When crafting an entry into the U.S. markets, U.K. and European financial institutions need to carefully plan an appropriate strategy. Sebastian Barling, host of “The Capital Ratio” is joined by financial institutions regulatory co-head Mark Chorazak and associate Olivia Merrett to guide companies though the process, including determining the purpose of the U.S. operations, choosing a bank-level regulator and managing their domestic regulators.
Episode Summary
The U.S. regulatory system may be “infamously fractured,” but only one or two agencies are of practical concern to foreign banks thinking about entering the country, says Mark Chorazak, the New York-based co-head of Skadden's Financial Institutions Regulatory Group. In this episode of "The Capital Ratio," Mark and colleague Olivia Merrett, London-based associate in the group, unpack key considerations for UK and European financial institutions that want to enter the U.S. market. With host Sebastian Barling, they outline the important regulatory agencies (the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation), pathways for entry, and strategies for success..
Speaker 1 (00:02):
Welcome to the Capital Ratio, where Skadden explores the dynamic world of financial institution regulation, offering insights for institutions navigating the regulatory environments in the UK, EU, and us.
Sebastian Barling (00:18):
Hi, and welcome to the Capital Ratio, a series in which we examine the key regulatory topics relevant to the banking and financial sector. I’m your host, Sebastian Barling, head of the UK European Financial Regulatory Practice here at Skadden. And I’m delighted to be joined today by two of my colleagues, Mark Chorazak, a partner in New York who co-heads our US financial institutions regulatory practice. And Olivia Merrett, an associate here in the London regulatory team.
(00:42):
So what are we going to be talking about today? Well, we’re going to be discussing a question we’ve been hearing from many of our clients recently. How do I go about entering the US bank market? In particular, we’re going to be looking at some of the key considerations which UK and European financial institutions, and in particular banks, need to be thinking about when considering their US entry strategy. But before we get going, let’s start by breaking down the US regulatory framework in a little more detail, since it turns out it can vary quite a bit depending on what you’re looking to achieve in the US and there’s a whole host of new acronyms to get used to as well. Mark, would you mind sharing a bit more about who the key US regulators are as this differs a lot from the UK and EU regimes?
Mark Chorazak (01:19):
Sure. Well, thanks, Seb. It’s great to be here. Well, the US regulatory system is infamously fractured, but financial institutions thinking about entering the US generally need to be concerned with one or two federal agencies as a practical matter, depending on their activities and how they entered the US market. We have a dual banking system in the United States. We have federal regulators, we have state regulators. For non-US banks, the Federal Reserve is probably the most important regulatory agency because all banks must apply to the Federal Reserve for permission to establish or acquire a US bank or to otherwise have a US presence.The Fed supervises all US operations of a foreign banking organization, including non-bank affiliates, and it’s also the federal supervisor for state licensed offices and branches of a foreign bank.
(02:09):
Now, a foreign bank can choose the Federal Reserve as the primary federal regulator of a state bank that establishes or acquires. Finally, the Federal Reserve banks operate much of our payment system in the United States, including offering things like the Fedwire and ACH services, and historically they have limited access to that system to federally regulated banking entities. Then you have two bank-level supervisory agencies. You have the Office of the Comptroller of the Currency, which we refer to as the OCC, and the Federal Deposit Insurance Corporation, which is the FDIC.
(02:45):
The OCC is responsible for overseeing national banks and federally chartered branches of non-US banks. Because these banks or branches are federally chartered, they benefit from what’s known as preemption, meaning that they can operate in all 50 states without local licenses. However, the OCC’s supervisory fees are typically higher than those of state agencies, so that’s something that we typically have questions about.
(03:13):
The FDIC is responsible for overseeing most state chartered banks, although they can elect for supervision by the Federal Reserve. FDIC-supervised banks may lend nationally at the rate permitted in their home state, but otherwise do not benefit from preemption, meaning that they have to comply with financial regulatory requirements under the laws in which they operate, although they do not need a separate license in each state. The FDIC also acts as an insurance agency of sorts because it insures deposit of all insurer depository institutions.
(03:44):
Closing out the list of federal agencies that we get a lot of questions about is the Financial Crimes Enforcement Network, or FinCEN. It’s really a unit of the Treasury Department, and it’s really the primary anti-money laundering authority. For banks, most of the time, FinCEN functions as an omnibus coordinating role. The actual AML regulations to which banks are subject are issued and implemented by the Federal Banking Agency, so the Fed, the OCC, the FDIC. For non-US banks though, FinCEN plays a more prominent role issuing AML rules, registering money services businesses or money transmission companies, and those are supervised by the states as well as there’s a FinCEN registration for those. When AML violations are discovered, FinCEN plays an important role in enforcement and often seeks significant penalties, but it also has a very important referring role to other agencies and bodies.
(04:36):
At the state level, Seb, every bank or branch that’s not chartered by the OCC must be chartered by a state financial regulatory agency, and most non-banks must be licensed in every state in which they operate. State regulators generally oversee banks in a manner similar to that of federal banking agencies with regular examinations and reporting, although they often have fewer resources than their federal peers, which can be good or bad. State regulators and regulatory requirements for non-banks, however, vary wildly. Requirements can range from a form application and modest annual registration fee and other requirements, to extensive financial reporting and supervision depending on the resourcing and sophistication of the state agency.
(05:20):
Finally, there’s a whole suite of different requirements relating to investment advisors, broker dealers, and other financial markets-orientated firms, but let’s set those aside for now and really just focus on the banking side.
Sebastian Barling (05:34):
Thanks, Mark. And that’s certainly quite the thicket of regulatory agencies over there in the US. So then if I am a UK or European finance institution looking to move into the US, which of these do I really need to care about?
Mark Chorazak (05:46):
Sure. Well, it really depends on what you’re trying to do. So broadly speaking, there are three pathways that foreign financial services firms entering the US have followed, and those really depend on what their planned US operations are. So let’s just take the first bucket. The first bucket are those firms that are planning a non-banking business such as a money transmission or similar. Those are similar to e-money institutions in the UK or a consumer-lending business. They can pursue licensing at the state level by state regulators in the states in which they operate. In some cases, like I said, they’ll have to register with FinCEN, but largely it’s a state affair, and even if a financial institution is a bank outside the US, it can go this route if it’s planning to limit its activities here. This is what some institutions like Klarna, for example, have done. Even though it has a subsidiary with Swedish Banking Charter, it has limited its activities in the US based on its licensing choices.
(06:39):
The benefit is that these state licensing regimes are often considered lighter touch, meaning that they’re less intrusive supervision or limited prudential regulatory requirements like capital and liquidity. So this route can make a lot of sense for firms looking to engage in a specific set of activities in the United States. However, these licenses do not confer direct access to the US payment system through the Federal Reserve, so the firm will need to establish correspondent or partner banking relationships with a US bank. That’s a very common route. They also need to manage the complexity of complying with state-level licensing regimes where they operate, which can be quite a significant endeavor if they’re operating on a nationwide business. 50 state licenses means 50 state regulators who can supervise your operations and seek penalties for compliance problems, so it’s something to really consider.
(07:31):
The second bucket, Seb, are those banks based outside the US but open up some sort of office here, for example, like a representative office or a branch in the United States to facilitate business. So as mentioned, US offices and branches of non-US banks are subject to regulation at the federal level by the OCC, as well as the Federal Reserve and the state in which they’re located. And the parent bank or the parent foreign bank is also regulated by the Federal Reserve. Branches have direct access to the US payment system. They have broad lending power, so it’s a very common initial entry strategy. OCC-chartered branches also benefit from preemption, which can limit the burden of complying with various states’ laws. On the other hand, branches are limited in their ability to accept deposits from US customers, so the general rule is that they’re prohibited from accepting retail deposits.
(08:27):
Representative offices are even more constrained, so they have limitations on what they can do. They can largely help facilitate business transactions between US customers and their home office, but they can’t engage in deposit taking of course, or any of the activities that generally are reserved for a branch. So this bucket or this route makes a lot of sense in two different situations. One, if the financial institution has specific plans that require Federal Reserve payments access, but they don’t require the ability to accept deposits or take deposits, and this is what some banks have done. For example, Adyen, for example, opened up a federal branch in San Francisco, but it hasn’t sought a full-blown banking license.
(09:09):
Secondly, for some non-US banks, this makes the route for future expansionary proposals. For example, you may have seen OakNorth Bank, a UK bank, recently proposed to enter the US by acquiring a bank in Michigan, but they established a representative office first and they were approved by the Federal Reserve for that last year. The third route or bucket to think about, Seb, is where foreign banks jump right into the deep end of US banking regulation, and they do so by chartering a de novo banker acquiring an existing bank. In that case, the US bank would be supervised by either the OCC in the case of a federal charter, national bank charter, or by the state regulator and either the Federal Reserve or the FDIC, depending on whether that state bank is a member or not of the Federal Reserve system.
(10:01):
And again, the foreign bank parent along with any intermediate US holding companies, would be supervised by the Federal Reserve. US banks are the most intensely supervised and regulated institutions. They are the only entities capable of providing the full range of banking products and services, including payments, accepting deposits, making loans, etc. And this path is a very good fit for financial institutions looking to offer their full product set to US-based customers over the medium to long-term.
(10:34):
As I just noted, this is the route that OakNorth is looking to pursue based on their recent announcement, and that BAWAG Bank, for example, recently followed with its acquisition of Peak Bancorp in November of 2023. And based on the expressions of interest that we’ve been hearing, and of course that the market has been hearing, you’ll probably see a good number of more institutions follow in their footsteps in the coming months and years.
Sebastian Barling (11:01):
Thanks, Mark. That’s really interesting. So if you are a UK bank and you’ve put your thinking cap on and you’ve decided to go down the full fat option and you want to take deposits and go down for a full US bank charter, what do you do next? How do you go and set up a US bank?
Mark Chorazak (11:15):
That’s a good question, and we get this question all the time, especially post-election. The first thing you need to do is decide who do you want as your bank regulator? As I mentioned, the OCC tends to be the agency of choice for banks that want to operate nationally in the United States because of the preemptive effect of the federal charter, but its supervisory fees are meaningfully higher. That’s a consideration. If you’re going to go the state route instead, it’s advisable to spend sufficient time identifying a regulator that will be familiar with foreign banking organizations and mapping out your product offerings to ensure that they comply with the state law and all the states where you’re planning to operate.
(11:53):
Once you’ve made a decision there, the next step is to put together a charter and deposit insurance application. This requires a very detailed business plan. This is not a business plan that MBA grads and other businesses are most familiar with. This is a very detailed business plan that goes to regulators and that contains things like financial projections, it identifies how the bank will be profitable after a three-year time horizon, how it will satisfy regulatory capital requirements.
(12:21):
The application also has to identify most of the US personnel who will make up the management team. There is also a heavy lift of preparing policies that satisfy US regulatory requirements, securing key vendors undergoing a very detailed review of your management’s and company’s financial information and background. And the good news is that the hardest part of setting up a US bank is often raising capital, so as an existing entity you have less to worry about since you can capitalize it out of your existing capital stack. The whole process, Seb, it ranges depending on the facts and circumstances and the type of acquirer and the institution that you’re looking at, but it can range from one to well over two years, and many proposed de novo banks of course never get off the ground.
Sebastian Barling (13:09):
Thanks, and that certainly doesn’t sound like a quick process with a fair amounts of investment needed, both from a time and management perspective. I mean, is it any easier to go an alternative route and just try and buy a US bank rather than set one up from scratch?
Mark Chorazak (13:23):
Yeah, absolutely. There’s often two forks in the road. Do you build or do you buy? And the buy route, it can be quite attractive. The benefit of going through the process to set up a bank is that you can wind up with a bank tailored to your specific needs, but that takes a lot of time. So the simplest and faster way to route is just to identify an existing bank that’s already operating here, it comes with a management team, there’s an existing capital stack, there’s an existing regulatory compliance program, there’s already key systems and vendor relationships in place.
(13:56):
And that’s what most non-U.S banks ultimately choose to do if they’re looking to go beyond a branch presence in the United States, because it can be a quicker process. The process still takes a lot of time, over a year in some cases. But it’s a well-worn pathway, especially for foreign banks breeding in jurisdictions that have long histories of effective cooperation with US regulators such as the UK and most of Europe. And I’d also said for regulators, there’s kind of a muscle memory with approving M&A transactions where looking at a set of applications for a de novo bank can take much more time.
Sebastian Barling (14:30):
Thanks, Mark. That’s really interesting. So let’s say I got my US bank up and running. Either I’ve set it up from scratch or I’ve gone and bought an existing one in the US. Presumably, I still need to pay attention to US regulations and I’m not just good to go. What are some of the key things I need to be thinking about?
Mark Chorazak (14:43):
Sure. Yeah. Well, thanks, Seb. US banks owned by foreign banks are subject to the full range of US prudential requirements. That’s things like capital requirements, liquidity requirements, stress testing, activity restrictions. In the United States, we have this historical separation of banking and commercial activities. We also have restrictions on what affiliates can do together when they’re transacting together. And foreign banking organizations also have to think about reporting requirements that we have in the United States.
(15:11):
The good news is that non-US banks are intimately familiar with these requirements by this point in the process, and particularly if they’re already prudentially regulated, some of these themes like capital and activity restrictions are not new. Foreign banking organizations generally are not restricted in their ability to make investments outside the United States and non-US companies with no US business. But things can get complicated when a foreign bank makes an investment in a foreign company that then starts operating in the United States, especially if that business becomes significant. So that’s something to think about.
(15:45):
The other thing is information sharing with respect to AML programs, that can be tricky, although US banks and branches are generally permitted to share information with their parent to facilitate AML efforts. FinCEN, which is that part of the Treasury Department that I mentioned earlier, FinCEN was supposed to kick off a pilot program sharing what’s referred to as SARs, or Suspicious Activity Reports, within a foreign banking organization. But that pilot program has not really gotten off the ground, but it’s something to look ahead on.
(16:16):
Thirdly, and I think this falls in the category of suffering from success, but foreign banking organizations with $250 billion or more in total assets begin to have what’s referred to as enhanced prudential standards in the United States. And these standards are stricter if the US portion of the assets crest to $100 billion dollars or more. In those cases, a foreign banking organization must establish what’s referred to as an intermediate holding company that holds all of the US assets other than the branch assets in that company, referred to as an IHC, once those assets exceed $50 billion, so that’s an important structural point.
Sebastian Barling (16:53):
Thanks, Mark. So it strikes me there’s still quite a lot of think about, and you’re certainly going to need a US-focused compliance program, but we have been spending a lot of time thinking about the US considerations. And actually, let’s jump across the pond a little bit because there’ll also be the need to manage your own local regulator.
(17:08):
So, Olivia, would you be able to talk us through some of the key considerations you’d have to think about if you’re a UK-headquartered bank looking at doing this and interacting with the PRA and FCA here in the UK?
Olivia Merrett (17:17):
Thanks, Seb. Absolutely. It’s probably the most important consideration and the thing that really should underscore all the thinking is the obligation for all the UK banks and regulated entities to have open and cooperative relationships with their regulators. Now, thankfully, we don’t have quite so many to worry about here as in the US, but as any UK-headquartered bank will already know, it’s crucial that both their relationships with the PRA and the FCA, that they are open and cooperative, so it’s really critical to make sure you don’t leave the regulators behind if you’re thinking about a US expansion.
Sebastian Barling (17:49):
Thanks, Olivia. So we want to see the regulators being informed of any US expansion plans at an early stage?
Olivia Merrett (17:55):
Definitely. I mean, I think it’s important to think of taking the PRA and the FCA on the journey with you. It’s a very material step for a UK business to be looking to set up material US operations, so it’s really important to get the regulators on board at an early stage and make sure they’re comfortable with the plans so you don’t get any issues further down the line.
Sebastian Barling (18:13):
Thanks. That’s useful. And in respect to those issues, what do you think the key ones, the regulators are really going to want to get some comfort on?
Olivia Merrett (18:20):
Well, obviously the way that the PRA and FCA are going to be thinking about any kind of plans is what the impact’s going to be on the UK operations and the kind of UK market of that UK bank expanding out. So I think in particular, they’ll want to understand what’s going to happen with staffing, and they want to make sure that management time in the UK is not taken too far away from the UK business. That will also include wanting to probably look quite closely at any dual-hatting arrangements, so there aren’t any kind of conflicts of interest that will be entered into.
(18:48):
Beyond this, I probably expect that the PRA and FCA will ask questions about any plan outsourcing arrangements and how transactions will be booked so they can make sure that’s still compliant with the UK regulations, also probably want to understand how this is going to impact on the regulatory consolidation position for the group so they can make sure that they’ve got a good picture of their supervisory situation going forward.
Sebastian Barling (19:08):
Thanks, Olivia. That’s really useful. And I think on that note, let’s wrap up. There is clearly a lot to grapple with here for financial institutions thinking about entering the US regardless of the path they’re planning to take, be that a new build and acquisition, considerable work and planning is going to be needed to right-size an institution’s strategy for its plans to enter into the US.
(19:25):
At the same time, the prospects for effective entry into the US market are as strong as they have ever been with multiple heads of the US regulatory agencies expressing interest in revitalising the bank chartering and M&A process, so it’s certainly a time to be looking at this seriously. On that note, if you have any questions or comments on any of the topics we spoke about today, please do feel free to contact us. Otherwise, thank you and we hope you’ll join us next time.
Speaker 1 (19:49):
Thank you for joining us for today’s episode of The Capital Ratio. If you like what you’re hearing, be sure to subscribe in your favorite podcast app so you don’t miss any future conversations. Additional information about Skadden can be found at skadden.com..
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