Yesterday afternoon, Senate Banking Committee Chairman Richard Shelby (R-AL) released a discussion draft of “The Financial Regulatory Improvement Act of 2015” (the “Discussion Draft”). This proposed legislation would significantly amend certain aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), in particular the current regulatory framework for designating and regulating so-called systemically-important financial institutions, or “SIFIs.” In addition, the 216-page Discussion Draft would substantially broaden the Dodd-Frank safe harbor for “qualified mortgages” and includes a number of other notable provisions relating to the regulation of insurance companies, the structure and operation of the Federal Reserve System, and housing finance, among other matters.
In a statement accompanying the release of the Discussion Draft, Chairman Shelby described it as a “working document intended to initiate a conversation with all members of the Committee who are interested in reaching a bipartisan agreement to improve access to credit and to reduce the level of risk in [the] financial system.” The Committee’s Ranking Minority Member, Sen. Sherrod Brown (D-OH), issued a statement maintaining that, “[r]ather than focusing on issues that enjoy bipartisan support,” the Discussion Draft is a “sprawling industry wish list of Dodd-Frank rollbacks,” but he pledged to “work with Republicans . . . to provide small financial institutions the help they need without undermining important financial safeguards.” Similarly, the Treasury Department commented that the Discussion Draft “appears to roll back and undermine significant portions of Wall Street reform,” but stated that Treasury “stand[s] ready to work with the Committee on targeted efforts that would strengthen reforms, building on the tiered and tailored regulatory framework established by [Dodd-Frank].” The Committee is scheduled to hold a mark-up of the legislation on May 21, 2015.
DISCUSSION DRAFT
This memorandum is based on our preliminary review of the legislative text and the accompanying section-by-section summary, also released yesterday by Chairman Shelby’s staff. Key provisions of the Discussion Draft include:
- Revisions to Dodd-Frank’s $50 Billion “SIFI Threshold”: Perhaps most notably, the Discussion Draft would amend the current $50 billion statutory asset threshold, codified in Sec. 165 of Dodd-Frank, under which bank holding companies (“BHCs”), including foreign banking organizations that are treated as BHCs under the International Banking Act of 1978, are subject to “enhanced prudential standards” and SIFI regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).[1] Specifically, the current $50 billion BHC threshold for “automatic” SIFI regulation would be raised to $500 billion. Any BHC with total consolidated assets equal to or greater than $50 billion but less than $500 billion would have to be individually designated by the Financial Stability Oversight Council (the “FSOC”) to become subject to the full range of Sec. 165 enhanced prudential standards. This designation would be based on criteria that include size, interconnectedness, substitutability, cross-border activity, and complexity.[2] Importantly, however, these $50B – $500B BHCs would remain subject to the Dodd-Frank risk committee and company-run stress testing (“DFAST”) requirements[3] and would not automatically be exempt, by virtue of the legislation, from the Federal Reserve’s CCAR capital planning rule. In addition, because the intermediate holding company (“IHC”) requirement in the Federal Reserve’s Enhanced Prudential Standards for Foreign Banking Organizations was not tied to a particular provision in Dodd-Frank, that requirement would appear to continue to apply, unless modified by the Federal Reserve. The FSOC would be required to provide any BHC under review for possible designation with (1) a “detailed explanation” for any proposed or final designation, (2) opportunities to meet with FSOC members and staff, and (3) the opportunity to submit a “remedial plan” prior to final designation. Although the Discussion Draft would authorize the Federal Reserve to recommend that the FSOC evaluate a particular BHC for designation, the FSOC could also initiate the process on its own. The FSOC would be required to reevaluate existing BHC SIFI designations at least once every five years or at the request of the Federal Reserve. BHCs with more than $500 billion in total consolidated assets would not be subject to this reevaluation requirement.
- Nonbank Financial Company SIFI Designations: Although the increase in the BHC SIFI threshold would not establish an asset floor for the designation of “nonbank financial companies” (such as savings and loan holding companies (“SLHCs”), insurance companies, and asset managers, among others), the Discussion Draft would introduce a number of modifications intended to provide “greater transparency” regarding the FSOC’s nonbank financial company designation process. Among other things, the FSOC would be required to provide companies under consideration for designation with greater information during the review process (including the opportunity to submit a “remedial plan”) and afford the company’s primary regulator an opportunity to “assess and respond to [the FSOC’s] analysis of the company and take regulatory action, if appropriate” in lieu of designation. The FSOC would be required to vote annually on whether to rescind a company’s designation and, if it chose not to rescind the designation, would be required to provide the company with “meaningful information about why [the company] should continue to be designated, why any remedial plan submitted is unsatisfactory, and what the company can do to no longer be designated.” In addition, at least once every five years, the FSOC would have to provide a designated company the opportunity to appear at a hearing to contest its designation, after which the FSOC would be required to vote to renew the designation. In the absence of such a vote, the company’s SIFI designation would be automatically rescinded.
- Federal Reserve: The Discussion Draft includes a number of provisions addressing the operations and structure of the Federal Reserve System, including the required submission of quarterly monetary policy reports to Congress by the Federal Open Market Committee. In addition, the Federal Reserve would be required to vote, on a non-delegable basis, on “whether to settle any civil money penalty assessment order or other enforcement action if the settlement of such order or action involves the payment” of more than $1 million and to “promptly post the results of such votes” on the Federal Reserve’s website. The proposal would also authorize each Federal Reserve Board Governor to hire a “maximum of four staff members to serve and advise such governor”; require that the President of the Federal Reserve Bank of New York be appointed by the president and confirmed by the Senate; and establish an “independent commission” to conduct a study and make recommendations to Congress on “whether it is appropriate to restructure the Federal Reserve districts, including an analysis on potential benefits and costs of restructuring.” Moreover, the Government Accountability Office would be directed to assess the “effectiveness” of the Federal Reserve’s supervision of both BHC SIFIs and nonbank SIFIs in order to “best address systemic risk and prevent regulatory capture,” while the Federal Reserve would be charged with conducting a study and preparing a report to Congress every two years on its plan to “regulate and supervise nonbank institutions.”
- Insurance Regulation: The Discussion Draft includes several provisions relating to the regulation of the insurance industry, including a “[s]ense of the Congress that the McCarran-Ferguson Act . . . remains the preferred approach to regulating the business of insurance.” It also contains provisions, which are substantively identical to legislation recently introduced by Senators Dean Heller (R-NV) and Jon Tester (D-MT), that would (1) establish, within the Federal Reserve, a new “Insurance Policy Advisory Committee on International Capital Standards and Other Insurance Issues”; (2) require the Federal Reserve and Treasury Department to issue an annual report to Congress on global insurance regulatory activities at “global insurance or international standard-setting regulatory or supervisory forums”; and (3) direct the Federal Reserve, Treasury Department, and the Federal Insurance Office, in consultation with National Association of Insurance Commissioners, to complete a study on the impact on U.S. consumers and markets “before supporting or consenting to the adoption of any key elements in any international insurance proposal or international insurance capital standard.” Also included is a provision that would limit the circumstances in which an insurance company could be required to serve as a “source of strength” to its insured depository institution subsidiaries.
- Volcker Rule Exemption for Small Banks: Depository institutions with $10 billion or less in total consolidated assets and a CAMELS composite rating of 1 or 2 would be exempted from the Volcker Rule (Sec. 619 of Dodd-Frank).
- Mortgage Finance: The Discussion Draft contains a provision, originally authored by Senator Bob Corker (R-TN), that would prohibit the “sale, or other disposition, of preferred stock in Fannie Mae or Freddie Mac, by the U.S. Treasury, unless it is directed to do so by Congress.” In addition, the mortgage finance-related title would prohibit the use of increases in Fannie Mae or Freddie Mac guarantee fees to offset federal budgetary outlays or reductions in revenues for any purposes other than “enterprise business functions or housing finance reform as passed by the Congress in the future.”
- Regulatory Relief: Finally, Title I of the Discussion Draft includes a variety of “regulatory relief” proposals that would, among other things: (1) substantially broaden the scope of the Dodd-Frank “Qualified Mortgage” safe harbor to cover certain mortgages held in portfolio; (2) expand the availability of the 18-month exam cycle for smaller insured depository institutions; (3) require the federal financial regulators to “perform a comprehensive review of regulations to identify outdated or otherwise unnecessary regulatory requirements imposed on financial institutions”; and (4) establish in the Federal Financial Institutions Examination Council an Office of Examination Ombudsman to “investigate complaints concerning examinations, examination practices, or examination reports” and to “ensure that the written examination policies of the agencies are being followed in practice,” among other responsibilities.
Implications
As noted above, the Senate Banking Committee is expected to consider this legislation at a mark-up scheduled for May 21, although modifications are likely to be made to the Discussion Draft prior to the mark-up and/or during the Committee amendment process. We will continue to monitor this situation and provide additional information and analysis, as appropriate.
ENDNOTES
[1] The Sec. 165-mandated enhanced prudential standards include risk-based capital requirements and leverage limits, liquidity requirements, overall risk management requirements, supervisory stress-testing, resolution planning and credit exposure reporting, and concentration/credit exposure limits. Enhanced Prudential Standards for Bank Holding Companies and Foreign Banking Organizations, 79 Fed. Reg. 17240 (Mar. 27, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-03-27/pdf/2014-05699.pdf. See our Client Memorandum, “Enhanced Prudential Standards” for Large U.S. Bank Holding Companies and Foreign Banking Organizations, dated Feb. 24, 2014, available at http://www.sullcrom.com/siteFiles/Publications/SC_Publication_Enhanced_Prudential_Standards_for_Large_US_Bank_Holding_Companies_and_Fore.pdf.
[2] The Basel Committee on Banking Supervision, in its international framework for identifying global systemically-important banks, or “G-SIBs,” that are subject to a G-SIB capital surcharge, and the Federal Reserve, in its proposed rules to implement the G-SIB surcharge, apply these same criteria for identifying banking organizations as G-SIBs subject to the surcharge. See Basel Committee on Banking Supervision, Global systemically important banks: updated assessment methodology and the higher loss absorbency requirement, dated July 2013, available at http://www.bis.org/publ/bcbs255.pdf and Risk-Based Capital Guidelines: Implementation of Capital Requirements for Global Systemically Important Bank Holding Companies, 79 Fed. Reg. 75473 (Dec. 18, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-12-18/pdf/2014-29330.pdf.
[3] The Discussion Draft would raise the threshold for DFAST applicability from $10 billion to $50 billion in total consolidated assets.
The full and original memorandum was published by Sullivan & Cromwell on May 13, 2015 and is available here.