Institute of International Bankers

Emerging Trends and Key Developments in the Regulation and Supervision of Branches and Agencies of International Banks and in the Regulation of International Banks Themselves as Bank Holding Companies and Financial Holding Companies

Institute of International Bankers

Annual Seminar on Regulatory Examination, Risk Management and Compliance Issues

Oct. 30, 2007

Randall D. GuynnHead of Financial Institutions GroupDavis Polk & Wardwell

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Emerging Trends and Key Developments

“Near” CCS

Strategic Minority Investments

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“Near” CCS: Key Recent Development

ICICI Bank Order (Oct 19, 2007).

For first time since 2003, Fed allowed international bank to open U.S. branch without demonstrating it was subject to CCS

Relied on “actively working toward” CCS standard

– Found India to be actively working toward CCS

– Importantly, found India’s anti-money laundering regime and applicant’s AML procedures to be consistent with approval

May signal new willingness to approve branch applications and FHC elections based on “near” CCS standard, if AML safeguards are sufficient

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“Near” CCS

When does CCS or “Near” CCS matter?

CCS and “Near” CCS countries

What is CCS?

What is “Near” CCS?

What does this mean for the future?

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“Near” CCS: When does CCS or “Near” CCS matter?

No U.S. domestic bank acquisitions by international banks unless subject to CCS – no discretion

No U.S. branch, agency or commercial lending subsidiary unless international bank is subject to CCS or home country is “actively working” toward CCS

No FHC election unless international bank is subject to CCS or home country has made “significant progress” toward CCS

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“Near” CCS: CCS and “Near CCS” Countries

"Near" CCSNo

Determination

Argentina Italy Cayman Islands BahrainBelgium Japan Colombia China

Chile Korea India Czech RepublicFinland Mexico Egypt DubaiFrance Netherlands Korea* HungaryAustria Norway Peru New ZealandBrazil Portugal Pakistan

Greece Spain PolandAustralia Sweden RussiaCanada Switzerland Saudi Arabia

Germany Taiwan SingaporeHong Kong SAR Turkey South Africa

Ireland United Kingdom UkraineIsrael Venezuela

* Subsequently found to have achieved CCS

Source: 71 Fed. Reg. 2, 516 n.4 (Jan. 4, 2006)

Subject to CCS

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“Near” CCS: What is CCS?

Comprehensive consolidated supervision (CCS)

Supervised or regulated in a manner such that

home country supervisor

receives sufficient information on the worldwide operations of foreign banking group (including all affiliates)

to assess overall financial condition and compliance with law and regulation.

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“Near” CCS: What is CCS? (Cont’d)

Does home country supervisor:

Ensure that foreign banking group has adequate procedures for monitoring and controlling group’s activities worldwide?

Obtain information on the condition of the foreign bank and its subsidiaries and overseas offices through regular examinations, audit reports or otherwise?

Obtain information on the dealings and relationship between the foreign bank and its affiliates, both foreign and domestic?

Receive from foreign banking group worldwide consolidated financial statements or comparable information?

Evaluate prudential standards, such as capital adequacy and risk asset exposure on a worldwide basis?

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“Near” CCS: What is “Near” CCS?

“Actively Working” Toward CCS

Standard used in applications for U.S. branches, agencies or commercial lending subsidiaries

No guidance in statutes, regulations or releases on what it means

– Except that in exercising discretion to rely on this standard, Fed must consider applicant’s AML procedures and may consider home country’s AML regime

“Substantial Progress” Toward CCS

Standard used in FHC elections

No guidance in statutes, regulations or releases on what it means

– Except that applicant’s AML procedures are a companion factor in exercising discretion to grant FHC status

“Near” CCS standard to be used only in “rare” instances.

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“Near” CCS: Guidance from Orders on “Actively Working” Toward CCS

Clear home country supervisor

with adequate scope of authority

that exercises its authority adequately

Subject to prudential regulations

Transactions with affiliates

Large exposures

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Scope of authority

license banks

supervise and regulate their activities

approve expansions (both domestically and abroad)

access to information (as to both domestic and foreign operations)

enforcement

Exercise of authority

Comprehensive on-site examinations on regular basis

Off-site monitoring

Enforcement

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Comprehensive on-site examinations on regular basis

operations

capital adequacy

management (including risk-management)

asset quality (including loan portfolio analysis)

earnings

liquidity

internal controls and procedures (including AML controls and procedures)

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Off-site monitoring

review of periodic financial reports, including asset quality, earnings, liquidity, capital adequacy, loans and on- and off- balance sheet exposures

monitors foreign activities in a way that is designed to ensure that risks are identified, controlled and minimized

periodic auditing of foreign operations

financial statements and internal controls subject to regular internal and external audit

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Enforcement

Penalties for failure to comply with disclosure request or for providing false or misleading information

Conditions on licensees

Penalties for failure to comply with home country supervisor’s rules, orders, directions

Range of penalties: monetary fines, removal of management, revocation of authority to conduct business

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“Near” CCS: Anti-Money Laundering

Home country AML legal regime

Applicant’s AML policies and procedures

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Home country AML legal regime

Written law, regulations and guidelines

Adequate compliance and enforcement infrastructure accountable to finance ministry and law enforcement

– receive, process, analyze, disseminate information related to cash and suspicious activity reports

– investigate and prosecute money laundering cases

Complies with international standards (FATF, etc.)

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Applicant’s AML policies and procedures

Designed to result in compliance with home-country AML laws, regulations and guidelines

International standards (e.g., FATF)

– enterprise-wide, risk-based

– compliance officers

– training

– internal, external and supervisory audits

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“Near” CCS: What does this mean for the future?

International banks from India and other countries may be able to establish U.S. branches, agencies or commercial lending companies, or even become FHCs, without satisfying the CCS standard

Must satisfy the relevant “Near” CCS standard

Must have adequate AML procedures and (probably) adequate home-country AML regime

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Open questions:

Is there any material difference between true CCS and what the Fed will accept as “Near” CCS?

Are there any material differences between the two “Near” CCS standards?

– “Actively Working” Toward CCS

– “Substantial Progress” Toward CCS

Any difference in Fed’s willingness to rely on either standard in the two contexts (e.g., branch vs. FHC)?

Can international bank whose home country has an inadequate AML regime nevertheless satisfy Fed’s criteria for approval if it establishes sufficient AML policies and procedures?

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Which countries are next?

China?

New Zealand?

Singapore?

South Africa?

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Key Trends and Developments for International Banks as BHCs and FHCs

“Actively Working Toward” CCS


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Historical Patterns

Emerging Patterns

Historical Consequences

FHC Consequences

Solutions

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Strategic Minority Investments: Historical Patterns

Non-U.S. banks in other non-U.S. banks

Examples:

RBSG / Santander

ABN AMRO / BAPV

Credit Agricole / Banca Intesa

U.S. stakeouts when interstate banking restricted

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Strategic Minority Investments: Emerging Patterns

Lines between U.S. banks and non-U.S. banks are blurring

Lines between U.S. banks and non-banks are blurring

Examples:

BofA’s 9% stake in China Construction Bank

RBSG’s 10% stake in Bank of China

GS/Allianz/American Express 10% stake in Industrial and Commercial Bank of China

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Strategic Minority Investments: Emerging Patterns

More Examples:

26% stake in Nordbank by investors led by J.C. Flowers

24.9% stake by Santander in Sovereign Bancorp

Passive minority investments by investment banks, private equity funds or international banks not subject to IBA in U.S. thrifts:

– 9.9% voting equity

– 49.9% total equity (including non-voting equity)

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Strategic Minority Investments: Historical Consequences

International Bank deemed to “control” target of strategic minority investment

Fed’s low threshold for deemed control

25% of voting shares or board majority

Controlling (significant) influence

Activities of minority target attributable to international bank for U.S. BHC Act investment restrictions and reporting requirements

Problem: Deemed control = real control

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Strategic Minority Investments: FHC Consequences

International Bank deemed to “control” target of strategic minority investment

If international bank is FHC and target is not well-capitalized or well-managed, bitter choice:

Lose FHC status

Debank in the U.S.

Don’t make minority investment or divest it

Try to convince target to become well-capitalized and well-managed despite lack of real control

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Strategic Minority Investments: Solutions

FHC release included passage giving hope that Fed would adopt different definition of control for FHC conditions

But hope has so far proven to be a mirage

FHC must show “clear” lack of control using “controlling influence” test instead of an actual control test

One cause for hope: U.S. FHCs may put pressure on Fed or Congress because of their increased proclivity to make cross-border strategic minority investments (e.g., China) the way international banks historically have done.

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About the Davis Polk’s Financial Institutions Group Davis Polk & Wardwell has one of the world's premier financial institutions practices with

over 150 years of experience.

Our Global Financial Institutions Group (FIG) advises many of the world's leading banking, insurance and securities organizations on a broad array of areas, including financial regulatory advice, capital markets, mergers and acquisitions, and compliance and enforcement.

Significant recent financial regulatory advice to U.S. or international banks has included advice on:

Capital markets: Industrial and Commercial Bank of China on its $22 billion IPO; ICICI Bank (India) on its $1.8 billion equity offering; structured many tax-advantaged tier 1 hybrid securities; structured many 3(a)(2)-exempt equity and credit derivatives.

M&A: ABN AMRO on its $101 billion sale to a consortium led by the Royal Bank of Scotland Group; LaSalle on its $21 billion sale to Bank of America; Sanpaolo IMI on its €65 billion merger with Intesa; Sallie Mae on its proposed $25 billion sale to an investor group led by JC Flowers; Santander on its $2.4 billion strategic minority investment in Sovereign Bancorp.

Enforcement actions: ABN AMRO, Union Bank of California, Israel Discount Bank

For more information, see http://www.dpw.com/practice/fig.htm.

Anti-money laundering Corporate governance FHC elections Regulatory capital

Anti-tying Criminal defense Geographic expansion Sarbanes-Oxley

Basel II Debanking / Rebanking Insurance powersStrategic minority investments

Branch applications / conversions

Derivatives (credit, energy, equity)

Internal controls Supervisory actions

Change of control Enforcement actions Loss of FHC status 23A/23B

Complex structured products Federal preemption Merchant banking Utah industrial banks

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Randall D. Guynn

Mr. Guynn graduated, with highest honors, from Brigham Young University in 1981 and in 1984 received his J.D., Order of the Coif, from the University of Virginia School of Law, where he was executive editor of the Virginia Law Review.

212-450-4239 [email protected]

Mr. Guynn is head of Davis Polk & Wardwell’s Financial Institutions Group. His practice focuses on providing strategic bank regulatory and enforcement advice and advising on M&A and capital markets transactions when the target or issuer is a banking organization or other financial institution. He also advises on corporate governance and internal controls, cross-border collateral transactions, securities settlement systems and payment systems.

His clients include all three of the largest U.S. and many of the world’s leading European and Asian banking organizations. Recent publicly announced M&A transactions include ABN AMRO on its $101 billion acquisition by a consortium consisting of The Royal Bank of Scotland, Fortis and Santander; ABN AMRO on its $21 billion sale of LaSalle Bank Corporation to Bank of America; SLM Corporation (Sallie Mae) on its proposed $25 billion sale to an investors group led by J.C. Flowers; Sanpaolo IMI on its €65 billion merger with Banca Intesa; Mercantile Bancshares on its $6 billion sale to PNC Financial; Huntington Bancshares on its $3.6 billion acquisition of Sky Financial; Citigroup on its $3.1 billion stake in Guangdong Development Bank; ABN AMRO on the $1.5 billion acquisition by a group of investors of AXA Re; Industrial and Commercial Bank of China (ICBC) on its sale of a $3.8 billion minority interest to Goldman Sachs, Allianz and American Express; and Santander in its $2.7 billion minority investment in Sovereign Bancorp. Recent capital markets transactions include ICBC in its $16.1 billion international IPO, which together with its $5.9 billion domestic offering, was the largest IPO in history; structuring various tax-deductible trust preferred securities that qualify for Tier 1 regulatory capital and Moody’s basket C treatment; and structuring various 3(a)(2)-exempt equity and credit derivatives programs. Recent bank regulatory advice has included advice on merchant banking, anti-money laundering, economic sanctions (OFAC), energy derivatives, controlling and non-controlling investments, 23A/23B, debanking, rebanking, FHC status, hedge funds, federal preemption, anti-tying, Utah industrial banks, corporate governance and internal controls.

Mr. Guynn joined Davis Polk in 1986 and became a partner in 1993. He practiced in the Paris office from 1988 to 1990 and the London office from 1994 to 1999.

He was a law clerk for the Honorable William H. Rehnquist, U.S. Supreme Court, from 1985 to 1986, following a clerkship with the Honorable J. Clifford Wallace, U.S. Court of Appeals, Ninth Circuit, from 1984 to 1985.

Documents

Institute of International Bankers