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Our Take: financial services regulatory update - March 26, 2021

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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 - March 26, 2021

Fed announces June 30 end to dividend and buyback restrictions

Yesterday, the Fed announced that it will extend current restrictions on dividend payments and stock buybacks until June 30. On this date, it will lift the restrictions on firms that are adequately capitalized during this year’s Comprehensive Capital Analysis and Review (CCAR) exercise or are exempt from it this year. Banks that fall below minimum capital levels will continue to face the restrictions for an additional three months. Following the lifting of restrictions, distributions will be limited by the stress capital buffer (SCB), which integrates Fed-modeled start-to-trough stressed capital depletions into ongoing capital requirements.

The Fed imposed strict limitations on dividend payments and stock buybacks following last year’s CCAR results as the scenarios were developed before the pandemic and the Fed’s additional sensitivity analyses demonstrated the risk of approaching capital minimums. At that time the Fed also required firms to resubmit capital plans and undergo additional stress testing scenarios in September 2020. In December, it eased the restrictions to allow banks to (a) pay dividends up to the level they paid in Q2 and (b) pay dividends and make share repurchases in Q1 2021 up to an amount equal to the average of their net income for the four prior quarters.

Our Take

As we predicted, the Fed is aiming to return to its intended path towards adjusting ongoing capital requirements via the SCB following this year’s CCAR. Although it has hinged the lifting of restrictions on firms’ stress test performance, there are a number of signs that they will remain well-capitalized including the Fed’s decision last week not to extend interim supplementary leverage ratio (SLR) relief. In addition, this year’s CCAR scenarios are less severe than the 2020 sensitivity analyses and resubmission scenarios, both of which saw the firms remain above their capital minimums. As a result, it is reasonable to assume that firms can expect to increase their distributions within the bounds of their SCBs. Firms received their first SCBs following last year’s CCAR and given that this year’s scenarios are similar in design to those, we do not expect significant readjustments to firms’ SCBs and ongoing capital requirements. With strong capital levels, new stimulus spending and the ongoing vaccine roll out, firms are well-positioned to take advantage of flexibility to increase their actual distributions beyond those included in their capital plans and avoid holding excess capital.

LIBOR Transition: Time is running out

On Monday, the Alternative Reference Rates Committee (ARRC) published a progress report on the transition away from USD LIBOR. Compared to estimates of industry-wide exposures to USD LIBOR published by the committee just over three years ago, the use of USD LIBOR appears to have increased rather than decreased. Amid slower than hoped for transition progress, especially in the loan markets, the committee suggests that “the transition needs to accelerate quickly” if firms want to meet regulatory expectations for an end of issuances of new LIBOR based products by year end 2021. This sentiment was echoed later in the day by Fed Vice Chair for Supervision Randal Quarles, who in his keynote address at the ARRC’s SOFR Symposium suggested regulators would place “intense supervisory focus” on firms’ transition progress, specifically with respect to their efforts to end the use of USD LIBOR in new products.

On Tuesday, the ARRC announced that the committee would not be in a position to recommend a forward-looking SOFR term rate by its original target date of Q2 2021. At this time, insufficient liquidity in SOFR derivatives would prevent the construction of such a term rate. Market participants are encouraged to continue their transition efforts without relying on a SOFR term rate as the committee continues to evaluate a limited set of cases in which a term rate might be used.

On Wednesday, the New York State legislature passed a bill to address certain legacy LIBOR-based contracts based on a legislative proposal brought forward by the ARRC. Upon cessation, the bill would allow for a statutory replacement of USD LIBOR in contracts subject to New York State law containing no or inadequate fallback language. The bill, which would also provide a safe harbor from litigation related to contracts subject to the legislation, will now be submitted to the state governor for signature. The ARRC promptly welcomed the passage of the bill.

Later on Wednesday, the ARRC published a white paper describing a potential methodology and formula to calculate a fallback for the USD LIBOR ICE Swap Rate based on a spread-adjusted SOFR-based Swap Rate. The methodology represents the US equivalent to a similar proposal made by the WG on Sterling RFRs to replace the GBP LIBOR ICE Swap Rate with SONIA-based rates, published in February of this year.

Yesterday, the ARRC published supplemental versions of its recommended fallback language for syndicated and bilateral business loans. The recommended language has been simplified, incorporating additional information on cessation timing and spread adjustment values as a result of the FCA’s announcements on the end of LIBOR earlier this year.

Finally, the UK’s Prudential Regulation Authority and Financial Conduct Authority wrote to the CEOs and senior management accountable for the transition at the largest and most complex organizations. The letter echoed many of the themes touched on by Quarles in his address on Monday, cementing the UK regulators’ expectation that firms meet communicated target dates for ending the issuance of new LIBOR-based products.

Our Take

When the UK’s Financial Conduct Authority (FCA) confirmed earlier this month that publication of USD LIBOR would continue into June 2023, many market participants breathed a sigh of relief at the prospect of being afforded extra time in the transition away from the much maligned benchmark. That reprieve, however, turned out to be short lived, as US regulators quickly re-emphasized their expectation that firms stop the use of USD LIBOR in new products by the end of 2021. Even amid the prospect of supervisory actions targeting institutions falling behind in their transition efforts, firms have been slow to reduce their reliance on USD LIBOR – especially in the loan markets. Some held out hope for a credit sensitive alternative or supplement to SOFR, while others counted on the emergence of a forward looking term rate version of SOFR. Between the ARRC’s progress report, the unsurprising concession that a SOFR term rate was unlikely to arrive – if at all – until later in the year and Quarles’ reminder that regulators would be watching banks’ transition progress intently over the coming months, it is becoming abundantly clear that time has already started to run out. Embracing SOFR in its current forms as a lending rate, at least for the time being, should represent the most practical, direct path to meeting regulatory expectations for ending LIBOR-based issuances before year-end. Other alternatives may well, and should be expected to, evolve over time. But with the deadline approaching, any bank that continues to hesitate in moving away from USD LIBOR as lending rate is bound to face difficult questions from its supervisors.

Any acceleration in the shift away from LIBOR not only entails establishing the operational capabilities to process RFR transactions or the development and pricing of new RFR-based products but also needs to be supported by increased customer outreach and engagement. Amid the continued publication of USD LIBOR, corporate borrowers might not feel the same urgency to make the shift to alternative reference rates. For banks to be successful in accelerating the move away from LIBOR, they will need an effective strategy to educate and communicate the urgency to change gears to their corporate customers.

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

Regulators continue climate change focus

Yesterday, the New York Department of Financial Services (NYDFS) proposed detailed guidance for insurers to integrate climate change risks. The guidance builds on NYDFS’ September 2020 letter to insurers with details on its expectations for the inclusion of climate risk across an insurers’ organization, including integration into governance, risk management, scenario analyses, and disclosures. It also focuses on organizational structure, suggesting that various functions throughout the enterprise should have sufficient expertise to handle climate risks and, regardless of whether a risk assessment shows material climate risks, all firms should have a board member and a senior officer responsible for climate risk due to the changing nature of such risks. In providing guidance around climate risk assessments, it provides that firms should take a quantitative approach that considers the following factors: credit, legal, liquidity, market, operational, pricing and underwriting, reputational, and strategic risks. Recognizing the inherent uncertainty associated with climate risk, the guidance provides that insurers should conduct scenario analysis exercises that consider a) the impact of physical and transition risks; b) the evolution of climate risk under multiple scenarios; c) the fact that climate risk may not be fully reflected in historical data; and d) how climate risks may materialize in the short, medium and long term. It encourages insurers to consider publicly-available scenarios such as those provided by the Network for Greening the Financial System. The guidance further explains that the NYDFS expects insurers to publicly disclose their climate risk management practices and considerations that factor into their climate risk assessments, and when providing disclosures they should follow recommendations set forth by the Task Force on Climate-Related Financial Disclosures (TCFD) or other similar initiatives. For many of the proposed expectations, the guidance acknowledges that firms may not be able to comply in the near-term. For example, it explains that firms should develop a quantitative approach to risk assessments “over time” and provides a three year timeframe for more quantitative climate risk disclosures.

Meanwhile, Fed Governor Lael Brainard gave a speech on Tuesday announcing the creation of a Financial Stability Climate Committee (FSCC) at the Fed, which will be tasked with identifying and addressing climate-related risks to financial stability from a macroprudential perspective. She also provided additional detail into potential climate scenario analysis exercises, which she explained will consider potential impact on banks, nonbanks, and the financial markets more broadly. The Treasury Department followed by announcing that at the Financial Stability Oversight Council’s (FSOC’s) first meeting under the Biden Administration on March 31, it will discuss climate change and its potential impacts on financial stability.

Our Take

The proposed guidance from NYDFS sends a clear message that the department is serious about raising the bar on climate risk management. Most insurers’ current practices are significantly behind the expectations set forth in the guidance, with only the most forward-looking firms – often the largest ones – developing scenario analysis exercises and having staff with climate risk expertise embedded throughout the organization. While the number of insurers providing climate risk reporting is generally increasing, these disclosures are not standardized and often lack specificity. By pointing insurers to recognized risk management and disclosure and frameworks such as TCFD, NYDFS is setting the expectation that disclosures should be meaningful and provide insight into what insurers are doing to address climate change risks.

The good news for insurers is that the proposed guidance gives a relatively long runway for the more onerous expectations. However, firms should not wait to begin developing and improving their programs to catch up with the guidance. With the NYDFS’s track record of not being afraid to issue supervisory findings to firms that fail to meet its expectations, insurers need to be prepared to show their work and answer detailed questions from examiners. Although the guidance is in the proposal stage, we recommend insurers prepare as though the finalized guidance will be similar, if not more detailed, and plan accordingly. Banks and other financial institutions should also be paying close attention as the NYDFS’s 2020 letter to insurers was followed by the department announcing similar expectations for the broader financial industry. With many of the expectations in the guidance applicable to the financial services industry as a whole, we would not be surprised to see them resurface in a broader proposal in the near future.

On our radar:

These notable developments hit our radar over the past week:

  • Powell and Yellen on the Hill. This week, Treasury Secretary Janet Yellen and Fed Chairman Jerome Powell had their first joint testimony before the Senate Banking Committee and House Financial Services Committee on the Quarterly CARES Act Report to Congress. When asked about the possibility of the Financial Stability Oversight Committee (FSOC) designating nonbanks as systemically important, Secretary Yellen expressed that it may be preferable to regulate risky activities rather than to designate specific entities. Yellen also noted that she believes the FSOC can play a role in coordinating climate-risk policy between the financial services regulators. Both Yellen and Powell said that they do not support an anonymous digital dollar and both endorsed a federal legislative solution to address issues with certain legacy LIBOR contracts.
  • CFPB on payday lending and complaints. On Tuesday, CFPB Acting Director Dave Uejio released a statement emphasizing the importance of protecting consumers against lenders with “business models dependent on consumers’ inability to repay their loans.” The statement explains that the bureau will not defend in court the merits of 2019 modifications to the payday lending rule that eliminated the requirement that lenders take steps to determine whether borrowers have the ability to repay before issuing loans. It also pledges that the bureau will use the full extent of its powers to address harms related to this form of predatory lending. In addition, on Wednesday, the CFPB released its annual complaint report, noting a high volume of complaints regarding credit reporting issues.
  • PPP extended. Yesterday, the Senate passed a bill to extend the deadline to submit Paycheck Protection Program (PPP) loan applications from March 31 to May 31. The PPP received an additional $7 billion in funding in the recent stimulus package and saw a number of changes in recent months to allow larger loans for sole proprietors and to prioritize the smallest businesses.
  • Congressional Democrats introduce true lender rule repeal. Earlier today, Senate Banking Committee Chair Sherrod Brown (D-OH), Senator Chris Van Hollen (D-MD) and Representative Chuy Garcia (D-IL) introduced legislation to use the Congressional Review Act to repeal the OCC’s rule clarifying that the “true lender” in bank-fintech partnerships is either a) the lender listed at the time of origination or b) the firm that funds the loan. Democrats and consumer groups have criticized the rule as opening the door for fintechs to get around state interest rate caps by partnering with nationally-chartered banks.

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Julien Courbe

Financial Services Leader, PwC US

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