Late last month, the US federal banking agencies (the Federal Reserve Board (FRB), Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC), collectively, the “banking agencies”) issued an interim final rule that implements section 403 of the recently enacted “Economic Growth, Regulatory Relief, and Consumer Protection Act” (the “Act”), to allow certain banking organizations to use municipal obligations to meet their mandatory liquidity maintenance requirements. Our blog post on passage of that law can be found here.

The regulation was effective August 31, 2018, but the public can submit comments on any proposed changes no later than October 1, 2018.

Promulgation of the LCR

In September 2014, the banking agencies finalized Liquidity Coverage Ratio (LCR) rules, based on international liquidity standards for banks. The LCR requires that certain large banking organizations maintain sufficient high quality liquid assets (HQLA) to cover cash outflows during a 30 day liquidity stress scenario that includes certain levels of deposit run-off or a reduction in wholesale funding capacity. HQLA include cash and, among other instruments, securities issued or unconditionally guaranteed by the US Treasury, and certain securities issued by US-government sponsored enterprises, but only at 85% of the dollar amount of the assets. Many commenters had raised concerns at the proposed stage about not including US state and municipal debt securities as HQLA arguing that their liquidity profile met or exceeded that of other assets classified as HQLA, but they were not classified as HQLA in the final LCR rule.

In 2016, the FRB finalized a regulation (the “2016 Rule”), applicable only to large banking organizations under their jurisdiction, to allow certain obligations issued or guaranteed by a US public sector entity (i.e., a state or local authority), defined as “municipal securities” to be treated as a Level 2B liquid asset under the LCR rule ( a level that includes certain types of corporate debt and equity), subject to certain qualifications and limitations. A copy of our blog post on the 2016 FRB rule can be accessed here.

The Final Rule

As provided in the final rule:

The regulation incorporates the mandate set out in Section 403 of the Act to allow banking organizations subject to the LCR to use municipal obligations as Level 2B liquid assets to meet their LCR requirements provided that as of the date of calculation they are “investment grade” and “liquid and readily-marketable.”

• A “municipal obligation” is defined as an obligation of a State or any political subdivision thereof, or any State agency or instrumentality or any political subdivision thereof.
• “Investment grade” is defined by reference to an OCC regulation, 12 CFR 1.2, as “the issuer of a security has an adequate capacity to meet financial commitments under the security for the projected life of the asset or exposure. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low and the full and timely repayment of principal and interest is expected.”
• “Liquid and readily marketable” is defined by reference to an FRB regulation, 12 CFR 249.3, as “with respect to a security, that the security is traded in an active secondary market with: (1) more than two committed market makers; (2) a large number of non-market maker participants on both the buying and selling sides of transactions; (3) timely and observable market prices; and (4) a high trading volume.”
• The calculation date is the date that a banking organization subject to the requirement must calculate its LCR, which is each business day.

As part of the final interim rule, the FRB is rescinding its 2016 Rule, which was narrower in scope than the new regulation.