Brexit countdown: Labour pains and runaway Tories
The Conservative Party under Boris Johnson won a thumping 78-seat majority in Thursday’s UK general election, the largest Conservative victory since the heyday of Margaret Thatcher in 1987, on a platform to “Get Brexit Done.” The UK is now set to leave the EU under Johnson’s Brexit plan on January 31 and will enter a transition period lasting through the end of 2020, during which it will try to negotiate its future trading arrangements with the EU. There will be no changes to the existing EU-UK trade arrangements and the UK has committed to implement new EU rules throughout this period.
In a new challenge to the Conservatives, however, the Scottish National Party won 48 of Scotland’s 59 Parliamentary seats on the promise of a new referendum on Scottish independence. The regional government for Scotland argues that Scots do not want to be taken out of the EU “against their will” and that they have earned the democratic right to hold another referendum on Scottish independence from the UK. Speaking at an EU summit in Brussels today, the new European Council President, Charles Michel, expressed the desire to maintain a future relationship that is as close as possible with the UK. He explained that the European Commission will now prepare to kick off negotiations on the future relationship with the UK immediately following the UK’s formal withdrawal from the EU.
A large Parliamentary majority brings the “will they or won’t they” debate about Brexit to a conclusion. The good news for financial services firms is that they have already put structures in place for a no-deal Brexit and therefore are largely already prepared for this outcome. Johnson’s Administration will now face the twin challenges of negotiating and implementing a comprehensive new trade deal with the EU in less than a year while also having to defend the integrity of the United Kingdom itself if it wants to keep Scotland as part of the union. Concluding and ratifying a comprehensive trade deal with the EU in the available time would be unprecedented, but Johnson has pledged that he will not ask for an extension which could result in painful compromises from the UK. For example, as financial services are the UK’s biggest export, the EU could drive a hard bargain in other sectors in return for granting equivalence recognition for UK trading venues.
FDIC and OCC propose CRA reform
Yesterday, the FDIC and OCC released a proposal to reform the Community Reinvestment Act (CRA). The CRA seeks to encourage lending, investment, and services in low- and moderate-income (LMI) communities where a bank has branches or deposit-taking ATMs. The proposal aims to adapt to the rise of digital banking by clarifying assessment areas for banks that originate significant percentages of their deposits from areas not adjacent to branches or ATMs and removing expectations for the provision of traditional retail banking services in underserved or low income communities.
The proposal would expand and clarify the activities that count toward CRA obligations, including by adding certain loans and investments outside banks’ assessment areas, increasing qualifying loans to small businesses and farms to $2 million, publishing an illustrative list of qualifying activities and establishing a process to determine whether an activity not on the list would qualify for credit. It would also create an objective benchmark-based evaluation framework that would assess banks based on the number of CRA-qualified loans as well as the total dollar amount of lending to LMI communities. This was reportedly an element of disagreement with the Fed, which did not join the proposal. In an effort to limit credit for gentrification activities, the proposal would also assess banks according to the portion of their retail lending that goes to LMI individuals as well as the impact of that lending activity but no longer allow credit for loans to high income individuals in LMI areas. Another change in the proposal would be to recognize the long-term nature of many community development loans by allowing credit for longer-term investments over the horizon of the investment and not just the review period in which the investment was initially made. Banks with less than $500m in assets would be able to choose whether they are evaluated under the new framework or existing standards.
House Financial Services Committee Chairwoman Maxine Waters (D-CA) was quick to register her disapproval of the proposal while attending the FDIC’s board meeting with a number of colleagues. Comments on the proposal will be due 60 days after it is published in the Federal Register, although Chairwoman Waters called for the period to be extended to 120 days.
Banks and community groups agree that updates to the CRA are long overdue, but that is largely where their agreement ends. Banks have a lot to celebrate in this proposal, particularly the transparency and consistency that come from a published list of qualifying investments and benchmarks for CRA ratings. Currently, a large part of what is spelled out in the proposal is determined behind the scenes by examiners with banks left wondering about which investments will qualify for CRA credit and whether they have done enough to merit a ‘satisfactory’ rating. Congress and community groups, however, will continue to criticize any aspect of the proposal they feel could limit services to LMI individuals, such as the possibility that banks could close rural or low income branches if the new evaluation framework determines that they can achieve the CRA rating they want without the providing retail banking services in those areas. Both critics and supporters will undoubtedly submit extensive comments and will also look to see what comes from the Fed. Although the FDIC and OCC issued the proposal on their own, we ultimately expect convergence as neither the industry nor the regulators would want the confusion and lack of consistency that would come from separate final standards.
SEC’s Clayton on the Hill
On Tuesday, SEC chair Jay Clayton testified before the Senate Banking Committee regarding the agency’s progress on its initiatives for 2019. He explained that the agency has completed 34 out of the 39 rulemakings on its agenda for this year, highlighting the best interest regulation, a series of technical fixes and simplifications to statistical disclosure requirements, expansion of “test-the-waters” rules that allow private companies to communicate with potential investors prior to initial public offerings, and guidance on proxy voting responsibilities. He also explained ongoing initiatives, including efforts to revise the “accredited investor” definition to account for expertise (instead of only wealth), expand small business crowdfunding abilities and move forward on a proposal to tailor certain reporting requirements. Regarding the Consolidated Audit Trail (CAT), he expressed his disappointment with delays but explained that he is working closely with the self-regulatory organizations to develop implementation plans while also focusing on data security concerns.
The SEC this week also rejected a New York Stock Exchange (NYSE) proposal that would have permitted companies going public to raise capital through primary direct listings, a method of selling shares to the public market without going through the traditional IPO process, thereby avoiding underwriting fees and road show expenses. Under current rules, direct listings only allow for the sale of existing shares to the public, while the NYSE’s proposal would allow for the creation of new shares to raise capital. The proposal would have also eliminated the current requirement to demonstrate that the company has at least $250 million in market value of publicly-held shares at the time of listing as long as the company sold at least $250 million in shares in the opening auction on the first day of listing. The SEC did not offer a reason for its rejection of the proposal to the public. Earlier today, the NYSE submitted a revised proposal after a spokesperson explained that the exchange is continuing to work with the SEC to address the issues the agency had with the original proposal.
As evidenced in his testimony, Clayton has been committed to rolling out a steady series of technical reforms to reduce burdensome reporting requirements, encourage companies to go public and increase access to capital markets while remaining focused on consumer protection and data security. As such, we expect to see rules such as the revisions to the “accredited investor” definition in the near future and for the SEC to take a more active role in the CAT’s implementation. We also think that, while it is unclear whether the NYSE has fully addressed the SEC’s issues in its revised proposal submitted earlier today, we will likely see some version go through eventually. While the SEC did not offer a public reason for its rejection, there are a number of factors that could have led to this result. For example, it may be concerned that the increase in direct listings as a result of the proposal would deprive investors of important information such as what the company intends to do with any capital raised and eliminate the due diligence period associated with IPOs. It also may wish to conduct a more extensive study of how its contents - including the lack of a required lock-up period during which existing shareholders are forbidden from selling shares - might impact the markets before it can be approved.
LIBOR transition: Trading time for clarity on pre-cessation triggers
Last week, ISDA sent a response to the Financial Stability Board’s (FSB’s) November letter requesting the inclusion of a pre-cessation trigger in ISDA’s protocol for derivative contracts tied to LIBOR. A pre-cessation trigger is an event that would signify that market participants can transition from LIBOR to an alternative reference rate even if LIBOR continues to be published. ISDA had consulted earlier this year on the inclusion of pre-cessation triggers in fallback language for derivatives tied to LIBOR but did not find market consensus on how, or even if, such triggers should be included.
In its response to the FSB, ISDA says it recognizes the importance of a scenario in which a determination has been made by the Financial Conduct Authority (FCA) that LIBOR is no longer representative of the underlying market but continues to be published. ISDA explains that it is prepared to re-consult on the topic “once the market has the benefit of appropriate clarity” on two issues that had been raised by market participants in response to the original consultation. Specifically, it requests a definitive statement from the FCA that LIBOR would only continue to be published for a minimal amount of time once it is deemed non-representative and confirmation from the central clearinghouses that they are prepared to amend their entire portfolio of cleared LIBOR derivatives in that scenario.
The FSB’s desire to include a pre-cessation trigger in derivative fallback language is understandable as it would provide the FCA with a mechanism to effect a switch from LIBOR to an alternative reference rate whenever it determines LIBOR to no longer be representative. It would also promote alignment in the transition timing of the various interconnected markets that reference LIBOR, including not only cleared and uncleared derivatives, but also cash products. However, clarity on the issues raised in ISDA’s request appears to be a prerequisite to building market consensus. That said, even If the FCA and CCPs provide the assurances requested, there are no guarantees that it would lead to market consensus. While it is almost an inevitability that not everybody will be satisfied with the ultimate outcome, organizations should ask themselves whether they would be willing to bilaterally negotiate a large number of deals to get the contract terms they prefer or whether they might be able to accept standard terms that differ from their preference.
On our radar
These notable developments hit our radar this week:
- FDIC on brokered deposits. On Thursday, the FDIC issued a proposal to ease restrictions on brokered deposits. It would establish a new framework to determine whether certain deposits qualify as brokered, revise the deposit broker definition and amend a key exception to that definition. The day before the proposal was released, FDIC Chairman Jelena McWilliams gave a speech in which she called on Congress to change the law on brokered deposits to have a cap on asset growth rather than an outright restriction for banks with insufficient capital levels.
- OCC on systemic risks. On Monday, the OCC released its semiannual risk perspective report. It explains that while capital levels are at an all-time high and bank performance is strong overall, loan growth has slowed and banks are accumulating increasing amounts of credit risk in their portfolios. It also highlights cybersecurity, the LIBOR transition and competition from fintechs as key risks.
- OFR annual report. On Wednesday, the Office of Financial Research (OFR) released its 2019 annual report to Congress. The report finds that overall risks to financial stability remain in a medium range and specifically that leverage risk is low, macroeconomic risk is moderate, and market risk is elevated.
- CFTC rules. On Tuesday, the CFTC voted to reopen the comment period for proposed capital requirements for swap dealers and major swap participants (SDs and MSPs). The CFTC will also hold an open meeting on December 18 to discuss several rules including cross-border registration thresholds and requirements for SDs and MSPs.
- DFS proposes BitLicense updates. On Wednesday, the New York Department of Financial Services (DFS) (DFS) released for comment guidance on the approval process for companies to conduct business in digital assets. The proposed guidance would list certain pre-approved assets on DFS website that are permitted to be used without DFS pre-approval and would also provide a framework for the coin-listing process.
- FFIEC on resilience. The Federal Financial Institutions Examination Council (FFIEC) recently updated its Business Continuity Management booklet, representing the council’s first significant update in more than four years. It expands its focus to business continuity management, not just business continuity planning. For more, see PwC’s Banking on resilience: critical paradigm shift for Financial Service examiners.
- EU on sustainable finance. Last Friday, the European Banking Authority (responsible for the EU’s banking rule book) released its action plan for sustainable finance. The plan calls for the EU to develop technical standards for disclosure and communication, implement climate stress tests and consider whether implementing environmental concerns into capital requirements.