Liquidity
LIQ 1. Inter-Company "Frictions"
Q. Can the Agencies clarify what kinds of frictions might occur between affiliates beyond regulatory ring-fencing?
A. Frictions are any impediments to the free flow of funds, collateral and other transactions between material entities. Examples include regulatory, legal, financial (i.e., tax consequences), market, or operational constraints or requirements.
LIQ 2. Distinction between Liquidity Forecasting Periods
Q1. How long is the stabilization period?
A1. The stabilization period begins immediately after the U.S. IHC bankruptcy filing and extends until each material entity reestablishes market confidence. The stabilization period may not be less than 30 days. The reestablishment of market confidence may be reflected by the maintaining, reestablishing, or establishing of investment grade ratings or the equivalent financial condition for each entity. The stabilization period may vary by material entity, given differences in regulatory, counterparty, and other stakeholder interests in each entity.
Q2. How should we distinguish between the runway, resolution, and stabilization periods on the one hand, and RLAP and RLEN on the other, in terms of their length, sequencing, and liquidity thresholds?
A2. The Agencies have not specified a direct mathematical relationship between the runway period, the RLAP model, and RLEN model. As noted in prior guidance, firms may assume a runway period of up to 30 days prior to entering bankruptcy provided the period is sufficient for management to contemplate the necessary actions preceding the filing of bankruptcy. The RLAP model should provide for the adequate sizing and positioning of HQLA at material entities for anticipated net liquidity outflows for a period of at least 30 days. The RLEN model estimates the liquidity needed after the U.S. IHC's bankruptcy filing to stabilize the surviving material entities and to allow those entities to operate post-filing.
See "LIQ 4. RLEN and Minimum Operating Liquidity (MOL)," Question 1, for further detail on the components of the RLEN model.
Q3. What is the resolution period?
A3. The resolution period begins immediately after the U.S. IHC's bankruptcy filing and extends through the completion of the U.S. strategy. After the stabilization period (see "LIQ 2. Distinction between Liquidity Forecasting Periods," Question 1, regarding "stabilization period"), financial statements and projections may be provided at quarterly intervals through the remainder of the resolution period.
LIQ 3. Inter-Affiliate Transaction Assumptions
Q. Does inter-affiliate funding refer to all kinds of intercompany transactions, including both unsecured and secured?
A. Yes.
LIQ 4. RLEN and Minimum Operating Liquidity (MOL)
Q1. How should firms distinguish between the minimum operating liquidity (MOL) and peak funding needs during the RLEN period?
A1. The peak funding needs represent the peak cumulative net outflows during the stabilization period. The components of peak funding needs, including the monetization of assets and other management actions, should be transparent in the RLEN projections. The peak funding needs should be supported by projections of daily sources and uses of cash for each U.S. IHC subsidiary, incorporating inter-affiliate and third-party exposures. In mathematical terms, RLEN = MOL + peak funding needs during the stabilization period. RLEN should also incorporate liquidity execution needs of the U.S. resolution strategy for derivatives (see "DER 1. U.S. Resolution Strategy and Wind-Down Scenarios" in the Derivatives and Trading Activities section).
Q2. Should the MOL per entity make explicit the allocation for intraday liquidity requirements, inter-affiliate and other funding frictions, operating expenses, and working capital needs?
A2. Yes, the components of the MOL estimates for each surviving U.S. IHC subsidiary should be transparent and supported.
Q3. Can MOLs decrease as surviving U.S. IHC subsidiaries wind down?
A3. MOL estimates can decline as long as they are sufficiently supported by the firm's methodology and assumptions.
LIQ 5. RLAP, RLEN, and the Runway
Q. The August 2014 feedback letters instructed firms to make the following liquidity assumptions related to the LCR: "…assumptions during the runway period should be at least as severe as the outflow, inflow, and haircut assumptions contained in the …LCR Proposal". How should firms reconcile those instructions with the RLAP and RLEN expectations in the 2018 Guidance?
A. The August 2014 feedback letter instruction related to liquidity assumptions during the runway period no longer applies.
Liquidity projections during the runway period. The RLAP and RLEN expectations articulated in the 2018 Guidance supersede the instruction that assumptions during the runway period should be at least as severe as the LCR. The Agencies will not focus on firms' liquidity projections during the runway period. Consistent with prior feedback, your 2018 Plan must not assume that during the period of stress prior to the time of failure your firm will be able materially to reduce its size or interconnectedness or otherwise take similar steps that would have the effect of significantly mitigating the risks that the failure of your firm currently presents to the financial stability of the United States.
The development and implementation of an RLEN model make the scenario under which a firm fails, and the duration of runway, less critical in assessing the executability of that firm's resolution plan from a liquidity standpoint. Whether a firm experiences a rapid run or a long drawn out stress over the runway period should not impact the amount of liquidity required by a firm to successfully execute its U.S. resolution strategy (RLEN).
Rather, the only factor that should be impacted by the severity of runway period outflows should be the timing of the filing. This concept is illustrated in figure 1, which shows that more severe outflows during the runway period - the steeper downward sloping line - should simply result in a shorter runway period, say, 10 days as opposed to 15 days, and vice versa.
Thus for liquidity purposes in SPOE, the RLEN estimate effectively represents the firm's condition at failure as referenced in the August 2014 feedback letter. Rather than estimate that failure condition indirectly via an estimate of runway outflows, under the 2018 Guidance firms should estimate it directly via RLEN.
Relationship of RLAP to runway and RLEN. As noted in "LIQ 2. Distinction between Liquidity Forecasting Periods," Question 2, the Agencies have not specified a direct mathematical relationship between the runway period, the RLAP model, and RLEN model. To elaborate, a firm's RLAP is a distinct standalone estimate. RLAP and RLEN should be calculated independently of each other. The RLAP estimate should simply inform the necessary amount and positioning of a firm's liquidity to mitigate risks related to resolution stresses, such as ring fencing risk.3
Separately, the RLEN estimate should reflect how much liquidity each surviving U.S. IHC subsidiary needs to execute the firm's U.S. strategy post-filing and thus inform the timing of when a firm's U.S. IHC should file for bankruptcy.
With regards to liquidity, these two estimates--RLAP and RLEN--are the most critical to the executability of a firm's resolution strategy, and as such are the focus of the Agencies.
LIQ 6. Inter-Affiliate Transactions with Optionality
Q. How should firms treat an inter-affiliate transaction with an embedded option that may affect the contractual maturity date?
A. For the purpose of calculating a firm's net liquidity position at a material entity, RLAP and RLEN models should assume that these transactions mature at the earliest possible exercise date; this adjusted maturity should be applied symmetrically to both material entities involved in the transaction.
LIQ 7. Stabilization and Regulatory Liquidity Requirements
Q. As it relates to the RLEN model and actions necessary to re-establish market confidence, what assumptions should firms make regarding compliance with regulatory liquidity requirements?
A. Firms should consider the applicable regulatory expectations for each U.S. IHC subsidiary to achieve the stabilization needed to execute the U.S. resolution strategy. Firms' assumptions in the RLEN model regarding the actions necessary to reestablish market confidence during the stabilization period may vary by U.S. IHC subsidiary, for example, based on differences in regulatory, counterparty, other stakeholder interests, and based on the U.S. resolution strategy for each U.S. IHC subsidiary. See also "LIQ 2. Distinction between Liquidity Forecasting Periods."
LIQ 8. HQLA and Assets Not Eligible as HQLA in RLAP and RLEN Models
Q. The 2018 Guidance states that HQLA should be used to meet estimated net liquidity deficits in the RLAP model and that the RLEN estimate should be based on the minimum amount of HQLA required to facilitate the execution of the firm's U.S. resolution strategy. How should firms incorporate any expected liquidity value of assets that are not eligible as HQLA (non-HQLA) into RLAP and RLEN models?
A. A firm's RLAP model should assume that only HQLA are available to meet net liquidity deficits at U.S. IHC subsidiaries. For a firm's RLEN model, firms may incorporate conservative estimates of potential liquidity that may be generated through the monetization of non-HQLA. The estimated liquidity value of non-HQLA should be supported by thorough analysis of the potential market constraints and asset value haircuts that may be required. Assumptions for the monetization of non-HQLA should be consistent with the U.S. resolution strategy for each U.S. IHC subsidiary.
LIQ 9. Components of Minimum Operating Liquidity
Q. Do the Agencies have particular definitions of the "intraday liquidity requirements," "operating expenses," and "working capital needs" components of minimum operating liquidity (MOL) estimates?
A. No. A firm may use its internal definitions of the components of MOL estimates. The components of MOL estimates should be well-supported by a firm's internal methodologies and calibrated to the specifics of each U.S. IHC subsidiary.
LIQ 10. RLEN Model and Net Revenue Recognition
Q. Can firms assume in the RLEN model that cash-based net revenue generated by U.S. IHC subsidiaries after the U.S. IHC's bankruptcy filing is available to offset estimated liquidity needs?
A. Yes. Firms may incorporate cash revenue generated by U.S. IHC subsidiaries in the RLEN model. Cash revenue projections should be conservatively estimated and consistent with the operating environment and the U.S. strategy for each U.S. IHC subsidiary.
LIQ 11. RLEN Model and Inter-Affiliate Frictions
Q. Can a firm modify its assumptions regarding one or more inter-affiliate frictions during the stabilization or post-stabilization period in the RLEN model?
A. Once a U.S. IHC subsidiary has achieved market confidence necessary for stabilization consistent with the U.S. resolution strategy, a firm may modify one or more inter-affiliate frictions, provided the firm provides sufficient analysis to support this assumption.
LIQ 12. RLEN Relationship to DFAST Severely Adverse scenario
(See "CAP 3. RCEN Relationship to DFAST Severely Adverse Scenario" in the Capital section.)
LIQ 13. Liquidity Positioning and Foreign Parent Support
Q. May firms consider available liquidity at the foreign parent for meeting RLAP and RLEN estimates for U.S. non-branch material entities?
A. For a 30-day RLAP model, firms should use the requirements of Regulation YY in estimating the standalone liquidity position of each U.S. non-branch material entity. Firms should not rely on available liquidity at the foreign parent to meet net liquidity outflows of U.S. non-branch material entities. The firm's RLAP model should ensure that the consolidated U.S. IHC holds sufficient HQLA to cover net liquidity outflows of the U.S. non-branch material entities. For an RLAP model that extends beyond 30 days, firms may consider (after 30 days) available liquidity at the foreign parent to meet the needs for U.S. non-branch material entities.
To meet the liquidity needs informed by the RLEN methodology, firms may either fully pre-position liquidity in the U.S. non-branch material entities or develop a mechanism for planned foreign parent support of any amount not pre-positioned for the successful execution of the U.S. strategy. Mechanisms to support readily available liquidity may include a term liquidity facility between the U.S. IHC and the foreign parent that can be drawn as needed. If a firm's plan relies on foreign parent support, the plan should include analysis of how the U.S. IHC/foreign parent facility is funded or buffered for by the foreign parent.
LIQ 14. RLAP Model Time Horizon and Inter-Affiliate Transactions
Q. How should firms treat cash flow sources from affiliates in the RLAP model for models that use time periods in excess of 30 days, given the affiliate cash flow calculation requirements in section 252.157(c)(2)(iv) of Regulation YY?
A. An RLAP model that includes time periods beyond 30 days is not required to adopt the affiliate cash flow calculation requirements in section 252.157(c)(2)(iv) of Regulation YY for inter-affiliate cash flows beyond 30 days. However, beyond 30 days, the RLAP methodology still should take into account for each of the U.S. IHC, U.S. IHC subsidiaries, and any branch that is a material entity the considerations detailed in (A), (B), and (C) on page 9 of the 2018 Guidance.
LIQ 15. U.S. Branches and Agencies Liquidity Modeling
Q1. Are firms required to develop a RLAP model for U.S. branches and agencies?
A1. Firms are not required to develop a RLAP model for material U.S. branches and agencies; however, as described on page 22 of the 2018 Guidance, a firm should maintain a liquidity buffer sufficient to meet the net cash outflows for its U.S. branches and agencies on an aggregate basis for the first 14 days of a 30-day stress horizon. These expectations are consistent with the stress testing and liquidity buffer requirements in section 252.157(c)(3) of Regulation YY.
Q2. The Guidance states that in calculating RLAP estimates the U.S. IHC should calculate its liquidity position with respect to its foreign parent, branches and agencies, and other affiliates separately from its liquidity position with respect to third parties. How should firms interpret the RLAP requirements since RLAP is not required for U.S. branches and agencies?
A2. The RLAP estimates for U.S. non-branch material entities should take into account how cash flows and the stand-alone liquidity profile may be affected by all inter-affiliate transactions, which may include the impact on the U.S. non-branch material entities from flows transacted with U.S. branches and agencies.
LIQ 16. Material Service Entity Liquidity
Q. Is a standalone liquidity position estimate needed for material service entities?
A. For material service entities with no other operations other than providing services only to their affiliates and having no third-party debt obligations, a standalone liquidity position estimate is not required.
References
3. Note, the Agencies do not expect firms to hold sufficient HQLA to cover LCR outflows plus RLEN. A firm's liquidity buffer and positioning should be informed by its RLAP model. Return to text