Our Take: financial services regulatory update – September 20, 2024
Change remains a constant in financial services regulation. Read "our take" on the latest developments and what they mean.
Current topics – September 20, 2024
- 1. FDIC and OCC finalize new merger guidelines
- 2. FDIC proposes custodial deposit recordkeeping requirements
- 3. SEC finalizes market structure reforms
- 4. On our radar
1. FDIC and OCC finalize new merger guidelines
- What happened? On September 17th, the FDIC and OCC finalized updated guidelines on their bank merger review processes. The same day, the DOJ withdrew its 1995 merger guidelines and released an addendum to its 2023 guidelines explaining their application to the banking industry. The final FDIC and OCC guidelines are largely in line with their proposals, from March and January respectively.
- What are the FDIC guidelines? The guidelines include a new section on “jurisdiction and scope” outlining the types of applications that would require FDIC approval. It separately discusses five statutory factors the FDIC considers when evaluating a bank merger application:
- Financial stability risk: The focus is on the size of the entities involved in the transaction, the availability of other providers for critical products or services, the resulting firm’s degree of interconnectedness with and contribution to the complexity of the US financial system, and the extent of the resulting institution's cross-border activities.
The guidelines state that a resulting institution with $100 billion or more in assets is more likely to present potential financial stability concerns and thus will be subject to added scrutiny. The FDIC will also consider it “in the public interest” to hold a hearing for mergers resulting in an institution with over $50 billion in assets or if the application receives a significant number of Community Reinvestment Act (CRA) protests. - Competitive effects: Mergers that would substantially lessen competition will not be approved unless the transaction is “clearly outweighed in the public interest” such as cases to prevent a bank failure. The FDIC will also look beyond concentrations of deposits to consider other products and segments, such as small business or residential loans. The FDIC may require divestitures in advance of a merger.
- Financial and managerial resources: A close look will be given to the financial condition of each individual applicant and the resulting institution including capital adequacy, asset quality, and liquidity risk - including contingency funding strategies and reliance on uninsured deposits. It is also noted that the FDIC may impose higher non-standard capital requirements depending on the resulting institution’s anticipated risk profile. Managerial resource considerations include supervisory history such as responsiveness to supervisory recommendations and enforcement actions.
- Anti-money laundering (AML) effectiveness: The FDIC will look at each institution’s record of AML compliance, including their overseas operations. The guidelines note that significant unresolved deficiencies or outstanding enforcement actions would be “generally inconsistent with a favorable resolution of this factor.”
- Convenience and needs of the community: The guidelines specify that the application must demonstrate that the resulting institution would ”better meet” the convenience and needs of the community than the applicants would separately, such as through higher lending limits, greater access to products, services, and facilities, new or expanded products or services, reduced prices and fees, and greater convenience for customers.
- Financial stability risk: The focus is on the size of the entities involved in the transaction, the availability of other providers for critical products or services, the resulting firm’s degree of interconnectedness with and contribution to the complexity of the US financial system, and the extent of the resulting institution's cross-border activities.
- What are the OCC guidelines? The guidelines specify a number of areas that indicate whether a merger application would be beneficial for approval or inconsistent with approval:
| Beneficial for approval | Inconsistent with approval | |
| Asset size and capitalization |
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| Supervisory ratings |
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| Compliance record |
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- Other policy and competition considerations include whether the transaction would have a significant adverse effect on competition as well as whether the acquirer has engaged in multiple acquisitions or experienced rapid growth. The OCC will also look at the acquirer’s plans for systems compatibility and integration with the target as well as the transaction’s community impact, including branch closures, job losses and loss of services.
- No more “expedited review.” On a procedural level, the guidelines eliminate the current “expedited review” process where an application is deemed approved if the OCC is silent 15 days after the closure of the comment period. It also eliminates the ability to use a streamlined application for certain transactions.
- What are the DOJ guidelines? The guidelines list a number of conditions under which mergers would raise concerns, including if it would (1) significantly increase market concentration; (2) eliminate substantial competition; (3) increase the risk of coordination; (4) eliminate a potential entrant to a concentrated market; (5) limit access to a product or service that its rivals to compete; and (6) entrench a dominant position. The addendum explains that mergers involving banks with competing lines of business, such as branch overlaps in a geographic area, may raise concerns around market concentration, eliminating competition or increasing the risk of coordination. It notes that the DOJ will examine impact on competition in a wide variety of areas such as interest rates offered to depositors, varieties of mortgages, convenience and quality of service at branch locations and customer service. It will also consider the impact to distinct groups of customers, such as small businesses and economically underserved individuals.
Our Take
The guidelines provide a clearer rubric as to what “good” looks like. While the guidelines differ in their approaches and areas of focus, taken together they provide more specific insight into areas that will be evaluated, giving banks greater ability to pre-emptively assess the viability of potential merger activity and make necessary adjustments. The FDIC and OCC statements make clear that banks will need to make a strong case for a positive impact on customers and be able to demonstrate their ability to operate the new institution in a safe, sound, compliant and operationally resilient manner. With approvals now explicitly tethered to supervisory findings and ratings, banks should work to address these issues - and enhance their overall safety and soundness stature - well ahead of submitting applications.
The guidelines are more explicit in their skepticism of mergers involving larger banks, albeit with very different thresholds – the OCC considering an acquisition by a global systemically important bank to be “inconsistent with approval” and the FDIC setting a $100 billion threshold for “additional scrutiny.” Nonetheless, they are aligned in the underlying message: with greater size comes a greater burden of proof that a merger will benefit customers without detrimental risk or competitive effects.
Longer timelines for submissions and approvals. With increased clarity around regulatory expectations, banks now have an increased burden to show that a merger can meet these expectations, likely resulting in increased regulatory timelines for review. Pending bank merger applications are expected to be subject to the revised guidance and offer early test cases for how the guidelines will be applied.
Legal challenges ahead? We would not be surprised to see challenges to these new guidelines, potentially around assessments of “competitive effects” or “convenience and needs of the community,” especially considering the June Supreme Court decision to overturn the Chevron doctrine that protected agencies’ statutory interpretations (see Our Take here). Further, if the Administration were to change following the upcoming election, we expect to see significant changes to these guidelines.
2. FDIC proposes custodial deposit recordkeeping requirements
- What happened? On September 17th, the FDIC proposed new requirements aimed at enhancing recordkeeping for bank deposits received from third-party, non-bank companies, including fintechs. This rulemaking was undertaken directly in response to the bankruptcy of a fintech which left customers without access to their funds when its partner banks were unable to identify the beneficial owners of deposits. It also follows an interagency statement on the risks of third-party deposit arrangements and a request for information on bank-fintech arrangements which recently had its comment period extended to October 30th.
- What entities and accounts are in scope? The proposal applies to insured depository institutions (IDIs) with “custodial deposit accounts with transactional features,” except for a list of defined exemptions including accounts established by government depositors, brokers, dealers, investment advisers, or law firms on behalf of clients. In-scope accounts are typically omnibus accounts that are held at the sponsor IDI for the benefit of the fintech’s customers. The requirements would apply to accounts that already exist as well as accounts established after the requirements are in effect.
- What would be required? The proposal would introduce several requirements that would impact both IDIs and third parties that place deposits at IDIs on behalf of customers.
- Recordkeeping. IDIs holding covered accounts would need to maintain records related to those accounts, including the names of beneficial owners, their ownership category, and their individual balance reconciled at least daily. The records could be maintained by a third party but the IDI would need to have “direct, continuous, and unrestricted access” to the records, including in the event of a disruption of the third party as accounted for in continuity plans. The IDI would also need to have a direct contractual relationship with the third party including certain risk mitigation measures (e.g., periodic independent validations of records).
- Compliance. IDIs holding covered accounts would need to establish relevant written policies and procedures; submit an annual report on custodial deposit account activities to the FDIC and its primary federal regulator and have the highest ranking official of the bank annually certify compliance with the recordkeeping requirements. The proposal states that IDIs are ultimately responsible for compliance and that their primary federal regulator would cover these requirements in examinations and pursue enforcement actions if they are not met.
- What’s next? The proposal will be open for comment for 60 days after it is published in the Federal Register.
Our Take
From risk statements to requirements. While the banking agencies have taken several actions to demonstrate their concerns around third-party deposit placement and fintech partnerships more generally, this proposal is a substantial step towards adding guardrails around “banking as a service” arrangements. As with the interagency third party risk management guidance, the onus for compliance is on the IDIs even if their third parties maintain the records - which is likely to be a common model. For third parties that have operated more like technology companies than banks, this will require substantial effort to institute sub-ledgers of their accounts with daily reconciliation and ensure continuous access for their partner IDIs, even in the event of a disruption to their operations. For IDIs, the requirements will likely necessitate enhancements to contracts, monitoring and testing activities, which may need to be expanded significantly to gain assurance over third-party records, policies, and practices. In many cases, this would significantly increase the scrutiny and oversight by IDIs over their third parties.
Begin assessing impact now. With unanimous support from the FDIC board, including members from both parties, this proposal is likely to be finalized so IDIs with third party deposit placements should begin to assess the operational and procedural enhancements necessary to meet the requirements for both themselves and their third parties. The proposal’s inclusion of a high-level annual certification and reminder of the potential for enforcement actions demonstrate that the FDIC will have high expectations for compliance.
3. SEC finalizes market structure reforms
- What happened? On September 18th, the SEC adopted several amendments to its market structure regulations, including Regulation National Market System (Reg NMS), that were originally proposed in December 2022.
- What reforms were finalized?
- Reducing the minimum tick size, or pricing increment, for quoting stocks listed on a national securities exchange to $0.005 for bid-ask spreads of $0.015 or less and $0.01 for spreads greater than $0.015; the final amendment did not adopt the proposed $0.002 or $0.001 increments
- Reducing access fee caps to $0.001 for stocks priced over $1 and 0.1% of the quotation price for stocks under $1
- Increasing transparency around fees and rebates by prohibiting exchanges from imposing them unless they can be determined at the time of execution and requiring exchanges to publicize fees or rebates based on volume thresholds or tiers
- Increasing transparency of better priced orders by (a) accelerating the timing of requirements for market participants to comply with and disseminate information based on new round lot and odd-lot (i.e., amount less than a round lot) definitions adopted under the 2020 Market Data Infrastructure Rules and (b) adding a required data element about the best odd-lot order
- What’s next? The amendments will become effective 60 days after they are published in the Federal Register. For those concerning tick size and access fees, the compliance date is November 3rd, 2025 and for odd-lot information the compliance date is May 1st, 2026.
Our Take
Leveling the market playing field. These finalized amendments represent a step forward in SEC Chair Gary Gensler’s mission to increase market competition and transparency, with a particular focus on dynamics that result in concentration of trading through wholesalers. While half-penny pricing increments could present operational challenges for exchanges, they represent a compromise from the even smaller proposed increments and are broadly favored by buy- and sell-side market participants that have long sought for narrower bid-ask spreads in line with off-exchange trading venues, which can already offer sub-penny increments. Although none of the amendments directly address payment for order flow (PFOF), the amended access fee caps and transparency are an effort to increase fairness in access to the best prices and understanding of the fees and rebates involved in execution.
Where do the remaining December 2022 proposals stand? In addition to the amendments finalized this week, and order execution quality disclosure expansion finalized in March, there are two remaining unfinalized proposals from December 2022: a proposal to require certain stock orders to be exposed to an auction market before they can be executed by a wholesaler and the SEC’s first best execution standard. These are the two most controversial proposals and it is unclear whether the SEC still plans to finalize them, particularly following several successful challenges to SEC rulemaking even before the Supreme Court’s decision to overturn Chevron deference to regulatory agency interpretation of statutes. Gensler will likely receive questions on these proposals and other outstanding rulemaking when he appears before Congress next week.
4. On our radar
These notable developments hit our radar recently:
- Fed cuts rates. On September 18th, the Federal Open Market Committee announced that it would cut its benchmark interest rate by 50 basis points to a new range of 4.75% - 5%. For insight into how rate cuts may impact bank profitability, capital and liquidity see our Video insights: What's next for the banking and capital markets industry? featuring a discussion between Ashish Jain and Chris Tsingos.
- CFPB takes action to stop banks from collecting overdraft fees without consent. On September 17th, the CFPB published guidance to help federal and state consumer protection enforcers stop banks from charging overdraft fees based on phantom opt-in agreements. This circular is the latest step in the CFPB’s efforts to rein in what it considers to be “junk fees.”
- CFTC finalizes rule on listing of voluntary carbon credit derivative contracts. On September 20th, the CFTC issued final guidance regarding the listing for trading of voluntary carbon credit (VCC) derivative contracts. The guidance outlines factors that should be considered by designated contract markets (DCMs) when addressing certain regulatory requirements relevant to the listing for trading of VCC derivative contracts.
- FSOC meets. On September 20th, the Financial Stability Oversight Council (FSOC) met in an executive session where it received an update on efforts to enhance the resilience of the U.S. Treasury market and progress on the development of risk indicators and narrative analyses to monitor climate-related financial risks.
- Congress to hold SEC oversight hearings. The House Financial Services Committee will hold SEC oversight hearings featuring Chair Gary Gensler on September 24th and 25th, respectively.
- The countdown is on for expanded U.S. Treasury clearing. As the industry approaches the first deadlines for expanded U.S. Treasury clearing, see Our take on how market participants can begin to prepare for the significant changes required.
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