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Our Take: The changing regulatory landscape

Change is a constant so move with confidence by staying up to date.

Change remains a constant in FS risk & regulation. Here’s “our take” on key developments impacting the industry.

Current topics - July 23, 2021

Agencies propose third-party risk management guidance

Last Tuesday, the Fed, FDIC and OCC proposed joint TPRM guidance. The proposal is largely based on the OCC’s 2013 Third-Party Relationships: Risk Management Guidance and would replace the FDIC’s 2008 Guidance for Managing Third-Party Risk and the Fed’s 2013 Guidance on Managing Outsourcing Risk. As the agencies’ previous TPRM guidance documents included different levels of detail and were issued at different times, this new proposal seeks to unify their perspectives. In addition to including several questions on whether the agencies should clarify any concepts or include any additional details, the proposal requests feedback on whether to formally include any portion of the OCC’s 2020 FAQs, which clarified several concepts in its 2013 guidance and relationships with fintechs.

The proposed guidance includes risk management principles across all stages of the life cycle of a third-party relationship: planning, due diligence and selection, contract negotiation, ongoing monitoring and termination. As with all previous TPRM guidance, the proposal emphasizes that it is the responsibility of the financial institution to maintain compliance with relevant regulations and data security. To this end, the guidance outlines numerous considerations for scrutinizing and monitoring third parties, including responsibilities of the board and senior management to oversee TPRM practices. Within the 2020 FAQs, which may be adopted as part of the final guidance, there are discussions of relationships with cloud service providers, data aggregators, nonbank marketplace lenders and other recent types of third parties that are increasingly relevant to financial institutions. They also discuss the potential for institutions to collaborate on due diligence, contract negotiations and ongoing monitoring.

Comments are due by September 17, 2021.

Our Take

The agencies’ unified proposal and the nature of the questions posed for comment indicates that their primary goal is consistency and clarity for supervised institutions. As the agencies seem highly open to feedback on what additional details or clarifications to include in this guidance, institutions should see this as an opportunity to obtain greater certainty about any third-party relationships or TPRM practices not explicitly covered by the guidance. Institutions can also work separately or collaborate to elevate questions not covered in the 2020 FAQs as the agencies may choose to issue a new set of FAQs along with the finalized guidance.The extent to which the final guidance will differ from this proposal will depend on the nature of comments received but will be unlikely to add substantially new expectations, particularly given the agencies’ rules and policies to not base enforcement actions on guidance. That said, the agencies’ reminder that financial institutions are ultimately responsible for compliance with regulatory requirements means that they should carefully review their TPRM practices against those outlined in this proposed guidance to ensure that they have appropriate controls and monitoring in place.

Regulators in the US and abroad continue their digital currency focus

The past two weeks saw the following developments regarding digital currency:

  • On Monday, Treasury Secretary Janet Yellen convened the President’s Working Group on Stablecoins to discuss “the rapid growth of stablecoins [i.e., fiat-pegged digital currency], potential uses of stablecoins as a means of payment, and potential risks to end-users, the financial system, and national security.” Attendees included Fed Chair Jerome Powell, Fed Vice Chair for Supervision Randal Quarles, OCC Acting Chair Michael Hsu, FDIC Chair Jelena McWilliams, SEC Chair Gary Gensler, and CFTC Acting Chair Rostin Behnam. The readout of the meeting notes that Yellen stressed the need to act quickly to ensure there is an appropriate regulatory framework in place. The working group intends to release a set of policy recommendations in the coming months.
  • In his Congressional testimony last week, Fed Chair Jerome Powell stated that he does not believe that cryptocurrencies (e.g., Bitcoin) will become a significant part of the payments system, expressing that they have only caught on as a payment mechanism for “people who desire anonymity.” However, he noted that stablecoins could see broader adoption for payments, in which case the US needs to develop an appropriate regulatory framework for them. He also briefly answered questions related to the potential development of a US central bank digital currency (CBDC), explaining that he is “genuinely undecided” on whether the pros outweigh the cons, but he conceded that one of its benefits would be to make cryptocurrencies and stablecoins unnecessary.
  • The European Commission (EC) released a series of proposals that would extend certain anti-money laundering (AML) rules to digital currencies, including the requirement that digital wallets and exchanges collect the same know-your-customer information that banks are required to collect during onboarding. The proposals would also create a new EU AML agency to assist with cross-border supervision and coordinate national authorities.

Our Take

Taken together, these recent developments demonstrate the sharp focus regulators both in the US and abroad are taking to address the risks associated with digital currency. The announcement of forthcoming policy recommendations from the President’s Working Group on Stablecoins has been much-anticipated, especially considering SEC Chair Gensler’s previous work researching digital currency and OCC Acting Chair Hsu’s statements that he will work toward a unified regulatory digital currency framework. While the set of policy recommendations will likely be just the start of a long process to bring stablecoins into the federal regulatory fold, ultimately it will eliminate regulatory uncertainty for digital wallets and exchanges, providing them with uniform federal rules instead of the current complex web of state-by-state requirements governing crypto and stablecoins. The EC’s proposal to bring digital currency into the AML regime likely foreshadows a similar appearance in the upcoming policy recommendations, especially considering the recent inclusion of digital currency considerations in FinCEN’s AML priorities and comments from Treasury Secretary Yellen around concerns that digital currency is being used in terrorist financing.

Meanwhile, Fed Chair Powell’s comments reveal a glimpse into the debate as to whether to issue a digital dollar. His view that a benefit of doing so would be eliminating the need for stablecoins notably contrasts with a speech by Vice Chair for Supervision Quarles earlier this month that emphasized the benefits of stablecoins (e.g., private sector innovation), the difficulties associated with developing a CBDC (e.g., cybersecurity, privacy), and his skepticism as to the purported benefits of a CBDC. While both Chair Powell and Vice Chair Quarles’ future at the Fed remain uncertain, their comments show that the debate around CBDCs and stablecoins is only beginning. The Fed’s upcoming discussion paper in September should spur this debate by laying out the potential benefits, drawbacks and open questions while inviting public feedback. Stay tuned.

For more information on AML and digital currency, see our First take, Five key points from FinCEN’s 180-day AML reform update.

For more information on CBDCs, see our Regulatory brief, The evolution of money: What financial institutions need to know about central bank digital currencies.

OCC to rescind solo CRA reform, unify with Fed and FDIC

On Tuesday, the OCC announced that it will issue a proposal to rescind its Community Reinvestment Act (CRA) reform rule which was finalized in May 2020. 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. It is jointly administered with the Fed and FDIC, but former Comptroller Joseph Otting opted to finalize the reforms without the other two agencies. Following the OCC’s announcement, all three agencies issued statements committing to collaborate on a joint rulemaking to modernize the CRA.

Acting Comptroller Michael Hsu indicated that the joint rulemaking would build on a framework proposed by the Fed in September 2020. Similar to the OCC’s final rule, the Fed’s proposal would expand and clarify qualifying activities to meet CRA obligations, including by publishing an illustrative list and establishing a pre-approval process for activities not on the list. The Fed’s proposal would also address a number of goals of the OCC’s rule but would diverge in its approach. For example, it places greater weight on the overall number of loans offered in low- and moderate-income communities as opposed to the OCC rule’s emphasis on the total value of loans. While it shares the OCC’s focus on updating the CRA to recognize the shift toward digital banking, the Fed’s proposal would evaluate banks without physical branches based on a nationwide assessment area as opposed to where they derive 5% or more of their deposits. Both the proposal and the OCC rule create objective metrics for evaluation, but the proposal would allow banks to rely on existing data while the OCC rule would require that banks expand their data collection and recordkeeping practices.

Our Take

Along with the joint TPRM proposal discussed above, this commitment to unified CRA reform is well aligned with Hsu’s early public commitments to work closely with his fellow regulators. This announcement is a welcome development for financial institutions which supported efforts to modernize the CRA but did not relish the idea of complying with different standards. Hsu’s statement that the joint reform effort will build from the Fed’s proposal comes as little surprise given his background at the Fed and its generally more positive reception from consumer advocacy groups. While the Fed’s proposal provides a starting point for the joint reform, it will take much time and deliberation for the three agencies to get on the same page – particularly as the Fed and FDIC are still led by Trump appointees and there is no confirmed Comptroller. Accounting for a public comment period, revisions, and implementation periods there is still plenty of time before institutions will need to comply with any new standards.

LIBOR transition: Term SOFR poised to take off?

On Wednesday, the Alternative Reference Rates Committee (ARRC) hosted its fourth symposium during this final year of the transition from USD LIBOR to SOFR. Panel discussions focused on the committee’s progress toward formally recommending a forward-looking SOFR term rate (Term SOFR). Such a recommendation is largely dependent on continued growth in SOFR derivatives trading volumes as Term SOFR is based on transacted prices in SOFR futures. To that extent, the ARRC’s symposium provided an update on the quickly approaching target date of July 26, 2021 for interdealer brokers to base USD swap trading on SOFR rather than USD LIBOR. The change in convention mirrors a similar switch made in Sterling derivatives markets earlier this year and is expected to further accelerate the shift toward SOFR swaps trading.

The change in swap trading conventions from USD LIBOR to SOFR represents the first phase of a broader initiative, also dubbed “SOFR First,” which was recommended by the CFTC’s Market Risk Advisory Committee (MRAC) earlier this month. The MRAC also recommended an analogous change in convention for interdealer cross-currency swaps, i.e., phase two, for September 21, 2021 — with a target date for the switch for non-linear derivatives yet to be determined. Also yet to be confirmed is a target date for the final phase of the initiative, which would include a broader recommendation for a switch in convention for exchange traded derivatives. Earlier on Wednesday, the ARRC formally endorsed the recommendation of September 21 as the target date for phase two. The Bank of England and the Financial Conduct Authority issued a similar statement of support.

At the ARRC’s symposium, Chair Tom Wipf reiterated that a formal recommendation of Term SOFR could come in a matter of days following the successful implementation of phase one of SOFR First on July 26. In anticipation, the ARRC earlier on Wednesday issued additional guidance on the use of Term SOFR, including recommendations on conventions for the use of SOFR in advance and Term SOFR in business loans, as well as recommended best practices for the scope of use of Term SOFR. The committee supports the use of Term SOFR, in addition to other forms of SOFR, in new multi-lender facilities, middle market loans, trade finance loans and certain securitizations. Its use in derivatives markets, however, should be limited to a narrow set of transactions for the purpose of hedging cash products referencing a forward-looking term rate.

Our Take

A forward-looking term rate has long been desired by a segment of the market keen on operational ease. With the ability to have the rate known at the beginning of the interest period, using Term SOFR would operationally (if not economically) feel a lot like using LIBOR. Some market participants have recently been looking to forward-looking, credit-sensitive alternatives to USD LIBOR, in part due to concerns about the complexities of using a daily in-arrears rate. With a growing chorus of regulators cautioning against the use of credit-sensitive rates (CSRs), a seemingly imminent endorsement of Term SOFR could come at just the right time for those concerned about possible regulatory scrutiny.

The expectation is for most new retail products (such as student loans and adjustable rate mortgages) to employ SOFR in advance rather than Term SOFR. For example, the transition to SOFR has effectively been completed in the USD adjustable rate mortgage market. With regard to new business loans, however, the ARRC’s recommended scope of use for Term SOFR could well be considered somewhat broader than what had been expected. The adoption of SOFR in loan products has been very limited to this point. Perhaps in a nod to the slow pace of progress, perhaps with an eye on stemming the rise of CSRs, the idea of Term SOFR playing a bigger role in the transition away from LIBOR appears to be gathering momentum.

Subscribe to PwC’s LIBOR Transition Market Update here to read more about these and other developments.

On our radar

These notable developments hit our radar over the past week:

  • Yellen urges Congress to act on debt limit. Earlier today, Treasury Secretary Janet Yellen sent a letter to Congress explaining that the outstanding debt of the US will reach the statutory limit on August 1, and Treasury is suspending the sale of State and Local Government Series securities until the debt limit is suspended or raised. The letter urges Congress to act as soon as possible. On Wednesday, the Congressional Budget Office issued a statement projecting that Treasury “would probably run out of cash and be unable to make its usual payments” in October or November if the debt limit is not raised.
  • Powell on the hill. In addition to discussing digital currency in his hearings before the House Financial Services Committee and Senate Banking Committee, Fed Chair Powell fielded a number of questions in different areas of monetary policy and regulation. Many questions concerned the recent rise in inflation, which Powell suggested is coming from a select group of goods and services and is not yet a major cause for concern. He also indicated that the Fed would use its tools to tamp down inflation if it does not slow, but that it would not act prematurely. On the regulatory policy front, Powell faced criticism from Senate Banking Committee Chair Sherrod Brown (D-OH) and Senator Elizabeth Warren (D-MA) for the rollback of Fed requirements during his tenure. He responded to questions about climate stress tests with an indication that he sees a benefit to using them and that the Fed is closely following inaugural efforts in Europe.
  • Agencies release resolution plans. On Monday, the Fed and FDIC released the public sections of resolution plans for eight large US global systemically important banks (GSIBs). These were the first “targeted” plans that the GSIBs were required to file after relief finalized in 2019 instituted alternation between targeted and full plans every two years for GSIBs and every three years for other large banks. The public sections highlighted the originally required sections of the targeted plans, including capital, liquidity, plans for recapitalization, and material changes to prior plans, as well as an updated request from the agencies to include lessons learned from the pandemic. Most of the banks indicated how their resolution and resilience plans and strategies aided their pandemic responses.
  • Treasury personnel advancements. Last Thursday, the Senate voted to confirm Nellie Liang, a former senior Fed staffer and Governor nominee, as Treasury undersecretary of domestic finance. In this position she will advise public debt management and financial regulation policy. On Monday, President Biden announced his intention to nominate Graham Steele, a former chief counsel to Senator Brown, to be assistant secretary for financial institutions, a position that reports to the undersecretary of domestic finance and covers financial regulation policy.
  • Breach notification bill introduced in the Senate. On Wednesday, a bipartisan group of Senators led by Mark Warner (D-VA) and Susan Collins (R-ME) introduced a bill that would require cybersecurity firms, federal contractors and operators of critical infrastructure to report attempted or successful breaches of their systems within 24 hours.
  • FSOC meeting. Last Friday, the Financial Stability Oversight Council held a meeting in which they discussed the Fed’s recent stress test results, housing market trends, and a progress update on the upcoming FSOC report on climate-related risks and actions.


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Julien Courbe

Financial Services Leader, PwC US

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