Frequently Asked Questions about Regulation Q
Capital Adequacy of Bank Holding Companies, Savings and Loan Holding Companies, and State Member Banks
Staff of the Board of Governors of the Federal Reserve System has developed the following frequently asked questions (FAQs) to assist entities in complying with the Board’s Regulation Q. Except as noted below, these FAQs are staff interpretations and have not been approved by the Board of Governors. Staff may supplement or revise these FAQs as necessary or appropriate in the future. Any questions regarding these FAQs, or requests for modification, rescission, or waiver, should be submitted through the Board’s Contact Us form.
In General
In General
Q1: Aside from this page, where can I find guidance, interpretations, and statements from the Board concerning Regulation Q—Capital Adequacy of Bank Holding Companies, Savings and Loan Holding Companies, and State Member Banks?
A1: Additional guidance and interpretations for Regulation Q may be found elsewhere on the Board’s website, available here. In particular, SR letter 15-6, “Interagency Frequently Asked Questions (FAQs) on the Regulatory Capital Rule” (April 6, 2015), available here, includes many relevant interpretations.
Posted: 9/28/2023
Q2: How should Board-regulated institutions that issue “credit-linked notes” treat those notes under the Board’s capital rule?
A2: There are various forms of instruments referred to as credit-linked notes, which firms can use to reduce their risk. However, the treatment under the capital rule of a transaction using credit-linked notes depends on the form of the transaction. In certain instances, the capital rule recognizes when a firm has utilized these instruments as a form of risk mitigation and permits a firm to reduce its risk-weighted assets to reflect the risk mitigation.
Credit-linked-note transactions generally involve the issuance of notes to investors for cash, where the principal amount due on the notes is reduced if there are losses on a reference pool of loans or other financial exposures. As a result, the note purchasers provide credit protection on the reference pool by paying cash for the notes and having their principal reduced as losses accrue on the reference exposures.
In some synthetic securitizations, a Board-regulated institution transfers the risk of a reference portfolio of on-balance sheet exposures to a special purpose vehicle using a guarantee or credit derivative. The special purpose vehicle issues credit-linked notes to investors, and the Board-regulated institution takes the cash proceeds of the notes as collateral supporting the special purpose vehicle’s performance on the guarantee or credit derivative.
Under the Board’s capital rule, a Board-regulated institution can recognize the credit risk mitigation of the collateral on the reference portfolio under the rules for synthetic securitizations provided that the requirements in section 41 or 141, as applicable (12 CFR 217.41, .141), are met and that the transactions satisfy the definition of “synthetic securitization” (12 CFR 217.2, “synthetic securitization”).
In contrast, when a Board-regulated institution directly issues credit-linked notes that reference loans or other financial exposures on its balance sheet (“directly issued credit-linked notes”), it is less clear that the transaction meets the definitional requirements in section 2 (12 CFR 217.2) to be considered a synthetic securitization and the operational requirements in section 41 or 141, as applicable (12 CFR 217.41, .141), to recognize the credit risk mitigation of the credit-linked notes in risk-weighted assets. First, a synthetic securitization must include a guarantee or credit derivative and, in the case of a credit derivative, the derivative must be executed under standard industry credit derivative documentation. Directly issued credit-linked notes frequently reference, but are not executed under, standard industry credit derivative documentation. Second, the operational criteria for the simplified supervisory formula approach (SSFA) require use of a recognized credit risk mitigant, such as collateral. The cash purchase consideration for directly issued credit-linked notes is property owned by the note issuer, not property in which the note issuer has a collateral interest.
The directly issued credit-linked-note transactions Board staff has reviewed generally do not satisfy the definition of synthetic securitization and generally do not satisfy the operational requirements of the SSFA. Board-regulated institutions that are issuers of directly issued credit-linked notes, or have consolidated subsidiaries that are issuers of directly issued credit-linked notes, would therefore not automatically be able to recognize such transactions as synthetic securitizations under the capital rule.
Source: 12 CFR 217.2, .41, and .141.
Posted: 9/28/2023
Q3: How may a Board-regulated institution request approval to treat a directly issued credit-linked-note transaction as a synthetic securitization and use the simplified supervisory formula approach under the capital rule?
A3: While the way a directly issued credit-linked-note transaction transfers risk is somewhat different from the capital rule’s criteria, it is similar to practices commonly used for mitigating credit risk that the Board recognizes in its capital rule. Through a directly issued credit-linked-note transaction, firms can, in principle, transfer a portion of the credit risk on the referenced assets to the credit-linked-note investors at least as effectively as the synthetic securitizations that qualify under the capital rule. Therefore, the Board, on appropriate facts, is willing to exercise a reservation of authority where the primary issues presented by the transaction are limited to the two common issues of directly issued credit-linked notes described in the answer to question 1 above.
A Board-regulated institution may request a reservation of authority under the capital rule for directly issued credit-linked notes in order to assign a different risk-weighted-asset amount to the reference exposures. To make such a request, a Board-regulated institution should contact supervisory staff at the appropriate Federal Reserve Bank. Board staff will review a request from an individual firm based on the facts and circumstances presented, including a review of the transaction documents that the firm is using. The Board’s response to the request will be communicated in writing to the firm, describing the action taken and any limitations or conditions related to the action. A firm may not rely on these FAQs or on written action issued to any other firm as the basis for the capital treatment of any transaction.
Source: 12 CFR 217.1(d)(3).
Posted: 9/28/2023