Other Federal Reserve Operations

Regulatory Developments: Dodd-Frank Act Implementation

Throughout 2013, the Federal Reserve continued to work diligently to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) (Pub. L. No. 111-203), which gives the Federal Reserve important responsibilities to issue rules and supervise financial companies to enhance financial stability and preserve the safety and soundness of the banking system. The Board also continued to implement various international frameworks developed under the auspices of the Basel Committee on Banking Supervision (BCBS).

The Board has issued a variety of final rules to implement the provisions of the Dodd-Frank Act and BCBS international frameworks that are designed to promote the safety and soundness of the banking system and enhance consumer financial protection. The following is a summary of the key regulatory initiatives that were completed during 2013.

The Volcker Rule: Prohibitions against Proprietary Trading and Other Activities

Section 619 of the Dodd-Frank Act generally prohibits insured depository institutions (IDIs) and their affiliates (collectively, banking entities) from engaging in proprietary trading or from investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund. These prohibitions and other provisions of section 619 are commonly known as the "Volcker rule."

On December 10, 2013, the Board--jointly with the Commodity Futures Trading Commission (CFTC), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and the Securities and Exchange Commission (SEC)--issued final rules to implement section 619. The final rules prohibit banking entities from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures, and options on these instruments for their own account. This prohibition is subject to exemptions for underwriting, market making-related activities, risk-mitigating hedging, activities of foreign banking entities solely outside the United States, and certain other activities.

The final rules also prohibit banking entities from acquiring or retaining an ownership interest in, or having certain relationships with, a hedge fund or private equity fund (covered fund), subject to exemptions for investments made in connection with organizing and offering a covered fund, including making and retaining de minimis investments in a covered fund, certain investments made on behalf of customers, activities of foreign banking entities solely outside the United States, and certain other activities.

The final rules require a banking entity to establish a compliance program designed to help ensure and monitor compliance with the prohibitions and restrictions of section 619 and the final rules. The compliance requirements vary based on the size of the banking entity and the size, scope, and complexity of activities conducted. The final rule requires banking entities with total assets greater than $10 billion and less than $50 billion to have a compliance program that includes six pillars (including written policies and procedures, internal controls, management framework and accountability, independent testing and audits, training, and recordkeeping). Banking entities with significant trading operations and banking entities with total assets of $50 billion or more will be required to establish a detailed compliance program, and their chief executive officers will be required to attest that the program is reasonably designed to achieve compliance with the final rule.

The final rules reduce the burden on smaller, less-complex institutions by limiting their compliance requirements. For a banking entity that has total assets of $10 billion or less that engages in some activity regulated under the final rule, the compliance program may be limited to appropriate references in existing compliance policies, appropriate to the activities, size, scope and complexity of the banking entity. A banking entity that does not engage in covered activities or investments (other than trading in certain government obligations) will not need to establish a compliance program.

The Dodd-Frank Act directs the Board to adopt rules governing the conformance period for section 619 and requires banking entities to conform their activities and investments by July 21, 2014, unless extended by the Board. On December 10, 2013, the Board extended the conformance period until July 21, 2015, to ensure effective compliance with the rules.

Integrated Regulatory Capital Framework

On July 2, 2013, the Board adopted a final rule (Regulation Q) that revises its risk-based and leverage capital requirements to implement the Basel III regulatory capital reforms and integrate the Board's capital rules into a comprehensive regulatory framework. The final rule was published jointly with the OCC, and the FDIC published a substantively identical interim final rule.

Under the final rule, minimum requirements increase for both the quantity and quality of capital held by all depository institutions, bank holding companies (BHCs) with total consolidated assets of $500 million or more, and savings and loan holding companies (SLHCs) that are not substantially engaged in commercial or insurance underwriting activities (collectively, banking organizations). Consistent with the BCBS international standard, the rule includes a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent, raises the minimum ratio of tier 1 capital to risk-weighted assets from 4 percent to 6 percent, and includes a minimum leverage ratio of 4 percent for all banking organizations. In addition, the rule requires a banking organization to hold a capital conservation buffer of common equity tier 1 capital in an amount greater than 2.5 percent of total risk-weighted assets to avoid limitations on capital distributions and discretionary bonus payments to executive officers. The final rule also incorporates the new and revised minimum requirements into the agencies' prompt corrective action framework.

In addition, for advanced approaches banking organizations (generally, the largest, most complex banking organizations), the final rule includes a new 3 percent minimum supplementary leverage ratio based on the BCBS international leverage standard that takes into account off-balance-sheet exposures. The rule also introduces a countercyclical capital buffer applicable to advanced approaches banking organizations to augment the capital conservation buffer during periods of excessive credit growth.

The final rule enhances the quality of banking organizations' regulatory capital through the establishment of standards based on common equity tier 1 capital--the most loss-absorbing form of capital--and the implementation of strict eligibility criteria for regulatory capital instruments. The final rule also improves the methodology for calculating risk-weighted assets to enhance risk sensitivity.

The final rule also establishes transition periods designed to provide sufficient time for banking organizations to meet the new capital standards while supporting lending. Under the final rule, the phase-in period for smaller, less complex banking organizations and all covered SLHCs begins in January 2015. The phase-in period for larger banking organizations that are not SLHCs began in January 2014.

Consistent with section 939A of the Dodd-Frank Act, the final rule removes references to, and reliance on, credit ratings from the Board's capital rules.

On December 6, 2013, the Board issued a final rule that makes technical changes to the market risk capital rule to align it with the Basel III revised capital framework. Technical changes to the rule reflect modifications by the Organisation for Economic Co-operation and Development regarding country risk classifications. The final rule also clarifies criteria for determining whether underlying assets are delinquent for certain traded securitization positions. It clarifies disclosure deadlines and modifies the definition of a covered position.

Stress Testing Requirements: Basel III Application and Transition Period

On September 24, 2013, the Board issued two interim final rules to clarify how companies should incorporate the Basel III regulatory capital reforms into their capital and business projections for capital plan submissions and their stress tests required under the Dodd-Frank Act.

The first interim final rule applies to BHCs with $50 billion or more in total consolidated assets. The rule clarifies that for the 2013-14 capital planning and stress-testing cycle, these companies must incorporate the revised capital framework into their capital planning projections and into the stress tests required under the Dodd-Frank Act using the transition paths established in the Basel III final rule. This rule also clarifies that for the 2013-14 cycle, capital adequacy at large banking organizations would continue to be assessed against a minimum 5 percent tier 1 common ratio calculated in the same manner as under previous stress tests and capital plan submissions, ensuring consistency with those previous exercises.

The second interim final rule provides a one-year transition period for most banking organizations with between $10 billion and $50 billion in total consolidated assets to incorporate the Basel III capital reforms into their stress tests. These companies conducted their first company-run stress test under the Board's rules implementing the Dodd-Frank Act during the fall of 2013. The interim final rule requires these companies to calculate their stress test projections in their 2013-14 stress tests using the Board's then-current regulatory capital rules to allow the firms time to adjust their internal systems to the revised capital framework.

Swaps Push-Out Provision Applicability to Uninsured U.S. Branches and Agencies of Foreign Banking Organizations

Section 716 of the Dodd-Frank Act, commonly referred to as the swaps push-out provision, prohibits the provision of certain kinds of federal assistance to IDIs and other institutions that engage in swaps activities, subject to certain exceptions. Under section 716, which became effective on July 16, 2013, the appropriate federal banking agency for an IDI is required to provide a transition period of up to 24 months for conformance with the requirements of section 716 if requested by an IDI.

The Board issued an interim final rule on June 5, 2013, and a final rule on December 24, 2013, clarifying the treatment of uninsured U.S. branches and agencies of foreign banks under section 716. The final rule provides that, for purposes of section 716, uninsured U.S. branches and agencies of foreign banks are treated as IDIs. The final rule also establishes the process for state member banks and uninsured state branches or agencies of foreign banks to apply to the Board for a transition period of up to 24 months.

Supervisory Assessment Fees

Section 318 of the Dodd-Frank Act directs the Board to collect assessments from BHCs and SLHCs with $50 billion or more in total consolidated assets and from nonbank financial companies designated by the Financial Stability Oversight Council (Council) equal to the expenses the Board estimates are necessary or appropriate to carry out its supervision and regulation of those companies.

The Board issued a proposed rule on April 15, 2013, and a final rule on August 16, 2013, establishing how the Board will determine which companies are charged, estimate the applicable expenses, determine each company's assessment fee, and bill for and collect assessments. Under the final rule, each calendar year is an assessment period. Payments for the 2012 assessment period, the first assessment period under the final rule, were due by December 15, 2013. Beginning with the 2013 assessment period, the Federal Reserve will notify each company of the amount of its assessment no later than June 30 of the year following the assessment period, with payment due by September 15. The Federal Reserve will transfer the assessments it collects to the U.S. Department of the Treasury.

Bank Secrecy Act Regulations

On December 3, 2013, the Board and the Financial Crimes Enforcement Network, a bureau of the Treasury, issued a final rule to amend the definitions of "funds transfer" and "transmittal of funds" under regulations implementing the Bank Secrecy Act (BSA). The final rule addresses an ambiguity regarding the amendments to the Electronic Funds Transfer Act made by the Dodd-Frank Act by affirming the scope of funds transfers and transmittals subject to the BSA prior to the enactment of the Dodd-Frank Act.

Requirements for Determining When a Nonbank Financial Company Is Predominantly Engaged in Financial Activities

The Dodd-Frank Act established the Council, which, among other authorities and duties, may subject a nonbank financial company to supervision by the Board and consolidated prudential standards. The act defines a nonbank financial company to include a company (other than a BHC and certain other specified types of entities) that is predominantly engaged in financial activities. A company is considered to be predominantly engaged in financial activities if 85 percent or more of its revenues or assets are related to activities that are defined as financial in nature under the Bank Holding Company Act. The Dodd-Frank Act directs the Board to establish the requirements for determining if a company is predominantly engaged in financial activities.

On April 3, 2013, the Board issued a final rule that establishes the requirements for determining when a company is predominantly engaged in financial activities. Under the final rule, the computation of assets and revenues for purposes of determining if a company meets the statutory threshold would be based on the relevant company's annual financial revenues in, or financial assets at the end of, either of its two most recent fiscal years. The final rule lists in an appendix the activities that will be defined as financial for the purposes of determining whether a company is predominantly engaged in financial activities.

The Dodd-Frank Act requires the Board to define "significant nonbank financial company" and "significant bank holding company," and the final rule also defines these terms. Among the factors the Council must consider when determining whether to designate a nonbank financial company for consolidated supervision by the Board is the extent and nature of the company's transactions and relationships with other significant nonbank financial companies and significant BHCs. If designated, those nonbank financial companies would be required to disclose to the Federal Reserve, the Council, and the FDIC the nature and extent of the company's credit exposure to other significant nonbank financial companies and significant BHCs as well as the credit exposure of such significant entities to the company. Under the final rule, a firm will be considered significant if it has $50 billion or more in total consolidated assets or has been designated by the Council as systemically important.

Federal Reserve Accounts and Services for Financial Market Utilities

Title VIII of the Dodd-Frank Act establishes a supervisory framework for financial market utilities (FMUs) that are designated as systemically important by the Council. FMUs are multilateral systems that provide the essential infrastructure for transferring, clearing, and settling payments, securities, and other financial transactions among financial institutions or between financial institutions and the system. Among other things, the act permits the Board to authorize a Federal Reserve Bank to establish and maintain an account for a designated FMU and provide certain services, including wire transfers, settlement, and securities safekeeping, to the designated FMU. Title VIII also permits a Federal Reserve Bank to pay earnings on balances maintained by or on behalf of a designated FMU in the same manner and to the same extent as the Federal Reserve Bank may pay earnings to a depository institution under the Federal Reserve Act, subject to any applicable rules, orders, standards, or guidelines provided by the Board.

On December 5, 2013, the Board issued a final rule to amend Regulation HH that sets out standards, restrictions, and guidelines for the establishment and maintenance of an account at, and provision of financial services from, a Reserve Bank for a designated FMU. The terms and conditions for access to Reserve Bank accounts and services are intended to facilitate the use of Reserve Bank accounts and services by a designated FMU in order to reduce settlement risk and strengthen settlement processes while limiting the risk presented by the designated FMU to the Reserve Banks.

In addition, the final rule would authorize a Reserve Bank to pay interest on the balances maintained by a designated FMU in accordance with the statute and other terms and conditions as the Board may prescribe. The final rule provides that interest on balances paid to designated FMUs will be the rate paid on balances of depository institutions or another rate determined by the Board from time to time, not to exceed the general level of short-term interest rates.

Retail Foreign Exchange Futures and Options

On April 4, 2013, the Board issued a final rule that sets standards for institutions regulated by the Federal Reserve that engage in certain types of foreign exchange transactions with retail customers. The rule outlines requirements for disclosure, recordkeeping, business conduct, and documentation for retail foreign exchange transactions. Under the final rule, institutions engaging in such transactions are required to notify the Federal Reserve and to be well capitalized. Such institutions are also required to collect margin for retail foreign exchange transactions.

Appraisals for Higher-Risk Mortgage Loans

On January 18, 2013, the Board--jointly with the Consumer Financial Protection Bureau, the FDIC, the Federal Housing Finance Agency, the National Credit Union Administration, and the OCC--issued a final rule to implement section 129H of the Truth in Lending Act, added by the Dodd-Frank Act, which requires a creditor to obtain an appraisal before issuing a "higher-risk mortgage." Under the act, mortgage loans are higher-risk if they are secured by a consumer's home and have interest rates above a certain threshold.

For higher-risk mortgage loans, the final rule requires creditors to use a licensed or certified appraiser who prepares a written appraisal report based on a physical inspection of the interior of the property. The final rule also requires creditors to disclose to applicants information about the purpose of the appraisal and provide consumers with a free copy of any appraisal report. Creditors are required to obtain an additional appraisal at no cost to the consumer for a home-purchase higher-risk mortgage loan if the seller acquired the property for a lower price during the past six months and the price difference exceeds certain thresholds. This requirement addresses fraudulent property flipping by seeking to ensure that the value of the property being used as collateral for the loan legitimately increased.

The rule exempts several types of loans, such as qualified mortgages, temporary bridge loans and construction loans, and loans for mobile homes, trailers, and boats that are dwellings. The rule also has exemptions from the second appraisal requirement to facilitate loans in rural areas and other transactions.

On December 12, 2013, the Board, together with the other agencies, issued a supplemental final rule that provides additional exemptions from the appraisal requirements for higher-risk mortgage loans. The rule provides that loans of $25,000 or less and certain "streamlined" refinancings are exempt from the appraisal requirements. In addition, the final rule contains special provisions for manufactured homes. These provisions are intended to save borrowers time and money while still ensuring that the loans are financially sound.

Key Regulatory Initiatives Proposed in 2013

A number of important regulatory developments are in the proposal stage. The following is a summary of additional regulatory initiatives that the Board proposed in 2013.

Liquidity Requirements for Large Financial Institutions

On October 24, 2013, the Board issued a proposed rule for comment that would strengthen the liquidity positions of large financial institutions. The proposal is based on an international standard agreed to by the BCBS and was published for comment jointly with the FDIC and OCC.

The proposal would require institutions subject to the rule to meet a minimum quantitative liquidity requirement in the form of a liquidity coverage ratio (LCR). Under the LCR, each institution would hold an amount of high-quality, liquid assets such as central bank reserves and government and corporate debt that is equal to or greater than its projected cash outflows less up to 75 percent of its projected cash inflows during a short-term stress period. The proposal defines various categories of liquid assets and also specifies how a firm's projected net cash outflows over the stress period would be calculated using common, standardized assumptions about the outflows and inflows associated with specific liabilities, assets, and off-balance-sheet obligations.

The LCR would apply to all internationally active BHCs and SLHCs--generally, those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance-sheet foreign exposure--and to nonbank financial companies designated by the Council. It would also apply to depository institutions with $10 billion or more in consolidated assets that are subsidiaries of BHCs or SLHCs subject to the rule. The proposal also would apply a less stringent, modified LCR to BHCs and SLHCs that are not internationally active but have more than $50 billion in total assets. BHCs and SLHCs with substantial insurance subsidiaries and nonbank financial companies supervised designated by the Council with substantial insurance operations are not covered by the proposal.

Supplementary Leverage Ratio for Large Financial Institutions

On July 9, 2013, the Board, together with the FDIC and the OCC, issued a proposed rule to strengthen the leverage ratio standards for the largest, most systemically significant financial institutions. The Board proposed to establish a new leverage buffer for BHCs with more than $700 billion in consolidated total assets or $10 trillion in assets under custody (covered BHCs) above the minimum supplementary leverage ratio requirement in Regulation Q of 3 percent tier 1 capital to total leverage exposure. Under the proposal, a covered BHC that maintained a leverage buffer of tier 1 capital in an amount greater than 2 percent of its total leverage exposure would not be subject to limitations on discretionary bonus payments and capital distributions. In addition to the leverage buffer for covered BHCs, the proposed rule would establish under the prompt corrective action rules a "well capitalized" threshold of 6 percent for the supplementary leverage ratio for IDI subsidiaries of covered BHCs. The proposed rule would currently apply to the eight largest, most systemically significant U.S. BHCs and their IDI subsidiaries.

Credit-Risk Retention

Under section 941 of the Dodd-Frank Act, the Board--along with the OCC, the FDIC, and the SEC, and with respect to residential mortgages, the Federal Housing Finance Administration and the Secretary of Housing and Urban Development--must establish regulations to require securitizers (sponsors of securitization transactions) to hold at least 5 percent of the credit risk of the assets they securitize. On August 28, 2013, the Board and the other agencies issued a revised proposal to implement the requirements of section 941 (new proposal). The original proposal was released on March 29, 2011 (original proposal). The agencies issued the new proposal after considering the many comments received on the original proposal.

As required by the statute, the new proposal includes a variety of exemptions, including an exemption for mortgage-backed securities that are collateralized exclusively by residential mortgages that qualify as qualified residential mortgages (QRMs). The new proposal would define QRMs to have the same meaning as "qualified mortgages" as defined by the Consumer Financial Protection Bureau under the Truth in Lending Act, as amended by the Dodd-Frank Act. The new proposal also requests comment on an alternative definition of QRM that would include certain underwriting standards in addition to the qualified mortgage criteria.

As under the original proposal, the new proposal includes various options to allow securitizers to meet their risk-retention requirement, including standard risk retention based on holding a "vertical" interest in each tranche of the transaction, a "horizontal" interest in the residual tranche of the transaction, or a combination of the two. However, the new proposal would allow greater flexibility in combining vertical and horizontal risk retention and includes modifications to measuring risk retention. The original proposal generally measured compliance with the standard risk-retention requirement based on the par value of securities issued in a securitization transaction and included a provision intended to ensure the securitizer retained an economically meaningful risk retention interest. Under the new proposal, risk retention generally would be based on fair-value measurements, which the agencies believe should generally ensure meaningful risk retention.

Like the original proposal, the new proposal contains risk-retention options explicitly designed for specific asset classes, including commercial real estate transactions, securitizations through revolving master trusts, and asset-backed commercial paper securitizations. The provisions in the new proposal were modified in certain cases for these options in response to comments received on the original proposal. In addition, the new proposal includes an option that would allow lead arrangers in syndicated loans to satisfy risk retention by retaining risk with respect to that loan, with no further risk retention required with respect to the loan if it was securitized through a collateralized loan obligation transaction.

Similar to the original proposal, under the new proposal, securitizations of commercial loans, commercial mortgages, or automobile loans that meet underwriting standards that reflect low credit risk would not be subject to risk retention. Also similar to the original proposal, the rule would recognize the full guarantee on payments of principal and interest provided by Fannie Mae and Freddie Mac for their residential mortgage-backed securities as meeting the risk-retention requirements while Fannie Mae and Freddie Mac are in conservatorship or receivership and have capital support from the U.S. government.

Federal Reserve Emergency Lending Authority

Section 1101 of the Dodd-Frank Act made extensive amendments to the emergency lending provisions of section 13(3) of the Federal Reserve Act. The amendments generally prohibit the Federal Reserve from extending emergency credit to any single or specific company and instead require emergency credit to be extended only to participants in a program or facility with broadbased eligibility. The amendments also require the Board to establish, by regulation, policies and procedures that impose additional limitations on extensions of emergency credit.

On December 23, 2013, the Board issued proposed amendments to Regulation A to implement the changes to section 13(3) made by the Dodd-Frank Act. As required by the act, the proposed amendments are designed to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system and not to aid a failing financial company. The proposed amendments would establish procedures to prohibit extensions of emergency credit to insolvent borrowers. In addition, they would establish that a program or facility that is structured to remove assets from the balance sheet of a single and specific company, or that is established for the purpose of assisting a single and specific company to avoid insolvency proceedings, would not be a program or facility with broadbased eligibility.

The proposed amendments also would require the security for emergency loans to be sufficient to protect taxpayers from losses and would require the lending Reserve Bank to assign, at the time the credit is initially extended, a lendable value to all collateral for the program or facility, consistent with sound risk-management practices, in determining whether the extension of credit is secured to the Reserve Bank's satisfaction. The proposed amendments would further implement additional requirements imposed by section 1101 of the DoddFrank Act, such as requirements relating to reporting and termination of emergency credit programs or facilities.

Flood Insurance

On October 11, 2012, the Board and four other federal regulatory agencies issued a proposed rule to implement certain provisions of the Biggert-Waters Flood Insurance Reform Act of 2012, which significantly revised federal flood insurance statutes. The proposed rule would require that regulated lending institutions accept private flood insurance to satisfy mandatory purchase requirements. In addition, the proposal would require regulated lending institutions to escrow payments and fees for flood insurance for any new or outstanding loans secured by residential improved real estate or a mobile home, not including business, agricultural, and commercial loans, unless the institutions qualify for a statutory exception.

The proposal includes new and revised sample notice forms and clauses concerning the availability of private flood insurance coverage and the escrow requirement. The proposal also would clarify that regulated lending institutions have the authority to charge a borrower for the cost of force-placed flood insurance coverage beginning on the date on which the borrower's coverage lapsed or became insufficient and would stipulate the circumstances under which a lender must terminate force-placed flood insurance coverage and refund payments to a borrower.

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The Board of Governors and the Government Performance and Results Act

Overview

The Government Performance and Results Act (GPRA) of 1993 requires federal agencies, in consultation with Congress and outside stakeholders, to prepare a strategic plan covering a multiyear period. GPRA also requires each agency to submit an annual performance plan and an annual performance report. The GPRA Modernization Act of 2010 further refines those requirements to include quarterly performance reporting. Although the Board is not covered by GPRA, the Board follows the spirit of the act and, like other federal agencies, prepares an annual performance plan and an annual performance report.

Strategic Framework, Performance Plan, and Performance Report

The Board's 2012-15 Strategic Framework (framework) articulates the Board's mission within the context of resources required to meet Dodd-Frank Act mandates, close cross-disciplinary knowledge gaps, develop appropriate policy, and continue addressing the recovery of a fragile global economy. The framework sets forth major goals, outlines strategies for achieving those goals, and identifies key measures of performance toward achieving the strategic objectives.

The annual performance plan outlines the planned projects, initiatives, and activities that support the framework's long-term objectives and resources necessary to achieve those objectives. The annual performance report summarizes the Board's accomplishments that contributed toward achieving the strategic goals and objectives identified in the framework.

The framework, performance plan, and performance report are available on the Board's websites at www.federalreserve.gov/publications/gpra/files/2012-2015-strategic-framework.pdf, www.federalreserve.gov/publications/gpra/files/2013-gpra-performance-plan.pdf, and www.federalreserve.gov/publications/gpra/files/2012-gpra-performance-report.pdf.

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