ONE LESS THING TO WORRY ABOUT?

Silvano Stagni, Global Head of Research at IT consultancy, Hatstand explains why cross-border transactions with the US will no longer be a headache.

The United States is targeting non-US owned banks that do not channel their transactions with the United States through their US branch or subsidiary. The good news is that implementing Enhanced Prudential Standards (EPS) rules will turn cross-border financial trades with the US into US domestic trades. The bad news is that EPS will mean that those transactions will fall under US jurisdiction and therefore Dodd-Frank will have to be fully implemented.

If a financial company executes cross border financial trades from a non-US based entity as a normal part of business, it finds itself in an interesting compliance position. (Activities carried out through a US branch or subsidiary are not within the scope of this article). If the organisation meets the extraterritorial provision of Title VII of Dodd-Frank, as implemented either by the CFTC or by the SEC, it must comply with the European Regulatory obligation under EMIR or MiFID I (for the time being) and with a sort of “Dodd-Frank light” for the American side. If business is conducted away from the US office (branch or subsidiary), it is not subject to any restriction on proprietary trading.

The only headache is cross-border compliance. If the financial organisation is a large Foreign Bank Organisation (FBO) with a turnover of above USD 50 bn (that is 50,000m), with significant non-branch based business in the United States above USD 50 bn it will not have to deal with cross-border issues beyond July 1st, 2016. Non-agency business will have to be conducted through an International Holding Company (IHC). The Enhanced Prudential Standards (EPS) will force the organisation to set up an IHC, which will be a United States-based company.

If the Enhanced Prudential Standards are applicable to the financial organisation, the following deadlines have been laid down:

• July 1, 2016         Deadline of formation/designation of IHC. IHC’s must comply with EPS
• August 1, 2016    Notification to Fed of IHC and compliance certification of IHC EPS requirements
• January 2017      Submission of IHC annual capital plan to the Fed
• July 1, 2017         Completion of transfer of all remaining applicable assets from FBO to IHC
• October 1, 2017  First Dodd-Frank stress testing cycle
• January 1, 2018  IHC Compliance with US Basel III leverage ratio requirements
• January 2018      Submission of IHC annual capital plan to the Fed
• March 2018         Summary results of company run stress test to the Fed
• July 2018             Submit mid-year Dodd-Frank stress tests to the Fed

So, what are the consequences for a European based FBO to set up an IHC? What does it mean for a financial organisation?

Another Legal Entity must be created and an LEI acquired. All assets will have to be separated; all the relevant transactions will have to have the new code. For operational reasons it might be necessary to build a trail that permits the history of that client across the two legal entities to be seen. This may have repercussions on Client Management, Order Management and possibly other reporting or monitoring workflows.

A gap analysis between what is actually happening for the whole company and what EPS requires should not highlight any major issue to remediate because the Capital Requirement Directive and Regulation in the EU imply a stricter implementation of Basel III than the one effective in the US. In any case the ‘gap-analysis and remediation plan’ should be on record, just in case there is the need to prove that a plan to implement EPS exists, even if it has not yet been completed.

Clients will have to be onboarded by the IHC according to US rules. Although KYC requirement are fairly similar, the classification of clients and the action to take to ensure that they receive the required level of protection may differ between the US and Europe

The IHC will have its own data. The corporate database must be ring-fenced to allow a view of the IHC data architecture separated from the FBO overall data. EPS has requirements on data accuracy and this needs to be taken into account together with any requirement on data that derives from Dodd-Frank. An IHC is a separate legal entity so any licence or contract, for instance Market Data, would have to be reviewed and amended to ensure that this new IHC is either covered by the existing arrangement or has its own contract or licence.

The IHC is a new Legal Entity in a different jurisdiction. There may be Connectivity issues, system issues or any other potential changes deriving from the location of users or systems, etc.

It is possible that any of the points above will not only generate remedial action but be the trigger for further changes. This needs to be verified and ultimately taken care of.

If the volume of non-branch, or non-subsidiary, related business in the United States is below USD 50,000m the financial organisation is not subject to these rules. If the organisation is subject to these rules, this must be implemented prior to the end of 2017. In a way, EPS is fairly straightforward to implement in itself. ‘Unfortunately’, an International Holding Company (IHC) will be a US-based financial legal entity and therefore subject to Dodd-Frank, Volcker and other US practices. In 2007, at the time of the banking crisis it was estimated that over 70% of financial trades across borders happened between London and New York. Things have changed but there are still a considerable number of financial trades between the two major world financial centres each day. If the organisation where you work contributes to their number, you’d better start reviewing the total volume of trades carried out outside your US office. July 1st, 2016 is not very far away.

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