary Liquidation Maintaining and Increasing A Net Due To Position. Federal and state supervisors closely monitor the extent to which a U.S. branch is a net recipient of funds from its parent bank head office and other related depository institutions (i.e., the branch is in a net due to position) or a net supplier of funds to the head office and other related depository institutions (i.e., the branch is in a net due from position). 31 As supervisory concerns arise with respect to the financial condition of the branch, the supervisor has the inherent authority to require the branch to maintain its operations in a net due to position at a level prescribed by the supervisor, which may be increased as the supervisor believes is warranted by the circumstances. 28 As discussed above in note 1, this memorandum does not address the treatment of claims of third-party depositors in connection with the liquidation of a grandfathered U.S. insured branch. 29 See 11 U.S.C. 109(b)(3)(B) (a foreign bank that has a U.S. branch or agency may not be a debtor under Chapter 7 of the Bankruptcy Code) and 1501(c )(1) (the provisions of the Bankruptcy Code permitting the recognition in the United States of comparable foreign proceedings do not apply to proceedings involving foreign banks that have U.S. branches or agencies). 30 See Challenges of Cross-Border Coordination: New York Perspectives on Convergence, Cooperation and Protection of National Interests, remarks by the New York Banking Department General Counsel at the IIB s Conference on U.S. Bankruptcy/Resolution Issues and Cross-Border Regulatory/Implications (Nov. 10, 2009). The most well-known of the New York cases is the Bank of Credit and Commerce International ( BCCI ), which failed in BCCI also had a California-licensed agency, which was liquidated under California law with full payment to its third-party depositors and other creditors. 31 Amounts due to the parent bank head office and other related depository institutions are reported as a liability of the branch on its Call Report (see Schedule RAL, line item 5), while amounts due from the head office and other related depository institutions are reported as an asset (see Schedule RAL, line item 2). 9

10 As discussed below, claims by a branch s head office and other members of the affiliated group are subordinated to those of third-party depositors and other creditors of the branch in liquidation. The net due to level at which a branch is required to operate in advance of its liquidation therefore plays an important role in determining the amount that would be available to satisfy those third-party claims. Increasing the Asset Pledge Requirement. U.S. branches, whether OCC- or statelicensed, are required to maintain at all times with a third-party custodian located in the state in which the branch maintains its office a prescribed amount of unencumbered, liquid assets that are pledged to their licensing authority in order to ensure that, upon liquidation of the branch, the receiver will have a source of readily available funds. As with the net due to/due from position of the branch, the licensing authority has full discretion to increase the amount of the asset pledge as it determines necessary in the circumstances. While a branch has the right under the asset pledge requirement to receive interest earned on pledged assets and to substitute or withdraw pledged assets in the ordinary course of its business, provided that it at all times continues to satisfy the terms of the asset pledge requirement, the supervisory authority may revoke, terminate or suspend these rights at any time. Section 202-b.1 of the New York Banking Law mandates that New York-licensed branches establish and maintain an asset pledge in accordance with such rules and regulations as the Superintendent shall adopt, and the Superintendent is authorized to require that the asset pledge be maintained at such amount in such form and subject to such conditions as he or she shall deem necessary or desirable for the maintenance of a sound financial condition, the protection of depositors and the public interest, and to maintain public confidence in the business of such branch (emphasis added). Part 51 of the General Regulations of the Superintendent prescribes the requirements for the asset pledge agreement between the branch and its third-party custodian, 32 and Part 322 of the Superintendent s Regulations fixes the minimum amount of the asset pledge at an amount equal to the greater of (i) 1% of the branch s third-party liabilities (subject to certain adjustments) and (ii) $2 million. 33 In the case of foreign banks determined by the Superintendent to be well-rated the asset pledge is based on a sliding scale percentage of the branch s third-party liabilities (decreasing in 0.25% increments from 1% of the first $1 billion of such liabilities to 0.25% of such liabilities in excess of $10 billion) with a cap set at $100 million See 3 New York Codes, Rules and Regulations Section 51.2(d) incorporates into the agreement the Superintendent s right to substitute or withdraw pledged securities or funds at any time. Section 51.2(g) provides that the Superintendent may order revocation of the third-party custodian s payment of interest earned on the pledged assets to the branch. 33 See id., Section 322.1(a). The list of eligible assets under the asset pledge requirement is available on the NYDFS web site at: 34 See id., Section 322.1(f). Well rated banks are those determined by the Superintendent to be well capitalized and well managed pursuant to criteria prescribed in Section 322.7(a). 10

11 Section 36a-428c(a) of the Connecticut Banking Law mandates an asset pledge for Connecticut-licensed branches and, like New York law, grants the Commissioner broad discretion to prescribe its requirements. In exercising that discretion, the Commissioner has adopted an asset pledge requirement that is the same as the New York requirement in its purpose and operation but differs in the details of how the minimum amount of the asset pledge is calculated and the amount of assets required to be pledged. That calculation is made pursuant to Section 36a-428c-4 of the Commissioner s Regulations, which in general requires that the asset pledge at all times be maintained in a minimum amount equal to the greater of $1 million or 2% of adjusted third-party liabilities, subject to a cap of $100 million. The regulation also sets forth criteria that, if satisfied, may result at the discretion of the Commissioner in prescribed increases in the amount of the asset pledge to a maximum of $500 million, 35 and it more generally provides as follows: If the commissioner determines that the protection of the public interest requires that a foreign bank should keep deposit assets on deposit in an amount greater than that required by this section, the commissioner shall so notify the foreign bank, which shall immediately thereafter keep deposit assets on deposit in such greater amount. The asset pledge requirement for OCC-licensed branches is set forth in Section 4(g)(1) (3) of the IBA (codified at 12 U.S.C. 3102(g)(1)-(3)), which requires the pledge to the Comptroller of the Currency (the Comptroller ) of unencumbered, high-quality assets to a third-party custodian located in the state in which the federal branch maintains its office in an amount equal to at least 5% of a federal branch s third-party liabilities. The assets pledged pursuant to this required are referred to in the OCC s implementing regulations (12 C.F.R ) as capital equivalency deposits ( CED ). The statute authorizes the Comptroller to set the amount of the CED requirement in such amounts as he may from time to time deem necessary or desirable, for the maintenance of a sound financial condition, the protection of depositors, and the public interest, but not greater than would be required to conform to generally accepted banking practices as manifested by banks in the area where the branch or agency is located (emphasis added), 36 and Section 28.15(b) of the OCC s Regulations provide that [f]or prudential or supervisory reasons, the OCC may require, in individual cases or otherwise, that a foreign bank increase its CED above the minimum amount. Imposing and Increasing an Asset Maintenance Requirement. In addition to the ongoing asset pledge requirement, U.S. branches are subject to a so-called asset maintenance requirement, pursuant to which the supervisory authority may prescribe the type and amount of assets that a branch is required from time to time to maintain on its books in relation to its thirdparty liabilities (in determining compliance with an asset maintenance requirement, the supervisory authority will give credit for assets subject to the asset pledge requirement and reserves held at the Federal Reserve). 35 The criteria include decreases in the ROCA and/or SOSA ratings and downgrades in the rating of any outstanding issue of the foreign bank s debt. 36 See 12 U.S.C. 3102(g)(2). 11

12 As compared to the asset pledge requirement, which simply requires the pledge of a specified amount of high quality assets, the asset maintenance requirement provides the supervisory authority a means to impose more stringent limitations on the overall composition and liquidity of the branch s asset (for example, by means of limiting the types of assets the branch may hold and/or requiring the branch to apply prescribed discounts to the value of the assets on its books). For example, asset maintenance may be imposed on a case-by-case basis as the financial condition of a branch begins to deteriorate or the supervisory authority otherwise has concerns regarding the branch s safety and soundness or, if concerns arise regarding a particular jurisdiction, it may be applied to branches of foreign banks headquartered in that jurisdiction. Asset maintenance provides the supervisory authority maximum flexibility to limit the composition and liquidity of a branch s assets in a manner tailored to the circumstances of a particular branch (or group of branches). New York-licensed branches are subject to asset maintenance pursuant to Section 202-b.2 of the New York Banking Law, but the statute leaves the requirement s implementation to the discretion of the Superintendent. As implemented by Section 52.1 of the General Regulations of the Superintendent, the asset maintenance is set at 0% as a general matter, but the Superintendent retains the discretion to impose specific asset maintenance requirements in cases where he deems it necessary for the protection of the public interest and the interest of depositors and creditors (emphasis added). Thus, a New York-licensed branch is not subject to asset maintenance unless the Superintendent determines such action to be warranted under the circumstances, in which case the Superintendent has considerable flexibility in prescribing the asset maintenance requirement (for example, by limiting the types of asset a branch may hold and requiring such assets to be held in a prescribed amount that exceeds 100% of the value of the branch s third-party liabilities. More generally, Section 52.1 provides the Superintendent broad authority to impose in specific cases such other requirements as he deems necessary in order to effectuate the purpose of the provisions of Banking Law section202-b (which, as discussed above, is the statutory basis for both the asset pledge and asset maintenance requirements). Asset maintenance for Connecticut-licensed branches is essentially the same as for New York-licensed branches. Section 36a-428c(b) imposes an asset maintenance requirement which, as provided in Section 36a-428c-2 of the Commissioner s Regulations is established at 0% as a general matter, but the commissioner may impose specific asset maintenance requirements as deemed necessary for the protection of the public interest and the interest of depositors and creditors (emphasis added). Further, as in New York, the regulation provides the Commissioner broad authority to impose in specific cases such other requirements as he deems necessary in order to effectuate the purpose of section 36a-428c(b). Asset maintenance for OCC-licensed branches is provided for in Section 4(g)(4) of the IBA (12 U.S.C. 3102(g)(4)), which, like New York law, leaves the specifics of the requirement to the discretion of the Comptroller, the exercise of which shall be based on the Comptroller s 12

13 determination of what may be necessary or desirable for the maintenance of a sound financial condition, the protection of depositors, creditors and the public interest (emphasis added). Section of the OCC s regulations implements asset maintenance in a manner that leaves it entirely to the discretion of the OCC whether to impose asset maintenance on a federal branch and, if such action is taken, the amount and composition of assets that are eligible to satisfy the requirement. B. Circumstances in Which A U.S. Branch May Be Placed in Involuntary Liquidation Action by the Federal Reserve. The Federal Reserve has authority to order a foreign bank to terminate the activities of its state-licensed branch upon its determination, after notice and an opportunity for a hearing and notice to the appropriate state banking authority, that there is reasonable cause to believe that the foreign bank, or any of its affiliates, has committed a violation of law or engaged in an unsafe or unsound banking practice in the United States. 37 The termination of the activities of the New York-licensed branch of The Daiwa Bank Limited, as well as the rest of Daiwa s U.S. operations, in 1995, for concealing from U.S. authorities trading losses at the New York branch in excess of $1 billion over a 12-year period was undertaken pursuant to this authority and involved joint, coordinated action by the Federal Reserve and the New York State Banking Department (the predecessor to the NYDFS), among other federal and state agencies. 38 In the case of a federal branch, the Federal Reserve is authorized to recommend to the OCC that it terminate the license of the federal branch on the basis of the same types of concerns that can trigger termination of a state-licensed branch s activities. 39 The Federal Reserve s termination of the operations of a U.S. branch may trigger its involuntary liquidation by the appropriate licensing authority. 40 Action by A State Licensing Authority. The appropriate state banking authority may undertake the involuntary liquidation of a state-licensed branch in connection with its seizure of 37 See 12 U.S.C. 3105(e)(1). In addition to notifying the appropriate state banking authority of its intentions, the Federal Reserve is required under 12 U.S.C. 3105(g) to request and consider the views of that authority. Further, in the case of a foreign bank that presents a risk to the stability of the United States financial system, the Federal Reserve may order the bank to terminate the activities of its state-licensed branch if the Federal Reserve finds that the home country of the foreign bank has not adopted, or made demonstrable progress toward adopting, an appropriate system of financial regulation for the financial system of such home country to mitigate such risk (this latter authority was added by Section 173(b) of the Dodd-Frank Act, codified at 12 U.S.C. 3105(e)(1)(C)). State banking authorities have independent authority revoke a foreign bank s branch license. See, e.g., Section 40.1 of the New York Banking Law and Section 36a-51 of the Connecticut Banking Law. 38 See the November 2, 1995 joint agency press release: 39 See 12 U.S.C. 3105(e)(5). Termination of a federal branch s license is further discussed in footnote 42 below. 40 For example, as discussed below the OCC s receipt of such a recommendation from the Federal Reserve with respect to a federal branch is one of the grounds for the appointment of a receiver for the branch. 13

14 the branch for a variety of reasons as specified in applicable state law. In New York, for example, Section 606.4(a) of the Banking Law provides the Superintendent the discretion to take possession of the business and property in this state of any foreign banking corporation that has been licensed by the superintendent under the provisions of this chapter, including, for the purposes of this article, any such corporation whose license has been surrendered or revoked, upon his or her finding that any of the reasons enumerated in subdivision one of this section[ 41 ] exist with respect to such corporation or that it is in liquidation at its domicile or elsewhere or that there is reason to doubt its ability or willingness to pay in full the claims of [its third-party] creditors. Connecticut law takes a very similar approach. Section 36a-428n(b) of the Connecticut Banking Law authorizes the Commissioner to immediately take possession of the business and property in this state of any foreign banks with a state branch... upon the commissioner s determination that such action is necessary for the protection of the interest of creditors of such foreign bank s business in this state of for the protection of the public interest, and that the foreign bank has taken any of the actions prescribed by the statute, which are substantially the same as those actions provided for in Section 606.4(a) of the New York Banking Law. Action by the OCC. Section 4(j)(1) of the IBA (12 U.S.C. 3102(j)(1)) authorizes the Comptroller, without prior notice or a hearing, to appoint a receiver for a federal branch in any of the following circumstances: the Comptroller has revoked the federal branch s license; Section of the New York Banking Law authorizes the Superintendent to take possession of the business and property of a banking corporation upon a determinations by the Superintendent that the banking corporation: (a) has violated any law; (b) is conducting its business in an unauthorized or unsafe manner; (c) is in an unsound or unsafe condition to transact its business; (d) cannot with safety and expediency continue business; (e) has an impairment of its capital; (f) has suspended payment of its obligations; (g) has neglected or refused to comply with the terms of a duly issued order of the Superintendent; (h) has refused, upon proper demand, to submit its records and affairs for inspection to an examiner of the NYDFS; (i) has refused to be examined upon oath regarding its affairs; or. (j) has neglected, refused or failed to take or continue proceedings for voluntary liquidation in accordance with any of the provisions of this chapter. 42 As set forth in 12 C.F.R (a), the circumstances in which the Comptroller may revoke a federal branch s license include: (1) the OCC determines that there is reasonable cause to believe that the foreign bank has violated or failed to comply with any of the provisions of the IBA, other applicable federal laws or regulations, or orders of the OCC; 14

15 at the request of a creditor with a duly enforceable judgment from a federal or state court against the foreign bank arising out of a transaction with the federal branch that is accompanied by a certificate from the clerk of the court that the judgment has been rendered and remains unpaid for 30 days; or the Comptroller determines that the foreign bank is insolvent. C. Ring-Fence Protection of the Claims of Third-Party Depositors and Other Creditors of A Branch in Liquidation As discussed below, involuntary liquidation proceedings are undertaken pursuant to socalled ring-fencing provisions of law. The scope of the ring-fence may vary, but in all cases its purpose is the same: to maximize the assets available to satisfy the claims of the branch s thirdparty depositors and other creditors arising out of their transactions with the branch and provide legal certainty regarding the priority status of those claims in connection with the distribution of those assets vis-à-vis any claim of the foreign bank s head office and other offices and affiliates. Under the ring-fence regime, any excess amount remaining after payment of recognized third-party claims is distributed to the appropriate authority in the foreign bank s home country. 43 The New York ring-fence is provided for in Section 606.4(a), which provides that, upon the Superintendent s taking possession of the business and property in New York of the foreign bank: Title to such business and property shall vest by operation of law in the superintendent and his or her successors forthwith upon taking possession. Thereafter the superintendent shall liquidate or otherwise deal with such business and property in accordance with the provisions 43 (2) a conservator is appointed for the foreign bank, or a similar proceeding is initiated in the foreign bank's home country; (3) one or more grounds for receivership specified in Section 4(j)(1) of the IBA exists; (4) one or more grounds for termination, including unsafe and unsound practices, insufficiency or dissipation of assets, concealment of books and records, a money laundering conviction, or any of the other grounds that would support appointment of a receiver of an insured depository institution; or (5) the OCC receives a recommendation from the Federal Reserve that the federal branch s license should be terminated. Where a foreign bank operates branches in more than one state, applicable state law in some cases calls for an intermediate distribution of any excess to pay claims brought in connection with the liquidation of those other offices with only the excess, if any, remaining thereafter turned over to the appropriate home country authority. See, e.g., Section 606.4(b) of the New York Banking Law; and Section 36a-428n(f) of the Connecticut Banking Law. In the case of a federal branch, Section 4(j)(2) of the IBA (12 U.S.C. 3102(j)(2)) requires the turnover of any excess to the appropriate home country authority. 15

16 of [the New York Banking Law] applicable to the liquidation of banking organizations, except that the superintendent may deal with such business and property and prosecute and defend any and all actions relating thereto in his or her own name as superintendent. Only the claims of creditors of such corporation arising out of transactions had by them... with its New York branch or branches, shall be accepted by the superintendent for payment out of such business and property in this state as provided in this article. Acceptance or rejection of such claims by the superintendent shall not prejudice such creditors' rights to otherwise share in the assets of such corporation. The following claims shall not be accepted by the superintendent for payment out of such business and property in this state: (1) claims which would not represent an enforceable legal obligation against such branch or agency if such branch or agency were a separate and independent legal entity; and (2) amounts due and other liabilities to other offices, agencies or branches of, and affiliates of, such foreign banking corporation. [Emphasis added.] Regarding the scope of the New York ring-fence, Section 606.4(c) defines the term business and property in this state to include, without limitation, all property of the foreign bank, real, personal or mixed, whether tangible or intangible that (i) constitutes part of the business of the New York-licensed branch as it appears on its books regardless of where such business or property may be situated, and (ii) is situated within New York State whether or it is part of the business of the branch. Depending on the scope and scale of a foreign bank s overall operations in New York, the ring-fence therefore may be quite broad and encompass substantial assets outside the business of the branch. Within the ring-fence, claims of depositors of an uninsured New York-licensed branch are treated the same as those of other unsecured creditors. The provisions of the Connecticut ring-fence are in substance the same as in New York. 44 Federal law provides a significantly broader ring-fence for OCC-licensed branches than is the case under New York or Connecticut law. Section 4(g)(1) of the IBA provides that, upon its appointment by the Comptroller, the receiver of a federal branch shall take possession of all the property and assets of such foreign bank in the United States. Pursuant to Section 4(g)(2), the receiver is instructed to give priority to payment of the full amount of the claims of third-party depositors and other creditors of the branch arising out of transactions had by them with any branch or agency of such foreign bank located in any State of the United States. 44 See the following provisions of the Connecticut Banking Law: Section 36a-428n(a)(3) (defining the term business and property in this state ); Section 36a-428n (c) (vesting of title of such business and property in the Commissioner by operation of law upon taking possession); and Section 36a-428n(e)(1) (creditors claims limited to those arising out of transactions entered into by the creditor with the branch and excluding amounts due and other liabilities to other offices, agencies, branches and affiliates of such foreign bank ); and Section 36a-237(b)(1) and (d) (order or priority and sequencing of distributions). 16

17 D. The Involuntary Liquidation Process As quoted above, Section 606.4(a) of the New York Banking Law directs the Superintendent, upon taking possession of the business and property in New York of a foreign bank with a New York-licensed branch to liquidate or otherwise deal with such business and property in accordance with the provisions of [the New York Banking Law] applicable to the liquidation of banking organizations. Those provisions call for the supervision of the liquidation process by the New York State Supreme Court in the judicial district in which the banking organization s principal office is located, 45 prescribe the procedures for the identification, verification and disposition of creditors claims, and prohibit the Superintendent from compromising claims brought by depositors of the branch. 46 The Connecticut Banking Law prescribes substantially the same process with respect to the liquidation of a Connecticut-licensed branch, which is undertaken by the Commissioner under the supervision of the Superior Court for the Judicial District of Hartford. 47 As provided in Section 4(j)(1) of the IBA, the receiver for a federal branch appointed by the Comptroller shall... exercise the same rights, privileges, powers and authority with respect to the [property and assets of the foreign bank in the United States that come into the possession of the receiver upon appointment] as are now exercised by receivers of national banks appointed by the Comptroller. The receivership provisions for national banks are set forth at 12 U.S.C The Comptroller is required by 12 U.S.C. 191to appoint the FDIC as receiver for an insured federal branch (as well as in the case of an insured national bank), but has considerable discretion in appointing the receiver for an uninsured federal branch. 48 As discussed above, we are not aware of any instance in which a federal branch has been placed in receivership and so there is no practical guidance regarding whom the Comptroller would appoint receiver for an uninsured 45 In New York, the Supreme Court is the lowest level state court (comparable to a U.S. federal district court), and the New York Court of Appeals stands at the highest level (comparable to the U.S. Supreme Court). In the case of the liquidation of a New York-licensed branch, the New York Supreme Court for New York County oversees the process. 46 Section 618.1(a)(ii) of the New York Banking Law expressly permits the Superintendent, with the approval of the court, to compromise claims against [the branch], other than deposit claims (emphasis added). 47 See the following provisions of the Connecticut Banking Law: Section 36a428n(c) (appointment and supervision of Commissioner as receiver for the branch by the Superior Court; Commissioner conducts the receivership in accordance with the provisions of the Connecticut Banking law applicable in circumstances where the Commissioner is appointed receiver of a Connecticut-chartered bank); Section 36a-223(d)(2) (authority of Commissioner to compromise any claim, other than a deposit claim (emphasis added); Sections 36a-225 and 237f (procedures for submission and proof of claims); and Section 36a-237 (payment of claims). 48 See OCC Interpretive Letter no. 768 (October 4, 1995) (response by the OCC s Chief Counsel to a request for guidance regarding treatment of insured and uninsured federal branches in receivership), available at the following link on the OCC s web site: 17

18 federal branch. It is clear, however, that any such receiver acts as the agent of, and subject to direction and control by, the Comptroller See OCC Interpretive Letter no. 733 (June 19, 1996) (response by the OCC s Chief Counsel to a request for guidance regarding treatment of uninsured federal branches in receivership), available at the following link on the OCC s web site: 18

19 APPENDIX 1: COMPOSITION OF FOREIGN BANKS U.S. BRANCH AND AGENCY OPERATIONS Type of Licensed Office Total number Number and % Licensed by or Located in NY Total Assets (millions) % Held by Offices Licensed by or Located in NY Uninsured Branch State-Licensed (64%) 1,783,939 87% OCC-Licensed (63%) 196,611 92% Agency State-Licensed (32%) 170,830 88% OCC-Licensed 1 1 (100%) % Grandfathered FDIC-Insured Branch State-Licensed 6 4 (66%) 30,402 93% OCC-Licensed 4 4 (100%) 35, % TOTAL ASSETS (millions) -- $2,218,072 % held by uninsured state-licensed offices 88% % held by uninsured OCC-licensed offices 9% % held by grandfathered FDC-insured offices 3% % held by all offices licensed by or located in NY 88% SOURCE: Federal Reserve Structure Data as of March 31, 2013, available at: 19

20 APPENDIX 2: FOREIGN BANKS PRINCIPAL U.S. BRANCH OPERATIONS OUTSIDE NEW YORK State Number of Branches Total Assets (millions) Total Assets As % of Total U.S. Branch/Agency Assets California State-Licensed OCC-Licensed TOTAL , ,234 1% Connecticut State-Licensed OCC-Licensed , < 3% Florida State-Licensed OCC-Licensed TOTAL 7 4 8,692 1,690 10,382 < 0.5% Illinois State-Licensed OCC-Licensed TOTAL ,747 1,438 89,185 4% Texas State-Licensed OCC-Licensed , < 3% NOTES: The deposits in one California-licensed branch and one Illinois-licensed branch are insured by the FDIC. The deposits in all other branches reported above are not insured by the FDIC. SOURCE: Federal Reserve Structure Data as of March 31, 2013, available at: 20