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Title VI - Improvements to Regulation of Banks and Savings Association Holding Companies and Depository Institutions
The short title of Title VI of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) is the “Bank and Savings Association Holding Company and Depository Institution Regulatory Improvements Act of 2010.” While Title VI effects a number of changes to the Federal banking statutes, the Title primarily: (1) increases the examination authority for the Board of Governors of the Federal Reserve System (the Board) and explicitly requires a source of strength requirement for bank and savings and loan holding companies; (2) expands the transactions with affiliates rule under Section 23A of the Federal Reserve Act and lending limits to include derivative transactions and securities lending and borrowing transactions; (3) restricts proprietary trading and investments by bank and savings and loan holding companies and imposes concentration limits on large financial firms, which is contained in the so-called “Volcker Rule”; (4) liberalizes interstate bank mergers and de novo branching and restricts regulatory conversions; and (5) eliminates the prohibition of paying interest on demand deposits.
Increased Examination Authority and Source of Strength
Sections 604 and 605 authorize and require the Board, subject to subtitle B of the Consumer Financial Protection Act, to examine and regulate bank and savings and loan holding companies1 and each subsidiary of a bank and savings and loan holding company in order to understand the nature of the: (1) operations and financial condition of the entities; (2) financial, operational and other risks within the bank or savings and loan holding company system that may pose a threat to the safety and soundness of the entity or any subsidiary or to the stability of the United States financial system; and (3) systems used by the bank or savings and loan holding company to monitor and control risks. The Board’s examination authority exists regardless of whether any subsidiary is a “functionally regulated subsidiary.” Sections 604 and 605 become effective on the transfer date of the transfer of the functions of the Office of Thrift Supervision (the OTS) and the Director of the OTS to the other Federal banking agencies (the Transfer Date).
Section 616 adds a statutory requirement that bank and savings and loan holding companies serve as a source of strength for their insured depository institution subsidiaries. Section 616 becomes effective on the Transfer Date.
Transactions With Affiliates and Lending Limits
Section 608 includes as a covered transaction, for Federal Reserve Act Section 23A2 purposes, derivative transactions and securities lending and borrowing transactions. A derivative transaction is defined to include any transaction that is a contract, agreement, swap, warrant, note, or option that is based, in whole or in part, on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities, securities, currencies, interest or other rates, indices, or other assets.3 Section 608 further expands affiliates to include an investment fund with respect to which a member bank or affiliate is an investment adviser. Section 608 becomes effective one year after the Transfer Date.
Section 610 (lending limits for national banks), Section 611 (lending limits for insured State banks) and Section 614 (lending limits to insiders) add to the definition of an extension of credit for lending limit purposes, credit exposure to a person arising from a derivative transaction, repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions. The amendments made by Sections 610 and 614 become effective one year after the Transfer Date, and Section 611 becomes effective 18 months after the Transfer Date.
Volcker Rule
In General
The Volcker Rule, which is contained in Section 619 of the Act, prohibits, with some limited exceptions, banking entities and nonbank financial entities supervised by the Board under Section 102 of the Act from engaging in proprietary trading or acquiring or retaining any equity, partnership, or other ownership interest in or sponsoring a hedge fund or a private equity fund.4 Section 619 does not limit or restrict sales and securitizations of loans in a manner otherwise permitted by law. The Volcker Rule contains a number of studies and rulemakings (including rules relating to capital and recordkeeping requirements) that will make the ultimate impact of the Volcker Rule uncertain.
Banking entities are defined as: (1) any insured depository institution as defined in Section 3 of the Federal Deposit Insurance Act (subject to a limited exception for certain trust institutions); (2) any company that controls an insured depository institution; (3) any company that is treated as a bank holding company for purposes of Section 8 of the International Banking Act of 1978; and (4) any affiliate or subsidiary of such companies.
Exceptions
Subsection (d)(1) sets forth a number of limited exemptions:
- Investments in certain governmental and quasi-governmental securities.
- Investments in securities and (h)(4) instruments in connection with underwriting or market-making related activities to the extent that any such activities are designed not to exceed the reasonably expected near-term demands of clients, customers or counterparties.
- Risk-mitigating hedging activities that are designed to reduce specific risks to the banking entity in connection with and related to such positions, contracts or other holdings.
- The purchase, sale, acquisition or disposition of securities and (h)(4) instruments on behalf of customers.
- Investments in small business investment companies as defined under the small business investment act and certain investments of the type permitted under 12 U.S.C. 24(11) or investments that are qualified, rehabilitation expenditures with respect to a qualified rehabilitated building or certified historic structure as such terms are defined in Section 47 of the Internal Revenue Code or a similar state historic tax credit program.
- Certain qualified transactions for the general account of an insurance company. Organizing and offering a private equity fund or hedge fund, including serving as a general partner, managing member, or trustee of the fund and in any manner selecting or controlling5 a majority of the directors, trustees or management of the fund–only if several tests are met, among them:6
- The banking entity provides bona fide trust, fiduciary or investment advisory services to the fund.
- The fund is offered only to the banking entity’s customers and only in connection with providing bona fide trust, fiduciary, or investment advisory services.
- The banking entity does not maintain an ownership interest in the fund other than a de minimis interest as defined by the act.
- Proprietary trading conducted pursuant to Sections 4(c)(9) or 4(c)(13) of the Bank Holding Company Act provided that the trading occurs solely outside the United States and the banking entity is not directly or indirectly controlled by a banking entity that is organized under the laws of the United States.7
- Investment in or sponsorship of a hedge fund or private equity fund pursuant to Sections 4(c)(9) or 4(c)(13) of the Bank Holding Company Act solely outside the United States provided that no ownership interest in such fund is offered for sale or sold to a resident of the United States and the banking entity is not directly or indirectly controlled by a banking entity that is organized under the laws of the United States.
- Other activities as may be provided by rule, subject to safety and soundness requirements.
Exceptions to the Exceptions
A transaction, however, will not be deemed a permitted transaction if it would: (1) involve or result in a material conflict of interest between the banking entity and its clients, customers or counterparties; (2) result, directly or indirectly, in a material exposure by the banking entity to high risk assets or high risk trading strategies; (3) pose a threat to the safety and soundness of the entity; or (4) pose a threat to the financial stability of the United States.
De Minimis Investments
Subsection (d)(4) sets forth an exception for de minimis investments in funds organized and offered by the banking entity. While this exception contains a number of requirements, the investment limitation is 3% of the total ownership interests in the fund with the total interest in all such funds to aggregate less than 3% of the Tier 1 capital of the banking entity.
Effective Date
Section 619 will become effective upon the earlier to occur of 12 months after the promulgation of required rules under the section or July 22, 2012. An additional two-year divestiture period follows the effective date in order for a banking entity or a nonbank financial company supervised by the Board to bring the company into compliance. Additional limited extensions will also be available subject to the approval of the Board.
Concentration Limits
The second part of the Volcker Rule is contained in Section 622 and imposes restrictions on the size of large financial companies, which are defined as insured depository institutions, bank holding companies, savings and loan holding companies, companies that control an insured depository institution,8 nonbank financial companies supervised by the Board under Title I of the Act, and foreign financial banks or companies that are treated as bank holding companies for purposes of the Act. Section 622(b) provides that, subject to the recommendations of the Financial Stability Oversight Council, a financial company may not merge or consolidate with or acquire all or substantially all of the assets of, or otherwise acquire control of another company if the total consolidated liabilities of the surviving company upon consummation of the transaction would exceed 10% of the aggregate consolidated liabilities of all financial companies at the end of the calendar year preceding the transaction.
The term liabilities is generally defined as total risk-weighted assets of the financial company as determined under the risk-based capital rules applicable to bank holding companies, with regulatory capital adjustments, less the total regulatory capital under risk-based capital rules applicable to bank holding companies. For foreign entities subject to the restrictions, assets and capital are based on the U.S. operations of the entities. The Board is instructed to promulgate rules that will provide for equitable and consistent treatment of insurance companies.
The concentration limits under Section 622 became effective on July 22, 2010.
Interstate Bank Mergers, De Novo Branching and Conversions
Section 623 of the Act amends the Bank Merger Act, the Bank Holding Company Act and the Home Owners’ Loan Act to provide that except in the instance of acquisition of an insured depository institution in default or in danger of default, the Federal banking agencies may not approve an interstate merger transaction, if after the transaction the acquiring entity would control more than 10% of the total amount of deposits of insured depository institutions in the United States.9
Section 613 allows the establishment of de novo branches by national and State banks in the various States regardless of State laws to the contrary.
Section 612 prohibits the conversion of insured depository institutions subject to enforcement orders or agreements into another form of depository institution.
Sections 612, 613 and 623 became effective on July 22, 2010.
Interest on Demand Deposits
Section 627 repeals the restriction on banks and savings associations from paying interest on demand deposits. This section becomes effective on July 22, 2011.
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[1] Section 604(i) excludes from the definition of savings and loan holding company a company that controls a savings association that functions solely in a trust or fiduciary capacity as described in Section 2(c)(2)(D) of the Bank Holding Company Act. 12 U.S.C. 1841(c)(2)(D).
[2] 12 U.S.C. 371c.
[3] Section 610(a)(3).
[4] Proprietary Trading is defined as engaging as principal for the trading account of the banking entity or nonbank financial company supervised by the Board in any transaction to purchase or sell or otherwise acquire or dispose of an (h)(4) instrument. A trading account is defined as any account used for acquiring or taking positions in securities and (h)(4) instruments principally for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short-term price movements) and any other such accounts as may be determined by future rulemaking. Section (h)(4) instruments are securities, derivatives, contracts of sale of a commodity for future delivery, options on any such securities, derivatives, contracts of sale, and any other security or financial instrument that may be determined by future rulemaking. Private equity funds and hedge funds are generally defined as issuers that would be investment companies under the Investment Company Act, but for Sections 3(c)(1) or 3(c)(7) of such Act and similar funds as to be defined by future rulemaking.
[5] Including having employees, officers, directors or agents that constitute a majority of the directors, trustees, or management of the fund.
[6] The Act also applies the requirements of Sections 23A and 23B of the Federal Reserve Act (transactions with affiliates) to the transaction with the fund, provided that certain prime brokerage services are excepted from Section 23A.
[7] Sections 4(c)(9) relates to investments in companies organized under the laws of a foreign country, the greater part of whose business is conducted outside the United States, and Section 4(c)(13) relates to investments in companies that do no business in the United States, except as an incident to the companies’ international or foreign business.
[8] It is not clear how “a company that controls an insured depository institution” differs from a bank holding company or a savings and loan holding company.
[9] This restriction is similar to existing law contained in the Federal Deposit Insurance Act at 12 U.S.C. 1831u(b)(2) and the Bank Holding Company Act at 12 U.S.C. 1841(d)(2).
If you have questions regarding anything you have read on Title VI, please contact any of the attorneys listed below or your regular Sutherland contact.
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Roadmaps
Title VI - Key Provisions and Regulatory Rulemakings
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