Our take: The changing regulatory landscape

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

Current topics - September 25, 2020

Agencies offer relief and flexibility for crisis management

Over the past week, the financial services regulatory agencies have continued to take actions to support the economy and markets in response to heightened volatility and uncertainty. Specifically:

9/22 - 9/24 - Fed and Treasury - This week, Fed Chair Powell and Treasury Secretary Steven Mnuchin testified before the House Financial Services Committee and the Senate Banking Committee on the Fed and Treasury Department response to the crisis as well as the CARES Act. Powell also testified before the House Select Subcommittee on the Coronavirus Crisis (HSSCC). Notable statements include:

  • Powell acknowledged recent positive economic trends but reiterated that the path ahead remains highly uncertain.
  • Powell continued to indicate that further fiscal support, particularly for small businesses and the unemployed, would be beneficial for the continuation of positive signs of recovery following the passage of the CARES Act.
  • When asked about the limited uptake of the Main Street Lending Program (MSLP) and continued stress on small businesses, Powell said that grants, such as the forgivable loans through the Paycheck Protection Program (PPP) would be a better way to address small business concerns than the MSLP.
  • Mnuchin said he would be open to lowering the minimum MSLP loan amount from $250k to $100k and acknowledged that the Treasury Department expects to take losses on the program.
  • Mnuchin said that he is continuing discussions on further stimulus with House Speaker Nancy Pelosi (D-CA).

9/24 - FHFA - The Federal Housing Finance Administration (FHFA) announced that it will extend flexibilities around buying loans that are in forbearance until October 31, 2020.

9/23 - HSSCC - The HSSCC issued an analysis of the Fed’s Secondary Market Corporate Credit Facility (SMCCF). The analysis found that companies whose bonds were purchased by the facility laid off over 1m workers since March 2020, including 95 companies that both laid off workers and issued shareholder dividends.

9/23 - Boston Fed - Boston Fed President Eric Rosengren gave a speech stressing that a possible second wave presents “the biggest challenge to the economy,” particularly impacting commercial real estate and small business loans. He called for additional fiscal stimulus and noted that the Main Street Lending Program could play an important role in providing bridge loans in case of extended periods of stress.

9/23 - Fed - Fed Vice Chair for Supervision Randal Quarles gave a speech detailing the state of the economy during the crisis, noting that while there are positive signs in unemployment and household spending, many risks remain including those in commercial real estate and highly-leveraged businesses. He also said that he intends to deliver a report to the G20 in November on the particular stress that nonbank financial firms felt in the early stages of the crisis.

Our take

While Chair Powell is careful not to tell Congress what to do, he has all but said that a failure to pass another relief bill will prolong economic recovery and hardship for many individuals and businesses. Combined with Boston Fed President Rosengren’s warning about the potential impact of a second wave, the central bank message to Congress should be clear: pass more stimulus before it’s too late. Both Mnuchin and Pelosi have signalled the resumption of negotiations, but the Senate has yet to pass a Continuing Resolution to fund the government past October 1 and now faces a contentious Supreme Court confirmation battle. In addition, a number of Senators and Representatives will be pulled away from Washington to campaign ahead of the rapidly approaching election. These competing priorities and the lack of progress so far have led many to doubt the possibility of a stimulus package by the end of the year, but vulnerable lawmakers may provide the crucial push for a deal if they want to offer relief to hard-hit constituents before November.
 

Fed issues Community Reinvestment Act reform proposal

On Monday, the Fed issued 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. In May of this year, the OCC finalized a separate CRA reform rule without sign-on from the Fed and FDIC, the other agencies that administer the CRA.

Similar to the OCC’s 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. It 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.

The proposal will be open for a 120-day comment period following publication in the Federal Register. The accompanying fact sheet as well as Fed Vice Chair for Supervision Randal Quarles’s statement both note that the Fed is working with the other regulatory agencies in efforts to create a consistent approach.

Our take

The industry has long pushed for reforming the CRA to account for the growing use of technology in banking and bring transparency to its often opaque evaluation. However, the industry did not likely envision two sets of rules to grapple with - and potentially three depending on how the FDIC proceeds. Despite presenting several conflicts with the OCC rule, the Fed’s proposal may ultimately result in a more palatable compromise for both the industry and community groups. The industry will appreciate the ability to rely on existing data for the metrics-based framework as it has expressed concerns that the OCC’s framework will require banks to significantly enhance their data collection programs. Similarly, the proposed nationwide assessment area for digital banks would create fewer implementation challenges than the OCC’s deposit-based assessment areas as most banks do not currently have processes in place to allocate digital deposits to specific geographies. Community groups will also appreciate the rule’s emphasis on the number of loans offered due to concerns that the OCC’s consideration of the total value of loans could allow banks to direct CRA investments toward larger revenue generating projects.

Considering that the OCC rule’s compliance deadline is not until 2023, there remains a significant runway for the regulators to work together to create a uniform standard. With the Fed’s indication that it is coordinating with the other agencies, we think there is a good possibility that banks will be able to follow one set of rules rather than two or three.
 

NYDFS announces climate change expectations for insurers

On Tuesday, the New York Department of Financial Services (NYDFS) announced that it expects all New York insurers to start integrating financial risks from climate change into their governance frameworks, risk management processes, and business strategies. Specifically, insurers will be expected to designate a board member or board committee as well as a senior management function to be responsible for the assessment and management of climate change risk. They will also be expected to incorporate climate change into their enterprise risk management function, including risk assessments, giving consideration over how it may impact a wide variety of factors including investment risk, liquidity risk, and operational risk. NYDFS also expects insurers to develop an approach to climate-related financial disclosures, specifically suggesting that they consider engaging with recognized frameworks for doing so, such as the Task Force on Climate-Related Financial Disclosures (TCFD). It will begin incorporating these new expectations into its examination process beginning in 2021.

This is NYDFS’s first major climate change-related action following the appointment earlier this year of a dedicated Sustainability and Climate Initiatives Director. The agency has indicated that it will publish additional detailed guidance and organize a series of webinars to allow industry participants to share their goals, experiences, and lessons learned in their efforts to manage financial risks from climate change.

Our take

The concept of building climate change into enterprise risk management is not new, but by explicitly incorporating the expectation into examinations NYDFS is making it clear that firms need to start taking action. While the number of insurers providing climate change and sustainability reporting is generally increasing, these disclosures are often boilerplate and lack specificity. In pointing insurers to recognized disclosure frameworks such as TCFD, NYDFS is setting the expectation that disclosures should be meaningful and provide insight into the insurer’s positioning to address the material climate change risks.

In meeting these expectations, insurers will need to consider not only the emerging physical risks of climate change, but also the risk arising from the transition to a low carbon economy and the resulting policy, legal, technology, and market changes. In order to appropriately understand the nature and magnitude of these risks, insurers should consider implementing a scenario analysis exercise looking at both physical and transition related risks.

Going forward, insurers will face the significant challenge of addressing NYDFS’s expectations in advance of next year’s examination cycle. The agency has demonstrated that it will not hesitate to take enforcement actions over new guidance and regulations - for example, its cybersecurity rule became fully effective in 2019 and the first enforcement action was announced in July 2020. As such, insurers should be proactive in meeting its expectations and not wait to assess the impact of this announcement.
 

CFTC issues compliance program evaluation guidance

Earlier this month, the CFTC released new guidelines for its Division of Enforcement staff to evaluate firms’ compliance programs when considering enforcement actions. This issuance provides further detail on the CFTC’s May 2020 guidance outlining factors it considers when recommending civil monetary penalties (CMP). The penalty guidance directed staff to evaluate the adequacy of the company’s compliance program, including improvements made after misconduct was identified, when determining the appropriate CMP and any required remediation in an enforcement action.

The guidance instructs staff to apply a risk-based analysis in determining whether the compliance program was reasonably designed and implemented to prevent, detect, and remediate the misconduct. Specifically, the enforcement staff will consider: (1) written policies and procedures in effect at the time of misconduct; (2) training; (3) failure to cure past identified deficiencies in the program; (4) structure; oversight and reporting; (5) the internal surveillance and reporting systems in place (including complaints reporting); and (6) whether the response to the misconduct was sufficient and timely.

Our take

This guidance is consistent with CFTC Chairman Heath Tarbert’s efforts to increase transparency around how the CFTC enforces its mandates. The industry will welcome this additional transparency, but market participants’ appreciation should be tempered by the reality that this will likely increase scrutiny of their overall compliance programs and could result in remediation requirements beyond addressing the misconduct at issue. As such, CFTC-supervised firms should proactively review their compliance programs and be prepared to show that they have robust controls in place to prevent, identify and address misconduct. Firms should look to their prudentially-regulated affiliates or peers to make sure they are caught up with industry standards to meet expectations for an effective compliance program.
 

OCC and SEC warm to stablecoins

On Monday, the OCC published an interpretive letter clarifying that nationally-chartered banks are permitted to hold fiat currency reserves backing “stablecoins,” i.e., cryptocurrency issued with stable value backed by and redeemable for fiat. While a number of stablecoins have been issued by regulated entities in the US, up to now the issuing cryptocurrency enterprises have all been state-chartered. The OCC’s letter notes that, as with other deposit products, banks that choose to hold currency that backs stablecoins should incorporate the activity into their risk management programs. It particularly stresses that reserves associated with stablecoins could present significant liquidity risks.

Shortly after the OCC published its letter, the SEC’s Strategic Hub for Innovation and Financial Technology (FINHub) followed with a statement clarifying that digital assets may be structured in a certain way that it does not constitute a security and trigger SEC registration and reporting requirements. It noted that parties seeking to structure and sell digital assets could engage with FINHub to discuss the specifics of their proposed asset and the prospect of granting a “no action” letter, if appropriate.

Our take

In the competition between state and federal regulators to increasingly embrace innovation, crypto is winning. While the OCC FinTech charter remains mired in legal disputes, the federal regulators’ recent guidance allowing nationally-chartered banks to enter the digital asset space is not subject to such backlash. In addition, the OCC’s announcement could be a boon to state-chartered banks in jurisdictions that have been silent on crypto due to state wild card statutes (i.e., laws permitting state banking authorities to authorize activities permitted for similar nationally chartered institutions). With state regulators focused on making sure their charters remain competitive, they may be hesitant to deny requests to engage in OCC-permitted crypto activity as doing so may encourage firms to opt for a national charter instead.

 

On our radar

These notable developments hit our radar over the past week:

  1. California targets consumer protection. Earlier today, California Governor Gavin Newsom signed a bill to transform the Department of Business Oversight into a consumer protection focused agency called the Department of Financial Protection and Innovation. It will be tasked with protecting consumers against unfair practices through enforcement, licensing and examining “under-regulated” industries, encouraging innovation and providing consumer education.
  2. CFTC chair pledges US-UK coordination. On Wednesday, CFTC chair Heath Tarbert delivered a speech in London where he highlighted previous steps the agency has taken to increase cross-border regulatory coordination and explained that he will work with the UK to ensure a smooth transition once post-Brexit grace periods expire.
  3. Conversation on a credit-sensitive LIBOR alternative continues. Last Friday, the Bank Policy Institute held a virtual symposium on credit-sensitive benchmark rates, continuing the discussion that has been at the center of the NY Fed's credit sensitivity group workshops over the past months. The workshops convened in response to concerns about the suitability of SOFR as a lending rate which was voiced by a number of regional banks that fear SOFR might not accurately reflect their funding costs, especially in stress periods. However, there was agreement amid panel discussions exploring the different viewpoints held by lenders, borrowers, academics and trade organizations that it remains highly unlikely that a credit-sensitive benchmark or dynamic credit-spread — that could be applied to SOFR — will become available prior to LIBOR’s anticipated cessation at year end 2021.

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

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Julien Courbe

Financial Services Leader, PwC US

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