Our Take: financial services regulatory update – May 17, 2024

Change remains a constant in financial services regulation. Read "our take" on the latest developments and what they mean.

Current topics – May 17, 2024

1. Supreme Court finds CFPB funding is constitutional

  • What happened? On May 16th, the Supreme Court in a 7-2 decision rejected a challenge to the CFPB’s funding structure. The decision reversed the Fifth Circuit’s finding that the CFPB is “double insulated” from the Congressional appropriations process because it is funded through the Fed, which itself operates independently from the appropriations process. As a result of the Fifth Circuit decision, the agency’s 2017 payday lending rule was vacated in the areas covered by the Fifth Circuit court, specifically Texas, Louisiana and Mississippi.
  • What did the Supreme Court decision say? The Court found that an “appropriation” only requires that Congress pass a law specifying a source of funding for a specific purpose and that the CFPB’s funding structure meets this requirement.
  • What’s next? Following the decision, the CFPB released a statement welcoming the result and pledging to “continue carrying out the vital consumer protection work Congress charged us to perform for the American people.” The agency can now file for dissolution of the Fifth Circuit’s payday lending rule as well as a stay of its credit card late fee rule issued under identical reasoning.

Our Take

The CFPB has cleared a major legal hurdle but there are more challenges to come. This week’s decision confirms that the CFPB is here to stay, removing the possibility that virtually every rulemaking and action taken by the agency would be deemed unconstitutional. While this existential threat is now gone, we expect continued challenges to individual rulemaking and guidance by the agency - as we have seen with the small business lending rule and updates to its exam manual - by alleging that the CFPB (a) issued the rulemaking or guidance arbitrarily and capriciously, and (b) failed to perform an adequate cost benefit analysis. If the Supreme Court pares back agencies’ abilities to interpret their own statutory authority in an upcoming decision regarding “Chevron deference,” the door will open for even more legal challenges around the CFPB’s interpretation of terms such as “unfair, deceptive, or abusive acts or practices” as well as its ability to oversee nonbanks and areas such as AI and digital currency.

Despite these challenges, we expect that the agency will go full steam ahead with its investigations, enforcement and rulemaking agenda. Firms should anticipate continued high scrutiny of areas that have become key priorities under Director Chopra’s tenure such as fees and contract clauses that the agency considers unfair, deceptive or abusive as well as issues related to fair lending, anti-competitive practices and big tech companies offering financial services. As evidenced by its enforcement action, updated small business lending compliance schedule, and the fact that the agency is actively recruiting enforcement attorneys, the CFPB’s already vigorous pursuit of its agenda is set to only pick up.

2. Regulators on the Hill

  • What happened? On May 15th and 16th, the Fed Vice Chair for Supervision (VCS) Michael Barr, FDIC Chair Martin Gruenberg, and Acting OCC Comptroller Michael Hsu testified before the House Financial Services Committee (HFSC) and the Senate Banking Committee (SBC).
  • What was discussed? Some of the key topics raised included:
    • FDIC culture. The majority of questions in both hearings concerned workplace culture and misconduct allegations at the FDIC and cited the recently released third-party report. Gruenberg took full responsibility for the allegations and outlined changes that have been made at the agency and plans for more actions in line with the report. Many Republicans called for Gruenberg to resign, and while no Democrats directly joined these calls, several signaled serious concerns with his ability to lead the FDIC.
    • Basel III endgame. The second most covered topic was the Basel III endgame proposal, with the regulators testifying that they have not yet decided whether to finalize or re-propose the rule. They also generally declined to comment on timing, with Barr stating that he is focused on “getting it right,” but all three responded affirmatively to Senator Elizabeth Warren (D-MA) asking if they are committed to finalizing a rule by the fall. Barr also said the Fed’s anticipated quantitative impact study would be released “relatively soon” and that he expects broad and material changes across the rule’s three main components - operational risk, credit risk and market risk. Several Republicans including HFSC Chair Patrick McHenry (R-NC) expressed their view that significant changes would require a re-proposal with an adequate notice and comment period under the Administrative Procedure Act.
    • Bank stress. There were several comments related to actions stemming from last year’s bank stress. In his testimony, Gruenberg stated that large regional banks are using "more granular depositor concentration monitoring" and the FDIC is evaluating the impact of social media and new technologies on deposit stability. The regulators agreed that further action is needed to encourage discount window borrowing, with Barr saying the Fed is reaching out to a wide range of banks to learn from their experiences and identify changes to discount window operations.
    • Merger policy. The regulators received several questions on the recent OCC and FDIC updates to merger review. Hsu disagreed with suggestions that the OCC’s new policy would put a stop to merger and acquisition activity and stated that an application satisfying the framework’s criteria will be approved. Barr said the Fed will not issue its own updated policy but is working with the OCC, FDIC and DOJ on this issue.
    • Operational resilience and technology. Hsu’s testimony noted that the banking regulators are engaged in discussions to consider potential changes to the operational resilience framework" to ensure critical operations and banking services can withstand or recover from disruptive events. He also said the OCC has seen "a notable increase in the number of generative AI pilots at some of the larger banks we supervise."
    • Executive compensation. When questioned on the Fed’s absence from the recent multi-agency executive compensation re-proposal, Barr responded that they wanted to do more analysis before joining the other agencies.

Our Take

Gruenberg in the hot seat with little insight on policy questions. The embattled FDIC Chair left the hearings with a heavy load of criticism but few indications that he will need to leave his post. Without direct calls for his resignation from Democrats or the Biden Administration, it is unlikely that Republican pressure will be enough to cause Gruenberg to step down with a packed agenda of unfinished rulemaking on the table. With the vast majority of questions focused on FDIC misconduct allegations, there were few attempts to grill the regulators on specifics of their plans for Basel III endgame and other rulemaking. While they stated that they have not reached a decision to finalize or re-propose the rule, their answer to Senator Warren on finalization by fall calls into question whether there will be enough time to issue, receive feedback and finalize a new proposal by that deadline. However, Republican invocations of the Administrative Procedure Act indicate that they are ready to take legislative or legal action if the agencies finalize the existing proposal with significant changes and no opportunity for the public to provide comments. Clearer indications of what will change and how substantial it will be could come “relatively soon” through the Fed’s delayed impact analysis.

3. On our radar

These notable developments hit our radar recently:

  • SEC adopts rule amendments to Reg S-P. On May 16th, the SEC adopted amendments to Regulation S-P to modernize and enhance the rules that govern the treatment of consumers’ nonpublic personal information by certain financial institutions. The amendments update the rules’ requirements for broker-dealers (including funding portals), investment companies, registered investment advisers, and transfer agents to address the expanded use of technology and corresponding risks that have emerged since Regulation S-P was originally adopted in 2000. Covered institutions will have 18 to 24 months, depending on size, to comply with the amendments following the rules being published in the Federal Register.
  • Fed denies two rulemaking petitions. On May 17th, the Fed announced its denial of two rulemaking petitions due to legal and policy considerations. The first petition asked the Board to develop a framework requiring Board-supervised firms to disclose promised financial commitments to certain corporate initiatives, and the second asked for revisions to the Uniform Financial Institution Rating System framework and adjustments to the framework for financial holding company eligibility.
  • CFPB extends 1071 compliance deadlines. On May 17th, the CFPB extended the compliance deadlines for its small business lending rule to account for the 290 day period since a Texas court stayed the rule on July 31st, 2023.
  • Treasury releases 2024 strategy report on combating illicit financing. On May 16th, Treasury released a report on its strategy for combating illicit financing. It continues the four priorities from its 2022 report: (1) assessing and addressing gaps in the AML regime; (2) making the regulatory and supervisory framework more effective and risk-focused; (3) enhancing the effectiveness of law enforcement and other agencies; and (4) supporting responsible innovation to mitigate illicit finance risks.
  • SEC and FinCEN issue proposed rule on customer identification program requirements. On May 13th, the SEC and FinCEN issued a proposed rule to apply customer identification program obligations to certain investment advisers. This rulemaking compliments a separate FinCEN proposal issued in February 2024, which includes certain investment advisers in the definition of “financial institution” under the Bank Secrecy Act and subjects them to AML/CFT program requirements, as well as obligations to file suspicious activity reports. Comments must be received on or before 60 days after publication in the Federal Register.
  • CRS releases CBDC report. On May 13th, the Congressional Research Service (CRS) released a report on central bank digital currencies (CBDCs). Despite the longstanding debate of its benefits and risks as well as the widespread adoption of international CBDC initiatives, the report highlights that no consensus has been reached yet on whether a CBDC would be adopted in the U.S.
  • CFTC extends comment period. On May 13th, the CFTC extended the comment period by 21 days for its March proposal amending existing regulations for designated contract markets and swap execution facilities to establish governance and fitness requirements with respect to market regulation functions, as well as related conflict of interest standards.
  • Agencies announce public meeting on proposed acquisition by Capital One of Discover and extended the comment period. On May 14th, the Fed and OCC announced a joint virtual public meeting on July 19th on the March 2024 proposal by Capital One to acquire Discover. Members of the public seeking to present oral comments must register by noon ET on June 28, 2024. The agencies also announced that they are extending the public comment period through July 24, 2024.
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