Fed Opens The Door To Increased Chinese Investment In U.S. Banking Organizations

On May 9, 2012, the Federal Reserve Board ("FRB") released three orders approving investments in the U.S. banking market by entities based in China. The investments, which consist of the acquisition of 80 percent of a national banking association and the establishment of two foreign branch offices, are particularly notable because the investments are coming from China. The Chinese Government will be an indirect owner of a national bank, and the conclusions that the FRB draws regarding the financial regulatory system of China are significant and will facilitate greater investment in U.S. banking organizations by Chinese-based companies in the future.

The Proposed Acquisition

The most significant of the three orders involves the Industrial and Commercial Bank of China Limited ("ICBC"), China Investment Corporation ("CIC"), and Central Huijin Investment Ltd. ("Huijin") – all of Beijing, and all of which requested approval to become bank holding companies under section 3 of the Bank Holding Company Act of 1956 ("BHC Act"), by acquiring up to 80 percent of the voting shares of The Bank of East Asia, National Association ("BEA-USA"), New York, New York.1 ICBC engages primarily in retail and commercial banking throughout China. CIC is an investment vehicle organized by the Chinese Government for the purpose of investing the latter's foreign exchange reserves, and controls Huijin, a Chinese Government-owned investment company organized to invest in Chinese financial institutions.2 BEA-USA, with total consolidated assets of approximately $780 million and deposits of approximately $621 million (as of December 31, 2011), engages in retail and commercial banking in the United States, and operates 13 branches in New York and California.

Decisional Factors

In evaluating an application by a foreign banking organization to acquire a U.S. domestic depository institution, the FRB considers several factors, namely: (1) supervision or regulation on a consolidated basis; (2) competitive considerations; (3) financial, managerial, and other supervisory considerations; (4) convenience and needs considerations; and (5) financial stability.

Supervision or Regulation on a Consolidated Basis

In what is perhaps the most significant aspect of the FRB's BEA-USA acquisition approval, the FRB evaluated whether the Chinese financial regulatory regime meets the "comprehensive, consolidated supervision" or "CCS" standards required for a foreign banking organization to acquire a U.S. domestic depository institution.3 Section 3 of the BHC Act requires the FRB to consider whether the applicants are subject to comprehensive supervision or regulation on a consolidated basis by appropriate authorities in their home country.4 The FRB has long held that "the legal systems for supervision and regulation vary from country to country, and comprehensive supervision or regulation on a consolidated basis can be achieved in different ways."5 In applying this standard, the FRB has considered the Basel Core Principles for Effective Banking Supervision ("Basel Core Principles"), which are recognized as the international standard for assessing the quality of bank supervisory systems, including with respect to comprehensive, consolidated supervision.

The FRB's Regulation K provides that a foreign bank is subject to consolidated home country supervision if the foreign bank is supervised or regulated in such a manner that its home country supervisor receives sufficient information on the worldwide operations of the foreign bank (including the relationships of the bank to any affiliate) to assess the foreign bank's overall financial condition and compliance with law and regulation.6 In assessing this standard under section 211.24 of Regulation K, the FRB considers, among other indicia of comprehensive, consolidated supervision, the extent to which the home country supervisors: (1) ensure that the bank has adequate procedures for monitoring and controlling its activities worldwide; (2) obtain information on the condition of the bank and its subsidiaries and offices through regular examination reports, audit reports, or otherwise; (3) obtain information on the dealings with and relationship between the bank and its affiliates, both foreign and domestic; (4) receive from the bank either financial reports that are consolidated on a worldwide basis or comparable information that permits analysis of the bank's financial condition on a worldwide consolidated basis; and (5) evaluate prudential standards, such as capital adequacy and risk asset exposure, on a worldwide basis.

In determining that the enhancements to standards of bank supervision in China warranted a finding that ICBC is subject to CCS, the FRB was particularly persuaded by the following factors:

The China Banking Regulatory Commission ("CBRC") is the principal supervisory authority of ICBC, including its foreign subsidiaries and affiliates, for all matters other than money laundering, and monitors Chinese banks' consolidated financial condition, compliance with laws and regulations, and internal controls through a combination of on-site examinations, off-site surveillance through the review of required regulatory reports and external audit reports, and interaction with senior management. The CBRC has issued guidance in various supervisory areas, including strict...

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