Since the financial crisis, regulators have pushed megabanks to simplify their legal operations in order to make them easier to seize and dismantle if they later become troubled.
But now regulators are working to force the largest banks to rethink their legal entity regimes in an effort to improve operational efficiency.
Until now, the effort has largely been driven by the Federal Deposit Insurance Corp. and Federal Reserve Board, both of which want banks to become more "resolvable" in an effort to end "too big to fail."
But the Office of the Comptroller of the Currency said last week it was also urging banks to simplify regimes on a supervisory basis and plans to share data about simplification projects with the other banking agencies.
"Every now and then you need to kind of clean out the attic. It gets cluttered," Martin Pfinsgraff, the OCC's senior deputy comptroller for large-bank supervision, said in an interview. "You need to rethink and reorganize."
The OCC's involvement in legal entity simplification projects which was discussed in a March 3 speech by Charles Taylor, the deputy comptroller for capital and regulatory policy has turned a few heads. The agency has incorporated legal entity simplification into its "heightened expectations" program, the OCC's broad series of steps to beef up supervision of the largest banks. (Taylor was addressing a conference for the Institute of International Bankers.)
On the one hand, observers said numerous large banks are already far along in streamlining their webs of branches, subsidiaries and other entities in the years since the crisis, which is necessary as some pieces of an organization become outdated and add to complexity.
"Some subsidiaries have outlived their usefulness or original purpose for which they were created, so some companies have started to consolidate them into fewer entities," said Michael Krimminger, a former FDIC general counsel and now a partner at Cleary Gottlieb Steen & Hamilton LLP.
But experts say banks must conduct structural simplification cautiously, since proceeding too quickly could actually hurt efficiency.
"The larger banks have already done a pretty good scrub of their subsidiaries and of their organization," said Gregory Lyons, a partner at Debevoise & Plimpton LLP.
He noted, however, that reducing legal entities could have unintended consequences. In certain circumstances, Lyons said, a national bank's more complex legal structure can perhaps provides it with more flexibility to preempt state laws, or avoid limits on affiliate transactions.
"It's important if the [OCC] raises an issue, that the bank ultimately has the ability to structure itself as it wants to for a variety of reasons," Lyons said. "Before you do any structural change, it's not just about simplification. There is a whole number of factors you need to take into account, including preemption, capital charges and affiliate transaction rules. Banks would need to be cautious about implementing the OCC's recommendations."
Others were more explicit and suggested the OCC's support for legal simplification efforts unveils a sea change in the agency's thinking.
In a note to clients, analyst Karen Shaw Petrou said her "takeaway" from Taylor's speech was the agency may be pushing "subsidiarization," a concept opposed by big banks in which a firm's operations are all placed in discrete subsidiaries that could be more easily resolved in a failure.
Petrou said simplification is needed at megafirms with overly complex structures, but she noted the OCC's message departs from its past focus on how national bank subsidiaries can "get national banks around lots of state rules and federal restrictions on mixing banking and commerce.
"These subs were crafted in the OCC's heady days of thinking everything any bank wanted fell within the 'business of banking' as long as it could be kept out of the state's clutches," she said. "Now, the agency much chastened by the crisis is singing from a very different hymnal."
Pfinsgraff acknowledged that banks need to be able manage certain lines of business across multiple legal entities, and the OCC is "not trying to completely disrupt that in any way." He said subsidiarization "has not been a focus" at the agency.
But he said an overly complex structure of legal entities, which may be hard to decipher in a period of stress, could challenge the institution's ability to avert a crisis.
"Ultimately, solvency is measured on a legal entity basis, so we want to make certain that from a risk management and governance perspective that legal entity complexity is not contributing in some way to greater difficulty, particularly under a stressful environment," Pfinsgraff said.
Simplifying an institution's legal structure, for example, could aid its recovery in a liquidity crisis, he said.
"When you have stress in a family, you sell the family jewels in order for the family to survive to live another day," Pfinsgraff said. "If you have extraordinary complexity within an organization that limits your ability to do just that... you may have organized yourself for a non-stress period."
He also said simpler legal entity structures help institutions more efficiently comply with other regulatory requirements. Pfinsgraff raised the example of a foreign bank chief executive complaining about the cost of having to ensure compliance at its multiple U.S.-based branches.
"I would hear that lament from CEOs from time to time. I would look at them and say, Why would you not consolidate those branches?' " Pfinsgraff said. "You have a chief risk officer or you have risk management audit and compliance staff in place and have to for every one of these legal entities. Why would you not consolidate them? You would probably be more efficient doing so."
To a large extent, the OCC's newfound focus on legal simplification is not entirely new. Just like the agency informally began the "heightened expectations" program years before it was formally introduced, numerous megabanks have already conducted simplification projects much to the agency's satisfaction.
"Several of our banks started this process well ahead of our rolling out heightened expectations in 2011," Pfinsgraff said. "They were already engaged because they had good reason to be."
In his speech, Taylor also detailed the OCC's plans to compile data on banks' projects to simplify their regimes. The data initiative appears to be aimed at ensuring the OCC is on the same page with the Fed and FDIC on how banks are progressing.
The latter two agencies are in the process of evaluating banks' internal resolution plans. The so-called living wills required under the Dodd-Frank Act are meant to help the FDIC in developing its wind-down powers for megabanks, but also to force banks to recognize how the complexity of their structures could be an obstacle to efficient resolutions.
Pfinsgraff said the data shared between the agencies will not be public, but he did not rule out potential future steps for outside parties to see information about how banks are simplifying their regimes.
"We need to make sure we're on the same page with our peer regulators so we're not giving mixed signals back to the industry. Once we reach that point, we'll have more communication back to the industry and I would think that certainly some of that would be public," Pfinsgraff said.
"We have access to this data already through our exam processes. As it applies to resolution and recovery planning, both the Fed and the FDIC have collected a considerable amount of data and so we are working and will be reaching out probably more to them then to the industry to ensure that we're all looking at the same data."
Joe Adler is the deputy Washington bureau chief for American Banker
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