On November 18, 2014, the Federal Deposit Insurance Corporation (the “FDIC”) published a final rule (the “Final Rule”) modifying certain elements of its deposit insurance assessment system for insured depository institutions (“IDIs”). The Final Rule amends the FDIC’s 2011 revised methodology for determining insurance assessment rates both for large institutions and for highly complex institutions (the “2011 Assessments Rule”)—the so-called “scorecard” method that is currently used to calculate assessment rates for these institutions. The Final Rule indicates that it is intended to align the deposit insurance assessment system for all IDIs—including advanced approaches banking organizations—with the standardized approach (the “Standardized Approach”) under the new U.S. Basel III-based revised capital rules (the “U.S. Basel III Capital Rules”), which were adopted by the Federal banking agencies in 2013.
The scorecards for both large and highly complex institutions introduced in the 2011 Assessments Rule use quantitative measures in attempting to predict a large institution’s long-term performance. The scorecard for highly complex institutions, however, includes additional measures, such as (i) the ratio of top 20 counterparty exposures to Tier 1 capital and reserves and (ii) the ratio of the largest counterparty exposure to Tier 1 capital and reserves. The methodology used to calculate exposure is the sum of exposure at default associated with derivatives trading and securities financing transactions (“SFTs”) and the gross lending exposure for each counterparty or borrower.
Although the Final Rule largely adopts the FDIC’s rule as originally proposed (the “Proposed Rule”), the Final Rule includes the following modifications in response to comments received by the FDIC:
- Allows highly complex institutions to reduce their scorecard counterparty exposure amount associated with derivative transactions by the amount of cash collateral that is all or part of variation margin that satisfies the same conditions that would allow such collateral to be excluded
from the institution’s total leverage exposure for purposes of the U.S. supplementary leverage ratio. This calculation, however, differs from the applicable methodology in the Standardized Approach, which permits other types of collateral to reduce an institution’s derivative counterparty exposure.
- Provides that any changes to the conversion of the counterparty exposure measures to scores (that is, recalibration of the minimum and maximum cut-off values) will be done through a future notice-and-comment rulemaking. The minimum and maximum cut-off values are used to scale the exposure measures across highly complex institutions so that an institution’s score is determined relative to other highly complex institutions. The FDIC adjusts the minimum and maximum cut-off values as it collects additional data that affect what the cut-off values should be. For example, as exposures to central counterparties (“CCPs”) increase, the existing cut-off values, which were established before clearing mandates came into effect, may need to be adjusted. The FDIC continues to reserve the general right to update the minimum and maximum
cut-off values for all other measures in the scorecards without additional notice-and-comment rulemaking.
- Allows custodial banks to continue to deduct from their assessment base certain securitization exposures that have a risk weight of 20% under the Standardized Approach. The Proposed Rule would not have permitted custodial banks to deduct any assets that qualify as securitization exposures from the assessment base.
The Final Rule largely rejects the comments received, in particular with respect to better aligning the proposal with actual economic risk, and thereby continues to shift the burden of deposit premium assessments to the largest banks. In particular, the Final Rule continues to require exposures to non-U.S. sovereigns, affiliates and CCPs, including default fund contributions to CCPs, to be included as counterparty exposures. In addition, the Final Rule, consistent with the Proposed Rule, eliminates the internal model method (“IMM”) option for measuring counterparty exposure. The rejection of the previously adopted more risk sensitive IMM for these purposes, even when the models involved would require regulatory approvals, underscores the growing skepticism of some in the regulatory community of models-based approaches.
Except as noted above, the Final Rule is consistent with the Proposed Rule. Specifically, the Final Rule revises the ratios and ratio thresholds for “well-capitalized,” “adequately capitalized,” and “undercapitalized” evaluation categories used in the FDIC’s risk-based deposit insurance assessment
system to conform to the prompt corrective action (“PCA”) capital ratio thresholds adopted by the Federal banking agencies as part of the U.S. Basel III Capital Rules. Additionally, the Final Rule expands the category of liquid assets that a custodial bank may deduct from its total average consolidated assets at 50% to include those assets with a Standardized Approach risk weight greater than 0% and up to and including 20%, in order to include cleared transactions with Qualified Central Counterparties, which carry 2% or 4% risk weights. Custodial banks may continue to deduct 100% of liquid assets with a Standardized Approach risk weight of 0%.
The Final Rules will be effective on January 1, 2015, except with respect to the supplementary leverage ratio equivalent PCA requirement, which does not become effective until January 1, 2018, the effective date under the U.S. Basel III Capital Rules.
 FDIC, Assessments (Nov. 18, 2014), available at https://www.fdic.gov/news/board/2014/2014-11-18_notice_dis_a_fr.pdf.
 76 Fed. Reg. 10,672 (February 25, 2011). The FDIC amended Part 327 in a subsequent final rule by revising some of the definitions used to determine assessment rates for large and highly complex insured depository institutions. 77 Fed. Reg. 66,000 (Oct. 31, 2012). The term “2011 Assessments Final Rule” includes the October 2012 final rule. Under the 2011 Assessments Final Rule, a “large institution” generally is an IDI with assets of $10 billion or more and a “highly complex institution” generally is an IDI (i) with assets of $50 billion or more that is controlled by a holding company with assets of $500 billion or more or (ii) that is a processing bank or trust company with assets of $10 billion or more and fiduciary assets of $500 billion or more. The Final Rule does not change those definitions.
 The “U.S. Basel III Capital Rules” refer to those rules issued by the Federal banking agencies that replace the agencies’ Basel I-based generally applicable risk-based capital rules. Among other things, the U.S. Basel III Capital Rules create the Standardized Approach for non-advanced approaches banking organizations to measure credit risk, which is based in substantial part upon the Basel II standardized approach capital rules that were never adopted for U.S. banking organizations. Additionally, under section 171 of the Dodd-Frank Act—the so-called “Collins Amendment”—this generally applicable standardized approach serves as a risk-based capital floor for banking organizations subject to the advanced approaches risk-based capital rules. Under the U.S. Basel III Capital Rules effective January 1, 2015, the minimum capital requirements as determined by the regulatory capital ratios based on the standardized approach become the “generally applicable” capital requirements under the Collins Amendment.
 The FDIC adopted an interim final rule on September 7, 2013 and published a final rule on April 14, 2014 that, in part, revised the definition of regulatory capital. 78 Fed. Reg. 55,340 (Sept. 10, 2013) and 79 Fed. Reg. 20,754 (Apr. 14, 2014). The Federal Reserve and OCC adopted a final rule in October 2013 that is substantially identical to the FDIC’s interim final rule and final rule. 78 Fed. Reg. 62,018 (Oct. 11, 2013).
 Sullivan & Cromwell LLP, Deposit Insurance Assessment System: FDIC Proposes Changes to Ratios and Ratio Thresholds to Align the Deposit Insurance System with U.S. Basel III Capital Rules (July 21, 2014), available at http://sullcrom.com/deposit-insurance-assessment-system.
 See, e.g., Letter from The Clearing House to the FDIC (Sept. 22, 2014), available at https://www.fdic.gov/regulations/laws/federal/2014/2014-assessments-c_03.pdf.
 In general, the conditions are that: (1) for derivative contracts that are not cleared through a Qualified Central Counterparty, the cash collateral received by the recipient counterparty is not segregated (by law, regulation or an agreement with the counterparty); (2) variation margin is calculated and transferred on a daily basis on the mark-to-fair value of the derivative contract; (3) the variation margin transferred under the derivative contract or the governing rules for a cleared transaction is the full amount that is necessary to fully extinguish the net current credit exposure to the counterparty of the derivative contract, subject to the threshold and minimum transfer amounts applicable to the counterparty under the terms of the derivative contract or the governing rules for a cleared transaction; (4) the variation margin is in the form of cash in the same currency of settlement set forth in the derivative contract, provided that for the purposed of this paragraph, currency of settlement means any currency for settlement specified in the governing qualifying master netting agreement and the credit support annex to the qualifying master netting agreement, or in the governing rules for a cleared transaction; (5) the derivative contract and the variation margin are governed by a qualifying master netting agreement between the legal entities that are the counterparties to the derivative contract or by the governing rules for a cleared transaction, and the qualifying master netting agreement or the governing rules for a cleared transaction must explicitly stipulate that the counterparties agree to settle any payment obligations on a net basis, taking into account any variation margin received or provided under the contract if a credit event involving either counterparty occurs; (6) the variation margin is used to reduce the current credit exposure of the derivatives contract and not the potential future exposure; and (7) for the purpose of the calculation of the net-to-gross ratio, variation margin may not reduce the net current credit exposure or the gross current credit exposure. See 12 C.F.R. § 324.10(c)(4)(ii)(C)(1)-(7) (FDIC); 12 C.F.R. § 3.10(c)(4)(ii)(C)(1)-(7) (OCC); and 12 C.F.R. § 217.10(c)(4)(ii)(C)(1)-(7) (Federal Reserve). “Qualified Central Counterparties” are central counterparties that meet the standards established by the Committee on Payment and Settlement Systems (CPSS) and International Organization of Securities Commissions (IOSCO). See 78 Fed. Reg. at 62,097 and 78 Fed. Reg. at 55,414.
 Section 38 of the Federal Deposit Insurance Act (the “FDIA”) directs the Federal banking agencies to take “prompt corrective action” to resolve the problems of IDIs at the least cost to the Deposit Insurance Fund. The five PCA categories under Section 38 of the FDIA are: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized,” and the FDIC is required to take certain actions (such as limits on capital distributions) if an IDI becomes undercapitalized. The Federal banking agencies have established capital thresholds for each of the PCA categories using the following capital measures: leverage ratio, Tier 1 risk-based capital ratio, total risk-based capital ratio, and common equity Tier 1 capital ratio. Additionally, the PCA leverage measure for advanced approaches IDIs includes the supplementary leverage ratio. 12 C.F.R. § 208.43.
 See 78 Fed. Reg. 62,184-85 and 78 Fed. Reg. 55,502.
The full and original memo was published by Sullivan and Cromwell on November 24, 2014 and is available here.