The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which became law on May 24, contains the first major package of revisions to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Act leaves the architecture and core features of Dodd-Frank intact but significantly recalibrates applicability thresholds. While the changes mandated by the Act are significant, it also places significant discretion for further changes in the hands of the Federal Reserve Board.
Both the House of Representatives and the Senate passed the Act on bipartisan votes. The Chairman of the House Financial Services Committee and the Senate Majority Leader have signaled a commitment to take up additional regulatory relief legislation that would make further changes to Dodd-Frank. Whether additional legislation would garner the bipartisan support ultimately required for passage remains to be seen.
Most of the Act’s reforms reduce burdens on mid-size and smaller banks and bank holding companies. Significantly, the Act raises the asset threshold for application of Dodd-Frank’s enhanced prudential standards from $50 billion to $250 billion, thereby exempting a number of smaller and regional institutions from stress testing, resolution planning and heightened risk management requirements, among other things. In other significant changes, banks and bank holding companies with assets of $10 billion or less are exempt from the Volcker Rule, and could be exempt from risk-based capital rules if they maintain a high “community bank leverage ratio”.
As with Dodd-Frank, the ultimate effect and scope of the Act will depend significantly on how it is implemented by the Federal Reserve Board and other bank regulators. Our companion Alert Memorandum analyzes key implementation considerations, including highlighting a number of regulations for which the regulatory agencies, and in particular the Federal Reserve Board, will likely need to reconsider applicability, scope and thresholds.
Enhanced Prudential Standards
The Act makes significant changes to the enhanced prudential standards (“EPS”) provisions of Dodd-Frank. EPS include heightened capital, liquidity and risk management standards, as well as resolution planning requirements, mandatory stress testing and single counterparty credit limits, for large bank holding companies (“BHCs”) and foreign banking organizations (“FBOs”).
The Act also enhances the Federal Reserve Board’s (“FRB”) discretion to tailor EPS standards to BHCs and FBOs based on their risk profile.
- Increased Asset Thresholds
$250 Billion EPS Threshold
- Among the Act’s most significant reforms is a substantial increase in the threshold for subjecting a BHC to EPS. The Act raises the threshold from $50 billion in total consolidated assets to $250 billion, with staggered effective dates.
- BHCs with less than $100 billion in assets are immediately exempt from EPS.
- BHCs with between $100 billion and $250 billion in assets are exempt 18 months following enactment.
- The FRB is authorized to accelerate the off-ramp for BHCs with total assets between $100 billion and $250 billion during the 18-month transition period.
- The FRB retains discretion to apply any or all EPS to BHCs below $250 billion in total consolidated assets.
- The FRB would need to determine that application of the EPS is appropriate to prevent or mitigate risks to U.S. financial stability or to promote the safety and soundness of the BHC (or group of BHCs), after taking into consideration capital structure, riskiness, complexity, financial activities, size and any other risk-related factors that the FRB deems appropriate.
- A BHC that qualifies as a Global Systemically Important Bank (“GSIB”), under the FRB’s systemic indicator score remains subject to the most stringent EPS, regardless of its asset size.
- The FRB’s systemic indicator score aligns with the Basel capital framework’s methodology for identifying GSIBs and takes into account size, interconnectedness, substitutability, complexity and cross-jurisdictional activity.
- There are currently 8 U.S. GSIBs: JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs, Wells Fargo, Morgan Stanley, State Street, and Bank of New York Mellon.
OCC and FDIC Regulatory EPS for Subsidiary Banks
- Many of the changes in the Act amend provisions of Dodd-Frank that apply at the BHC or FBO level, and not to subsidiary national banks or other insured depository institutions (“IDIs”). The Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”) have adopted their own counterparts to some EPS for the bank subsidiaries that they regulate, including recovery and resolution planning. A key consideration will be whether the OCC and the FDIC take similar measures under their regulations and guidance to align asset thresholds with what is reflected in the Act.
- For example, the FDIC may have a different focus in evaluating thresholds for resolution planning as applied to mid-size IDIs. Regulatory changes at the bank subsidiary level will remain an area to watch. The FDIC is responsible for bank resolutions irrespective of the asset threshold or systemic importance of the bank, and the FDIC historically has been concerned about complications in resolving banks smaller than $100 billion. As a result, while a new Board and Chairman may consider simplifying the resolution planning requirements for some banks below the proposed BHC thresholds, it is unlikely that the FDIC will eliminate resolution planning requirements for those banks entirely.
- At both the OCC and FDIC, regulatory changes at the bank subsidiary level will remain an area to watch.
- Recalibration of Stress Testing Requirements
Supervisory Stress Tests
- BHCs with more than $250 billion in total consolidated assets remain subject to annual supervisory stress tests, although the Act reduces the number of stress test scenarios from three to two by eliminating the “adverse” scenario (leaving only the “baseline” and “severely adverse” scenarios).
- Eighteen months after enactment, BHCs with total consolidated assets between $100 billion and $250 billion would be subject to periodic supervisory stress tests to evaluate whether they have capital sufficient to absorb losses under adverse economic conditions. The frequency of these periodic tests remains to be determined.
- BHCs with less than $100 billion in total consolidated assets are longer be subject to capital stress testing.
Company-Run Stress Tests
- The Act exempts all banking organizations—including not only BHCs, but also depository institutions and savings and loan holding companies (“SLHCs”)—with less than $250 billion in total consolidated assets from the current requirement to conduct company-run stress tests.
- Banking organizations with $250 billion or more in total consolidated assets are still required to conduct company-run stress tests on a periodic basis but are no longer be required to do so on a semi-annual or annual basis.
- Consistent with the proposed changes to the supervisory stress tests, the Act also reduces the number of scenarios for the company-run stress tests from three to two.
- Foreign Banking Organizations
Asset Thresholds: The Act generally applies the asset-based thresholds to domestic BHCs and FBOs similarly.
- FBOs are treated as BHCs for purposes of the EPS requirements, and the increase in asset thresholds for domestic BHCs applies to FBOs. However, the FRB has interpreted the Dodd-Frank asset threshold to apply to FBOs based on their global assets, rather than U.S. assets, and the Act appears not to change that approach.
Intermediate Holding Companies of FBOs
- Under a rule of construction for FBOs, nothing in the Act may be construed to: (1) affect the legal effect of the FRB’s intermediate holding company (“IHC”) rules as applied to FBOs with $100 billion or more of total consolidated assets, or (2) limit the FRB’s authority to require the establishment of an IHC, impose EPS, or tailor regulation of an FBO with $100 billion or more of total consolidated assets.
- The existing IHC asset threshold is $50 billion in U.S. non-branch assets. Any revisions to the threshold must be made by the FRB amending its regulations (since the threshold, like the IHC requirement itself, was created by the FRB and was not a feature of Dodd-Frank).
- Credit Exposure Reports
The Act amends Dodd-Frank to authorize, instead of require, the FRB to promulgate rules regarding BHCs’ reporting of credit exposure to the FRB, the Financial Stability Oversight Council (“FSOC”) and the FDIC. The FRB had proposed credit exposure reporting requirements in connection with its resolution planning rulemaking, but it never finalized those requirements pending completion of its single-counterparty credit limit rules.
The Act eliminates assessments on BHCs with less than $250 billion in total assets to fund expenses of the Office of Financial Research.
Regulatory Capital and Liquidity Requirements
- Supplementary Leverage Ratio
The Act requires the federal banking agencies to amend the Supplementary Leverage Ratio (“SLR”) to exempt from the SLR denominator funds on deposit with certain central banks for BHCs and their subsidiaries that are “predominantly engaged in custody, safekeeping and asset servicing” activities, provided that the funds are less than or equal to deposits linked to fiduciary, custodial or safekeeping accounts.
- The large custody banks have argued that cash they hold on deposit at the FRB in connection with their trust and fiduciary businesses should not result in SLR capital requirements. Other large banking organizations have argued to exclude cash from the SLR calculation more broadly, but the Act takes a narrower approach.
- This provision causes the U.S. SLR to diverge from the Basel leverage framework in its treatment of central bank deposits. While the so-called “Basel IV” revisions of December 2017 allow for national discretion to exempt central bank reserves from the leverage ratio exposure measure, the exemptions are permitted only temporarily and in exceptional macroeconomic circumstances, and they must be accompanied by a corresponding increase in the calibration of the minimum leverage ratio to offset the impact of exempting central bank reserves.
- The Federal Reserve has indicated that the Act likely will result in a recalibration of its proposed revision to the enhanced SLR. See 83 Fed. Reg. 17317 (Apr. 19, 2018).
- Liquidity Coverage Ratio
The Act requires the banking agencies to amend their liquidity coverage ratio (“LCR”) rules to permit more favorable treatment of municipal bonds—as Level 2B high quality liquid assets (50% haircut)—so long as the bonds are liquid, readily-marketable and investment grade.
- The FRB amended its LCR rule in 2016 to permit certain municipal securities to be treated as level 2B assets, subject to a number of limitations in addition to the requirements in the Act. However, the OCC and the FDIC have not adopted or proposed similar amendments.
- Risk Weight for Certain High-Risk Real Estate Loans
The Act prohibits federal banking agencies from assigning heightened risk weights to high volatility commercial real estate (“HVCRE”) exposures, unless the exposures are classified as HVCRE acquisition, development, and construction loans.
Currently, a 150% risk weight applies to loans classified as HVCRE under the U.S. capital rules. The federal banking agencies issued a proposal in September 2017 to simplify the treatment of HVCRE and to create a new category of commercial real estate loans—“high-volatility acquisition, development or construction” (“HVADC”) exposures—with a lower risk weight of 130%.
- The most significant difference between the Act and the agencies’ HVADC proposal arises from the Act’s preservation of the exemption for projects where the borrower has contributed at least 15% of the real property’s appraised “as completed” value. The agencies’ HVADC proposal would have eliminated this exemption in the interest of simplification.
Banks and BHCs with (1) $10 billion or less in total consolidated assets and (2) total trading assets and liabilities of 5% or less of total consolidated assets are exempt from the Volcker Rule.
Any banking entity may share its name with a hedge fund or private equity fund for which it serves as an investment adviser, provided that (1) the investment adviser is not, and does not share a name with, an IDI, a company that controls an IDI, or an FBO, and (2) the name does not contain the word “bank.”
Although not related to the Volcker Rule amendments in the Act, a provision designed to provide relief for certain small venture capital funds has Volcker Rule implications. The Act expands the exemption from the definition of “investment company” under Section 3(c)(1) of the Investment Company Act of 1940 (the “Investment Company Act”) for venture capital funds that have fewer than 250 investors and $10 million or less in capital commitments. This has the possibly unintended consequence of sweeping these funds into the scope of the Volcker Rule, since the agencies’ definition of “covered funds” uses the Section 3(c)(1) exemption as a baseline definition.
Acquisitions of Interests in Nonbanks
As amended by the Act, Dodd-Frank requires FHCs with assets of $250 billion or more (up from $50 billion or more) to obtain prior FRB approval if the non-bank target engaged in Gramm-Leach-Bliley Act “financial in nature” activities has assets of more than $10 billion.
- Capital Rules
Banks and BHCs that have less than $10 billion in total consolidated assets and that maintain a “community bank leverage ratio” (defined as tangible equity capital to average total consolidated assets) of at least 8-10% are exempt from U.S. risk-based capital rules imposed under Basel III and the generally applicable leverage ratio and would be deemed well-capitalized.
- The federal banking agencies maintain discretion to disqualify banks and BHCs from this relief if they determine the relief is not appropriate to the bank’s or BHC’s risk profile.
The threshold for qualifying for the FRB’s “Small Bank Holding Company Policy Statement” is increased from $1 billion to $3 billion, provided the small BHC or SLHC is not engaged in significant non-banking activities, is not engaged in significant off-balance sheet activities and does not have a material amount of debt or equity registered with the Securities and Exchange Commission (the “SEC”).
- Risk Committee
The Act raises the total asset threshold from $10 billion to $50 billion for the Dodd-Frank risk committee requirement for publicly traded BHCs, although the FRB retains discretion to require a risk committee at smaller institutions.
- Savings Association Election to Operate as a National Bank
Federal savings associations with total consolidated assets of $20 billion or less have the option to operate as national banks and to have the same privileges and duties as national banks without converting their charters.
Real Estate and Mortgage Lending
- Mortgage Lending Requirements for Small Banks
Certain mortgage loans that are (1) originated by an IDI or an insured credit union with less than $10 billion in total consolidated assets, (2) held in portfolio, and (3) satisfy certain other criteria are deemed to satisfy the Truth in Lending Act’s “ability to repay” requirements and therefore be treated as “qualified mortgages.”
The Act directs federal banking agencies to issue regulations exempting certain IDIs and insured credit unions with assets of $10 billion or less from the requirement to establish escrow accounts in connection with certain residential mortgage loans.
Certain mortgage loans of $400,000 or less made with respect to property in rural areas are exempt from appraisal requirements under the Financial Institutions Reform, Recovery, and Enforcement Act, provided that the originator makes a good faith effort to find a state-certified or state-licensed appraiser and is unable to do so.
- Home Mortgage Disclosure Act Reporting
IDIs and insured credit unions that originated fewer than 500 closed-end mortgage loans or 500 open-end lines of credit in each of the two preceding years are exempt from a subset of disclosure requirements (recently imposed by the Consumer Financial Protection Bureau (“CFPB”)) under the Home Mortgage Disclosure Act (“HMDA”), provided they have received certain minimum Community Reinvestment Act ratings in their most recent examinations.
The Act also directs the Comptroller General to conduct a study assessing the effect of the exemption described above on the amount of HMDA data available at the national and local level.
The Act provides a limited exemption from treatment as “brokered deposits” for certain “reciprocal deposits” placed by an IDI through a deposit placement network. Reciprocal deposits of an agent institution are not considered to be brokered deposits up to the lesser of $5 billion or 20% of the IDI’s total liabilities, provided that the IDI (1) has an “outstanding or good” composite condition examination rating and is well capitalized, (2) has obtained a waiver, or (3) if it has a rating less then outstanding or good, or is less than well-capitalized, the reciprocal deposits received do not exceed certain average amounts held prior to receiving a rating or capital downgrade.
- Investment Company Act Exemptions
Venture capital funds with less than $10 million in capital commitments and fewer than 250 investors may rely on the exemption from the definition of “investment company” in Section 3(c)(1) of the Investment Company Act.
The Act eliminates the Section 6(a)(1) exemption from registration under the Investment Company Act for companies organized under the laws of Puerto Rico and the U.S. territories.
- State Blue Sky Laws
The Act expands the federal exemption from state Blue Sky Laws to cover securities qualified for trading in the national market system, rather than those listed on a limited number of specified exchanges.
- Algorithmic Trading
The Act directs the SEC to conduct a study on the costs and benefits of algorithmic trading and to make a recommendation about whether the SEC should change any of its regulations based on its analysis and, if so, whether it needs additional legal authorities or resources.
- Closed-End Funds
The Act directs the SEC to issue rules permitting publicly listed closed-end funds to use the securities offering and proxy access rules available to other issuers and to consider the disclosures necessary to treat such funds as well-known seasoned issuers.
Consumer Financial Protection
- Identity Theft, Fraud, and Exploitation
The Act institutes a number of consumer protection reforms, including measures targeting identity fraud, permitting consumers to place freezes on their credit reports without charge, and providing protection for whistleblowers who report the exploitation of senior citizens by financial institutions.
- Student Loans
Private student loan borrowers and co-signors are protected by a number of measures that generally prohibit counting the bankruptcy or default of a borrower or co-signor as an event of default. Government-funded loans are not be affected.
The Act eases requirements for private student loan borrowers to remove defaults from consumer credit reports if they participate in loan rehabilitation programs offered by lenders.
The Act directs the Secretary of the Treasury to issue a report assessing the threat of cyber-attacks on U.S. financial institutions, evaluating current efforts to address such risks, and recommending additional legal authorities or resources for financial regulatory agencies.
What the Act Does Not Cover
- It does not alter the CFPB’s authorities, governance structure, or appropriations.
- It does not change the composition or role of FSOC.
- It leaves intact core elements of Dodd-Frank adopted in response to the financial crisis, such as the resolution planning process, the orderly liquidation authority, FSOC’s authority to designate nonbanks as systemically important financial institutions, and the power to force troubled BHCs to divest certain assets if they pose a grave threat to financial stability.
This post comes to us from Cleary, Gottlieb, Steen & Hamilton LLP. It is based on the firm’s memorandum “Financial Regulatory Relief Enacted,” dated May 24, 2018, and available here.