1. Foreign Banks Raising Capital in the U.S.
Anna Pinedo
Bradley Berman
September 2016

2. Agenda Commercial Paper Section 3(a)(2) bank note programs
Rule 144A bank note programs
“Bail-in” Requirements
MREL
Total Loss Absorbing Capacity (TLAC)

3. Commercial Paper and Commercial Paper Programs

4. What Is Commercial Paper?
Commercial paper is a term that tends to be used to refer to corporate short-term debt securities. Maturities are typically less than 12 months.
Classically, commercial paper meant debt securities issued under Section 3(a)(3) of the Securities Act.
There has also developed a market in short-term corporate debt issued under Section 4(a)(2) of the Securities Act.
There are differences between the two types of commercial paper in terms of investor base, use of proceeds and securities law requirements for issuance.

5. Historical Roots
The legislative history of the Securities Act provides an explanation of the genesis of Section 3(a)(3).
Commercial paper was issued by merchants and manufacturers for short-term financing of operations and was sold primarily to banks through commercial paper dealers.
There was a concern that if short-term paper that arises out of or finances current transactions and rarely bought by private investors were required to be registered, it would radically interfere with commercial banking transactions.
The original Federal Reserve Act included commercial paper as an instrument rediscountable by Federal Reserve banks.
In 1933, the Federal Reserve requested an exemption for commercial paper and provided the language that became Section 3(a)(3).

6. Section 3(a)(3) Requirements
Section 3(a)(3) provides an exemption from the registration requirements of the Securities Act for:
Any note, draft, bill of exchange, or banker’s acceptance which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited;
In 1961, the SEC stated in Rel :
The legislative history of the Securities Act makes clear that Section 3(a)(3) applies only to prime quality negotiable commercial paper of a type not ordinarily purchased by the general public, that is, paper issued to facilitate well-recognized types of current operational business requirements and of a type discountable by Federal Reserve banks.
[T]he staff of the Commission has interpreted Section 3(a)(3) to exclude as not satisfying the nine-month maturity standard, obligations payable on demand or having provisions for automatic “roll-over.”

7. Section 3(a)(3) Requirements, cont’d
The SEC imposed six separate characteristics as necessary for qualifying for Section 3(a)(3):
Negotiable
Prime quality
Eligible for discount at Federal Reserve banks
Not ordinarily purchased by the general public
Used to facilitate “current transactions”
Maturity of nine months or less with no automatic roll-over.
Section 3(a)(3) Requirements, cont’d

8. “Current Transactions”
Through a long series of no-action letters, the staff has defined current transaction for a variety of businesses.
Traditionally, it was necessary to trace the use of proceeds to identifiable current transactions.
Today, following a 1986 staff response, it is only necessary to demonstrate that current transactions on the balance sheet exceed the amount of commercial paper outstanding at any time.
Inventories and accounts receivable have long been accepted as current transactions. Also operating expenses, such as salaries, short-term lending, federal, state and local taxes, and various types of bank loans with maturities not exceeding five years, have been accepted.
However, acquisition financing is NOT considered a current transaction.

9. Section 3(a)(3) as Public Offering
Section 3(a)(3) provides an exemption from the requirement in Section 5 of the Securities Act to register any offer or sale of securities with the SEC.
3(a)(3) commercial paper is not a privately placed security
This is important, for example, in connection with 1940 Act exemptions under Sections 3(c)(1) and 3(c)(7), which may not be used if the issuer is making a public offering.
To meet the “not ordinarily purchased by the general public” standard, commercial paper is normally issued in minimum denominations of $100,000, although occasionally you will see $25,000 minimum denominations.
3(a)(3) commercial paper is usually rated “A-1” to satisfy the prime quality standard.

10. Continuous Issuance
Commercial paper is issued in continuously offered programs.
Typical maturities are in the range of 7 to 21 days
See FRB H.15 releases and the Commercial Paper releases for maturity distributions and other statistics.
Volume statistics are available at:
Proceeds of commercial paper are often used to pay off maturing commercial paper.
In the days before shelf registration, it would have been impossible to issue this frequently if registration were required.
And even today, the registration costs would be prohibitive considering the high frequency of issuance.

11. Book-entry Considerations
Since 1990, virtually all commercial paper is issued in book-entry form through DTC or other clearing entities.
The issuing and paying agent (or depositary bank) holds a master note for the benefit of DTC and records on its records daily issuance and redemptions of commercial paper.
There is generally no involvement of counsel in daily issuances.
Companies issue commercial paper by direct calls to a dealer’s commercial paper desk.
Upon agreement on terms, dealers will buy the entire daily issuance and resell to investors.

12. Private Commercial Paper
Nowadays, commercial paper may also be issued under Section 4(a)(2) as a private placement of securities.
Historically, the 3(a)(3) market was larger and deeper than the 4(a)(2) market because privately placed securities are restricted securities.
Today the two markets provide about the same liquidity.
The advantage of Section 4(a)(2) is that the section does not have any maturity limitations, so longer dated paper can be issued, and proceeds do not have to be used for current transactions.
Most privately placed commercial paper is issued in Rule 144A programs, although some programs still issue to institutional accredited investors.

13. 4(a)(2) Requirements
Historically, private placements were conducted under old Section 4(2) with resales to a limited number of investors under the so-called Section 4(1½) exemption. This sharply limited the size of the market.
Today, between Regulation D and Rule 144A, the private placement market is approaching the public securities market in size.
Until the recent enactment of the JOBS Act, the prohibition on general solicitations in Rule 502(c) applied to commercial paper issued under Section 4(a)(2).
Occasionally, issuers would trip over this limitation and have to stay out of the market for 30 to 60 days.

14. JOBS Act Changes to 4(a)(2) Offers
Title II of the Jumpstart Our Business Startups (JOBS) Act of 2012 directed the SEC to eliminate the ban on general solicitation and general advertising for certain offerings under Rule 506 of Regulation D and under Rule 144A.
Under the SEC rulemaking, new paragraph (c) was added to Rule 506 to permit general solicitations under certain circumstances.
Incidentally, this rulemaking now permits general solicitation in an offering even though the issuer is relying on Section 3(c)(1) or 3(c)(7) of the 1940 Act, which prohibits a public offering.
Thus, a Rule 144A program no longer risks being out of the market for 30 to 60 days as a result of an inadvertent publicity problem.

15. JOBS Act Changes to 4(a)(2) Offers, cont’d
However, in order to use general solicitation under Rule 506(c), the issuer and offering participants must not be “bad actors.”
An offering is disqualified from relying on Rule 506(c) if a “covered person” has a relevant criminal conviction, regulatory or court order or other disqualifying event.
“Covered persons” include: (1) the issuer, including its predecessors and affiliated issuers; (2) directors, general partners, and managing members of the issuer; (3) executive officers of the issuer, and other officers of the issuers that participate in the offering; (4) 20% beneficial owners of the issuer, calculated on the basis of total voting power; (5) promoters connected to the issuer; (6) for pooled investment fund issuers, the fund’s investment manager and its principals; and (7) persons compensated for soliciting investors, including their directors, general partners and managing members.
Certifications as to bad actor status are time-consuming to obtain and this is not practical for commercial paper which can be issued daily.
As a result, issuers and dealers do not use general solicitation and instead rely just on Section 4(a)(2) rather than Rule 506(c)
JOBS Act Changes to 4(a)(2) Offers, cont’d

16. Use of Proceeds of 4(a)(2) Paper
One of the advantage of 4(a)(2) commercial paper is that there is no requirement to use the proceeds for current transactions.
4(a)(2) commercial paper programs are often used to finance acquisitions until term financing can be arranged.
Proceeds can be used for any legitimate purpose consistent with the board resolutions for the program.

17. Disadvantages of 4(a)(2) Paper
4(a)(2) commercial paper is still a “restricted security.”
Some investors have limits on the amount that they can invest in restricted securities.
This might have some impact in the secondary market, but generally the secondary market is a dealer market, i.e., most sales in the secondary market are back to dealers who may hold or may resell the paper to other customers.

18. Conversion of 3(a)(3) to 4(a)(2)
It is not uncommon for issuers to convert 3(a)(3) commercial paper programs to 4(a)(2) programs.
Historically, there were transition issues in moving from a public offering program to a privately placed program to avoid integration of the private program with the public program while losing the 3(a)(3) exemption.
This was addressed by covenants to use the proceeds for current transactions, but to make sales only to QIBs, for a six month period.
With the changes brought about by the JOBS Act, this overlap should no longer be necessary to deal with the general solicitation issues created by the 3(a)(3) programs.

19. Side-by-side Programs
Some issuers still operate side-by-side 3(a)(3) and 4(a)(2) programs.
Historically, there had to be careful segregation of proceeds and use of proceeds, and perhaps different maturities to deal with the integration issue.
Today, after the JOBS Act, the integration concern from general solicitation is removed but also perhaps there is no longer a reason to operate two programs.

20. Asset-Backed Commercial Paper
Starting in the 1980s, asset-backed commercial paper (ABCP) programs become common.
Under accounting rules at the time, the sponsor of the program could operate the program off-balance sheet, so no capital was required to be held against the assets.
Numerous ABCP programs foundered during the financial crisis and today they are much less common; ABCP volumes have declined from a high of about $1.2 trillion to less than $300 billion today.
Revised accounting rules and other regulatory developments have made it increasingly difficult to maintain these programs off-balance sheet, so much of the reason for their separate existence is gone.
They are still used, however, for trade receivables financing and other short-term, maturity-matched lending situations.

21. 1940 Act Considerations
With ABCP, because the issuer is an SPV and not an operating company, it is necessary to consider what exemption from the 1940 Act may be available.
Many ABCP programs previously relied on Sections 3(c)(1) or 3(c)(7) for an exemption.
For bank sponsors, the Volcker Rule will now require a careful examination of other possible exemptions under the 1940 Act or exemptions under the Volcker Rule from the definition of “covered fund.”
Section 3(c)(5) of the 1940 Act or Rule 3a-7 under the 1940 Act are possibilities and also compliance with the definition of “qualifying asset-backed commercial paper conduit” under the Volcker Rule.
If swaps are used in the program, attention must also be paid to the Commodity Exchange Act and initial and variation margin requirements.

22. Disclosure Considerations
Disclosure practices for commercial paper developed from the historical antecedent of Section 3(a)(3), where commercial paper was used for commercial banking transactions.
Section 3(a)(3) itself does not impose any disclosure requirements.
Disclosure documents for commercial paper have traditionally been very brief, providing little more than identification of the issuer. Accordingly the offering documents may be little more than a term sheet.
4(a)(2) commercial paper adopted the same disclosure approach.
As a consequence, 10b-5 letters from counsel are not utilized in the commercial paper market.

23. Issuing Documents Issuing Agreement Agreement with distributing dealer
Issuing and Paying Agency Agreement
Depositary Agreement
Agreement with distributing dealer
Commercial Paper Dealer Agreement
Private Placement Agreement
Disclosure Document
Offering Circular
Private Placement Memorandum
Liquidity Agreement

24. Practical Considerations
Maturity limits on 4(a)(2) commercial paper:
Seldom sold with maturities longer than 390 days, a limit determined by money market fund considerations, as money market funds have traditionally been very active purchasers of commercial paper;
MTN and senior note programs are usually established for issuance of maturities of one year or more;
Generally, investment banks have separate desks for commercial paper and MTN and senior note programs;
MTN and senior note programs have more traditional prospectus disclosure; at longer maturities, the rationale for brief disclosure documents isn’t supported.

25. Securities Law Liability
No liability under Section 11 of the Securities Act for issuers with respect to 3(a)(3) or 4(a)(2) programs.
After Gustafson v. Alloyd, there is no liability under Section 12(a)(2) of the Securities Act for privately placed commercial paper.
Section 17 of the Securities Act will support SEC actions, but not investor actions.
Sections 12(a)(2) and 17 of the Securities Act apply to 3(a)(2) commercial paper, notwithstanding the exemption from registration provided by Section 3(a)(3).

26. Securities Law Liability, cont’d
For investors, Rule 10b-5 under the Securities Exchange Act provides principal remedy against both dealers and issuers.
Consider the exclusion from the definition of a “security” in Section 3(a)(10) of the Securities Exchange Act for “any note which has a maturity at the time of issuance of not exceeding nine months,” which appears to exclude 3(a)(3) commercial paper. However, notes which fail the ‘prime quality’ standard have been held to fall outside this exclusion.
After the SEC’s enforcement proceeding settlement against Goldman Sachs in the 1974 arising out of the Penn Central bankruptcy and commercial paper default, many dealers have assumed that they will be unable to avoid liability for any defaulted commercial paper.
The SEC stated that Goldman had failed to conduct a reasonable investigation of Penn Central and had implicitly represented to its customers that the issuer was creditworthy.
Securities Law Liability, cont’d

27. Due Diligence Defense
Classic due diligence inquiry not possible due to issuance mechanics.
No 10b-5 opinions are given.
No accountant’s comfort letters are received.
There is no questioning of management prior to each issuance.
Thus there can be no “reasonable investigation.”
Some dealers established credit departments to monitor their issuers continuously.
Generally, dealers act defensively and rating downgrades or headline events can lead to dealers and investors refusing to roll over an issuer’s commercial paper, forcing the issuer to rely on bank lines of credit.

28. Bank Note Issuances

29. Bank Debt Financing Activities
Type of bank debt issuances
Senior unsecured debt
Senior secured debt
Subordinated debt
Structured debt (e.g., equity-linked and commodity-linked notes)
Issuing entities:
U.S. banks
Home offices of foreign banks
U.S. branches of foreign banks
Other affiliated entities of foreign banks
U.S. branches of foreign banks as guarantors
Issuance formats
Section 3(a)(2) offerings
Rule 144A offerings

30. Section 3(a)(2) Bank Note Programs
A Section 3(a)(2) bank note program is a medium-term note program that enables an issuing bank to offer debt securities on a regular and/or continuous basis.
The issuer (or a guarantor of the notes) must be a “bank,” as defined in Section 3(a)(2) of the Securities Act of 1933.
Bank note programs are exempt from registration under the Securities Act.

31. Types of Securities Issued
Senior or subordinated.
Fixed or floating rate, zero-coupon, non-U.S. dollar denominated, amortizing, multi-currency or indexed (structured) securities.
Common reference rates for floating rate bank notes include LIBOR, EURIBOR, the prime rate, the Treasury rate, the federal funds rate and the CMS rate.
Most bank note programs are rated “investment-grade” by one or more nationally recognized rating agencies.
Section 3(a)(2) structured notes can be linked to reference assets not always seen in registered programs:
Complex underlying assets;
Credit-linked notes;
Small-cap stocks; and
Non-U.S. stocks that do not trade on U.S. exchanges.

32. Section 3(a)(2) and Offerings by Banks
Section 3(a)(2) of the Securities Act exempts from registration under the Securities Act any security issued or guaranteed by a “bank.”
Basis: banks are highly regulated, and provide adequate disclosure to investors about their finances in the absence of federal securities registration requirements. Banks are also subject to various capital requirements that may increase the likelihood that holders of their debt securities will receive timely payments of principal and interest.

33. What Is a “Bank”?
Under Section 3(a)(2), the institution must meet both of the following requirements:
It must be a national bank or any institution supervised by a state banking commission or similar authority; and
Its business must be substantially confined to banking.
Examples of entities that do not qualify:
Bank holding companies
Finance companies
Investment banks
Foreign banks
Regulated U.S. branches and agencies of foreign banks may qualify.

34. Guarantees
Another basis for qualification as a bank: securities guaranteed by a bank.
Not limited to a guaranty in a legal sense, but also includes arrangements in which the bank agrees to ensure the payment of a security.
The guaranty or assurance of payment, however, has to cover the entire obligation; it cannot be a partial guarantee or promise of payment, and it must be unconditional.
Again, guarantees by foreign banks (other than those of an eligible U.S. branch or agency) would not qualify for this exception.
The guarantee is a legal requirement to qualify for the exemption; investors will not be looking to the U.S. branch for payment/credit. Investors will look to the home office.
Finance companies can issue under Section 3(a)(2), if the securities are guaranteed by a bank.

35. Non-U.S. Banks/U.S. Offices
U.S. branches/agencies of foreign banks are conditionally entitled to rely on the Section 3(a)(2) exemption.
1986: the SEC takes the position that a foreign branch/agency will be deemed to be a “national bank” or a “banking institution organized under the laws of any state” if “the nature and extent of federal and/or state regulation and supervision of that particular branch or agency is substantially equivalent to that applicable to federal or state chartered domestic banks doing business in the same jurisdiction.”
As a result, U.S. branches/agencies of foreign banks are frequent issuers or guarantors of debt securities in the U.S. Most issuances or guarantees occur through the NY branches of these banks.
A list of U.S. branches of foreign banks by branch size can be found at

36. Examples of Issuing Entities:
U.S. branch as direct issuer: UBS, CS, NAB, CBA and ANZ
U.S. branch as guarantor, headquarters as issuer: BNP, Rabo, SocGen, Svenska
U.S. branch as guarantor, SPV/Cayman branch as issuer: Fortis, BNP
More banks are using a guarantee structure to allow greater flexibility for use of proceeds.
Which Regulator?
Most U.S. branches have elected the N.Y. State Department of Financial Services (“NYDFS”) as their primary regulator with their secondary regulator as the Federal Reserve.
Some U.S. branches have opted for the Office of the Comptroller of the Currency (“OCC”) as their primary regulator.
Non-U.S. Banks/U.S. Offices, cont’d

37. OCC Registration/Disclosure
National banks or federally licensed U.S. branches/agencies of foreign banks regulated by the OCC are subject to the OCC’s securities offering (Part 16) regulations.
Part 16 of OCC regulations provides that these banks or banking offices may not offer and sell their securities until a registration statement has been filed and declared effective with the OCC, unless an exemption applies.
An OCC registration statement is generally comparable in scope and detail to an SEC registration statement; as a result, most bank issuers prefer to rely upon an exemption from the OCC’s registration requirements. Section 16.5 provides a list of exemptions, which includes:
Regulation D offerings
Rule 144A offerings to QIBs
Regulation S offerings outside of the United States
General solicitation would be allowed for Regulation D offerings and Rule 144A offerings; the Rule 506 “bad actor” disqualifications would also apply.

38. Part 16.6 of the OCC Regulations
12 CFR 16.6 provides a separate partial exemption for offerings of “non-convertible debt” to accredited investors in denominations of $250,000 or more.
Federal branches/agencies, as issuers, may rely on this exemption by furnishing to the OCC parent bank information which is required under Exchange Act Rule 12g3-2(b), and to purchasers the information required under Securities Act Rule 144A(d)(4)(i).
The securities are “investment grade” – the new definition focuses on the probability of repayment, rather than an external investment-grade rating (Dodd-Frank Act requirement).
The offering document and any amendments are filed with the OCC no later than the fifth business day after they are first used.

39. FDIC Policy Statement
Statement of Policy Regarding the Use of Offering Circulars in Connection with Public Distribution of Bank Securities for state non-member banks (the “FDIC Policy”)
Which banks are affected?
State banks and state-licensed branches of foreign banks with insured deposits.
What does the FDIC Policy do? 
Requires that an offering circular include prominent statements that the securities are not deposits, are not insured by the FDIC or any other agency, and are subject to investment risk.
States that the offering circular should include detailed prospectus-like disclosure, similar to the type contemplated by Regulation A or the offering circular requirements of the former Office of the Thrift Supervision (the “OTS Regulations”).
The OTS Regulations require minimum denominations of $100,000.
The FDIC Policy has not been updated to reflect the elimination of the OTS.
Bank issuers include offering circular disclosure that is more detailed than that required by the FDIC Policy.

40. New York Regulatory Requirements
New York branches or agencies of foreign banks should contact the NYDFS prior to issuing bank notes.
An agency of a foreign bank subject to New York banking regulations would have to obtain a pre-offer no-objection letter from the Superintendent of the NYDFS, and would be able to sell only to certain authorized institutional purchasers in minimum denominations of $100,000.
New York branches of foreign banks issue bank notes in $250,000 minimum denominations in order to avoid the notes being viewed by a regulator as an impermissible retail deposit.
This limitation does not apply when the New York branch is a guarantor and the issuing entity is the foreign bank.

41. FINRA Requirements
Even though securities offerings under Section 3(a)(2) are exempt from registration under the Securities Act, public securities offerings conducted by banks must be filed with the Financial Industry Regulatory Authority for review under Rule 5110(b)(9), unless an exemption is available.
Exemption: the issuer has outstanding investment grade rated unsecured non-convertible debt with a term of issue of at least four years, or the non-convertible debt securities are so rated.

42. If an affiliated dealer is an agent for the offering, there is “prominent disclosure” in the offering document with respect to the conflict of interest caused by that affiliation and the bank notes are rated investment grade or in the same series that have equal rights and obligations as investment grade rated securities, then no filing will be required.
Transactions under Section 3(a)(2) must also be reported through FINRA’s Trade Reporting and Compliance Engine. TRACE eligibility provides greater transparency for investors. Rule 144A securities are also TRACE reported.
FINRA Requirements, cont’d

43. Denominations
The 3(a)(2) exemption does not require specific minimum denominations in order to obtain the exemption.
However, for a variety of reasons, denominations may at times be significantly higher than in retail transactions:
Offerings targeted to institutional investors.
Complex securities.
Relationship to 16.6’s requirement of $250,000 minimum denominations.
New York regulated agencies and branches.

44. Blue Sky Regulation
Securities issued under Section 3(a)(2) are considered “covered securities” under Section 18 of the Securities Act.
However, because bank notes are not listed on a national securities exchange, states may require a notice filing and a fee in connection with an offering of bank notes.
Generally, blue sky filings are not needed in any state in which the securities are offered.
State blue sky laws should be examined to ensure that either no notice filing or fee is required, or the state’s existing exemption for securities issued by banks does not require a filing.
A state may not view an agency of a foreign bank, whose securities are eligible for the Section 3(a)(2) exemption, as within the state’s exemption for securities issued by banks.
Rule 144A offerings of bank notes will fall within a state’s institutional purchaser exemption

45. Section 3(a)(2) Offering Documentation
The offering documentation for bank notes is similar to that of a registered offering.
Base offering document, which may be an “offering memorandum” or an “offering circular” (instead of a “prospectus”).
For foreign issuers:
IFRS financials or “home country” GAAP financials are acceptable;
Will need a reconciliation footnote or explanation if non-US GAAP or non-IFRS is used;
US GAAP financials are preferable;
Annual audited and at least semi-annual unaudited financial statements; and
Consider including Guide 3 statistical disclosures.
The base document is supplemented for a particular offering by one or more “pricing supplements” and/or “product supplements.”
These offering documents may be supplemented by additional offering materials, including term sheets and brochures.

46. 1940 Act Issues
Investment companies are subject to registration under the Investment Company Act of 1940, unless an exemption is available. An investment company is defined broadly as an entity that holds itself out as being engaged primarily, or proposing to engage, in “investing, reinvesting or trading in securities” and also includes entities engaged, or that propose to engage, in the business of investing, reinvesting, owning, holding or trading in securities if securities represent 40% or more of the value of its total assets (excluding cash and government securities).
As a result, issuers that are banks or specialized finance companies may inadvertently fall within the definition of an “investment company.”

47. 1940 Act Issues – Exemptions
U.S. banks are exempted under Section 3(c)(3) of the 1940 Act.
Foreign banks are exempted under Rule 3a-6 under the 1940 Act, subject to certain conditions.
U.S. branches or agencies of foreign banks are exempted under an interpretive release (1940 Act Release No (Aug. 17, 1990)).
Finance subsidiaries of U.S. or foreign banks are exempted under Rule 3a-5, subject to certain conditions.
Rule 3a-6 defines a “foreign bank” as a banking institution incorporated or organized under the laws of a country other than the United States, or a political subdivision of a country other than the United States, that is:
Regulated as such by that country's or subdivision's government or any agency thereof;
Engaged substantially in commercial banking activity; and
Not operated for the purpose of evading the provisions of the Act.

48. 1940 Act Issues – Rule 3a-6
“Engaged substantially in commercial banking activity” means engaged regularly in, and deriving a substantial portion of its business from, extending commercial and other types of credit, and accepting demand and other types of deposits, that are customary for commercial banks in the country in which the head office of the banking institution is located.” The SEC’s Division of Investment Management, in a no-action letter, interpreted the “substantial portion” language:
We believe, however, that the banking activities in which a foreign bank engages clearly must be more than nominal to satisfy the "substantial" standard in the rule. In addition, in order to meet this standard, we generally would expect a foreign bank: (1) to be authorized to accept demand and other types of deposits and to extend commercial and other types of credit; (2) to hold itself out as engaging in, and to engage in, each of those activities on a continuous basis, including actively soliciting depositors and borrowers; (3) to engage in both deposit taking and credit extension at a level sufficient to require separate identification of each in publicly disseminated reports and regulatory filings describing the bank's activities; and (4) to engage in either deposit taking or credit extension as one of the bank's principal activities.

49. Launching a Bank Note Program
Where do we start?
Does the bank have an affiliated dealer that may be the lead dealer for the program?
If the affiliated dealer does not have expertise in the particular market (e.g., structured products), an unaffiliated dealer with expertise should be brought in;
If the bank is planning on issuing structured products, it should engage a dealer that is familiar with FINRA’s suitability rules and has internal compliance procedures in place for sales of structured products;
The dealer may have particular views as to acceptable financial statements, if a foreign bank is the issuer;
If the dealer plans on distributing through third-party dealers, the issuer should inquire about the dealer’s “know your distributor” policies;
If the issuer uses an affiliated dealer, the appropriate FINRA filing exemption must be used; and
Dealer’s counsel will want to start its diligence early in the process in order to identify any potential issues.

50. Launching a Bank Note Program – Offering Circular
Documentation 
The offering circular tends to have information similar to that in a registered offering, due to 10b-5 concerns.
OCC 16.6 content requirements:
Description of the business of the issuer similar to that in a Form 10-K;
Description of the terms of the notes;
Use of proceeds; and
Method of distribution.
Branches or agencies of foreign banks’ disclosure is very limited, usually the address, primary business lines and the date of establishment; disclosure about the parent or headquarters is usually sufficient;
If a guarantee structure is used, a description of the guarantee; and
Product and pricing supplements for particular structures of structured notes.

51. Launching a Bank Note Program – Distribution Agreement
Very similar to an MTN distribution agreement for a registered offering;
Which deliverables, and when? Comfort letters, officers’ certificates and opinions:
Negotiate the scope of opinions early in the process;
Will multiple counsel give opinions (U.S., non-U.S., internal, underwriters’ counsel)?
Plan for future regular diligence session with the agents.
Does the issuer have a designated underwriters’ counsel?
If so, they will have a view as to the form of the distribution agreement.

52. Opinion Issues – Section 3(a)(2) and U.S. Branches of Foreign Banks
In the SEC’s 1986 release confirming that securities issued by a U.S. branch or agency of a foreign bank are within the Section 3(a)(2) exemption, reference was made to a series of previous no-action letters confirming that debt securities sold in minimum denominations ranging from $25,000 to $100,000 or sold only to certain types of sophisticated investors were exempt under Section 3(a)(2). The release also stated that the SEC would no longer express any view, or issue any no-action letters, regarding whether debt securities issued or guaranteed by a U.S. branch or agency of a foreign bank must satisfy any minimum denomination requirement, be sold to any type of investor or be principal protected, nor does the release require that such debt securities be subject to any of those limitations. Consequently, in opining on the availability of the Section 3(a)(2) exemption for notes issued or guaranteed by a U.S. branch or agency of a foreign bank, many firms will issue an opinion stating that the notes “should be exempt,” rather than the notes “are exempt.”

53. Launching a Bank Note Program – Paying Agency Agreement
Who will be the paying agent? Will it be an affiliate of the bank?
Usually, the form of paying agency agreement will be suggested by the paying agent.
Generally, indentures are not used.
Disclosure should clearly point out the differences between an indenture and a paying agency agreement; i.e., no trustee in a fiduciary relationship with the note holders.

54. Rule 144A Offerings

55. Rule 144A Offerings
Rule 144A provides a clear safe harbor for offerings to institutional investors.
Does not require extensive ongoing registration or disclosure requirements.
“Benchmark” sized issuances have good liquidity in the Rule 144A market.
A U.S. bank may use a Rule 144A program for marketing reasons – a desire to be clearly identified with the QIB market.
OCC Part 16.5: OCC regulated banks can issue in minimum denominations of less than $250,000 (a Section 3(a)(2) exempt security issued as a Rule 144A transaction).

56. Rule 144A – Overview
Rule 144A provides a non-exclusive safe harbor from the registration requirements of Section 5 of the Securities Act for resales of restricted securities to “qualified institutional buyers” (QIBs).
The premise: not all investors are in need of the protections of the prospectus requirements of the Securities Act.
The rule applies to offers made by persons other than the issuer of the securities (i.e., “resales”).
The rule applies to securities that are not of the same class as securities listed on a U.S. securities exchange or quoted on an automated inter-dealer quotation system.
A reseller may rely on any applicable exemption from the registration requirements of the Securities Act in connection with the resale of restricted securities (such as Regulation S or Rule 144).

57. Types of Rule 144A Offerings
Rule 144A offering for an issuer that is not registered in the U.S. – usually a standalone.
Rule 144A continuous offering program
Used for repeat offerings, often by financial institution and insurance company issuers, to institutional investors.
Often used for structured products sold to QIBs.

58. How Are Rule 144A Offerings Structured?
The issuer initially sells restricted securities to investment bank(s) as “initial purchasers” in a Section 4(a)(2) or Regulation D private placement.
The investment bank reoffers and immediately resells the securities to QIBs under Rule 144A.
Issuer  Initial Purchaser  QIBs
Often combined with a Regulation S offering.

59. Conditions for Rule 144A Offering
Reoffers or resales only to a QIB, or to an offeree or purchaser that the reseller reasonably believes is a QIB.
Reseller must take steps to ensure that the buyer is aware that the reseller may rely on Rule 144A in connection with such resale.
The securities reoffered or resold (a) when issued were not of the same class as securities listed on a U.S. national securities exchange or quoted on a U.S. automated inter-dealer quotation system and (b) are not securities of an open-end investment company, UIT, etc.
For an issuer that is not an Exchange Act reporting company or exempt from reporting pursuant to Rule 12g3-2(b) under the Exchange Act, the holder and a prospective buyer designated by the holder must have the right to obtain from the issuer, upon the holder’s request, certain reasonably current information.

60. What Is a QIB? The following qualify as “QIBs”:
Any corporation, partnership or other entity (but not an individual) that owns and invests on a consolidated basis $100 million in the aggregate in securities of non-affiliates (other than bank deposits and loan participations, repurchase agreements and securities subject thereto, and currency, interest rate and commodity swaps);
Registered dealers that own or invest $10 million of such non-affiliate securities or are engaged in “riskless principal transactions” on behalf of QIBs (to qualify, the QIB must commit to the broker-dealer that the QIB will simultaneously purchase the securities from the broker-dealer);
Any investment company that is part of a “family” that has the same investment adviser and together own $100 million of such non-affiliate securities; and
Any U.S. or foreign bank or S&L that owns and invests on a consolidated basis $100 million in such non-affiliate securities and has a net worth of at least $25 million
A QIB can be formed solely for purpose of conducting a Rule 144A transaction.

61. How Can a Reseller Ascertain a Person Is a QIB?
A reseller may rely on the following (as long as the information is no more than 16 months old):
The purchaser’s most recent publicly available annual financial statements;
Information filed with the SEC or another government agency or self-regulatory organization;
Information in a recognized securities manual, such as Moody’s or S&P;
Certification by the purchaser’s chief financial or other executive officer specifying the amount of securities owned and invested as of the end of the purchaser’s most recent fiscal year; and
A QIB questionnaire.
The SEC acknowledges that the reseller may use other information to establish a reasonable belief of eligibility.

62. Rule 144A – Legending
The reseller will make the buyer aware that the security is a Rule 144A security by:
Legending the security (i.e., the security must include language that it is not registered under the Securities Act);
Including an appropriate statement in the offering memorandum;
Obtaining an agreement that the purchaser understands that the securities must be resold pursuant to an exemption or registration under the Securities Act; and
By obtaining a restricted CUSIP number

63. Current Information Requirements
For securities of a non-public company, the holder and a prospective purchaser designated by the holder have the right to obtain from the issuer, upon request, the following information:
A brief statement of the nature of the business of the issuer, and its products and services;
The issuer’s most recent balance sheet and profit and loss and retained earnings statements, and similar financial statements for such part of the two preceding fiscal years as the issuer has been in operation; and
The financial statements should be audited, to the extent reasonably available.
The information must be “reasonably current.”

64. Rule 159: “Time of Sale Information”
Although Rule 159 under the Securities Act is not expressly applicable to Section 3(a)(2) or Rule 144A offerings, many investment banks apply the same treatment, in order to help reduce the risk of liability.
Use of term sheets and offering memoranda supplements, to ensure that all material information is conveyed to investors at the time of pricing.
Counsel is typically expected to opine as to the “disclosure package,” as in the case of a public offering.

65. Comparison of Section 3(a)(2) to Rule 144A
Required issuer:
Need a US state or federal licensed bank as issuer or as guarantor
No specific issuer or guarantor is required
Exemption from the Securities Act:
Section 4(a)(2) / Rule 144A
FINRA Filing Requirement:
Subject to filing requirement and payment of filing fee
(but an investment grade rating exemption is available)
Not subject to FINRA filing
Blue Sky:
Generally exempt from blue sky regulation
Listing on a non-U.S. exchange:
May be listed if issued in compliance with Part 16.6 No
“Restricted”
No; considered “public” and therefore eligible for bond indices, TRACE reporting
Yes, but subject to TRACE reporting

66. Comparison of Section 3(a)(2) to Rule 144A, cont’d
Required governmental approvals:
Banks licensed by the OCC are subject to the Part 16.6 limitations, unless an exemption is available.
Generally none.
Permitted Offerees:
All investors, which means that there is a broader market. However, banks licensed by the OCC are subject to the Part 16.6 limitations, unless an exemption is available. Generally, sales to “accredited investors.”
Only to QIBs. No retail.
Minimum denominations:
All denominations, subject to some limitations. However, banks licensed by the OCC are subject to minimum denomination requirement under Part 16.6.
No minimum denominations requirement.
Role of Manager/Underwriter:
Either agented or principal basis.
Must purchase as principal.
‘40 Act:
“Banks” not considered investment companies. Foreign banks will want to review 1940 Act guidance.
Non-bank issuer should consider whether there is a 1940 Act issue.
Settlement:
Through DTC, Euroclear/Clearstream.
Through DTC, Euroclear/Clearstream
Comparison of Section 3(a)(2) to Rule 144A, cont’d

67. Securities Liability – Rule 144A and Section 3(a)(2)
Neither Rule 144A offerings or securities offerings of, or guaranteed by, a bank under Section 3(a)(2) are subject to the civil liability provisions under Section 11 and Section 12(a)(2) of the Securities Act.
Rule 144A offerings and offerings under Section 3(a)(2) are subject to Section 10(b) of the Exchange Act and the anti-fraud provisions of Rule 10b-5 of the Exchange Act.
Impact on offering documents, and use of offering circulars to convey material information and risk factors.

68. Liability Under the Exchange Act
Rule 10b-5 applies to registered and exempt offerings.
Rule 10b-5 of the Exchange Act prohibits:
The use of any device, scheme, or artifice to defraud;
The making of any untrue statement of a material fact or the omission of a material fact necessary to make the statements made not misleading; or
The engaging in any act, practice, or course of business that would operate to deceive any person in connection with the purchase or sale of any securities.
To bring a successful cause of action under Rule 10b-5, the plaintiff must prove:
That there was a misrepresentation or failure to disclose a material fact,
Which was made in connection with plaintiffs’ purchase or sale of a security,
That defendants acted with “scienter,” or the intent or knowledge of the violation,
That plaintiffs “relied” on defendants’ misrepresentation or omission, and
That such misrepresentation or omission caused plaintiffs’ damages.

69. Regulatory Developments in Europe and the United States

70. BRRD/Bail-in
EU Bank Recovery and Resolution Directive (BRRD) entered into force on 2 July 2014
Most complex and controversial provisions for legislators to agree on were bail-in provisions
Member States were required to implement BRRD into national laws by 1 January 2015, except for bail-in provisions where the deadline was 1 January 2016
Appointment of national resolution authority for each EU member state – Bank of England for the UK
Single Resolution Board replaces national resolution authorities for banks subject to supervision by the ECB under the single supervision mechanism

71. Recovery plan to be prepared by each institution and submitted to national competent authority for review
Resolution authorities must draw up resolution plans for each supervised institution and must ensure any resolution action is taken in accordance with certain specified principles including:
The shareholders of the institution must bear first losses
Creditors of the institution bear losses after the shareholders in accordance with the priority of their claims under normal insolvency proceedings
Except where otherwise provided, creditors of the same class are treated in an equitable manner
No creditor shall incur greater losses than they would have incurred under normal insolvency proceedings
Covered deposits are fully protected
BRRD/Bail-in, cont’d.

72. BRRD – Scope of Bail-In Tool
Bail-in is the imposition of losses on liabilities owed by a financial institution which would not, by their terms, be required to absorb such losses
Loss absorption can be by conversion of the liability into a common equity instrument or writing down/off the principal amount of the liability
All liabilities that are not expressly excluded from the scope of bail-in are potentially bail-inable:
Express Exclusions
Covered deposits – up to the amount covered by a deposit guarantee scheme
Liabilities in respect of holding client assets or client money or from a fiduciary relationship
Liabilities to other non-group financial institutions with an original maturity of less than 7 days
Secured liabilities – expressly including covered bonds and hedging instrument liabilities of the covered bond issuer
Resolution authority can also exclude liabilities from bail-in in limited circumstances including where the liability cannot be bailed-in within a reasonable timeframe
Structured notes and derivatives are therefore potentially subject to bail-in provisions

73. BRRD – MREL
Under the BRRD, each Member State must set a minimum requirement for eligible (loss-absorbing) liabilities (MREL) expressed as percentage of the aggregate of an institution’s own funds (capital) and total liabilities
Minimum own funds are already established by Capital Requirements Regulation by reference to risk-weighted assets
Applies to all EU banks, not just G-SIBs
Where liability is governed by law of a non-EU country, it will only count towards minimum bail-inable liabilities if resolution authority is satisfied that the non-EU country would give effect to a decision to bail-in that liability whether by virtue of the terms of the contract creating the liability or by international agreement on the recognition of resolution actions / proceedings:

74. Total Loss Absorbing Capital (TLAC)
Financial Stability Board Proposal for Comment issued in November 2014; comment period closed in February 2015; final TLAC principles released in November 2015
Intended to be effective by January 2019
Designed to facilitate orderly resolution of G-SIBs
30 banks globally including eight US banks
Where does TLAC fit in?
A bank must satisfy minimum regulatory capital under Basel II
In addition to the minimum regulatory capital requirements, banks are subject to the Basel III capital conservation buffer and any applicable counter-cyclical capital buffer
In addition to that, G-SIBs must have “buffer” capital or a G-SIB “surcharge”
G-SIBs must meet TLAC requirements
Separately, EU banks must meet MREL requirements

75. Where does TLAC fit in?

76. Calibration of Minimum TLAC
Calibration of minimum TLAC from January 1, 2019 of 16% of risk weighted assets (RWAs) rising to 18% from January 1, 2022 and from January 1, 2019, 6% of the Basel III leverage ratio denominator and from January 1, 2022, rising to 6.75% of the Basel III leverage ratio denominator
Phased in requirements for GSIBs headquartered in emerging markets
Tier 1 and Tier 2 Capital is eligible
Other eligible TLAC that is not regulatory capital
Additional TLAC may be required for individual G-SIBs based on risk factors
Two elements: Risk-weighted TLAC ratio and a TLAC leverage ratio

77. FSB TLAC Term Sheet TLAC Eligible Securities: Excludes
Issued and maintained by each resolution entity (on a consolidated basis) within a G-SIB group
Paid in, unsecured
Remaining maturity of at least one year
Excludes
Insured deposits
Any liability callable on demand without supervisory approval
Liabilities funded by the issuer or a related party
Liabilities arising from derivatives or debt instruments with derivative-linked features—e.g., structured notes
Non-contractual liabilities, such as tax liabilities
Preferred liabilities
Other liabilities that cannot be written down or converted to equity by resolution authorities

78. No redemption without supervisory approval
Junior to excluded liabilities on the balance sheet of the resolution entity
No set-off
No redemption without supervisory approval
Resolution entity must maintain “External TLAC”
Material subsidiaries in jurisdictions outside of bank’s home country must have “Internal TLAC”
Each material subsidiary must have 75-90% of the external requirement that would apply if it were a resolution group
For this purpose, a “material subsidiary” is one that is not itself a resolution entity and that: (1) has more than 5% of consolidated RWAs of the G-SIB group; (2) generates more than 5% of consolidated RWAs of the G-SIB group; (3) has total leverage exposures that are more than 5% of the G-SIB group’s total leverage exposure; or (4) has been identified as material to the firm’s critical functions
FSB TLAC Term Sheet, cont’d.

79. Must be subordinated to excluded liabilities
Subordination can be achieved by one of three alternatives:
Structural Subordination
Statutory Subordination
Contractual Subordination
FSB TLAC Term Sheet, cont’d.

80. Single Point of Entry Resolution
In the United States, bank regulators intend to address a bank failure through a single point of entry (SPOE) resolution approach, illustrated below, in which the bank holding company is resolved and its operating subsidiaries continue to function under a bridge holding company

81. Federal Reserve Board Proposal
To facilitate an orderly resolution of a failed G-SIB, a G-SIB must maintain specified amounts of total loss absorbing capacity (TLAC)
The FRB released its proposal on October 30, 2015 which would establish for covered bank holding companies, or BHCs, and covered IHCs (defined below) an external TLAC requirement in the case of covered BHCs (and an internal TLAC requirement in the case of covered intermediate holding companies, or IHCs, of foreign banks), a related TLAC buffer, a minimum long-term debt requirement for covered BHCs (and a minimum internal long-term debt requirement for covered IHCs), and a “clean holding company” requirement
In addition, to avoid contagion risk, the Federal Reserve Board, or FRB, proposal also would penalize banks generally for holding unsecured debt of a covered BHC

82. FRB Proposal, cont’d There are eight U.S. G-SIBs, or U.S. covered BHCs
U.S. covered BHCs must maintain:
Outstanding eligible external long-term debt equal to the greater of: (i) 6% of risk-weighted assets, or RWAs, plus the applicable G-SIB buffer, and (ii) 4.5% of total leverage exposure, plus
Outstanding eligible external TLAC equal to the greater of: (i) 18% of RWAs (when fully phased-in), and (ii) 9.5% of total leverage exposure
An external TLAC buffer
FRB Proposal, cont’d

83. External Long-Term Debt
What is eligible external long-term debt?
Debt securities issued directly by the covered BHC that:
Are unsecured
Are “plain vanilla”
Are governed by U.S. law
Have a remaining maturity of over one year
Eligible external long-term debt with a maturity of less than two years would be subject to a 50% haircut
What is “plain vanilla” debt?
The debt cannot contain an embedded derivative, have a credit sensitive feature, contain any contractual conversion or exchange features, or include acceleration rights, other than on payment defaults
No structured notes

84. External TLAC What is eligible external TLAC?
The sum of (1) common equity Tier 1 capital and Additional Tier 1 (AT1) capital issued by the covered BHC, and (2) eligible external long-term debt, or LTD
What is the amount of the external TLAC buffer?
An external TLAC buffer is added on top of the 18% risk-based capital component of the external TLAC requirement, which can be met only with common equity Tier 1 capital
Equals the sum of 2.5%, any applicable countercyclical capital buffer, and the G-SIB surcharge calculated under Method 1
What is the consequence of failing to meet the external TLAC buffer requirement?
Restrictions on distributions and discretionary bonuses (similar to CCB)

85. Clean Holding Company What is the clean holding company requirement?
The proposal sets out a “clean holding company” requirement, which has two parts:
First, a covered BHC would be prohibited from
Engaging in short-term borrowings,
Entering into QFCs,
Issuing guarantees of subsidiary liabilities that could create cross-default, set-off or netting rights for creditors of the subsidiary
Second, a covered BHC’s third-party non-contingent liabilities (other than those related to eligible external TLAC) that are pari passu with or junior to its eligible external LTD to a cap of 5% of the value of its eligible external TLAC
The clean holding company requirement applicable to IHCs differs from the requirement applicable to U.S. G-SIBs as it does not provide for the 5% bucket of non-contingent liabilities

86. Regulatory Capital Deduction
Banks, savings and loans, and similar entities with total assets of more than $1 billion would suffer from a regulatory capital deduction for any investments in unsecured debt issued by covered BHCs (including eligible external LTD) in excess of certain thresholds

87. Timing
As proposed, covered BHCs would be required to comply with the external LTD and TLAC requirements by January 1, 2019, but the RWA component of the external TLAC requirement would be phased in with an initial 16% requirement applicable as of January 1, 2019, and the final 18% requirement applicable as of January 1, The clean holding company requirement would be applicable as of January 1, 2019.
Covered IHCs would be subject to similar effective dates and phase-ins.
The regulatory capital deduction would become effective as of January 1, 2019.

88. Issuances into the United States
For a financial institution considering an issuance of a contingent capital security or a security that converts into equity at the point of non-viability, there are a number of considerations
For a non-U.S. issuer that has a shelf registration statement in the United States, the issuer will want to ensure:
That the registration covers both the debt security and the underlying equity issuance;
That the issuer’s filed indenture would cover such an issuance;
That the issuer’s prospectus supplement addresses risk factors, regulatory considerations, and the tax treatment to a U.S. holder; and
That it addresses any potential Regulation M issues if an affiliated broker-dealer makes a market in the issuer’s securities.

89. Issuances into the United States, cont’d
For a non-U.S. issuer that does not have a shelf registration statement, the issuer might consider
Issuing the securities in reliance on Rule 144A; provided that the issuer does not have a class of equity securities that trade in the U.S.
Issuing the securities in reliance on Section 4(a)(2) to institutional investors
Issuances into the United States, cont’d