Section 165(e) of the Dodd‐Frank Act directs the Federal Reserve Board (FRB) to limit the risks that the failure of any one individual firm could pose to a systemically‐important counterparty by establishing single‐counterparty credit concentration limits for bank holding companies with $50 billion or more in assets and all FSOC‐designated nonbanks (covered companies).

Dodd‐Frank instructs the FRB to promulgate regulations prohibiting covered companies from having a credit exposure to any unaffiliated company in excess of 25% of the covered company’s capital stock and surplus. “Capital stock and surplus” is calculated by adding the covered company’s total regulatory capital to its excess loan loss reserves. The Act defines credit exposure to an unaffiliated company as:

• All repos, reverse repos, securities borrowing, and lending transactions with the company;
• All guarantees, acceptances, or letters of credit issued on behalf of the company;
• All purchases of or investments in securities issued by the company;
• Counterparty credit exposure to the company in connection with a derivative transaction; and
• Other similar transactions that the FRB designates by regulation.

The FRB has proposed a two‐tiered rule to implement Section 165(e):

Tier 1: No covered company may have an aggregate net credit exposure to any single unaffiliated counterparty in excess of 25% of the covered company’s capital stock and surplus.
Tier 2: No covered company with $500 billion or more in assets (major covered company) may have an aggregate net credit exposure in excess of 10% to any other major covered company or to any foreign banking organization with $500 billion or more in assets.

The FRB’s proposed definition of “counterparty” would include a natural person, a company, the United States, a State, and a foreign sovereign entity. Because the FRB believes credit exposure to governmental entities creates risks similar to the risks created by exposure to private companies, the
definition encompasses any agency or instrumentality of a sovereign entity.

The aggregate net credit exposure will include the net credit exposure between all of a covered company’s subsidiaries and all subsidiaries of the counterparty.

The FRB noted that it might amend its proposed rule to achieve consistency with an international initiative to coordinate exposure limits under consideration by the Basel Committee on Banking Supervision.

The Clearing House is the nation’s oldest banking association and payments company established in 1853 to bring order to clearing and settling between banks. For more information see theclearinghouse.org.