5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM THE TREACHEROUS LANDSCAPE FOR FOREIGN G-SIBS: THE IHC FRAMEWORK AND FINANCIAL STABILITY Mackenzie Humble* In 2010, the Dodd-Frank Wall Street Reform and Con- sumer Protection Act restructured the regulatory regime for fi- nancial institutions in the United States by mandating corpo- rate governance reforms and requiring that firms maintain high levels of high-quality capital reserves in their U.S. legal entities. Likely the most consequential of the statute’s provi- sions was that which authorized Regulation YY, a landmark regulation that transformed capital planning and risk man- agement processes among financial institutions in the United States. Along with implementing enhanced prudential stand- ards for the U.S. operations of large, complex financial insti- tutions, Regulation YY altered the corporate structure of for- eign banking organizations (“FBOs”) by requiring large foreign banking institutions to establish a new legal entity, called an intermediate holding company (“IHC”). Put simply, IHCs were created to reorganize and capture, in one umbrella legal entity, all non-branch U.S. operations of FBOs. Further, to ensure robust, localized oversight of U.S. operations, each IHC is required to establish their own board of directors and risk committee, separate and apart from the board and com- mittees of the broader organization. IHCs are also required to comply with both the capital and leverage ratio requirements applied to similarly large domestic financial institutions, and the programmatic requirements associated with firms of that size (resolution planning, CCAR, CLAR). * J.D. Candidate 2020, Columbia Law School; B.A. 2015, University of Michigan. My sincerest thanks to Professor Jeffery Gordon, who was very helpful in directing the formulation of the topic of this Note. Addi- tional thanks to my editorial staff at the Columbia Business Law Review for their diligent attention and wonderful work over the past year. I dedi- cate this Note, as I do all my work, to my mother Anita. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 337 There is another regulation, though, that when coupled with the far-reaching implications of Regulation YY has dis- parately impacted foreign banking organizations. That regu- lation is Regulation W, a longstanding regulation that limits the amount of intracompany transactions banking organiza- tions can engage in. Following the enactment of Dodd-Frank, Regulation W was amended in several ways which limited spe- cifically the types of transactions that FBOs often engage in with their affiliates to manage their liquidity risk and to ab- sorb liquidity shocks. The post-crisis changes made to Regula- tion W have already begun to be rolled back by U.S. regulators, however there has not yet been a detailed analysis of how spe- cifically the interaction between Regulation YY and Regulation W undermines global financial stability. The specific aim of this Note is to evaluate whether Regu- lation YY and Regulation W have destabilized the global fi- nancial system. Institutions’ 2018 and 2019 CCAR results will be the lens through which the impact of the regulations is eval- uated. Specifically, we look at both institutions’ Tier 1 capital ratios and Tier 1 leverage ratios to assess how specifically the IHCs have positioned their liquid capital and adjusted their business model in response to Regulation YY reorganization. Ultimately, we conclude that the interaction between Regula- tion YY and the revised Regulation W has dramatically frag- mented the global flow of capital among FBOs. Regulation YY’s IHC reorganization mandate largely cabins foreign banks’ ability to absorb liquidity shocks through their organi- zations—a result that may pose a serious threat to global fi- nancial stability. That is, the fundamental disruption of insti- tutions’ ability to funnel liquidity to their network of legal entities around the world raises a significant concern regard- ing their resiliency during periods of stress, particularly for those systemically important firms who experienced pervasive liquidity issues in the most recent crisis. I. Introduction ............................................................... 338 II. The Regulatory Environment for Large, Complex, Financial Institutions ................................................ 347 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 338 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 A. Brief History of Foreign Banking Organizations in the United States................................................. 347 B. Modern Regulatory Paradigm for International Banking Organizations ....................................... 354 C. Regulation YY, Regulation W, And IHC Reorganization ..................................................... 360 1. Regulation YY Subpart O and the Structure of International Banking Organizations .. 362 2. Regulation W and Intrabank Funding ..... 367 III. The Impact of Regulation YY and Regulation W on IHC Capital ................................................................ 375 A. 2018 CCAR Results ............................................. 376 B. 2019 CCAR Results ............................................. 382 IV. Proposed Amendments to Regulation W ................... 386 V. Conclusion .................................................................. 394 I. INTRODUCTION In the ten years since the close of the 2007–2009 financial crisis (“the crisis” or “the Great Recession”), much of the con- versation among economists, policymakers, and legal academ- ics has revolved around the regulatory and economic impact of the crisis within the United States. These discussions have been held for good reason; the congressional legislation passed in response to the crisis has now forced many financial insti- tutions to fundamentally alter their risk profiles and business models. More specifically, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) transformed the way banking organizations price, oversee, and structure their own investment activities by introducing new prudential risk management standards and financial measures of soundness that financial institutions must now meet to maintain their bank charter.1 These qualitative and quantitative expecta- tions are not static for all financial institutions; indeed, a cen- tral piece of Dodd-Frank’s statutory scheme is tailoring regu- lators’ qualitative risk management expectations and 1 See generally Dodd-Frank Wall Street Reform and Consumer Protec- tion (Dodd-Frank) Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010). 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 339 quantitative financial benchmarks to financial institutions’ size.2 Tailoring regulatory expectations to institutions’ rela- tive asset size3 in this way was meant to offer a risk-weighted regulatory framework for all financial institutions to operate within, acknowledging specifically the unique role of commu- nity banks and their higher cost of capital when compared to the largest financial institutions in the world.4 This approach 2 See Dodd-Frank Act §§ 116, 121, 163–65, 171, 210, 622. See also Dan- iel K. Tarullo, Governor, Fed. Reserve Bd., Speech at the Community Bank- ers Symposium: A Tiered Approach to Regulation and Supervision of Com- munity Banks 2 (Nov. 7, 2014), https://www.federalreserve.gov/newsevents/speech/files/ta- rullo20141107a.pdf [https://perma.cc/TKC2-RJNL]; DAVID W. PERKINS, CONG. RESEARCH SERV., R45051, TAILORING BANK REGULATIONS: DIFFER- ENCES IN BANK SIZE, ACTIVITIES, AND CAPITAL LEVELS 1–2 (2017). 3 For purposes of establishing most enhanced prudential risk manage- ment standards, a FBO’s size is to be measured by its combined U.S. assets (also commonly referred to as its “CUSO”). See Prudential Standards for Large Bank Holding Companies, Savings and Loan Holding Companies, and Foreign Banking Organizations, 84 Fed. Reg. 59,032, 59,033 (Nov. 1, 2019) (to be codified at 12 C.F.R. pts 217, 225, 238, 242 and 252). Im- portantly, though, apart from the enhanced prudential standards of Dodd- Frank, for intermediate holding company (“IHC”) reorganization institu- tions’ size is measured by their non-branch U.S. assets. See 12 C.F.R. § 252.153 (2020). Thus, while the dollar threshold for each of these two stand- ards is the same, their measurement of an institution’s “size” is different. See Daniel K. Tarullo, Member, Bd. of Governors of the Fed. Reserve Sys., Remarks at the Harvard Law School Symposium: Regulating Large Foreign Banking Associations 13–14 (Mar. 27, 2014), https://www.federalre- serve.gov/newsevents/speech/files/tarullo20140327a.pdf [https://perma.cc/Q9AN-HLFL]. However, note that for some select en- hanced prudential standards a FBO’s size is measured by its non-branch U.S. assets. See Prudential Standards for Large Bank Holding Companies, Savings and Loan Holding Companies, and Foreign Banking Organizations, 84 Fed. Reg. at 59,034. 4 See, e.g., Strengthening and Streamlining Prudential Bank Supervi- sion: Hearing Before the S. Comm. on Banking, Hous., & Urban Affairs, 111th Cong. 3–4 (2009) (statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation); Tarullo, supra note 2, at 2–3. But see Rep. Jeb Hensarling, Address at the American Enterprise Institute (July 21, 2015), https://republicans-financialservices.house.gov/news/documen- tsingle.aspx?DocumentID=399392 [https://perma.cc/GN6D-FRYG] (de- scribing the challenges faced by community banks as “an intended conse- quence of the [Dodd-Frank] Act. Dodd-Frank concentrates greater assets in fewer institutions”). 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 340 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 has been largely accepted as appropriate across the political spectrum, and in the years since the law’s enactment biparti- san political blocs have continued to lobby for increased strat- ification in financial regulatory thresholds.5 To apply these quantitative and qualitative standards to the largest financial institutions in the United States, Dodd- Frank introduced an entirely new concept in banking super- vision—the annual, uniform, publicly-filed stress test.6 Known as the Comprehensive Capital Annual Review (“CCAR”), this program, initially the brainchild of regulators’ improvisation during the financial crisis,7 emerged as the foundation of large, complex financial institution supervision in the post-recession era. Although intensely nuanced and complicated, at a high-level CCAR offers a point in time snap- shot of the financial condition and risk management practices of the largest financial institutions in the United States, and ultimately determines if they meet both the qualitative and quantitative capital planning benchmarks otherwise estab- lished by section 165 of Dodd-Frank.8 It is important to note at the outset that these programs have been extraordinarily controversial and costly for affected financial institutions,9 5 See Scott Heitkamp, Political Foes Agree: Banks Pounded by Dodd- Frank, HILL (June 27, 2017), https://thehill.com/blogs/pundits-blog/fi- nance/339693-helping-small-banks-is-something-we-can-all-agree-on [https://perma.cc/ZB3C-FLET]. See also Economic Growth, Regulatory Re- lief, and Consumer Protection Act, Pub. L. No. 115-174, 132 Stat. 1296 (2018). 6 See Dodd-Frank Act § 165(i). 7 See Beverly Hirtle, Exec. Vice President, Fed. Reserve Bank of N.Y., Remarks at the Effects of Post Crisis Banking Reforms Conference: Struc- tural and Cyclical Macroprudential Objectives in Supervisory Stress Test- ing (June 22, 2018), https://www.bis.org/review/r180718d.pdf [https://perma.cc/T3R3-HJ7V]; Daniel K. Tarullo, Member, Bd. of Gover- nors of the Fed. Reserve Sys., Remarks at the Stress Test Modeling Sympo- sium: Stress Testing After Five Years 2–8 (June 25, 2014), https://www.fed- eralreserve.gov/newsevents/speech/files/tarullo20140625a.pdf [https://perma.cc/7MTK-PZD6]. 8 See Capital Planning, 12 C.F.R. § 225.8 (2020). 9 See, e.g., U.S. GOV’T ACCOUNTABILITY OFFICE, GAO-17-48, FEDERAL RESERVE: ADDITIONAL ACTIONS COULD HELP ENSURE THE ACHIEVEMENT OF STRESS TEST GOALS 30 (2016) (surveying large financial institutions and finding that fifty percent of firms estimated their CCAR compliance costs 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 341 although key regulators have responded by pointing to the sig- nificant increase in affected institutions’ capital and liquidity buffers since CCAR began in 2010.10 Still, the push against these regulatory programs has recently achieved a large vic- tory with the passage of the Economic Growth, Regulatory Re- lief, and Consumer Protection Act (“the EGRRCPA”) in 2018.11 With this new law, the number of institutions required to participate in CCAR and comply with the most stringent enhanced prudential standards allowed by Dodd-Frank was reduced by increasing the qualifying asset threshold from $50 billion to $250 billion.12 This threshold shift was completed in two stages. First, immediately following the EGRRCPA’s en- actment, financial institutions with consolidated assets of less than $100 billion were exempt from section 165 of Dodd- Frank.13 Eighteen months after the date of the EGGRCPA’s to be between $15 million and $30 million annually); Letter from Jamie Dimon, Chief Exec. Officer & Chairman, J.P. Morgan Chase & Co., to J.P. Morgan Chase & Co. Shareholders (Apr. 4, 2019), https://reports.jpmor- ganchase.com/investor-relations/2018/ar-ceo-letters.htm?a=1 [https://perma.cc/C76N-DRR7]; Matthew C. Turk, Stress Testing the Bank- ing Agencies, 105 IOWA L. REV. (forthcoming May 2020) (manuscript at 20– 23), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3367546 [https://perma.cc/M356-QGVB]. 10 See Tarullo, supra note 7, at 6; Daniel K. Tarullo, Member, Bd. of Governors of the Fed. Reserve Sys., Remarks at the Clearing House 2014 Annual Conference: Liquidity Regulation 17 (Nov. 20, 2014), https://www.federalreserve.gov/newsevents/speech/files/ta- rullo20141120a.pdf [https://perma.cc/A52E-7YS5]. 11 Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. No. 115–174, 132 Stat. 1296 (2018). 12 Id. § 401(a). 13 Id. § 401(d). Although they are exempt from participating in the an- nual CCAR exercise, under the EGRRCPA the Federal Reserve retains the discretion to require institutions with over $100 billion in assets to comply with the enhanced prudential standards that only institutions with over $250 billion in consolidated assets are required to comply with. See id. § 401(a)(1)(B)(iii). The Federal Reserve does not retain this discretion for in- stitutions with between $50 billion and $100 billion in assets; the only “en- hanced standard” those institutions may be required to comply with is the risk committee requirement of section 165(h) of Dodd-Frank. See id. § 401(a)(4). See also Risk Committee Requirement for Bank Holding Compa- nies with Total Consolidated Assets of $50 billion or More, 12 C.F.R. § 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 342 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 enactment, the exemption threshold was raised to $250 bil- lion.14 This move was the first significant blow to Dodd- Frank’s regulatory paradigm, and was intended to “simplify and improve the regulatory regime for . . . midsize banks and regional banks to promote economic growth.”15 Despite all the paradigm-shifting developments that took place in the United States following the crisis, the economic and regulatory consequences of the Great Recession reached much farther than just the financial markets in the U.S. In- deed, the economic consequences and market impact of the crisis in European and South American countries have been acknowledged by economists as being the most severe.16 In 252.22 (2019). Importantly, the Federal Reserve has publicly stated that although endowed with this discretion under the EGRRCPA, the Board will not take action to require bank holding com- panies with less than $100 billion in total consolidated as- sets to comply with certain existing regulatory require- ments. These requirements include the enhanced prudential standards in the Board’s Regulation YY, the liquidity cover- age ratio requirements in the Board’s Regulation WW, and the capital planning requirements in the Board’s Regulation Y. . . . [Additionally,] the Board will not take action to re- quire [b]ank holding companies with total consolidated as- sets of less than $50 billion to comply with . . . Regulation YY, [or] subpart C ([the] risk committee [requirement]) . . . . Press Release, Bd. of Governors of the Fed. Reserve Sys., Statement Regard- ing the Impact of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) (July 6, 2018), https://www.federalre- serve.gov/newsevents/pressreleases/files/bcreg20180706b1.pdf [https://perma.cc/7TEC-3CCA]. 14 Economic Growth, Regulatory Relief, and Consumer Protection Act § 401(d). 15 Implementation of the Economic Growth, Regulatory Relief, and Consumer Protection Act: Hearing Before the S. Comm. on Banking, Hous., & Urban Affairs, 115th Cong. 1 (2018) (statement of Sen. Mike Crapo). As of June 2017, twenty-seven institutions had between $50 billion and $250 billion in consolidated assets. Fifteen institutions had above $250 billion in consolidated assets. See PERKINS, supra note 2, at 9 tbl.1. 16 See, e.g., Maria A. Arias & Yi Wen, Recovery from the Great Reces- sion Has Varied Around the World, REGIONAL ECONOMIST, Oct. 2015, at 10, 11; Shimelse Ali et al., Financial Transmission of the Crisis: What’s the Lesson?, CARNEGIE ENDOWMENT FOR INT’L PEACE (June 17, 2009), 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 343 response, just as policymakers in the United States restruc- tured the regulatory paradigm for financial institutions within their borders, global regulators have reformed their systems of financial regulation. Globally, the most dramatic of these regulatory redirec- tions was that adopted in the European Union. The most meaningful regulation adopted in the EU following the crisis was that which created the European System of Financial Su- pervisors (“the ESFS”),17 a body that provided an entirely new framework for financial supervision in the European Union. There are numerous regulatory agencies that operate under the ESFS framework, however two supervisory authorities are especially relevant for our purposes here: the European Banking Authority, which executes microprudential supervi- sory tasks for Europe’s financial institutions,18 and the Euro- pean Systemic Risk Board, which is tasked with preventing and mitigating systemic risk in the Eurozone.19 Parallel to the operations and responsibilities of the ESFS, in November 2012 the European Parliament adopted a reso- lution recommending that the European Commission estab- lish a Banking Union.20 The European Parliament has fol- lowed this recommendation, and has, in its own words, “contributed significantly to establishing a real Banking Un- ion.”21 The first large step Parliament took toward achieving a Banking Union occurred in 2013, when it established what is commonly known as “the first pillar of the Banking Union,” https://carnegieendowment.org/2009/06/17/financial-transmission-of-crisis- what-s-lesson-pub-23284 [https://perma.cc/EER2-J5SS]. 17 See Council Regulation 1092/2010, art. 1, 2010 O.J. (L 331) 1. 18 See Council Regulation 1093/2010, art. 2, 2010 O.J. (L 331) 12. The European Banking Authority maintains the authority to compel national regulators to take the regulatory actions it deems necessary in emergency situations. See Council Regulation 1093/2010, supra note 18, art. 18 19 See Council Regulation 1092/2010, supra note 17, arts. 1, 3. In- cluded on the European Systemic Risk Board are ECB representatives along with representatives from the national central banks of EU member states. See Council Regulation 1092/2010, supra note 17, art. 6. 20 See EUR. PARL. DOC. T7-0430 (2012). 21 See Fact Sheets on the European Union: Banking Union, EUROPEAN PARLIAMENT (Dec. 1, 2019), https://www.europarl.europa.eu/fact- sheets/en/sheet/88/banking-union [https://perma.cc/CSM7-3USH]. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 344 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 the Single Supervisory Mechanism (“the SSM”).22 The SSM removed primary responsibility for “significant” financial in- stitution regulation from the institutions’ home country regu- latory agency (“the Member State Regulator”), instead effec- tively centralizing the decisive regulatory authority for such institutions within the European Central Bank (“the ECB”).23 Under this framework, although Member State Regulators maintain a regulatory role in supervising the financial insti- tutions operating within their borders, direct supervision for significant institutions is delegated to the centralized SSM.24 The criteria for determining whether a financial institution is considered significant—and therefore falls under the ECB’s direct supervision—is set out in two separate regulations, and relates to a bank’s size, economic importance, cross-border ac- tivities and reliance on public “bailout funds.”25 Outside the scope of the Eurozone and purview of the ESFS and Banking Union, financial institutions in the United King- dom were also confronted with unique and unprecedently ag- gressive regulations in the wake of the financial crisis. In en- acting the Financial Services (Banking Reform) Act, the English Parliament imposed new funding regulations and en- hanced risk management standards on large banking institu- tions,26 and, critically, also mandated that banks with more than £25 billion in core deposits be ring-fenced.27 Although 22 See Council Regulation 1024/2013, art. 6, 2013 O.J. (L 287) 63. 23 See id. 24 See id.; European Central Bank Regulation 468/2014, art. 5, 2014 O.J. (L 141) 1 (EU). 25 See Council Regulation 1024/2013, supra note 22, art. 6; European Central Bank Regulation 468/2014, supra note 24, arts. 39–44. 26 Financial Services (Banking Reform) Act 2013, c. 33, §§ 4, 18–35 (Eng.). 27 See id. § 4; Financial Services and Markets Act 2000, SI 2014/1960, art. 3, ¶ 12 (Eng.). Following the enactment of the Banking Reform Act, the HM Treasury issued an order which clarified the definition of “core deposit.” Specifically, that order noted that “[a] deposit is a core deposit if it is held with the UK deposit-taker in an [European Economic Area] account except where one or more of the account holders is—(a) a relevant financial insti- tution; (b) a qualifying organisation; (c) a qualifying group member; or (d) an eligible individual.” Financial Services and Markets Act 2000, SI 2014/1960, supra note 27, art. 2, ¶ 2. As of 2019, seven institutions exceeded 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 345 notably ill-defined,28 the operative definition of ring-fencing relevant to the Banking Reform Act is the requirement that financial institutions separate their holding company that of- fers core deposits from those entities that provide other ser- vices, such as investment and international banking ser- vices.29 In other words, banking institutions in the U.K. with over £25 billion in core retail deposits are now required to es- tablish a distinct holding company encapsulating all core re- tail deposits collected in the Eurozone.30 The purpose of im- posing such a regulation, as explained by the Bank of England, is to: reduce the potential for risks which originate else- where in a banking group . . . ensure [affected banking institutions] are able to take decisions independently of the rest of their banking groups . . . reduce [affected banking institutions’] dependency on financial or other resources provided [] from other members of the banking group . . . and ensure [affected banking insti- tutions] are able to carry on their business even if other group members fail.31 the £25 billion threshold. See James Proudman, Exec. Dir., UK Deposit Tak- ers Supervision, From Construction to Maintenance: Patrolling the Ring- Fence 3 (Nov. 26, 2018), https://www.bis.org/review/r181127g.pdf [https://perma.cc/J6ER-JK9T]. 28 See Steven L. Schwarcz, Ring-Fencing, 87 S. CAL. L. REV. 69, 71–72 (2013) (“Because it is proposed in different contexts as a solution to ostensi- bly different problems, ring-fencing is inconsistently defined . . . .”). 29 See Financial Services (Banking Reform) Act 2013 § 4. Cf. Katie Britton et al., Ring-Fencing: What is It and How Will it Affect Banks and Their Customers?, 2016 BANK ENG. Q. BULL. 164, 165 (2016) (“But ring- fencing does not prevent RFBs being owned by a parent company that also owns a bank that undertakes prohibited or excluded activities; such enti- ties can sit within the same banking group . . . .”). 30 See Financial Services (Banking Reform) Act 2013, § 4; Financial Services and Markets Act 2000, SI 2014/1960, supra note 27, art. 2, ¶ 2. Note, however, that the Banking Reform Act “does not mandate what sort of entity may carry out activities such as mortgage lending or taking depos- its from large corporates. Some banking groups will place such activities in their RFBs, alongside their retail deposit-taking operations, but others may not.” Katie Britton et al., supra note 29, at 166. 31 Katie Britton et al., supra note 29, at 168. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 346 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 Thus, it should be gathered that the global regulatory over- haul following the financial crisis was dramatic, but frag- mented, around the world. This fragmentation has imposed a dynamic and complicated regulatory environment for interna- tional banking organizations with large-scale operations in many countries, ultimately resulting in extraordinarily high compliance costs.32 The central focus of this Note is to analyze the position of foreign banking organizations (“FBOs”) with consolidated U.S. assets over $50 billion,33 and their response to the regu- latory overhaul implemented by Dodd-Frank. Specifically, Part II will begin by offering a brief history of FBOs in the United States and will then describe how FBOs generally or- ganize their U.S. activities. Part II also introduces and de- scribes the regulatory rules promulgated out of Dodd-Frank that will be the anchor guiding our discussion. Part III will present and discuss the results of the 2018 and 2019 CCAR exercises, comparing the IHCs’ results to those of similarly sized institutions headquartered in the United States. Fi- nally, given the findings of Part III’s analysis, Part IV will ar- gue for the reinstatement of a limited exception to Regulation 32 See Matthias Lehmann, Legal Fragmentation, Extraterritoriality and Uncertainty in Global Financial Regulation, 37 OXFORD J. LEGAL STUD. 406, 419–21 (2017). See also INT’L FED’N OF ACCOUNTANTS & BUS. AT THE OECD, REGULATORY DIVERGENCE: COSTS, RISKS, IMPACTS 4 (2018), https://www.ifac.org/system/files/publications/files/IFAC-OECD-Regula- tory-Divergence.pdf [https://perma.cc/QL66-NKT9] (finding that the cur- rent system of piecemeal global financial regulation costs the global econ- omy more than $780 billion each year). 33 Despite the EGRRCPA’s change of CCAR’s consolidated U.S. asset threshold from $50 billion to $250 billion, in the interest of leveraging as much relevant data as possible to determine the impact of Regulation YY, all institutional data above $50 billion will be included in the empirical anal- ysis of Part IV. Because the EGRRCPA was not signed into law until May 2018, institutions with consolidated assets of more than $50 billion were required to participate in the exercise in 2018. See Economic Growth, Reg- ulatory Relief, and Consumer Protection Act, Pub. L. No. 115-174, 132 Stat. 1296 (2018). Although the role of the EGRRCPA’s threshold increase will no doubt be a ripe topic for further academic debate, it will only be a peripheral point in this Note. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 347 W that existed prior to Dodd-Frank’s enactment. Part V con- cludes. II. THE REGULATORY ENVIRONMENT FOR LARGE, COMPLEX, FINANCIAL INSTITUTIONS To assess the efficacy of the United States’ financial regu- latory regime in supervising foreign banking organizations and reducing global systemic risk, this Note will center its dis- cussion around the regulatory rules promulgated out of Dodd- Frank. Specifically with respect to foreign banking organiza- tions, the crucial regulatory changes that emerged out of Dodd-Frank were promulgated under Regulation YY and Reg- ulation W.34 Together, these rules require that foreign bank- ing organizations fundamentally restructure their global legal entity framework and, as a result, their funding strategy. Given that the IHCs submitted their first public stress test results in the summer of 2018,35 the impact of the IHC para- digm has yet to be assessed comprehensively. However, before reaching our evaluation of Regulation YY and Regulation W, it is first necessary to explain the history of foreign banking organizations in the United States and how that historical context informs current FBO regulation. A. Brief History of Foreign Banking Organizations in the United States The global financial system is largely an advent of the past thirty years. Indeed, while there was certainly cross-border banking activity before the 1980s, “the scale of international banking changed dramatically between 1985 and 2009.”36 34 See Enhanced Prudential Standards (Regulation YY), 12 C.F.R. § 252 (2020); Transactions Between Member Banks and Their Affiliates (Reg- ulation W), 12 C.F.R. § 223 (2020). 35 See Press Release, Bd. of Governors of the Fed. Reserve Sys., Federal Reserve Releases Results of Comprehensive Capital Analysis and Review (CCAR) (June 28, 2018), https://www.federalre- serve.gov/newsevents/pressreleases/bcreg20180628a.htm [https://perma.cc/9GLR-R8NW]. 36 COMM. ON THE GLOB. FIN. SYS., LONG-TERM ISSUES IN INTERNATIONAL BANKING 6 (2010), https://www.bis.org/publ/cgfs41.pdf 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 348 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 That is, in the years leading up to the financial crisis global banks’ cross-border and foreign currency claims increased pre- cipitously.37 One driver of this growth in international bank- ing was the globalization of the world’s economy generally, however international banking activity has significantly out- paced international trade38 in the twenty-first century.39 The commonly accepted explanation among financial economists as to what has driven the rise of international banking, par- ticularly over the past twenty years, is the emergence of FBOs as “market intermediaries.”40 Briefly, the market intermediary function of foreign bank- ing organizations refers to the active role FBOs have recently taken in global capital markets.41 Specifically, the evolution of [https://perma.cc/HS7N-HHZB]. See also Mitchell Berlin, New Rules for Foreign Banks: What’s at Stake?, BUS. REV., First Quarter 2015, at 1, 1–2; John C. Dugan et al., Forms of Entry and Operation in the United States, in REGULATION OF FOREIGN BANKS & AFFILIATES 1, 4–6 (Randall D. Guynn ed., 9th ed. 2016). 37 See Patrick McGuire et al., Highlights of International Banking and Financial Market Activity, 2008 BIS Q. REV. 17, 24 (2008). 38 International trade activity is generally accepted as a proxy to meas- ure the globalization of the world’s economy. See, e.g., OECD, MEASURING GLOBALISATION: OECD ECONOMIC GLOBALISATION INDICATORS 40 (2010), https://unstats.un.org/unsd/EconStatKB/KnowledgebaseArticle10422.aspx [https://perma.cc/PA6X-37WS]; Petra Vujakovic, How to Measure Globali- zation? A New Globalization Index (NGI), 38 ATLANTIC ECON. J. 237 (2010). 39 See COMM. ON THE GLOB. FIN. SYS., supra note 36, at 6–7. Growth in international banking activity largely mirrored international trade growth from 1986 to 2000. See COMM. ON THE GLOB. FIN. SYS., supra note 36, at 7 tbl.2. It can thus be presumed that, up until 2000, the observed rise in in- ternational banking activity was at least in part attributable to the globali- zation of the world’s economy generally. 40 See, e.g., COMM. ON THE GLOB. FIN. SYS., supra note 36, at 7, 18; Ber- lin, supra note 36, at 2–3; KATIE KOLCHIN, SIFMA INSIGHTS: THE IM- PORTANCE OF FBOS TO US CAPITAL MARKETS 4 (2019), https://www.sifma.org/wp-content/uploads/2019/04/SIFMA-Insights-The- Importance-of-FBOs-to-US-Capital-Markets.pdf [https://perma.cc/R4VB- VJ68]. 41 See, e.g., COMM. ON THE GLOB. FIN. SYS., supra note 36, at 18; Semyon Malamud & Andreas Schrimpf, An Intermediation-Based Model of Ex- change Rates 2 n.1 (Bank for Int’l Settlements, Working Paper No. 743, 2018), https://www.bis.org/publ/work743.pdf [https://perma.cc/6LAV- ABAA]. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 349 FBOs into market intermediaries has largely been driven by their expansion into derivatives and interbank lending mar- kets.42 To illustrate the impact this change has had on the funding strategy of FBOs, it is helpful to describe one type of fee-generating transaction that FBOs routinely engage in: as- set-backed securitizations. By way of background, asset-backed securitizations are fi- nancial products that allow banks to sell their loans by bun- dling them together into a tradeable bond and selling them to other financial institutions.43 In the lifecycle of a securitiza- tion large global banks serve as middlemen, buying loans from commercial banks and packaging them into securitized tranches to be sold to investors.44 That is, by design middle- men banks are not intended to retain exposure to the securit- ized products they create, they are meant to transfer credit risk from one party (the original lending commercial bank) to another (the securitization investor).45 Initially, when securit- izations became popularized in the 1970s, they were thought to be a force for stability given that they offered liquidity to commercial banks, whose balance sheets were otherwise in- flexible, and diversified risk around the financial system.46 At face value this understanding of securitizations is true, and indeed, there is nothing inherently unstable about securitized products. Practically, however, the transfer of credit risk as- sociated with securitized transactions is often “not complete for various reasons, either because banks provided explicit or 42 See COMM. ON THE GLOB. FIN. SYS., supra note 36, at 13–14, 17 tbl.6. See also KOLCHIN, supra note 40, at 11; McGuire et al., supra note 37, at 17– 19. 43 See SULEMAN BAIG & MOORAD CHOUDHRY, THE MECHANICS OF SECU- RITIZATION: A PRACTICAL GUIDE TO STRUCTURING AND CLOSING ASSET-BACKED SECURITY TRANSACTIONS 3 (2013). 44 See, e.g., Nicola Cetorelli & Stavros Peristiani, The Role of Banks in Asset Securitization, FRBNY ECON. POL’Y REV., July 2012, at 47, 48–50; Gary Gorton & Andrew Metrick, Securitized Banking and the Run on Repo, 104 J. FIN. ECON. 425, 426–28 (2012). 45 See Viral V. Acharya et al., Securitization Without Risk Transfer, 107 J. FIN. ECON. 515, 515 (2013). 46 See S.L. Schwarcz, Securitization and Structured Finance, in HANDBOOK OF KEY GLOBAL FINANCIAL MARKETS, INSTITUTIONS, AND INFRASTRUCTURES 565, 566 (Gerard Caprio et al. eds., 2013). 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 350 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 implicit support to special purpose vehicles, or because banks retained on [their] balance sheet some tranches of their struc- tured issuances.”47 In the years leading up to the crisis many large foreign48 banks retained remnants of their previously structured issu- ances on their balance sheet.49 Commentators have offered several strategic explanations as to why foreign banking or- ganizations retained these exposures leading up to the finan- cial crisis,50 however the structural explanation lies in the presence of “credit enhancements” in pre-crisis securitiza- tions.51 Credit enhancements are defined as “contractual ar- rangements in which a bank retains or assumes [securitized] exposure and, in substance, provides some degree of added protection to other parties in the transaction.”52 In effect, the 47 Alessandro Diego Scopelliti, Securitisation, Bank Capital and Fi- nancial Regulation: Evidence from European Banks 2 (Mar. 1, 2016) (un- published manuscript) (citations omitted), https://www.ecb.eu- ropa.eu/pub/conferences/ecbforum/shared/pdf/2016/scopelliti_paper.pdf [https://perma.cc/MA9V-8VU2]. 48 Although there is some evidence that foreign banking organizations outside Europe retained their securitized exposures in the pre-crisis period, European banks did so in much greater quantities. See Robert McCauley, The 2008 Crisis: Transpacific or Transatlantic?, 2018 BIS Q. REV. 39, 41–42 (2018). Additionally, because eight out of the twelve IHCs are headquar- tered in Europe, European banks generally are afforded the most attention in academic studies. See infra Table 1. 49 See Scopelliti, supra note 47, at 38; COMM. ON THE GLOB. FIN. SYS., supra note 36, at 21 fig.11. 50 See id. at 30, 38 (arguing that European banks retained securitized exposures on their balance sheets as a means of regulatory arbitrage); Santiago Carbó-Valverde et al., Securitization, Risk Transferring and Financial Instability: The Case of Spain, 31 J. INT’L MONEY & FIN. 80, 93 (2012) (arguing that foreign banks retained portions of their securitized issuances to leverage as collateral in their transactions with central banks). 51 See Anna Sarkisyan & Barbara Casu, Retained Interests in Securitisations and Implications for Bank Solvency 2 (European Cent. Bank, Working Paper No. 1538, 2013), https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1538.pdf [https://perma.cc/LWE5-E65R]. 52 See id. at 4. Credit enhancements are often used to achieve a specific credit rating for securitizations and to signal the strength of securitizations to investors. See id. at 4; Benjamin H. Mandel et al., The Role of Bank Credit 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 351 kind of internal credit enhancements that were leveraged by FBOs leading up to the crisis required them to retain junior interests in the securitized products they issued.53 Although there is nothing inherently wrong with banks retaining expo- sure to securitized products,54 the credit enhancements em- ployed in the pre-crisis period were particularly problematic because of the “first-loss” position they put issuers in.55 It is all important to note that, in addition to retaining jun- ior tranches in the years leading up to the crisis, FBOs fi- nanced their securitization activities almost exclusively with dollar denominated, short-term wholesale funding.56 That is, FBOs, while retaining long-term, illiquid assets on their bal- ance sheets in the form of securitized products, were funding their operations with short-term, market-based funding.57 This funding strategy is a classic “maturity mismatch,” and ultimately led to disaster.58 As junior tranches began to Enhancements in Securitization, FRBNY ECON. POL’Y REV., July 2012, at 35, 36. 53 See Sarkisyan & Casu, supra note 51, at 17–18. 54 In fact, following the crisis U.S. regulators promulgated a rule which now requires securitized issuers to retain five percent of the credit risk of the assets collateralizing their issuances. See Standard Risk Retention, 17 C.F.R. § 246.4 (2020). 55 See Sarkisyan & Casu, supra note 51, at 2–3. 56 See, e.g., Daniel K. Tarullo, Member, Bd. of Governors of the Fed. Reserve Sys., Remarks at the Yale School of Management Leaders Forum: Regulation of Foreign Banking Organizations 5–6 (Nov. 28, 2012), https://www.federalreserve.gov/newsevents/speech/files/ta- rullo20121128a.pdf [https://perma.cc/9Z5E-LV79]; Rita Babihuga & Marco Spaltro, Bank Funding Costs for International Banks 3 (Int’l Monetary Fund, Working Paper No. 14/71, 2014), https://www.imf.org/exter- nal/pubs/ft/wp/2014/wp1471.pdf [https://perma.cc/6CSY-BT75]; Eric S. Rosengren, President, Fed. Reserve Bank of Bos., Short-Term Wholesale Funding Risks 5–6 (Nov. 5, 2014), https://www.bostonfed.org/news-and- events/speeches/short-term-wholesale-funding-risks.aspx [https://perma.cc/2Z6A-2B22]. 57 See Babihuga & Spaltro, supra note 56, at 3. 58 See William C. Dudley, President, Fed. Reserve Bank of N.Y., Re- marks at the New York Bankers Association Annual Meeting: Fixing Wholesale Funding to Build a More Stable Financial System 2 (Feb. 1, 2013), https://www.newyork- fed.org/newsevents/speeches/2013/dud130201.html [https://perma.cc/AFZ6- AGWJ]. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 352 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 default in 2008, FBOs were left with a shortfall; they did not have a “natural base” of dollar deposits like their U.S. coun- terparts, and desperately needed dollar funding to support their dollar-denominated securitized assets.59 As a result of the growing insecurities of all banking organizations, both do- mestic and foreign banks largely stopped lending dollars in the interbank market after the collapse of Lehman Brothers.60 Additionally, short-term dollar funding (largely provided by money market funds in the U.S.) dried up following Lehman’s failure.61 The stress in dollar funding markets forced FBOs to sell their dollar-denominated assets and reduce lending rap- idly—actions that further aggravated the stress in global credit markets.62 The Federal Reserve responded to the widespread disrup- tion in funding markets by introducing the Term Auction Fa- cility (“TAF”), which allowed institutions experiencing liquid- ity pressures to borrow from the Federal Reserve at depressed interest rates.63 For their part, “foreign banks in the United States loaned relatively less in overnight interbank markets [and] borrowed more from the Federal Reserve’s Term Auction 59 See Niall Coffey et. al, The Global Financial Crisis and Offshore Dol- lar Markets, CURRENT ISSUES IN ECON. & FIN., Oct. 2009, at 1, 1. Banking organizations finance their assets with the currency they are denominated in to maintain a “currency-matched book” and reduce their currency risk. See COMM. ON THE GLOB. FIN. SYS., US DOLLAR FUNDING: AN INTERNATIONAL PERSPECTIVE 61 (2020), https://www.bis.org/publ/cgfs65.pdf [https://perma.cc/NS54-NQMU]. 60 See, e.g., Niall Coffey et al., supra note 59, at 1; Naohiko Baba et al., US Dollar Money Market Funds and Non-US Banks, 2009 BIS Q. REV. 65, 66 (2009). 61 See Niall Coffey et al., supra note 59, at 2. 62 See, e.g., Dudley, supra note 58, at 2–3; Governor Jeremy C. Stein, Address at the Meeting of the Board of Governors of the Federal Reserve System (Dec. 14, 2012), https://www.federalre- serve.gov/newsevents/press/bcreg/stein20121214a.htm. [https://perma.cc/2ZAU-XX89]. 63 See Press Release, Bd. of Governors of the Fed. Reserve Sys., Mone- tary Policy Release (Dec. 12, 2007), https://www.federalreserve.gov/mone- tarypolicy/20071212a.htm [https://perma.cc/Q6GV-Z85H]. The Federal Re- serve also established swap lines with foreign central banks during the crisis to offer dollar liquidity throughout global capital markets. See id. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 353 Facility.”64 Although the assistance the United States offered foreign banks during the financial crisis sparked outrage among some industry commentators,65 others have noted that without U.S. rescue programs, “a fair number of foreign banks operating in the U.S. likely would have failed, triggering a cas- cading crisis that would have been disastrous.”66 Thus, largely as a result of their role in U.S. capital mar- kets, it is safe to say that FBOs now pose a significant risk to the stability of the U.S. financial system. The risks posed by FBOs are often spoken on by policymakers, with Governor Brainard recently noting that “[t]he crisis demonstrated clearly that the combined U.S. operations of foreign banks can pose important risks to U.S. financial stability because of their reliance on dollar-denominated short-term wholesale funding from the United States to fund the banks’ global activities.”67 Thus, beyond the poor optics of the Federal Reserve providing financial assistance to foreign-owned financial institutions, it is clear that, should another crisis hit, U.S. regulators will have little choice but to rescue FBOs again. 64 Nicola Cetorelli & Linda S. Goldberg, Foreign Banks in the Great Recession: Diversity in Internal and External Lending 2–3 (Dec. 26, 2011) (unpublished manuscript), https://www.aeaweb.org/conference/2012/re- trieve.php?pdfid=513 [https://perma.cc/ZGF5-BDLL]. See also Efraim Ben- melech, An Empirical Analysis of the Fed’s Term Auction Facility, 2 CATO PAPERS ON PUB. POL’Y 57, 60 (2012) (finding that foreign banks accounted for fifty-eight percent of TAF lending during the financial crisis). 65 See Robin Harding & Tom Braithwaite, European Banks Took Big Slice of Fed Aid, FIN. TIMES (Dec. 1, 2010), https://www.ft.com/con- tent/4dd95e42-fd6d-11df-a049-00144feab49a [https://perma.cc/9DX8- V8TF]. 66 Better Markets, Comment Letter on Proposed Prudential Standards for Large Foreign Banking Organizations (June 21, 2019), https://better- markets.com/sites/default/files/Better%20Mar- kets%20CL%20Fed%20FBOs%20Enhanced%20Prudential%20Stand- ards%206-21-2019.pdf [https://perma.cc/SH4B-EN6U]. 67 Press Release, Bd. of Governors of the Fed. Reserve Sys., Statement by Governor Lael Brainard (Oct. 10, 2019), https://www.federalre- serve.gov/newsevents/pressreleases/brainard-statement-20191010.htm [https://perma.cc/M4CN-6N6A]. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 354 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 B. Modern Regulatory Paradigm for International Banking Organizations Before delving into the enhanced regulatory standards cer- tain foreign banking organizations are now tasked with com- plying with, it is first necessary to outline the relevant regu- latory actors in the United States and how they are each assigned responsibility under the Dodd-Frank paradigm. The U.S. financial regulatory framework has been heralded by outsiders as being extraordinarily complicated,68 and thus for our purposes here the discussion will be greatly simplified, with an intention to only discuss those regulators who have some insight into and peripheral responsibility under Regula- tion YY and Regulation W. There are three leading regulators of banking organiza- tions in the United States: the Federal Reserve System (“the FRS”), the Federal Deposit Insurance Corporation (“the FDIC”), and the Office of the Comptroller of the Currency (“the OCC”).69 Although each is tasked with a broad mandate, the relevant responsibilities of each changed significantly with the passage of Dodd-Frank and the advent of a new reg- ulatory paradigm for financial institutions in the United States. First, the Federal Reserve System is the relevant “owner” of Regulation YY. That is, the Federal Reserve is the agency tasked with implementing the stress tests and enhanced pru- dential standards of Regulation YY and ensuring that the me- chanical transformations of the regulation (including IHC 68 See, e.g., Chester S. Spatt, Complexity of Regulation, 3 HARV. BUS. L. REV. ONLINE 1–9 (2012); Andrew G. Haldane & Vasileios Madouros, Address at the Federal Reserve Bank of Kansas City’s Economic Policy Symposium: The Dog and the Frisbee 24 (Aug. 31, 2012), https://www.bankofeng- land.co.uk/-/media/boe/files/paper/2012/the-dog-and-the-fris- bee.pdf?la=en&hash=4DEAA2E6D1698A1A0891153A6B4CE70F308351D 7 [https://perma.cc/U2K2-Q7R6]. 69 See MARC LABONTE, CONG. RESEARCH SERV., R44918, WHO REGU- LATES WHOM? AN OVERVIEW OF THE U.S. FINANCIAL REGULATORY FRAMEWORK 8 tbl.1 (2020). 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 355 reorganization) are completed in a timely manner.70 Although the Federal Reserve has played a role in financial institution supervision since the passage of the Federal Reserve Act in 1913,71 Dodd-Frank fundamentally changed the supervisory role of the central bank, and as result, the tone of financial institution regulation in the United States.72 In the Regula- tion W context, the Federal Reserve maintains its primary ownership status in ensuring institutions’ ongoing compliance with internal transaction limits and collateral requirements,73 however the Federal Reserve’s Regulation W authority has been substantially diluted under Dodd-Frank. That dilution of FRS authority is a result of section 608 of Dodd-Frank,74 which vests the OCC and FDIC with the “statutory power to grant exemptions from the requirements of Section 23A to in- stitutions under their respective supervision.”75 Even in artic- ulating official interpretations of the regulation “the [Federal Reserve] Board [now] must act jointly with the federal bank- ing agency, either the OCC or the FDIC, which directly regu- lates and supervises such entities [affected by the interpreta- tion].”76 Generally speaking, the FDIC plays a smaller role in the Dodd-Frank regulatory regime, however in several contexts the FDIC has an outsized influence as a result of the agency’s chief responsibility of overseeing the federal deposit insurance 70 See Enhanced Prudential Standards (Regulation YY), 12 C.F.R. § 252.1 (2020). 71 Federal Reserve Act, Pub. L. No. 63-43, § 21, 38 Stat. 251, 271 (1913) (codified as amended in scattered sections of 12 U.S.C.). 72 It is important to note, for those not familiar with the framework of banking supervision in the United States, that the supervisory responsibil- ity of the Federal Reserve is in addition to, and separate from, its well- known role in executing monetary policy. 73 Transactions Between Member Banks and Their Affiliates (Regula- tion W), 12 C.F.R. § 223.1 (2020). 74 Dodd-Frank Act, Pub. L. No. 111-203, § 608, 124 Stat. 1376, 1608 (2010) (codified at 12 U.S.C. § 371c (2018)). 75 Saule T. Omarova, From Gramm-Leach-Bliley to Dodd-Frank: The Unfulfilled Promise of Section 23a of the Federal Reserve Act, 89 N.C. L. REV. 1683, 1766 (2011). 76 Id. at 1767. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 356 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 fund.77 As was previously alluded to, the FDIC plays a second- ary role in executing on the supervisory responsibilities intro- duced by Regulation YY. That is, although the FDIC acts as an independent actor in Regulation YY analyses, the Federal Reserve maintains its role as the final decisionmaker, and may overrule the input of FDIC examiners.78 With respect to Regulation W, however, the FDIC plays a much more active role. Largely as a result of the use of Regulation W during the financial crisis,79 Dodd-Frank for the first time gave the FDIC absolute authority to prevent exemptions under Section 23A “if the FDIC determines that such exemption presents an un- acceptable risk to the federal deposit insurance fund.”80 In other words, under Dodd-Frank the FDIC holds final decision making authority on Regulation W exceptions, although is not considered the regulation’s primary owner given that it is not held responsible for its implementation or ensuring compli- ance with its provisions. The FDIC was delegated primary authority as to one cru- cial provision of Dodd-Frank, that which mandates bank hold- ing companies with over $50 billion in non-branch U.S. assets submit resolution plans for their orderly liquidation, an exer- cise popularly known as “resolution planning.”81 Under Dodd- 77 Federal Deposit Insurance Act, Pub. L. No. 81-797, § 1, 64 Stat. 873, 873 (1950) (codified as amended at 12 U.S.C. § 1811 (2018)). 78 See LABONTE, supra note 69, at 12. See also Enhanced Prudential Standards (Regulation YY), 12 C.F.R. § 252.1 (2020). 79 See Omarova, supra note 75, at 1690 (“[D]uring the crisis, the Board effectively rendered section 23A irrelevant by repeatedly allowing deposi- tory institutions to provide financing to their affiliated securities firms, de- rivatives dealers, money market funds, and even automotive companies . . . .”). 80 Id. at 1766 (describing Dodd-Frank Act, Pub. L. No. 111-203, § 608(a)(4)(A), 124 Stat. 1376, 1609 (2010) (codified at 12 U.S.C. § 371c(f) (2018)). 81 See Resolution Plans (Regulation QQ), 12 C.F.R. § 243.1 (2020). Again, this threshold was altered with the passage of the EGRRCPA. Im- mediately following the EGRRCPA’s enactment, financial institutions with consolidated assets of less than $100 billion were exempt from the resolu- tion planning requirements of section 165(d) of Dodd-Frank. Eighteen months after the EGGRCPA’s enactment, the exemption threshold was raised to $250 billion. See Economic Growth, Regulatory Relief, and 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 357 Frank, the FDIC and the FRS are jointly primarily responsi- ble for implementing Regulation QQ, the regulation that man- dates that institutions submit resolution plans, and making final decisions as to a resolution plan’s adequacy.82 This dele- gation of responsibility to the FDIC, although perhaps seem- ingly out of sync with the rest of the FRS-centric paradigm of Dodd-Frank, is likely a result of the resolution planning pro- cess being derived from the FDIC’s existing mandate of “or- derly and efficiently managing and disposing of the assets of failed depository institutions.”83 Although delegated less authority under Dodd-Frank, the OCC “assumes responsibility for the ongoing examination, su- pervision, and regulation of federal savings associations”84 un- der Title III of the statute.85 Beyond its role in supervising savings associations, the OCC also maintains primary respon- sibility for federally chartered and licensed banks.86 This pri- mary regulatory authority gives the OCC unique insight into the operations of FBOs, as U.S. branches of foreign banking organizations are federally licensed.87 U.S. branches are cru- cial tools in FBOs’ global operations; they allow international banking organizations to participate in and clear dollar-de- nominated transactions in the United States while not requir- ing high levels of capital or liquidity to be held within the legal Consumer Protection Act, Pub. L. No. 115–174, § 401(a), 132 Stat. 1296, 1356 (2018). See also Resolution Plans Required, 84 Fed. Reg. 59,194 (Nov. 1, 2019) (to be codified at 12 C.F.R. pts. 243, 381). 82 See 12 C.F.R. §§ 243.1, 243.8. 83 OFFICE OF INSPECTOR GEN., OFFICE OF AUDITS & EVALUATIONS, EVAL-13-004, THE FDIC’S RESOLUTION PLANNING PROCESS i (2013). 84 Press Release, Office of the Comptroller of the Currency, OCC Issues Final Rule to Implement Provisions of the Dodd-Frank Act (July 20, 2011), https://www.occ.treas.gov/news-issuances/news-releases/2011/nr-occ-2011- 95.html [https://perma.cc/FST8-6RGN]. 85 See Dodd-Frank Act § 312(b)(2)(B). 86 See 12 U.S.C. §§ 21, 27 (2018). 87 See 12 U.S.C. § 3102. See also International Banking Activities, 12 C.F.R. § 28.12(a)(2) (2020) (“A foreign bank must receive a license from the OCC to open and operate its initial Federal branch or agency in the United States.”). 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 358 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 entity.88 The centrality of branches to FBOs’ funding flows and broader business strategies has resulted in the OCC working closely with the Federal Reserve in regulating FBOs, and now, the IHCs.89 Interestingly, in imposing its own heightened risk management standards in its capacity as a primary and sec- ondary regulator, the OCC has mirrored many of the en- hanced prudential standards adopted by the Federal Re- serve.90 This effort by the OCC illustrates a broader point that, even beyond the collaboration required by Dodd-Frank, the three main financial regulators in the United States have made a concerted effort towards uniformity in promulgating their risk management and corporate governance standards to ease the cost and complexity associated with compliance for affected institutions.91 88 See William Goulding & Daniel E. Nolle, Foreign Banks in the U.S.: A Primer 21–22, 64 (Bd. of Governors of the Fed. Reserve Sys., International Finance Discussion Paper No. 1064r, 2012), https://www.federalre- serve.gov/PubS/ifdp/2012/1064/revision/ifdp1064r.htm#foot106 [https://perma.cc/U2TP-C38C]. For an illustration of the legal entity rela- tionship between IHCs and their U.S. branches, see Figure 2, infra. 89 See OFFICE OF THE COMPTROLLER OF THE CURRENCY, APPROACH TO FEDERAL BRANCH AND AGENCY SUPERVISION 6 (2017), https://www.occ.gov/publications-and-resources/publications/banker-educa- tion/files/pub-approach-fed-branch-agency-sup.pdf [https://perma.cc/L7LE- 458P]. 90 See OCC Guidelines Establishing Heightened Standards for Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches; Integration of Regulations, 70 Fed. Reg. 54,518 (Sept. 11, 2014) (to be codified at 12 C.F.R. pts 30, 168, and 170). See also IRENA GECAS-MCCARTHY ET AL., DELOITTE CTR. FOR REGULATORY STRATE- GIES, STRONGER: OCC’S HEIGHTENED EXPECTATIONS 2 (2014), https://www2.deloitte.com/content/dam/Deloitte/us/Documents/audit/us- aers-occ-heightened-expectations-11-26-02-12042014.pdf [https://perma.cc/T6KV-93VP] (“The OCC has formalized its ‘heightened ex- pectations’ for risk management and governance . . . . These proposed stand- ards apply to large national banks and are consistent with the principles embedded in the Federal Reserve’s expectations for large bank holding com- panies.”). 91 See U.S. GOV’T ACCOUNTABILITY OFFICE, GAO-14-67, DODD-FRANK REGULATIONS: AGENCIES CONDUCTED REGULATORY ANALYSES AND COORDI- NATED BUT COULD BENEFIT FROM ADDITIONAL GUIDANCE ON MAJOR RULES 23 (2013) (“For 10 of the 49 rules, there was no Dodd-Frank requirement to 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 359 Although not directly relevant for our purposes here, it is pertinent to note in passing the existence of the Financial Sta- bility Oversight Council (“FSOC”). FSOC was created by Title I of Dodd-Frank92 and, in addition to monitoring the aggregate risk and stability of the U.S. financial system, is most im- portantly tasked with designating institutions as “systemi- cally important financial institutions” (“SIFIs”).93 The SIFI ti- tle is incredibly consequential, as it gives FSOC the authority to require nonbanks to comply with Regulation YY standards and thus be treated, for regulatory purposes, as banking or- ganizations with more than $50 billion in consolidated as- sets.94 It is not an over-exaggeration to note that this process has been the source of extreme outrage in the insurance and asset management communities,95 with several large insurers obtaining the designation in the early days of FSOC’s exist- ence.96 However, following successful litigation on the part of coordinate, but we found evidence that the agencies voluntarily coordinated on the rulemakings.”). 92 Dodd-Frank Act, Pub. L. No. 111-203, § 111, 124 Stat. 1376, 1392 (2010) (codified as amended at 12 U.S.C. § 5321 (2018)). 93 See id. §§ 112–13. 94 See id. § 113. Again, this threshold has shifted with the EGRRCPA, but for consistency (and because we are analyzing the 2018 CCAR filings, where institutions with $50 billion in consolidated assets were required to participate), throughout this Note the $50 billion threshold will be refer- enced. See supra notes 12–15 and accompanying text for an explanation of the modification of this asset threshold under the EGRRCPA. 95 See, e.g., Press Release, MetLife, Inc., MetLife Statement on Final SIFI Designation (Dec. 18, 2014), https://investor.metlife.com/news-and- events/financial-press-releases/news-details/2014/MetLife-Statement-on- Final-SIFI-Designation/default.aspx [https://perma.cc/LWT9-Z6WZ]; Paul Kupiec, Opinion, Our Worst Fears About Dodd-Frank’s FSOC Are Being Confirmed, FORBES (Nov. 26, 2013), https://www.forbes.com/sites/re- alspin/2013/11/26/our-worst-fears-about-dodd-franks-fsoc-are-being-con- firmed/#40183eba3c86 [https://perma.cc/8HFE-JKHZ]. 96 See, e.g., James O’ Toole, AIG, GE Capital Tagged "Systemically Im- portant," Will Face Greater Regulation, CNN (July 9, 2013), https://money.cnn.com/2013/07/09/news/economy/ge-capital-aig/index.html [https://perma.cc/REC4-5TW2]; Jim Puzzanghera, MetLife Designated Too Big to Fail, L.A. TIMES (Dec. 19, 2014), https://www.latimes.com/busi- ness/la-fi-metlife-financial-stability-oversight-federal-reserve-20141219- story.html [https://perma.cc/6SW4-L7ZT]. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 360 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 one designated nonbank,97 and a new policy direction on the part of the Trump administration,98 FSOC’s use of the SIFI label has now been removed from all nonbanks.99 Given this trend, it is increasingly unlikely, although not impossible, that a foreign-headquartered nonbank will be designated as a SIFI and thus brought into Regulation YY’s purview in the near future. C. Regulation YY, Regulation W, And IHC Reorganization Now, before delving into subpart O of Regulation YY and its implications for foreign banking organizations, it is first necessary to outlay the other prudential risk management provisions of Regulation YY. Beyond providing helpful context for our analysis, these regulations are applicable to both IHCs and domestic banking organizations with U.S. non-branch as- sets over $50 billion.100 As will become clear later in this anal- ysis, the holistic cost of compliance with Regulation YY looms large still today over the business decisions made by the IHCs in restructuring their U.S. operations. Undoubtedly, the most well-documented regulatory exer- cise introduced by Regulation YY is the capital stress test commonly known as “CCAR.”101 Broadly, the CCAR exercise requires that affected financial institutions stress their bal- ance sheets annually in accordance with stress scenarios cre- ated by the Federal Reserve while maintaining capital levels 97 See Metlife, Inc. v. Fin. Stability Oversight Council, 865 F.3d 661 (D.C. Cir. 2017). 98 See Memorandum from President Donald J. Trump to Secretary Ste- ven Mnuchin (Apr. 21, 2017), https://www.whitehouse.gov/presidential-ac- tions/presidential-memorandum-secretary-treasury/ [https://perma.cc/RA8N-PHAK]. 99 See John Heltman, Prudential, the Last Nonbank SIFI, Sheds the Label, AM. BANKER (Oct. 17, 2018), https://www.american- banker.com/news/prudential-the-last-nonbank-sifi-sheds-the-label [https://perma.cc/JN3M-5NBH]. 100 See Enhanced Prudential Standards (Regulation YY), 12 C.F.R. § 252 (2020). 101 See id. §§ 252.41–47, 225.8. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 361 above the regulatory minima.102 Additionally, the exercise re- quires that institutions demonstrate that they maintain ap- propriate contingency plans to obtain emergency funding in the event of a capital shortfall.103 Perhaps the most conse- quential component of the CCAR exercise is that its results are made publicly available.104 By the Federal Reserve’s own statements, the rationale behind publicly disclosing the re- sults of CCAR is to “help the public understand and interpret the results of the supervisory stress test, particularly with re- spect to the condition and capital adequacy of participating firms . . . [and] allow[] the public to make an evaluation of the quality of the Board’s assessment.”105 Beyond public pressure, however, compliance with CCAR’s risk management require- ments has become extremely costly, with the approximate ag- gregate annual cost to filers being in the hundreds of millions of dollars.106 As noted in section 165 of Dodd-Frank, in designing the enhanced risk management standards of Regulation YY the Federal Reserve has the authority to “differentiate among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, fi- nancial activities (including the financial activities of their subsidiaries), size, and any other risk-related factors that the Board of Governors deems appropriate.”107 As it relates to cor- porate governance, this flexible grant of authority to the Fed- eral Reserve has resulted in institutions with over $50 billion 102 See id. § 252.44. 103 See id. § 225.8. 104 See id. § 252.46. 105 Stress Testing Policy Statement, 84 Fed. Reg. 6,664, 6,669 (Feb. 28, 2019) (to be codified at 12 C.F.R. pt 252). See also Beverly Hirtle & Andreas Lehnert, Supervisory Stress Tests 3 (Fed. Reserve Bank of N.Y., Paper No. 696, 2014), https://www.newyorkfed.org/medialibrary/media/re- search/staff_reports/sr696.pdf [https://perma.cc/2W79-GVNU] (“A commit- ment by regulators to publish the results of supervisory stress tests and to tie certain actions to firms’ quantitative results on those stress tests offers a potential mechanism to increase the credibility of the regulatory regime and improve communication with market participants.”). 106 See U.S. GOV’T ACCOUNTABILITY OFFICE, supra note 9, at 30. 107 Dodd-Frank Act, Pub. L. No. 111-203, § 165(a)(2)(A), 124 Stat. 1376, 1423–24 (2010) (codified as amended at 12 U.S.C. § 5365(a) (2018)). 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 362 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 in consolidated U.S. assets being expected to have a well-qual- ified Chief Risk Officer in the United States and retain a local board risk committee to maintain a consolidated view of the institution’s risk across portfolios.108 Regulatory expectations as to the management of each individual risk stripe are largely institution-specific, however there are several broad themes consistent across institutions that regulators empha- size when identifying satisfactory risk management regimes. Namely, regulators expect that internal capital and liquidity stress tests are performed separate and apart from the CCAR exercise,109 appropriate and timely management reports are produced with key summary statistics as to the aggregate risk in each division,110 risk limits are established and complied with,111 and institutions’ internal controls and escalation pro- cesses are followed.112 1. Regulation YY Subpart O and the Structure of International Banking Organizations Certainly, as was previously alluded to, the frictions asso- ciated with coming into compliance with the enhanced pru- dential standards of Regulation YY are similarly experienced by both large foreign banking organizations and domestic banking organizations. However, foreign banking organiza- tions face an additional requirement under Regulation YY: in accordance with subpart O, FBOs with over $50 billion in con- solidated U.S. assets were required to reorganize their legal entity structure to establish an IHC by the compliance date of July 1, 2016.113 This process of reorganization was extremely complex and resulted in affected institutions fundamentally restructuring their investment activities in the U.S. and glob- ally, which will be succinctly described below. 108 See 12 C.F.R. § 252.33. 109 See id. §§ 252.51–58. 110 See id. § 252.155(a)(2)(ii). 111 See id. §§ 252.70–78, 252.33(b)(2)(i)(A), 252.34(a)(1). 112 See id. § 252.33(a)(2). 113 See Enhanced Prudential Standards for Bank Holding Companies and Foreign Banking Organizations, 79 Fed. Reg. 17,240, 17,271 (Mar. 27, 2014) (codified as amended at 12 C.F.R. pt 252). 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 363 Prior to IHC reorganization, large foreign financial insti- tutions were only required to hold capital in the United States to the extent that they maintained a chartered U.S. banking entity.114 Before Dodd-Frank was enacted, a foreign banking organization was required to establish a chartered banking entity in the United States only if the institution intended to accept retail deposits.115 Thus, because most FBOs were not involved in retail banking activity in the U.S. prior to Regula- tion YY’s promulgation, most did not have a chartered U.S. banking entity, operating instead through a “agency-branch” network.116 As a result of this regulatory regime in the United States, all business done by foreign banking organizations in the U.S. served not only to accomplish the enterprise goals of the institution, but also offered liquidity to the broader organ- ization, particularly for those business lines (retail banking, structured finance) that are relatively illiquid.117 That is, in the pre-crisis era funds could flow freely between FBOs’ U.S. branches and their global network of legal entities, and there 114 See Foreign Banks and the Federal Reserve, FED. RES. BANK OF N.Y. (Apr. 1, 2007), https://www.newyork- fed.org/aboutthefed/fedpoint/fed26.html [https://perma.cc/C3BD-T938]. See also Tarullo, supra note 3, at 11 (“[T]he United States did not—prior to the financial crisis—require that all broker-dealers and investment banks meet Basel capital standards.”). Note that although branches are not subject to U.S. capital adequacy requirements, under the International Banking Act they must maintain a capital equivalency deposit equal to five percent of their liabilities. See International Banking Act of 1978, Pub. L. No. 95-369, § 4(g), 92 Stat. 607, 611 (codified as amended at 12 U.S.C. § 3102(g) (2018)). 115 See 12 U.S.C. § 3102(d) (2018). Figure 1, infra, represents a case where an FBO chooses to establish a chartered banking entity under a bank holding company. Under that illustration, the FBO would be required to hold capital at both the holding company and bank level. See Capital Ade- quacy of Bank Holding Companies, Savings and Loan Holding Companies, and State Member Banks (Regulation Q), 12 C.F.R. § 217 (2020). 116 See Goulding & Nolle, supra note 88, at 3–4, 54 tbl.1. Recall that branches of FBOs are not chartered banking entities, they are only federally licensed. See supra note 87 and accompanying text. 117 See Nicola Cetorelli & Linda Goldberg, Liquidity Management of U.S. Global Banks: Internal Capital Markets in the Great Recession 2 (Fed. Reserve Bank of N.Y., Paper No. 511, 2012), https://www.newyork- fed.org/medialibrary/media/research/staff_reports/sr511.pdf [https://perma.cc/U3KZ-HN8L]; Berlin, supra note 36, at 3. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 364 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 is evidence to suggest that FBOs have responded to liquidity and capital shocks in the past by relying on their “internal capital markets.”118 Figure 1: Pre-Regulation YY International Bank Struc- ture119 With the promulgation of subpart O, the organizational structure and funding strategy of FBOs has been dramatically 118 See Cetorelli & Goldberg, supra note 117. “Internal capital mar- kets” refers to the funding banking organizations have access to through their network of parent companies/legal entities. See Berlin, supra note 36, at 3. 119 See DAVIS POLK & WARDWELL LLP, U.S. INTERMEDIATE HOLDING COMPANY: STRUCTURING AND REGULATORY CONSIDERATIONS FOR FOREIGN BANKS 6 (2014), https://www.davispolk.com/files/U.S.Intermediate.Hold- ing.Company.Structuring.and_.Regulatory.Considerations.for_.For- eign.Banks_.pdf [https://perma.cc/YE4F-QS2W]. Foreign Bank U.S. Branch U.S. Funding Vehicle U.S. Bank Holding Company U.S. Broker Dealer U.S. Financial Co. U.S. Commercial Co. U.S. Bank Non-U.S. Company Non-U.S. Company Edge Act Subsidiary U.S. Operating Subsidiary Non-U.S. Company 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 365 disrupted. First and most fundamentally, FBOs are required under subpart O to establish a chartered banking entity, the IHC itself, in the United States.120 Under subpart O, there are several entities that must be organized under the IHC. First, any U.S. company121 controlled by a FBO with total consoli- dated U.S. assets over $50 billion is required to be organized under the IHC.122 Any non-U.S. company controlled by the U.S. company also is mandated to be organized under the IHC.123 The relevant statutory definition states that control can be achieved in three ways—(1) through owning, control- ling, or having the power to vote more than twenty-five per- cent of any class of voting securities of the company; (2) by controlling in any manner the election of a majority of the di- rectors or trustees of the company; or (3) by directly or indi- rectly exercising a controlling influence over the management or policies of the company.124 Branches are to be considered outside this control determination, as they are explicitly named in subpart O as not being required to be organized un- der the IHC.125 As a result of this exception, affected firms desperately attempted to reorganize their assets into their U.S. branch before the IHC reorganization compliance date.126 120 See U.S. Intermediate Holding Company Requirement for Foreign Banking Organizations with Combined U.S. Assets of $100 Billion or More and U.S. Non-Branch Assets of $50 Billion or More, 12 C.F.R. § 252.153(a)(1) (2020). 121 A “U.S. company” is defined as a “corporation, partnership, limited liability company, business trust, special purpose entity, association or sim- ilar organization” that is incorporated in or organized under the laws of the United States or in any U.S. state. 12 U.S.C. § 1841(b) (2018). 122 See 12 C.F.R. § 252.153(b)(1). 123 See id. 124 See 12 U.S.C. § 1841(a)(2). Recently, rules were finalized to clarify what exactly a “controlling influence” is under the Bank Holding Company Act. See Control and Divestiture Proceedings, 85 Fed. Reg. 12,398 (Mar. 2, 2020) (to be codified at 12 C.F.R. pts 225 and 238). 125 See 12 C.F.R. § 252.153(b)(1). 126 See James Disalvo, How Foreign Banks Changed After Dodd-Frank, BANKING TRENDS, Third Quarter 2019, at 1, 4, 5 fig.7 (showing that, through their U.S. branches, FBOs “increased their cash holdings dramatically fol- lowing the financial crisis”); Lawrence L. Kreicher & Robert N. McCauley, The New US Intermediate Holding Companies: Reducing or Shifting As- sets?, 2018 BIS Q. REV. 10, 11 (2018) (“From end-2015 to September 2017, 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 366 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 Beyond this reorganization strategy, every FBO subject to subpart O has sold off assets from their U.S. businesses,127 a trend that has been the subject of recent congressional hear- ings.128 US branch assets for FBOs with new IHCs increased by 16%.”); Laura Noonan, European Banks Slash $280bn From Main US Businesses, FIN. TIMES (Nov. 24, 2019), https://www.ft.com/content/ef651618-0b08-11ea- bb52-34c8d9dc6d84 [https://perma.cc/7S9X-8C3F]. 127 See Kreicher & McCauley, supra note 126, at 10. 128 See Fostering Economic Growth: Midsized, Regional, and Large In- stitution Perspective: Hearing Before the S. Comm. on Banking, Hous., & Urban Affairs, 115th Cong. 32–50 (2017) (statement of Greg Baer, Presi- dent, Clearing House Association); Semi-Annual Testimony on the Federal Reserve’s Supervision and Regulation of the Financial System: Hearing Be- fore the H. Comm. on Fin. Servs., 115th Cong. 22–23 (2018) (statement of Rep. Andy Barr). 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 367 Figure 2: Post-Regulation YY International Bank Struc- ture129 2. Regulation W and Intrabank Funding Importantly, Regulation YY and all its transformational provisions do not exist in a vacuum, and how they interact with the other regulations promulgated out of Dodd-Frank is important to describe to understand the unique challenges faced by the IHCs. Arguably the most important of these other regulations is Regulation W, which greatly impacts the IHCs and how they structure and fund their global businesses.130 129 See DAVIS POLK & WARDWELL LLP, supra note 119, at 7. 130 Transactions Between Member Banks and Their Affiliates (Regula- tion W), 12 C.F.R. § 223 (2020). Foreign Bank U.S. Branch IHC U.S. BHC U.S. Broker Dealer U.S. Com- mercial Co. U.S. Fi- nancial Co. U.S. Bank Edge Act Subsidiary Non-U.S. Company U.S. Funding Vehicle U.S. Operating Subsidiary Non-U.S. Company Non-U.S. Company 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 368 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 The general concept propelling Regulation W has been de- bated for over eighty years,131 however the specific changes Dodd-Frank has made to the regulation illustrate how inap- plicable regulations designed for domestic financial institu- tions can be to foreign financial institutions. While several major changes have been made to Regulation W since the fi- nancial crisis, we will specifically focus on Dodd-Frank’s elim- ination of the financial subsidiary exemption132 and the deriv- atives exception.133 Together, these amendments to Regulation W have drastically changed how financial institu- tions calculate their affiliate transactions, and, as a result, have changed the ways in which FBOs take on and distribute risk through their global organizations. First, we begin with sections 23A134 and 23B135 of the Fed- eral Reserve Act, which introduced the idea that intrabank transfers of assets should be curtailed “based on the amount of the bank’s capital and surplus.”136 That is, sections 23A and 23B state that internal transactions within banking organiza- tions should be limited and made on market terms to prevent banking organizations from engaging in excessive risk-taking through their subsidiaries.137 Sections 23A and 23B were amended several times through the twentieth century,138 and eventually, to consolidate all the rulemakings which resulted from these amendments, in 2002 the Federal Reserve issued Regulation W.139 Regulation W’s quantitative limits on 131 See Omarova, supra note 75, at 1692–1702. 132 Dodd-Frank Act, Pub. L. No. 111-203, § 609, 124 Stat. 1376, 1611 (2010) (codified at 12 U.S.C. § 371c(e) (2018)). 133 Id. § 610. 134 12 U.S.C. § 371c-1 (2018). 135 Id. 136 Omarova, supra note 75, at 1692. 137 12 U.S.C. § 371c-1. See also S. REP. NO. 73-77, at 10 (1933) (“The greatest of such dangers is seen in the growth of ‘bank affiliates’ which de- vote themselves in many cases to perilous underwriting operations, stock speculation, and maintaining a market for the banks’ own stock often largely with the resources of the parent bank.”). 138 See Omarova, supra note 75, at 1695–97. 139 See Press Release, Fed. Reserve Bd. of Governors, Final Regulation W (Transactions Between Banks and Their Affiliates) (Nov. 27, 2002), 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 369 internal transactions, which were not altered by Dodd-Frank, are, as a percentage of an institution’s capital and surplus, ten percent to a single affiliate, and an aggregate maximum of twenty percent to all affiliates.140 Note that Regulation W is only concerned with the transfer of cash or value from a bank- ing organization to its affiliates, not the other way around.141 So, while there are meaningful restrictions in how the IHCs may provide liquidity to their affiliates around the world, there are virtually no restrictions on how they can accept li- quidity from their affiliates. It is all important to note that not all transactions to affil- iates are included in an institution’s Regulation W calcula- tion; only “covered transactions” are included in the computa- tion.142 This term has been historically controversial,143 and prior to the financial crisis, Regulation W was notable for in- cluding several important exceptions to what is to be consid- ered a “covered transaction.” Namely, before the financial cri- sis derivatives transactions were not considered “covered transactions,” an exception that, according to some, ulti- mately had disastrous consequences.144 Although the Federal Reserve initially justified the exception by pointing to the funding benefits that it would bring for large, complex, inter- connected organizations,145 many have argued that the https://www.federalreserve.gov/boarddocs/press/bcreg/2002/20021127/de- fault.htm#:~:text=FRB%3A%20Press%20Release%20%2D%2D%20Fi- nal,Affiliates)%20%2D%2D%20Novem- ber%2027%2C%202002&text=The%20Federal%20Reserve%20Board%20o n,of%20the%20Federal%20Reserve%20Act [https://perma.cc/3QZM- CGEM]. 140 See General Provisions of Section 23A, 12 C.F.R. § 223.11–12 (2020). 141 See MICHAEL S. BARR ET AL., FINANCIAL REGULATION: LAW AND POL- ICY 226 (2016). 142 See 12 C.F.R. § 223.11–12. 143 See Veryl Victoria Miles, Banking Affiliate Regulation Under Sec- tion 23A of the Federal Reserve Act, 105 BANKING L.J. 476, 490–93 (1988); Omarova, supra note 75, at 1692–1702. 144 See Omarova, supra note 75, at 1698–1700. 145 See Transactions Between Member Banks and Their Affiliates, 67 Fed. Reg. 76,560, 76,587 (Dec. 12, 2002) (codified as amended at 12 C.F.R. pt. 223). 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 370 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 exception contributed to the undercapitalization of large banks in the most recent financial crisis.146 Indeed, because many Regulation W waivers were granted by regulators dur- ing the financial crisis to allow institutions to provide emer- gency liquidity to their global affiliates,147 policymakers prior- itized changes to the regulation in their drafting of Dodd- Frank.148 The elimination of the derivatives exception149 has resulted in a dramatic disruption of FBOs’ funding strategies. Intra- company derivatives transactions are extremely important li- quidity risk management tools for financial institutions, and have historically afforded large financial institutions, partic- ularly those with complex legal entity structures, the ability to hedge risks and absorb liquidity shocks across their organ- izations.150 Now that the exemption has been eliminated and intracompany derivatives transactions are limited by the ten percent and twenty percent limits of Regulation W, some com- mentators have noted that banks’ ability to manage their risks is “totally change[d].”151 Further, others have shared concerns that the elimination of the exception undermines 146 See Omarova, supra note 75, at 1727–28; Letter from Sen. Bob. Ca- sey to Ben S. Bernanke, Chairman, Bd. of Governors of the Fed. Reserve (Oct. 27, 2011), https://www.casey.senate.gov/newsroom/releases/casey-to- federal-bank-regulators-must-ensure-risky-behavior-by-banks-does-not- threaten-taxpayers [https://perma.cc/Y5LE-KFMD]. 147 See Omarova, supra note 75, at 1769–70; BARR ET AL., supra note 141, at 228. 148 See BARR ET AL., supra note 141, at 228. 149 Note that only derivative transactions that create a “credit expo- sure to the affiliate” are included as covered transactions. See 12 U.S.C. § 371c(b)(7)(G) (2018). 150 See Patrick D. Morris, Comment, Hedging with “Financial Weapons of Mass Destruction”: Cleaning Up the Fallout of Treating All Derivative Transactions Between Bank Affiliates the Same, 22 N.C. BANKING INST. 381, 383 (2018); The Dodd-Frank Act’s Impact on Affiliate Transactions, CAD- WALADER (Apr. 21, 2011), https://www.cadwalader.com/resources/clients- friends-memos/the-dodd-frank-acts-impact-on-affiliate-transactions [https://perma.cc/5QXX-GRFB]. 151 Stacey Kaper, Obscure Provision in Reg Reform May Have Big Im- pact, AM. BANKER (Mar. 5, 2010), https://www.american- banker.com/news/obscure-provision-in-reg-reform-may-have-big-impact- ab1015477 [https://perma.cc/7VVW-EVV3]. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 371 global financial stability as complex banking organizations, rather than relying on intracompany derivatives to hedge their risks, are now forced to rely on third parties, ultimately increasing the interconnectedness of the financial system.152 Amending the definition of “covered transactions” was not the only impactful change Dodd-Frank made to Regulation W. Indeed, the statute also tackled the financial subsidiary ex- emption, a provision that was initially promulgated under the Gramm-Leach-Bliley Act.153 Although financial subsidiaries have always been included as “affiliates” for purposes of Reg- ulation W,154 prior to Dodd-Frank’s enactment they were ex- cluded from some of the regulation’s requirements.155 Specifi- cally, “the aggregate amount of covered transactions between a bank and any one financial subsidiary . . . was not limited to 10% of the bank’s capital and surplus, and the retained earn- ings of a financial subsidiary were excluded in calculating the bank’s investment in the financial subsidiary (which is a cov- ered transaction).”156 Section 609 of Dodd-Frank eliminated this exemption and brought financial subsidiaries fully within the boundaries of Regulation W,157 a change that many have criticized as “limit[ing] the expansion of any financial subsid- iary of a bank.”158 152 See id. See also Morris, supra note 150, at 396–97. 153 See Gramm-Leach-Bliley Act, Pub. L. No. 106-102, § 5136A(b), 113 State 1338, 1373 (1999). See also Transactions Between Member Banks and Their Affiliates, 67 Fed. Reg. 76,560 (Dec. 12, 2002) (codified as amended at 12 C.F.R. pt. 223). “Financial subsidiary” is defined under Regulation W to mean “any subsidiary of a national or state bank that engage[s] in an activ- ity that a national bank is not permitted to engage in directly or that is conducted under terms that differ from those that govern the conduct of the activity by national banks.” Robert E. Mannion & Tengfei (Harry) Wu, Transactions Between Foreign Banks and Affiliated Entities, in REGULATION OF FOREIGN BANKS & AFFILIATES 783, 804 (Randall D. Guynn ed., 9th ed. 2016). 154 See Mannion & Wu, supra note 153, at 805. 155 See id. 156 Id. 157 See Dodd-Frank Act, Pub. L. No. 111-203, § 609(a), 124 Stat. 1376, 1611 (2010) (codified at 12 U.S.C. § 371c(e) (2018)). 158 Mannion & Wu, supra note 153, at 805. See also Douglas Landy et al., Looking Back While Forging Ahead: What the History of Restrictions on 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 372 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 It’s worth describing, before discussing FBOs’ CCAR re- sults and their implications, the enormous impact the finan- cial subsidiary exemption had on complex banking organiza- tions’ liquidity risk management. We begin with describing the basic funding strategy of FBOs prior to Dodd-Frank’s en- actment. In the pre-crisis period banking organizations were able to funnel liquidity in the form of retained earnings from a profitable financial subsidiary (like their U.S. broker-dealer, for example) to an entity that, because of the nature of its busi- ness, is relatively illiquid.159 FBOs have made particular use of this funding strategy, which in the most recent financial crisis resulted in their relatively efficient absorption of liquid- ity shocks globally.160 Further, FBOs’ relatively efficient li- quidity risk management in 2007–2008 allowed them to sup- port their legal entities operating in struggling economic regions more effectively during the crisis.161 It is difficult to overstate how central this role of FBOs is for global financial Bank Affiliate Transactions May Tell Us About the Impact of the Dodd- Frank Changes, 128 BANKING L.J. 588, 596 (2010). 159 See BASEL COMM. ON BANKING SUPERVISION ET AL., THE MANAGE- MENT OF LIQUIDITY RISK IN FINANCIAL GROUPS 3 (2006). 160 See Daniel Belton et al., Foreign Banks, Liquidity Shocks, and Credit Stability (Bank for Int’l Settlements, Working Paper No. 845, 2020), https://www.bis.org/publ/work845.pdf [https://perma.cc/SU64-4JNY]. To be clear, emphasis should be put on the word “relatively” in this sentence. FBOs, like their domestic counterparts, struggled to manage liquidity shocks during the crisis; however there is a plethora of empirical evidence showing that their support of their global entities was more robust than that observed by similarly large U.S.-headquartered institutions. See Dan- iel E. Nolle, Foreign-Owned Banks: (Way) Underestimated—and Volatile– Participants in the U.S. Banking Market, 1 J. FIN. PERSP. 1, 7–14 (2013); Cornelia Düwel & Rainer Frey, Competition for Internal Funds Within Mul- tinational Banks: Foreign Affiliate Lending in the Crisis 3 (Deutsche Bun- desbank, Paper No. 19/2012, 2012), https://www.bundesbank.de/re- source/blob/618122/eb854427cb6625a2178a45ff5184d26b/mL/2012-08-28- dkp-19-data.pdf [https://perma.cc/3T9E-D2YU]. 161 See, e.g., Nicola Cetorelli & Linda S. Goldberg, Banking Globaliza- tion and Monetary Transmission, 67 J. FIN. 1811 (2012); Giorgia Barboni, Foreign Banks as Shock Absorbers in the Financial Crisis? (Nat’l Bank of Belg., Working Paper No. 322, 2017), https://www.nbb.be/doc/oc/repec/reswpp/wp322en.pdf [https://perma.cc/Q67D-G5FA]. See also supra note 118 and accompanying text. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 373 stability. That is, large FBOs often serve as critical stabilizing forces in economies with less developed banking systems, which in many cases prevents a broadscale contraction of credit in vulnerable regions.162 Without their presence, devel- oping economics around the world would be left significantly more vulnerable to economic crises, which, based on the inter- connectedness of the global financial system, have historically proven capable of starting a global domino effect.163 Now, with the elimination of the financial subsidiary ex- emption, complex banking organizations have lost control over how they manage their liquid assets. Including financial subsidiaries’ retained earnings in the revised definition of “covered transactions” forces FBOs to either transmit a per- centage of the earnings of its U.S. financial subsidiaries to the IHC parent, or to reduce its intracompany transactions in some other way. In other words, “[a]s the retained earnings of a financial subsidiary increases, the value of the parent bank’s investment in the financial subsidiary increases.”164 To illus- trate, consider an organization similar to that presented in Figure 2. In that case, the IHC’s investment in its U.S. broker- dealer will increase to a level over ten percent “[u]nless the growth of the [IHC’s] capital and surplus attributable to other business activities of the [IHC] outpaces that attributable to the financial subsidiary.”165 This outcome, that the growth of the IHC’s banking business will outpace the growth of its fi- nancial subsidiaries, is extremely unlikely as virtually all of the business of the IHCs is conducted through their financial 162 See Barboni, supra note 161, at 7; B. Gerard Dages et al., Foreign and Domestic Bank Participation in Emerging Markets: Lessons from Mex- ico and Argentina, FRBNY ECON. POL’Y REV., Sept. 2000, at 17, 21. 163 See Simon Romero, The Markets: Market Place; An Argentine ‘Dom- ino Effect’ on Brazilian Stocks, N.Y. TIMES (May 25, 1999), https://www.ny- times.com/1999/05/25/business/the-markets-market-place-an-argentine- domino-effect-on-brazilian-stocks.html [https://perma.cc/GCX3-B3FY]; Da- vid Faber, The Domino Effect of Greece, CNBC (Apr. 22, 2010), https://www.cnbc.com/2010/04/22/the-domino-effect-of-greece.html [https://perma.cc/5CZ4-ZR2W]. 164 Mannion & Wu, supra note 153, at 805. 165 Id. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 374 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 subsidiaries.166 Thus, because IHCs’ banking businesses will likely not be able to keep pace with the growth of their finan- cial subsidiaries, every subsidiary whose growth threatens to push an IHC over the ten percent single affiliate limit “will have to pay out at least some of its net income to the parent bank as dividends instead of reinvesting all of it in the expan- sion of the financial subsidiary.”167 Given the number of finan- cial subsidiaries observed in Figure 2, and the fact that the retained earnings of every one will now count toward an IHC’s twenty percent intracompany transaction limit, it is likely that liquid capital will be unnecessarily remitted back to the IHCs. Recall that any retained earnings that are not so remit- ted will be counted toward the ten percent and twenty percent limits of Regulation W. Additionally, any remittance the IHC attempts to make back to its U.S. financial subsidiaries (or any of its subsidiaries globally) will be subject to the ten per- cent single affiliate and twenty percent aggregate limits of Regulation W. As noted earlier, this outcome serves not only to deprive liquid capital from global affiliates of FBOs, but it also puts U.S. financial subsidiaries at risk. Thus, the inter- action between Regulation W and Regulation YY results in capital being unnecessarily herded to one parent legal entity in the United States, however that parent’s ability to support its subsidiaries, in the U.S. and around the world, is signifi- cantly cabined. It is predictable, then, that the elimination of the financial subsidiary exemption has resulted in FBOs winding down a significant amount of the business they conduct in the United 166 See, e.g., Barclays US LLC, Parent Company Only Financial State- ments for Large Holding Companies (Form FR Y-9LP) 2 (Feb. 28, 2019); Credit Suisse Holdings (USA), Inc., Parent Company Only Financial State- ments for Large Holding Companies (Form FR Y-9LP) 2 (Mar. 31, 2020); UBS Americas Holding LLC, Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) 2 (Feb. 14, 2019); DB USA Corp., Parent Company Only Financial Statements for Large Holding Com- panies (Form FR Y-9LP) 2 (Feb. 14, 2019). Note that the extent of reliance on financial subsidiaries varies by IHC. See TD Group US Holdings LLC, Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) 2 (Feb. 12, 2019). 167 Mannion & Wu, supra note 153, at 805. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 375 States.168 Beyond the economic implications of this trend in the U.S., FBOs now do not have the excess liquidity to spare to direct to targeted entities in times of stress. This reality, a problem of U.S. regulators’ own creation, poses a significant and meaningful threat to global financial stability.169 III. THE IMPACT OF REGULATION YY AND REGULATION W ON IHC CAPITAL To evaluate the efficacy of Regulation YY, specifically when coupled with the recent changes to Regulation W, we now turn to the 2018 CCAR filings of the IHCs. As a level set, as of 2018 there were twelve IHCs, reflected along with their total U.S. consolidated asset size in Table 1.170 Throughout this empirical analysis, we will largely consider the IHCs to- gether as a means to categorically compare them to the do- mestic financial institutions subject to CCAR.171 However, it is important to keep in mind the intrinsic differences in the strategies and business models of the individual firms. To highlight this point, and also to specifically exemplify broader thematic takeaways, institution-specific data will be cited throughout this analysis. 168 See Noonan, supra note 126. 169 See Examining Capital Regimes for Financial Institutions: Hearing Before the Subcomm. on Fin. Insts. & Consumer Credit of the H. Comm. on Fin. Servs., 115th Cong. 84–100 (statement of Keith A. Noreika, Partner, Simpson, Thacher, & Bartlett). 170 See BD. OF GOVERNORS OF THE FED. RESERVE SYS., COMPREHENSIVE CAPITAL ANALYSIS AND REVIEW 2018: ASSESSMENT FRAMEWORK AND RESULTS (2018), https://www.federalreserve.gov/publications/files/2018-ccar-assess- ment-framework-results-20180628.pdf [https://perma.cc/JE9N-NW7T]. 171 As of the date of the CCAR 2018 filing, there were twenty-three do- mestic filers. See id. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 376 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 Table 1: List of IHCs172 Institution Name U.S. Consolidated Assets Q417 ($bn) U.S. Consolidated Assets Q418 ($bn) Toronto Dominion 378 382 HSBC 273 272 Credit Suisse 228 134 Barclays 192 172 Deutsche Bank 159 137 UBS 147 137 BNP Paribas 145 127 MUFG 159 165 RBC 140 N/A173 Santander 130 135 BMO 132 158 BBVA 87 92 A. 2018 CCAR Results First, to fully understand the CCAR results as they are re- ported, it is necessary to briefly describe the metrics this anal- ysis will focus on: institutions’ Tier 1 capital ratio and Tier 1 leverage ratio. An institution’s Tier 1 capital ratio is defined as its Tier 1 capital divided by its total risk weighted assets (“RWAs”).174 The denominator of this equation, risk-weighted assets, is a sum of a bank’s assets after they are multiplied by 172 The data is sourced through the public Consolidated Financial Statements for BHCs (Form FR Y-9C) for each IHC. See Consolidated Fi- nancial Statements for BHCs (FR Y-9C), NAT’L INFO. CTR., https://www.ffiec.gov/NPW [https://perma.cc/SM3M-6JGL] (last visited Apr. 1, 2020). 173 There is no data for Royal Bank of Canada’s IHC past March of 2018, as RBC undertook a broad reorganization in 2018 and is now not con- sidered to have an “active” IHC. See RBC USA HoldCo Corporation: History, NAT’L INFO. CTR., https://www.ffiec.gov/npw/Institution/Pro- file/3226762?dt=20160701 [https://perma.cc/FX86-MVA3] (last visited Apr. 1, 2020). 174 See BD. OF GOVERNORS OF THE FED. RESERVE SYS., A USER’S GUIDE FOR THE BANK HOLDING COMPANY PERFORMANCE REPORT 3–66 (2013). 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 377 their “risk-weight,” a multiplier-system created to more accu- rately reflect the risk on an institution’s balance sheet.175 In- stitutions’ Tier 1 capital ratios are widely used in the regula- tory community to indicate the appropriateness of a firm’s capital planning, given that the measure reflects the size of a firm’s high quality capital stock as a percentage of the risk- adjusted size of its balance sheet.176 An institution’s Tier 1 lev- erage ratio, on the other hand, is defined as its Tier 1 capital divided by its average total consolidated assets.177 This meas- ure, constructed to “measure the extent to which a bank has financed its assets with equity[,]”178 reflects how reliant an in- stitution is on external debt.179 A certain degree of reliance on external debt is important to the healthy functioning of the financial system, however if banking organizations are too overleveraged liquidity and credit crises can result.180 These two metrics have been heralded by both U.S. and global regulators as being the most accurate high-level 175 See John Walter, US Bank Capital Regulation: History and Changes Since the Financial Crisis, 105 ECON. Q. 1, 10–11 (2019). 176 See Risk-Based Capital Ratios at US Banks, FED. RES. BANK OF CLEVELAND (Dec. 9, 2013), https://www.clevelandfed.org/en/newsroom-and- events/publications/economic-trends/2013-economic-trends/et-20131209- risk-based-capital-ratios-at-us- banks.aspx#:~:text=Tier%2D1%20risk%20based%20capi- tal,to%20its%20risk%2Dweighted%20assets.&text=Regulators%20con- sider%20banks%20well%2Dcapitalized,at%202%20percent%20or%20be- low [https://perma.cc/3749-SJ7M]. 177 See Minimum Capital Requirements, 12 C.F.R. § 217.10(b)(4) (2020). 178 See Stefan Ingves, Chairman, Basel Comm. on Banking Supervi- sion, Keynote Address at the Asia-Pacific High-Level Meeting on Banking Supervision: Banking on Leverage (Feb. 27, 2014), https://www.bis.org/speeches/sp140226.pdf [https://perma.cc/57UY-7D96]. 179 See Emilios Avgouleas, Bank Leverage Ratios and Financial Stabil- ity: A Micro- and Macroprudential Perspective (Levy Econ. Inst. of Bard Coll., Working Paper No. 849, 2015), https://www.econstor.eu/bit- stream/10419/146977/1/840973446.pdf [https://perma.cc/A3WD-R5MK] (“Banks typically leverage themselves by borrowing to acquire more assets, with the aim of increasing their return on equity. Economic leverage means that a bank is exposed to a change in the value of a position by an amount that exceeds what the bank paid for it.”). 180 See id. at 5–6. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 378 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 summaries of complex financial institutions’ safety and soundness.181 Although academics have a variety of concep- tions as to what constitutes financial stability,182 it is univer- sally agreed that high capital ratios are a prudent buffer against risk taking.183 181 See, e.g., Martin J. Gruenberg, Member, Bd. of Dirs., Fed. Deposit Ins. Corp., Remarks at the Peterson Institute for International Economics: An Essential Post-Crisis Reform Should Not Be Weakened (Sept. 6, 2018), https://www.fdic.gov/news/speeches/spsep0618.html [https://perma.cc/5XDM-FGFF]; Daniel K. Tarullo, Member, Bd. of Gover- nors of the Fed. Reserve Sys., Remarks at the 2016 Financial Stability Con- ference: Financial Regulation Since the Crisis 7–9 (Dec. 2, 2016), https://www.federalreserve.gov/newsevents/speech/files/ta- rullo20161202a.pdf [https://perma.cc/6D5G-FGM3]. 182 See Hilary J. Allen, What is “Financial Stability”? The Need for Some Common Language in International Financial Regulation, 45 GEO. J. INT’L L. 929, 941–51 (2015); William A. Allen & Geoffrey Wood, Defining and Achieving Financial Stability, 2 J. FIN. STABILITY 152–53 (2006). 183 See Examining Capital Regimes for Financial Institutions: Hearing Before the Subcomm. on Fin. Insts. & Consumer Credit of the H. Comm. on Fin. Servs., supra note 169, at 2. However, there is some disagreement about how high is too high. See BPI Staff, Former Fed Gov. Daniel Tarullo’s Misplaced Calls for Higher Capital Requirements, BANK POL’Y INST. (May 22, 2019), https://bpi.com/former-fed-gov-daniel-tarullos-misplaced-calls- for-higher-capital-requirements/ [https://perma.cc/8ZVS-VMAQ]; Jaime Ca- ruana, Address at IESE Business School: How Much Capital is Enough? (Nov. 26, 2014), https://www.bis.org/speeches/sp141216.pdf [https://perma.cc/4LLQ-7JZ5]. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 379 Table 2: 2018 CCAR Summary Statistics184 Tier 1 Capital (Adverse) Tier 1 Capital (Severely Adverse) Tier 1 Leverage (Adverse) Tier 1 Leverage (Severely Adverse) Domes- tics 9.48% 7.12% 6.67% 5.08% IHCs 14.83% 12.85% 7.84% 6.68% Clearly, as illustrated by Table 2, the 2018 quantitative CCAR results are dramatic, with the IHCs holding capital at levels well above that required by regulators, and at signifi- cantly higher levels than their peer firms headquartered in the United States. However, the capital retained by the IHCs, while relatively high as a percentage of their risk-weighted assets, is not relatively high as a percentage of their total con- solidated assets. These results suggest that, although the IHCs hold significantly more high-quality capital on their bal- ance sheets as a percentage of the risk they take, they are just as reliant on external debt as the Domestics. This finding is consistent with the reports that FBOs have wound down much of their U.S. operations in preparing for IHC reorganiza- tion.185 That is, based on the financial disclosures of the IHCs outside the CCAR exercise, we can conclude that their rela- tively high Tier 1 capital ratios likely result from a decrease in IHCs’ RWAs. On one hand this may be viewed as a positive trend by regulators, as it implies that FBOs have undergone a significant de-risking in the United States.186 On the other, 184 See CCAR Historical Data: CCAR 2018, BOARD OF GOVERNORS OF FED. RES. SYS., https://www.federalreserve.gov/supervisionreg/ccar- 2020.htm [https://perma.cc/SE24-YTHJ]. For reference, the Tier 1 Capital and Tier 1 Leverage regulatory minima as of the 2018 and 2019 CCAR fil- ings was six and four percent, respectively. See Minimum Capital Require- ments, 12 C.F.R. § 217.10(a)(1) (2020). 185 See Noonan, supra note 126. 186 See Randal K. Quarles, Vice Chair for Supervision, Bd. of Governors of the Fed. Reserve Sys., Spontaneity and Order: Transparency, Accounta- bility, and Fairness in Bank Supervision 8 (Jan. 17, 2020), 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 380 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 however, this trend also signals that the IHCs are maintain- ing unduly large stocks of high-quality capital stagnantly on their balance sheets. In other words, we can conclude that FBOs are not using their stock of high-quality capital in the U.S. to fund their activities; the capital is instead left “trapped” at extremely high levels in their IHCs.187 This de- velopment lends support to the analysis of Regulation W of- fered in Section II.C. However, there is another statistical point relevant to note from the 2018 CCAR exercise that fur- ther illustrates the impact of Regulation W on the IHCs’ cap- ital ratios. That is the standard deviation of the IHCs’ results, depicted in Table 3 below. https://www.federalre- serve.gov/newsevents/speech/files/quarles20200117a.pdf [https://perma.cc/Z3CT-ASW9]. 187 See, e.g., Lionel Laurent, Opinion, Trapped Capital Ails Global Banks, BLOOMBERG (Nov. 28, 2016), https://www.bloomberg.com/opinion/ar- ticles/2016-11-28/global-banks-face-a-nasty-case-of-trapped-capi- tal?sref=m42vRBnI [https://perma.cc/2WB7-MQDX]; Lawrence White, HSBC Walks U.S. Regulatory Tightrope Over $10 Billion of ‘Trapped’ Cap- ital, REUTERS (Sept. 23, 2016), https://uk.reuters.com/article/uk-hsbc-capi- tal-idUKKCN11T0W7 [https://perma.cc/NM75-P3Q2] (“HSBC . . . has more than $20 billion [] of capital in the United States earning a slim 1 percent return, of which up to half could be returned to the holding company via asset sales, analysts and investors say. The bank’s investors are currently missing out on higher profits and more secure dividends as a result of this hefty U.S. balance sheet. The bank earns a return on equity of just 1.4 per- cent on this, compared with 5 percent for HSBC globally and 13 percent for major U.S. commercial bank rivals . . . .”). 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 381 Table 3: 2018 CCAR Standard Deviations188 σ Tier 1 Capital (Adverse) σ Tier 1 Capital (Severely Adverse) σ Tier 1 Leverage (Adverse) σ Tier 1 Leverage (Severely Adverse) Domes- tics 1.51 1.26 0.78 0.87 IHCs 4.26 4.63 1.91 1.83 The extremely high standard deviation observed in the IHCs’ Tier 1 capital results is largely a function of three IHCs holding extremely high levels of capital: Credit Suisse, Deutsche Bank, and UBS.189 Each of these institutions’ Tier 1 capital ratio was above 22.8% under the adverse stress sce- nario created by the Federal Reserve, nearly eight percent higher than the IHC average,190 and nearly seventeen percent higher than the regulatory minimum.191 These three institu- tions are widely considered to be three of the four most sys- temically important FBOs operating in the United States due to their involvement in U.S. capital markets.192 It is all the 188 See CCAR Historical Data: CCAR 2018, supra note 184. 189 See id. 190 See id. As of the 2018 CCAR filing date each of these institutions was included in the Federal Reserve’s Large Institution Supervision Coor- dinating Committee (“LISCC”) portfolio. Just recently, following a reorgan- ization that resulted in “the substantial and sustained decrease in risk from [] U.S. operations” UBS was taken out of the portfolio. See Press Release, Meghan Milloy, IIB Statement on the Federal Reserve’s Announcement re: the LISCC Portfolio (Mar. 6, 2020), https://cdn.ymaws.com/www.iib.org/re- source/resmgr/website_press/20200306Fed.LISCC.Statement.pdf [https://perma.cc/GWV7-MC92]. However, UBS remains as a “globally sys- temically important bank” (“G-SIB”) as designated by the Financial Stabil- ity Board. FIN. STABILITY BD., 2019 LIST OF GLOBAL SYSTEMICALLY IM- PORTANT BANKS (G-SIBS) 3 (2019), https://www.fsb.org/wp- content/uploads/P221119-1.pdf [https://perma.cc/4SAF-GMTW]. 191 See Minimum Capital Requirements, 12 C.F.R. § 217.10(a)(1) (2020). 192 See Burke Speaker, Fed Risk List: 15 Firms That Pose Risk to U.S. Financial Stability, INV. PLACE (May 2, 2014), 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 382 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 more important, then, to explore these unusual results as they likely have had, and will continue to have, important economic implications in the United States. B. 2019 CCAR Results We now turn to 2019’s CCAR exercise which, as a result of the threshold changes introduced by the EGRRCPA, had only eighteen filers.193 As we would expect, the results from the 2019 exercise are similar, but even more stark, than those of the 2018 exercise. Table 4: 2019 CCAR Summary Statistics194 Tier 1 Capital (Adverse) Tier 1 Capital (Severely Adverse) Tier 1 Leverage (Adverse) Tier 1 Leverage (Severely Adverse) Domes- tics 10.87% 8.55% 6.78% 5.25% IHCs 18.23% 15.77% 7.9% 6.7% https://investorplace.com/2014/05/fed-risk-list-15-firms-risk-us-financial- stability/ [https://perma.cc/X9KP-NQFM]. The fourth is Barclays, whose 2018 Tier 1 capital and leverage ratios were in line with the IHC mean. See CCAR Historical Data: CCAR 2018, supra note 184. 193 See BD. OF GOVERNORS OF FED. RESERVE SYS., COMPREHENSIVE CAPI- TAL ANALYSIS AND REVIEW 2019: ASSESSMENT FRAMEWORK AND RESULTS (2019), https://www.federalreserve.gov/publications/files/2019-ccar-assess- ment-framework-results-20190627.pdf [https://perma.cc/X64F-TKEK]. Of the eighteen filers, six were FBOs. They were Barclays, Credit Suisse, Deutsche Bank, HSBC, Toronto Dominion, and UBS. See id. 194 See CCAR Historical Data: CCAR 2019, BOARD OF GOVERNORS OF FED. RES. SYS., https://www.federalreserve.gov/supervisionreg/ccar- 2020.htm [https://perma.cc/SE24-YTHJ]. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 383 Table 5: 2019 CCAR Standard Deviations195 σ Tier 1 Capital (Adverse) σ Tier 1 Capital (Severely Adverse) σ Tier 1 Leverage (Adverse) σ Tier 1 Leverage (Severely Adverse) Domes- tics 1.43 1.77 1.51 0.85 IHCs 5.59 5.47 1.07 1.09 These results suggest that the same trends described above continue through to today. In 2019, again, the three FBOs previously discussed were those that held Tier 1 capital at levels well above their IHC peers, resulting in a very high IHC Tier 1 standard deviation.196 Thus, despite the inefficien- cies that result from holding high-quality capital at such lev- els,197 it appears that those FBOs with large U.S. broker deal- ers cannot redirect their excess capital to their other global legal entities. This is the result we would expect following the elimination of Regulation W’s financial subsidiary exemption. That is, because the ten percent single affiliate and twenty percent aggregate annual limits now apply to IHCs’ invest- ment in their financial subsidiaries (which includes the sub- sidiaries’ retained earnings), it follows that the institutions are, with every passing year, building up more and more cap- ital at the IHC level. This relationship between IHCs’ finan- cial subsidiaries and their stock of high-quality capital will continue to exist as long as the growth of their financial sub- sidiaries “outpaces that attributable to . . . the parent.”198 This clearly explains why the IHCs have dramatically reduced the size of their U.S. operations in recent years, and has been 195 See id. 196 See CCAR Historical Data: CCAR 2019, supra note 194. 197 See Noonan, supra note 126. 198 See Mannion & Wu, supra note 153, at 805. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 384 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 reported by several journalists as being the driving force be- hind the IHCs’ de-risking.199 It seems as though these three firms themselves have also recognized Regulation W’s role in trapping capital in their IHCs. Industry groups that represent Deutsche Bank, Credit Suisse, and UBS have made public statements addressing the high levels of Tier 1 capital maintained by the IHCs, noting that the requirements of Regulation W have “trap[ped] liquid- ity in the United States that could potentially be deployed more effectively elsewhere.”200 Other industry trade associa- tions have also weighed in on the development, with the Bank Policy Institute noting that FBOs’ high capital ratios “under- mine the resiliency of the global financial system.”201 The Bank Policy Institute went on to offer a more detailed analysis of the complications associated with misallocation risk, noting that: Applying full requirements in the host jurisdiction . . . effectively increases consolidated requirements for the FBO because of the requisite high degree of pre-posi- tioning in host jurisdictions and the lack of flexibility to deploy resources throughout the organization. If 199 See Noonan, supra note 126; Yalman Onaran, European Banks Spend Billions to Get U.S. Unites Fit for Fed, BLOOMBERG (June 29, 2016), https://www.bloomberg.com/news/articles/2016-06-29/european-banks- spend-billions-to-get-u-s-units-fit-for-the-fed?sref=m42vRBnI [https://perma.cc/RY8A-6UW3]. See also Kreicher & McCauley, supra note 126, at 10. 200 See Institute of International Bankers, Comment Letter on Pro- posed Rule to Revise Prudential Standards for Large Foreign Banking Or- ganizations 22 (June 21, 2019), https://cdn.ymaws.com/www.iib.org/re- source/resmgr/2019_frb_tailoring_proposal/PDFFINALFBOTailoringLette r06.pdf [https://perma.cc/Q3E5-UAP6]. See also Briget Polichene, CEO, In- stitute of International Bankers: View From IMF 2019, BANKER (Oct. 19, 2019), https://www.thebanker.com/video/v/6096039756001/briget-poli- chene-ceo-institute-of-international-bankers-view-from-imf-2019 [https://perma.cc/N4F6-8G3U]. 201 Bank Policy Institute & American Bankers Association, Comment Letter on Proposed Changes to Applicability Thresholds for Regulatory Cap- ital Requirements for Certain U.S. Subsidiaries of Foreign Banking Organ- izations 32 (June 21, 2019), https://www.fdic.gov/regulations/laws/fed- eral/2019/2019-changes-to-applicability-thresholds-3064-ae96-c-018.pdf [https://perma.cc/6MRV-TUQG]. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 385 many, much less all, host authorities were to act inde- pendently to require full pre-positioning in their own jurisdictions, this would exacerbate the problem of de- pleting available resources at the top of the group and would thereby limit the group’s ability to allocate re- sources efficiently and, during stress, to deploy re- sources where actually needed. 202 Global regulators have also chimed in on this point. In a recent report the Financial Stability Board (“the FSB”) noted that “[t]he domestic requirements that were adopted in some jurisdictions (e.g. subsidiarisation requirements, require- ments to establish intermediate holding companies, high-lev- els of pre-positioning requirements) tend to favo[r] domestic activities and trap resources at local levels.”203 The statements of the FSB reflect a growing consensus among regulators that subpart O of Regulation YY and the revised Regulation W un- dermine one of the key pillars of the post-crisis global regula- tory regime: improving the resolvability of complex financial institutions.204 Thus, the problems identified in the 2018 and 2019 CCAR results are consistent with the Regulation W anal- ysis offered in Section II.C, the shrinking balance sheets of the IHCs, the statements of the FBOs themselves, and, increas- ingly, the perspective of both U.S. and global regulators. In- deed, regulators’ recognition of the complications associated with Regulation YY has already led to some changes in the IHC regulatory framework,205 however the most important provisions of the regulation have yet to be addressed. 202 Id. at 11–12. 203 FIN. STABILITY BD., FSB REPORT ON MARKET FRAGMENTATION 48 (2019), https://www.fsb.org/wp-content/uploads/P040619-2.pdf [https://perma.cc/P259-5JKV]. 204 See Randal K. Quarles, Vice Chairman for Supervision, Bd. of Gov- ernors of the Fed. Reserve Sys., Remarks at the Harvard Law School Pro- gram on International Finance Symposium: Trust Everyone—But Brand Your Cattle (May 16, 2018), https://www.bis.org/review/r180522a.pdf [https://perma.cc/4GV5-E9CQ]. 205 See Changes to Applicability Thresholds for Regulatory Capital and Liquidity Requirements, 84 Fed. Reg. 59,230 (Nov. 1, 2019) (to be codified at 12 C.F.R. pts 3, 50, 217, 249, 324 and 329); Margin and Capital Require- ments for Covered Swap Entities, 84 Fed. Reg. 59,970 (proposed Nov. 7, 2019) (to be codified at 12 C.F.R. pts 45, 237, 349, 624, and 1221). 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 386 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 IV. PROPOSED AMENDMENTS TO REGULATION W It goes without saying that the money, time, and political capital spent to establish the IHC framework in the United States make its repeal implausible. However, there are small, meaningful changes that can be made to Regulation W to lighten the burden on FBOs and, more importantly, improve the stability of the global financial system. We begin with the first provision of Regulation W dis- cussed in Section II.C—the elimination of the derivatives ex- ception. Recall that the elimination of that exception revised the definition of “covered transactions” under Regulation W to include derivatives transactions.206 This change was highly controversial, with some academics arguing that the change “was a mistake by Congress.”207 Critics of the exception’s elim- ination point to the liquidity risk management benefits asso- ciated with intracompany derivatives transactions208 and the systemic risk created by forcing complex financial institutions to rely on third parties to execute their hedging strategies.209 Indeed, one commentator went as far as to say that the elimi- nation of the exception “had nothing to do with the crisis and [it] . . . diminish[es] the ability of affiliated companies to man- age risk on a consolidated basis and . . . exacerbate[s] inter- connectivity among unaffiliated financial institutions.”210 However, while intracompany derivatives transactions do play an important role in complex financial institutions’ fund- ing strategies, they also are associated with a significant de- gree of credit risk. That is, in the words of Professor Omarova, the derivatives exception, when in effect, “opened up a nearly unlimited channel for . . . extensions of credit.”211 The experi- ence of U.S. regulators in the financial crisis exposed the sig- nificant risks these extensions of credit pose to the U.S. 206 See Dodd-Frank Act, Pub. L. No. 111-203, § 610, 124 Stat. 1376, 1611 (2010) (codified as amended at 12 U.S.C. § 84(b) (2018)). 207 Morris, supra note 150, at 393. 208 See id. at 393–96; Kaper, supra note 151. 209 See Morris, supra note 150, at 396–97; Kaper, supra note 151. 210 Kaper, supra note 151. 211 Omarova, supra note 75, at 1690. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 387 financial system. To illustrate these risks, we turn to the ex- ample of American Insurance Group, Inc. (“AIG”), a financial institution that nearly failed during the crisis.212 AIG is an in- surance company that was a major player in the credit default swap (“CDS”) market leading up to the financial crisis.213 As subprime bonds began to default in 2008 and CDS contracts became due, AIG was left with a shortfall.214 Complicating this position, AIG executed most of its CDS contracts, not through its parent entity, but through a subsidiary, AIG Fi- nancial Products (“AIGFP”).215 This organizational strategy is important for several reasons—first, because it allowed AIG to largely conceal its CDS activity from regulators,216 and sec- ond, because it resulted in massive intracompany derivatives transactions emanating from the AIGFP entity.217 This intra- company derivatives exposure led to what one government of- ficial called a “house of cards,”218 and made AIGFP critical to the survival of AIG, and the U.S. financial system more 212 See David Goldman, AIG Bailout: $127.7B and Counting, CNN (Dec. 30, 2008), https://money.cnn.com/2008/12/29/news/companies/aig/in- dex.htm [https://perma.cc/4NNF-FEWJ]. 213 See Adam Davidson, How AIG Fell Apart, REUTERS (Sept. 18, 2008), https://www.reuters.com/article/us-how-aig-fell-apart/how-aig-fell-apart- idUSMAR85972720080918 [https://perma.cc/GPV6-S4X2]. Credit default swaps are financial instruments that “insure” against the risk of a security issuer going bankrupt. Credit default swaps are derivative instruments, both in practical terms and for Regulation W purposes. See MOORAD CHOUDHRY, AN INTRODUCTION TO CREDIT DERIVATIVES 16 (2004). 214 See Davidson, supra note 213. 215 See id. 216 See CONG. OVERSIGHT PANEL, THE AIG RESCUE, ITS IMPACT ON MAR- KETS, AND THE GOVERNMENT’S EXIT STRATEGY 17–18 (2010). 217 See id. at 40. See also Gary Gensler, Chairman, Commodity Futures Trading Comm’n, Keynote Address at the FINRA Annual Conference: Cross-Border Application of Dodd-Frank Swaps Market Reforms (May 21, 2012), https://www.cftc.gov/PressRoom/SpeechesTestimony/opagensler-113 [https://perma.cc/4PZ5-7YQA] (describing the interconnectedness between derivatives affiliates and major banking organizations). 218 TARP and Other Government Assistance for AIG: Hearing Before the Cong. Oversight Panel, 111th Cong. 221–22 (2010) (testimony of Jim Millstein, Chief Restructuring Officer, U.S. Department of the Treasury). 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 388 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 generally.219 That is, the failure of AIGFP would not only leave its outside counterparties without the funding they had con- tracted for, but also would undermine many of its affiliate counterparties, almost certainly leading to the complete col- lapse of AIG.220 In the words of one regulator, “[w]hile the downfall of AIG was not caused by inter-affiliate swaps, the events surrounding AIG during the 2008 crisis demon- strate[d] how the risks of uncleared swaps at one affiliate can have significant ramifications for the entire affiliated busi- ness group.”221 Thus, despite the protests of critics, there is little doubt that intracompany derivatives transactions post some risk to the global financial system, and if left unregulated, may seri- ously damage the resiliency of systemically important finan- cial institutions. However, before moving on to a solution, we look to a proposal that was recently made by the OCC itself. In November 2019 the OCC issued a Notice of Proposed Rule- making which, if adopted, would eliminate the initial margin requirements associated with intracompany derivative trans- actions.222 By way of background, initial margin (“IM”) in de- rivatives transactions is a collateral tool that requires a coun- terparty to post a percentage of the derivative instrument’s value in cash or liquid assets prior to the performance of the contract.223 In the context of intracompany derivatives within 219 See CONG. OVERSIGHT PANEL, supra note 216, at 40; Economic and Budget Challenges for the Short and Long Term: Hearing Before the S. Comm. on the Budget, 111th Cong. 27 (2009) (statement of Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System). 220 See CONG. OVERSIGHT PANEL, supra note 216, at 40. 221 Clearing Exemption for Swaps Between Certain Affiliated Entities, 78 Fed. Reg. 21,750, 21,752 (Apr. 11, 2013) (codified as amended at 17 C.F.R. pt. 50). 222 Margin and Capital Requirements for Covered Swap Entities, 84 Fed. Reg. 59,970 (proposed Nov. 7, 2019) (to be codified at 12 C.F.R. pts 45, 237, 349, 624, and 1221). 223 See Thomas Hoenig, Why It’s So Difficult to Amend Inter-Affiliate Margin Rules, MERCATUS CTR. (Aug. 12, 2019), https://www.merca- tus.org/bridge/commentary/why-so-difficult-amend-inter-affiliate-initial- margin-rules#:~:text=A%20proposal%20currently%20under%20considera- tion,the%20same%20corporate%20bank%20group [https://perma.cc/ZF2R- TJC3]. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 389 banking organizations, IM resulted in high-quality capital be- ing hoarded at whatever banking legal entity was participat- ing in the intracompany transactions.224 Still, while the pro- posal to eliminate IM for intracompany derivatives has been politically controversial,225 it has largely been welcomed by banking organizations.226 Additionally, industry commenta- tors have noted that the proposal would unlock $40 billion in liquidity,227 a result that would seem to at least partially 224 See Press Release, Jelena McWilliams, Chairman, Fed. Deposit Ins. Corp., Statement by FDIC Chairman Jelena McWilliams on the Notice of Proposed Rulemaking 1 (Sept. 17, 2019), https://www.fdic.gov/news/speeches/spsep1719b.pdf [https://perma.cc/6AVU-V4FJ]. See also Letter from Am. Bankers Ass’n, to Jerome Powell, Chairman, Bd. of Governors of the Fed. Reserve Sys. (May 13, 2019), https://www.sifma.org/wp-content/uploads/2019/05/Joint-Trades- Letter-to-Prudential-Regulators-on-IA-IM-Requirements-dated-May-13- 2019.pdf [https://perma.cc/Z6PP-JNNX]. 225 See Press Release, Rep. Maxine Waters, Waters Statement on FDIC Proposal to Eliminate Inter-Affiliate Swaps Initial Margin (Sept. 17, 2019), https://financialservices.house.gov/news/documentsingle.aspx?Documen- tID=404339 [https://perma.cc/6P9M-B5B5]; Press Release, Sen. Thom Til- lis, Tillis Statement on Inter-Affiliate Margin Requirements (Sept. 18, 2019), https://www.tillis.senate.gov/2019/9/tillis-statement-on-inter-affili- ate-margin-requirements [https://perma.cc/4CEE-KS2K]. 226 See American Bankers Association, Comment Letter on Proposed Rules on Margin and Capital Requirements for Covered Swap Entities (Dec. 9, 2019), https://www.sifma.org/wp-content/uploads/2019/12/Joint-Trade- Associations-Comment-Letter-on-Proposed-Amendments-to-Margin-and- Capital-Requirements-for-Covered-Swap-Entities.pdf [https://perma.cc/EZ63-3782]; International Swaps and Derivatives Associ- ation, Inc., Comment Letter on Proposed Rules on Margin and Capital Re- quirements for Covered Swap Entities (Dec. 9, 2019), https://www.isda.org/a/yUxTE/Final-ISDA_Margin-NPR-Comment- 12.9.19.pdf [https://perma.cc/N869-MQ3F]. 227 See Lalita Clozel, Banks Set to Win $40 Billion in Relief from Post- crisis Rule, WALL ST. J. (Sept. 17, 2019), https://www.wsj.com/arti- cles/banks-set-to-win-40-billion-in-relief-from-postcrisis-rule-11568735719 [https://perma.cc/Y6C7-VCSL] (reporting that “[a]t the end of 2018, 20 of the largest financial firms had posted $39.4 billion of initial margin for trans- actions between affiliates”). See also BASEL COMM. ON BANKING SUPERVISION & BD. OF INT’L ORG. OF SEC. COMM’NS, MARGIN REQUIREMENTS FOR NON-CEN- TRALLY CLEARED DERIVATIVES 21 (2019), https://www.bis.org/bcbs/publ/d475.pdf [https://perma.cc/JW2M-SX6B] (“Although current market practices on this point vary, the exchange of in- itial or variation margin by affiliated parties to a non-centrally cleared 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 390 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 relieve the amount of Tier 1 capital that FBOs are currently holding in their IHCs. Indeed, the Chair of the FDIC herself seemed to endorse this notion in remarking that the NPRM aims to address the presence of “locked up” and “frozen” capi- tal maintained within banking legal entities.228 Assuming this NPRM is finalized in the coming months, the question still remains as to whether intracompany deriv- atives should be included as “covered transactions” at all un- der Regulation W. In considering this question we turn back to the experience of AIG during the financial crisis, and the emphasis regulators have placed on resolution and resolvabil- ity in the post-crisis era.229 Given the role AIG played in the financial crisis and the complications the firm’s intracompany derivatives introduced,230 it seems that a complete restate- ment of the derivatives exception would be unwise. The initial margin NPRM aims to address the major issue this Note iden- tified, the excessive pre-positioning of high quality capital in IHC legal entities, and further regulatory rollback that poten- tially exposes investors to greater risk and undermines U.S. regulators’ goals of orderly resolution is unnecessary and could be counterproductive. Indeed, as the affiliate margin proposal was tailored, several prominent regulators acknowl- edged that a writ large reintroduction of the exception may introduce financial stability issues,231 a sentiment that derivative is not customary. Accordingly, extending the initial margin re- quirements to such transactions would likely create additional liquidity de- mands for firms engaging in such transactions.”). 228 See McWilliams, supra note 224, at 1. 229 See Dodd-Frank Act, Pub. L. No. 111-203, §§ 201–17, 124 Stat. 1376, 1442–1520 (2010). See also Daniel K. Tarullo, Member, Bd. of Gover- nors of the Fed. Reserve Sys., Remarks at the Federal Reserve Bank of Rich- mond: Toward Building a More Effective Resolution Regime: Progress and Challenges (Oct. 18, 2013), https://www.federalre- serve.gov/newsevents/speech/files/tarullo20131018a.pdf [https://perma.cc/84AX-WKP4]. 230 See CONG. OVERSIGHT PANEL, supra note 216, at 119. 231 See Press Release, Bd. of Governors of the Fed. Reserve Sys., State- ment by Governor Lael Brainard (Oct. 28, 2019), https://www.federalre- serve.gov/newsevents/pressreleases/brainard-statement-20191028.htm [https://perma.cc/BUX8-ARRG]; Press Release, Martin J. Gruenberg, Mem- ber, Bd. of Dirs., Fed. Deposit Ins. Corp., Notice of Proposed Rulemaking: 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 391 banking organizations themselves appeared to endorse in their collective comment letter on the point.232 This agreement reflects how far we have come in the ten years since Dodd- Frank’s enactment—although still not agreeing on every- thing, it seems as though the process of regulatory “tailoring” has been more collaborative than adversarial. There is still one more provision of Regulation W to ad- dress: the financial subsidiary exemption. Recall that when the exemption was in effect, intracompany transactions with financial subsidiaries did not count toward Regulation W’s single affiliate limitation, and, most importantly, “the re- tained earnings of [] financial subsidiar[ies] were excluded in calculating the bank’s investment in the financial subsid- iar[ies] (which is a covered transaction).”233 The broader im- plications of the exemption’s elimination were discussed in Section II.C, however for our purposes here it is enough to note that many have remarked that the elimination will likely result in the forced upstreaming of high-quality capital away from U.S. financial subsidiaries (like U.S. broker-dealers, for example) to the parent IHC. The financial subsidiary exemption’s elimination is more likely to be driving the 2018 and 2019 IHC CCAR results than the derivative exception’s elimination. That is, while commen- tators noted that initial margin posted on intracompany de- rivative transactions drained nearly $40 billion of liquidity from affected institutions,234 a review of the IHCs’ FR Y-9LP disclosures reveals that the retained earnings of IHCs’ finan- cial subsidiaries dwarfs that number.235 For illustrative Swap Margin Requirements 2 (Sept. 17, 2019), https://www.fdic.gov/news/speeches/spsep1719.pdf [https://perma.cc/AM93- SCBE]. 232 See American Bankers Association, supra note 226, at 3–4. 233 See Mannion & Wu, supra note 153, at 805. 234 See Clozel, supra note 227. 235 See Barclays US LLC, Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Feb. 28, 2019); Credit Suisse Holdings (USA), Inc., Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Mar. 31, 2020); UBS Amer- icas Holding LLC, Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Feb. 14, 2019); DB USA Corp., 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 392 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 purposes, again, we turn to the examples of Credit Suisse, Deutsche Bank, and UBS, the three IHCs that held the high- est levels of Tier 1 capital in both the 2018 and 2019 CCAR exercises.236 Each of these institutions received over $1.5 bil- lion in remittances from their nonbank financial subsidiaries through 2018, with Credit Suisse and UBS receiving over $2.4 billion each.237 These remittances amount to between one and two percent of these IHCs’ total assets,238 and thus at least partially account for the elevated capital levels observed in the 2018 and 2019 CCAR results. Based on these disclosures, it appears that, rather than draining their financial subsidiaries of capital through remittances, IHCs are otherwise limiting their intracompany transactions to stay within the bounds of Regulation W’s limitations.239 Further, a review of the IHCs’ Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Feb. 14, 2019). 236 See CCAR Historical Data: CCAR 2018, supra note 184; CCAR His- torical Data: CCAR 2019, supra note 194. 237 See Credit Suisse Holdings (USA), Inc., Parent Company Only Fi- nancial Statements for Large Holding Companies (Form FR Y-9LP) (Mar. 31, 2020); Credit Suisse Holdings (USA), Inc., Parent Company Only Finan- cial Statements for Large Holding Companies (Form FR Y-9LP) (Mar. 31, 2020); Credit Suisse Holdings (USA), Inc., Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Mar. 31, 2020); Credit Suisse Holdings (USA), Inc., Parent Company Only Financial State- ments for Large Holding Companies (Form FR Y-9LP) (Mar. 31, 2020); UBS Americas Holding LLC, Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Feb. 14, 2019); UBS Americas Holding LLC, Parent Company Only Financial Statements for Large Hold- ing Companies (Form FR Y-9LP) (Nov. 14, 2018); UBS Americas Holding LLC, Parent Company Only Financial Statements for Large Holding Com- panies (Form FR Y-9LP) (Aug. 24, 2018); UBS Americas Holding LLC, Par- ent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (May 15, 2018); DB USA Corp., Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Feb. 14, 2019); DB USA Corp., Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Nov. 14, 2018); DB USA Corp., Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Aug. 24, 2018); DB USA Corp., Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (May 15, 2018). 238 See supra Table 1. 239 See supra notes 163–64 and accompanying text. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 393 2019 FR Y-9LP disclosures shows that the IHCs have sub- stantially reduced the amount of activity housed in their fi- nancial subsidiaries,240 supporting the reporting done by jour- nalists241 and the hypotheses several commentators posed before the exemption’s elimination went into effect.242 It is worth noting, though, that the elimination of the fi- nancial subsidiary exemption does not only affect FBOs. How- ever, the importance of the exemption specifically for FBOs relates to the traditional FBO funding model, discussed in Section II.C. That is, because IHCs have reached their Regu- lation W intracompany transaction limit through their “in- vestment” in their nonbank subsidiaries, they are unable to direct liquidity to their global affiliates around the world.243 This development may have already proven to seriously un- dermine global financial stability, as global affiliates of FBOs have struggled significantly during the COVID-19 pan- demic.244 Thus, beyond the economic damage trapped capital causes in U.S. capital markets, the elimination of the financial subsidiary exemption also fragments the flow of capital throughout the world, unnecessarily exposing certain regions’ financial systems to liquidity stress and potential collapse. For this reason, too, it is crucial that U.S. regulators begin to reconsider the elimination of the exemption to improve the stability of the global financial system. 240 See Credit Suisse Holdings (USA), Inc., Parent Company Only Fi- nancial Statements for Large Holding Companies (Form FR Y-9LP) (Feb. 14, 2020); UBS Americas Holding LLC, Parent Company Only Financial Statements for Large Holding Companies (Form FR Y-9LP) (Feb. 14, 2020); DB USA Corp., Parent Company Only Financial Statements for Large Hold- ing Companies (Form FR Y-9LP) (Feb. 14, 2020). 241 See Noonan, supra note 126. 242 See Mannion & Wu, supra note 153, at 805. 243 See supra notes 158–67 and accompanying text. 244 See Tobias Adrian & Fabio Natalucci, Covid-19 Worsens Pre-Exist- ing Financial Vulnerabilities, INT’L MONETARY FUND BLOG (May 22, 2020), https://blogs.imf.org/2020/05/22/covid-19-worsens-pre-existing-financial- vulnerabilities/ [https://perma.cc/ZW4U-NVXP]. 5_2020.1_HUMBLE (DO NOT DELTE) 10/7/2020 6:42 PM 394 COLUMBIA BUSINESS LAW REVIEW [Vol. 2020 V. CONCLUSION Ten years later, it is clear that the regulatory rules prom- ulgated under Dodd-Frank have had some unanticipated and consequential effects. Large foreign banks have perhaps been hit the hardest by post-crisis regulations in the United States, collectively spending hundreds of millions of dollars in at- tempting to achieve compliance.245 Namely, the changes made to Regulation YY and Regulation W have had enormous im- plications for FBOs’ funding models, which has resulted in the hoarding of capital at the IHC legal entity level in the United States. This development has been cited by many as unduly limiting the activity of FBOs and slowing down growth in U.S. capital markets, concerns which have led U.S. regulators to reconsider several post-crisis rules. However, the agencies tasked with overseeing IHC reorganization have maintained that the process has been largely successful, pointing to the performance of the IHCs in the Federal Reserve’s CCAR exer- cise as evidence of their soundness.246 The COVID-19 pandemic is beginning to reveal the short- sightedness of many countries’ conception of financial stabil- ity. That is, financial stability cannot be ring-fenced—as in- ternational banking has grown over the past thirty years so too has the interconnectedness of the financial system. This interconnectedness makes trapped capital and liquidity par- ticularly problematic, as legal entities with less liquid busi- ness models often struggle to obtain funding from third party sources during times of crisis. It is safe to say, then, that the elevated levels of capital the IHCs are holding in the U.S. are not benign. As we observed in the AIG case during the last financial crisis, the success of affiliates may dictate the suc- cess of parent entities, and during times of crisis regulators 245 See U.S. GOV’T ACCOUNTABILITY OFFICE, supra note 9, at 30. 246 See Randal K. Quarles, Vice Chairman for Supervision, Bd. of Gov- ernors of the Fed. Reserve Sys., Remarks at the Institute of International Bankers Annual Washington Conference: The Federal Reserve’s Regulatory Agenda for Foreign Banking Organizations 4 (Mar. 5, 2018), https://www.federalre- serve.gov/newsevents/speech/files/quarles20180305a.pdf [https://perma.cc/532J-YBH4]. 5_2020.1_HUMBLE (DO NOT DELETE) 10/7/2020 6:42 PM No. 1:336] TREACHEROUS LANDSCAPE 395 have in the past acknowledged the importance of supporting subsidiaries under stress for exactly this reason. This begs the question—why wait until a crisis hits to allow financial insti- tutions to manage their capital freely across their global or- ganizations? Binding the hands of large, systemically im- portant foreign banking organizations makes all of us less prepared for the next major financial crisis, which indeed, may already be in its beginning stages.