Our Take: financial services regulatory update – August 9, 2024

• What happened? On July 30th, the FDIC proposed modifications to its rules governing parent companies of industrial banks and loan companies (ILCs) and its brokered deposit regulations. It also issued a request for information (RFI) on deposit data.
• What would the ILC proposal do? The proposed changes would introduce new criteria for the FDIC to consider when evaluating the risks posed to an ILC by its parent company and assessing the bank’s capacity to operate independently without relying on the parent company for funding, lending or operational support. The FDIC would evaluate whether the industrial bank is a shell or captive entity as well as its effectiveness in serving the communities where it operates. The amendments would also clarify how written commitments relate to the FDIC’s assessment of the relevant statutory factors for an industrial bank’s application.
• What would the brokered deposit proposal do? The proposal would change the definition of “deposit broker” by adding a qualification around receiving fees for or related to the placement of deposits. It would also:
  • Eliminate the “exclusive deposit placement arrangement” exception that was added in 2020 to provide that any entity exclusively placing deposits at one IDI would not be considered a deposit broker;
  • Revise the primary purpose exception (PPE)⁴ criteria with additional FDIC analysis of the intent of the third party and its relationship with the IDI, including any fees paid to the third party, and only allow IDIs to file PPE applications;
  • Replace the “25% test” designated business exception⁵ with a broker-dealer sweep exception that would only be available to broker dealers and registered investment advisors with a lower limit on the amount they can automatically transfer (“sweep”) into accounts at one or more IDIs to 10% of their assets under administration; and
    
  • Eliminate the exception around third parties placing deposits to enable customer transactions.
    Banks currently relying on existing PPE, 25% test or enabling transactions exceptions would no longer be able to do so and would need to obtain pre-clearance for deposits that meet the new exception requirements. 
• What does the FDIC want to know about deposits? The RFI concerns deposit data that is not included on banks’ Call Reports or other regulatory reports, including information on uninsured deposits. Specifically, the FDIC asks about characteristics that could affect the stability and value of different types of deposits and the benefits of more frequent or detailed reporting on these characteristics for risk and liquidity management; risk/benefit analysis of deposit insurance coverage; and risk sensitivity in deposit insurance pricing.
• What’s next? Comments on the RFI are due by October 7th, 2024; comments on the proposals are due 60 days after they are published in the Federal Register.

Our Take

Rolling back 2020 reforms. Both of these proposals partially reverse or adjust reforms that were passed under Chair Martin Gruenberg’s predecessor, Jelena McWilliams. The proposals also similarly target areas in which nonbanks have influence over traditional banks or their deposits.

Coming just over a month after the FDIC’s first approval of a new ILC under the Biden Administration, the ILC proposal reflects Gruenberg’s view that these institutions need to meet high standards for independence from their parent companies. Accordingly, the approval should not be seen as a green light for future applications but instead a sign that the approved institution largely met the criteria in this proposal and that other applicants need to prepare for greater scrutiny. They will need to demonstrate a business model closely mirroring that of an independent bank and show that the creation of the ILC will broadly benefit the community, not just a segment of customers of an affiliated entity.

The brokered deposits proposal would significantly change the relief from 2020 in line with Chair Gruenberg’s dissent at that time. While it clarifies a number of definitions that could make the treatment of brokered deposits more consistent and complements a recent interagency statement on third party deposit arrangement risks, it removes a number of exceptions that banks and their third parties, including fintechs and non-bank affiliates, have relied on over the past four years. Banks that have grown these third party deposit placement arrangements, particularly exclusive partnerships, will likely push back on this proposal as they would need to re-apply for the exceptions and potentially be refused under the proposed criteria. Changes in their brokered deposit classifications could then affect their insurance assessments, safety and soundness ratings and their liquidity requirements.

Meanwhile, the deposit data RFI is an understandable development following last year’s misinterpretations and clarifications when the FDIC issued a special assessment following the bank failures. The questions included in the RFI lean into the benefits of additional data on brokered deposits and uninsured deposits, which indicates that a proposal to require such data is on the horizon.

Ultimately, the future of each of these proposals will be impacted by anticipated change in leadership at the FDIC. The President’s nominee to replace Gruenberg, Christy Goldsmith Romero, had a confirmation hearing on July 11th but has not yet received a vote in the Senate Banking Committee. If confirmed, she would likely take time to fully understand the proposals and comments before taking action to finalize them. If this timeframe then runs into next year, finalization of the proposals could be affected by changes either in the Presidency, which could result in a new Comptroller and CFPB Director, or the control of Congress, which could vote to reverse any rules finalized within 60 legislative days.

⁴ _{The PPE currently applies “when an agent or nominee whose primary purpose in placing customer deposits at IDIs is for a substantial purpose other than to provide a deposit-placement service or FDIC deposit insurance with respect to particular business lines.”}

⁵ _{Under the 2020 final rule, third parties that swept customer funds to IDIs were eligible for the PPE if they placed less than 25% of their assets under administration at IDIs.}

• What happened? On July 30th, the FDIC proposed modifications to its Change in Bank Control Act (CIBC Act) regulations.
• What would the bank control proposal do? Generally, under the CIBC Act, no persons or entities may acquire control of a bank (either directly or indirectly) without providing at least 60 days prior written notice to the appropriate federal banking agency. The FDIC’s current regulations exempt transactions from this notice requirement in cases where the transaction is subject to notice to the Fed. The new proposal would remove this exemption and end the FDIC’s current practice of accepting passivity agreements⁶ from investors.
• What’s next? Comments on the RFI are due by October 7th, 2024; comments on the proposals are due 60 days after they are published in the Federal Register.

Our Take

Chopra’s proposal won. After there were dueling proposals to amend the CIBC Act regulations in April, it appears that CFPB Director Rohit Chopra was able to win the vote of Comptroller Michael Hsu based on a commitment to work with the Fed and OCC to develop an interagency approach. As changes to the acceptance of passivity agreements were featured in both proposals, asset managers will likely need to adjust their practices in this area regardless of potential changes to other areas in a final rule. They should review (a) existing passivity commitments to determine compliance and (b) whether it could be interpreted that they “direct or attempt to direct management or policies” under various definitions. They should also prepare for potential increased scrutiny of passivity claims following acquisitions of bank voting securities. As they evaluate the cost and time needed to adapt to new processes, asset managers may weigh these factors against the benefit of continuing with investments in this space.

⁶ _{A “passivity agreement” outlines commitments to demonstrate that the asset manager will not have the power, directly or indirectly, to direct the management or policies of the covered institution. The FDIC currently has four passivity agreements in place with three asset management companies.}

These notable developments hit our radar recently:

• IDI resolution deadlines communicated to banks. On August 8, the FDIC established and communicated initial submission dates for resolution plans and informational filings for covered insured depository institutions (CIDIs) after new requirements were finalized in June. A full submission for Group A banks (greater than $100b in assets) and an interim supplement for Group B ($50-100b in assets) will be due by July 1st, 2025 and the first full submission for Group B will be due by July 1st, 2026.
• EU’s AI Act takes effect. On August 1, the European Commission’s European Artificial Intelligence Act (AI Act), the world’s first comprehensive regulation on artificial intelligence, came into effect. The regulation aims to establish a harmonized internal market for AI in the EU, encouraging the adoption of this technology and creating a supportive environment for innovation and investment. While the majority of the requirements will not apply until August 2026, the Commission invites developers to voluntarily adopt key obligations ahead of deadlines.
• Agencies issue joint NPR on data standards. On August 9th, the FDIC, joined by the Treasury Department, the Fed, the OCC, the CFPB, the SEC, the FHFA, the NCUA and the CFTC (together the “Agencies”) issued a joint proposal to establish data standards for collection of information reported to each Agency by financial entities. Comments must be received within 60 days after publication in the Federal Register.
• OFAC tightens sanctions on Belarus. On August 9th, the Treasury Department’s Office of Foreign Assets Control (OFAC) announced it would be taking action against 19 individuals, 14 entities and one aircraft that have been involved with military resource production and transshipment of goods to Russia, sanctions evasion on behalf of Belarusian defense entities, and revenue generation for Belarusian oligarchs. Financial institutions and other persons that engage in certain transactions or activities with the sanctioned entities and individuals may expose themselves to sanctions or be subject to an enforcement action.