Our take: financial services regulatory update - August 7, 2020

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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 - August 7, 2020

Agencies offer relief and flexibility for crisis management

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

8/6 - Boston Fed - The Federal Reserve Bank of Boston (FRBB) released updated FAQs regarding the expansion of the Main Street Lending Program (MSLP) to nonprofits.

8/6 – FRBNY - The FRBNY published a report on consumer credit, highlighting that household debt has fallen for the first time since 2014 and that, due to declines in consumer spending during the crisis, credit card debt has plummeted by $76b. 

8/4 – SBA - The Small Business Association (SBA) released a set of FAQs regarding Paycheck Protection Program (PPP) loan forgiveness.

8/4 – FRBNY - The FRBNY published a report on the impact of the crisis on black-owned businesses. The report explains that black-owned businesses were nearly twice as likely to close down due to the crisis than other businesses while fewer of such businesses in the hardest-hit areas received PPP loans.

8/3 – Fed - The Fed published its July 2020 Senior Loan Officer Opinion Survey on Bank Lending Practices. The report indicates that banks tightened their standards on business loans, including commercial and industrial and commercial real estate, as well as consumer loans, including residential real estate, credit cards, and auto. Banks also reported weaker demand for business loans and consumer loans other than residential real estate.

8/1 – FFIEC - The Federal Financial Institutions Examination Council released a statement reminding financial institutions that the federal regulators encourage them to work with borrowers to meet credit needs during the crisis and explaining their expectations for risk management and consumer protection for crisis-related issues such as loan modifications and credit risk assessments.

7/31 – FRBNY - The Federal Reserve Bank of New York (FRBNY) announced that $683m in loans were settled for the 7/21 Term Asset-Backed Securities Loan Facility (TALF) subscription date and updated FAQs for the facility.

7/31 – FRBB - FRBB issued forms and agreements for the nonprofit loans under the Main Street Lending Program (MSLP) although it is not yet purchasing such loans. The FRBB also updated FAQs for the for-profit business loans and nonprofit loans.

7/31 – FHFA - The Federal Housing Finance Agency (FHFA) extended its policy that allows for the purchase of certain single-family mortgages in forbearance for loans originated through 8/31.

7/29 – Fed - The Federal Reserve (Fed) announced that it will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities in order to support the flow of credit to households and businesses.

7/29 – Fed - In a press conference, Fed Chair Jerome Powell said:

● The course of the pandemic is the main factor in determining the recovery and there will likely be a need for more support from the Fed and Congress
● The Fed has not considered buying equities

He would support Congress modifying the Collins Amendment to give the Fed discretion to provide leverage ratio relief. He stressed that if Congress were to do so, the modifications should be temporary.

7/29 – Fed - The Fed announced that it would extend temporary US dollar swap lines and repurchase agreements for foreign and international monetary authorities until 3/31/21.

7/28 – Fed - The Fed announced that it would extend through December 31 its lending facilities that were scheduled to expire on September 30. Specifically, the extension applies to the Primary Dealer Credit Facility, the Money Market Mutual Fund Liquidity Facility, the Primary Market Corporate Credit Facility, the Secondary Market Corporate Credit Facility, TALF, the PPP Liquidity Facility and the MSLP.

7/28 – SBA - The SBA Inspector General released a report on potential fraud in the Economic Injury Disaster Loan and Advance grant programs. The report notes that financial institutions reports more than 5000 instances of suspected fraud.

7/27 – Congress - Senate Republicans released their COVID-19 relief bill proposal, which includes:

● Another round of direct $1200 payments to taxpayers

● $200 in enhanced unemployment benefits per week until September

● Extension of the PPP to allow second loans for certain businesses

● An increase in the employee retention tax credit from 50% to 65%

● $105b in funding for education, with the majority targeted to schools that reopen

● $15b for childcare providers

● Liability protections for schools that reopen

 

No agreement was reached between Republicans and Democrats before the Senate adjourned until 8/3 although expanded unemployment benefits expired on 7/31.

Our take

Over the past two weeks, the Fed has extended and expanded several of its lending facilities in accord with its commitment to continue to provide liquidity and access to credit for as long as it is necessary. However, demand for the Fed facilities has remained limited. According to the Fed’s latest balance sheet report, the MSLP has purchased $92b in loans as of this week. While this is over a six-fold increase from the $14b purchased as of July 22, it is still a small percentage of the program’s $600b capacity. There has been some criticism that the MSLP’s strict eligibility requirements with respect to more highly leveraged businesses has dampened demand by leaving out some of the hardest-hit industries such as hospitality and entertainment. Banks’ tightened standards due to the nature of MSLP loans - they are not forgivable and banks have to retain a piece of each loan - could also be playing a role in limiting usage of the facility.

Meanwhile, Congress failed to reach a deal yet again this week, with Republicans and Democrats still far off in the amount and manner of aid to be included in a new bill. As a result, Treasury Secretary Steven Mnuchin stated this afternoon that he will advise the President to issue Executive Orders (EOs) to handle the most pressing issues such as extending unemployment benefits and the moratorium on evictions. It remains to be seen whether the EOs will survive likely litigation regarding the President’s authority to control spending, but we nonetheless expect Congress to continue to seek broader compromise - particularly if unemployment numbers do not improve or if concern grows about funding for safety measures as the school year approaches.

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OCC approves Varo’s national charter application

Last Friday, the OCC approved Varo Money, Inc. (Varo)’s application for a national bank charter, which allows it to take deposits and offer other banking services directly rather than relying upon banking partners. It is the first mobile-only fintech to receive a national charter.

Varo first applied for the charter in August 2017 and received preliminary approval from the OCC at the end of August 2018. It temporarily withdrew its FDIC deposit insurance application in September 2018 to take actions to address concerns from the regulators, including hiring experienced senior management. The FDIC approved Varo’s deposit insurance application in February of this year, which was a prerequisite for obtaining the charter. In approving Varo’s national charter, the OCC determined that it meets the licensing guidelines for insured national banks and met its criteria for financial and managerial resources, adherence to laws and regulations, and anti-money laundering capabilities. Varo was the first fintech to pursue a full national banking charter.

Our take

The OCC’s approval goes to show that the licensing and regulatory requirements that have been barriers protecting incumbent banks from fintech competitors can be surmounted with enough time, funding and effort. Fintechs have been closely watching Varo’s three year journey and may now start to think more seriously about following suit rather than continuing to rely on partnerships with traditional banks or pursuing a more limited-purpose charter. Any fintech that does so, however, will need to gear up to satisfy the high expectations for safety and soundness, including sufficient capitalization, funding and robust risk management and controls.

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FinCEN releases customer due diligence FAQs

On Monday, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) released a set of FAQs to clarify certain requirements related to its customer due diligence (CDD) rule. The FAQs clarify that there is no prescriptive requirement for financial institutions to determine whether every customer’s expected activity is in line with their actual activity or to perform media searches on every customer but instead should conduct this analysis on the basis of customer risk. Similarly, they note that financial institutions are not required to automatically categorize customers as high risk based on government publications (such as Treasury’s 2020 National Illicit Finance Strategy); rather, they should consider the information provided by government publications as an input when evaluating the anti-money laundering and sanctions risk for each customer on a case-by-case basis. They also explain that financial institutions are not expected to update customer information on a set schedule but should do so on the basis of risk or if a significant update is found during ongoing monitoring.

Our take

The FAQs are in line with the approach that regulators have taken under the current Administration to allow financial institutions to tailor their programs using a risk based approach. While many firms will appreciate the clarification that certain due diligence activities are not for every customer - specifically, customers deemed to be low risk - they should be aware that they are not off the hook. For example, a common theme in enforcement actions is the presence of negative media that firms failed to investigate. Similarly, if firms do not create expected activity profiles to compare with actual activity, they will need to be prepared to show regulators how they “conduct ongoing monitoring to identify and report suspicious transactions” as required by the CDD rule. With FinCEN emphasizing that firms can take a risk-based approach to the level of due diligence conducted on customers, the need for firms to ensure that their risk assessment and customer risk rating methodologies are in shape is more important than ever.

For more on the CDD rule and expected-versus-actual activity analysis, see our Financial crimes observer, Six key points on CDD rule customer activity reviews.

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US-China tensions heat up with tech restrictions and potential stock delisting

Yesterday, the White House issued two Executive Orders (EOs) banning US businesses or persons from “transacting with” the parent companies of the social media platforms TikTok and WeChat (ByteDance and Tencent, respectively). The Treasury Department also imposed sanctions on 11 officials from China and Hong Kong, including Hong Kong’s Chief Executive Carrie Lam. These actions come one day after the US State Department announced its “Clean Network” program to prevent the Chinese government or businesses from access to US telecommunications, smartphone app stores, cloud infrastructure and undersea cables. Earlier this week, the Treasury Department also released recommendations to de-list certain Chinese companies from US stock exchanges, citing that the Chinese government does not allow US audit firms to ensure that they comply with securities laws.

The actions this week are the latest in recent escalating tensions between the US and China. Last month, the White House signed into law the Hong Kong Autonomy Act (HKAA), which authorizes the Administration to impose sanctions against any person or business that “contributes to the erosion of Hong Kong’s autonomy.” Simultaneously, it issued an EO implementing the HKAA and revoking Hong Kong’s preferential trade status. The US also recently ordered that China close its Houston consulate, and China responded by ordering the closing of the US consulate in Chengdu.

Our take

It’s been a rough week for US-China relations. With the EOs issued late last night, the industry is now trying to pick up the pieces and determine what the “transacting with” restriction means in practice. As of now, there is no consensus - it could range from simply prohibiting financial institutions to process in-app purchases to banning US app stores from carrying the apps entirely. While more guidance will be necessary to determine the impact, financial institutions should have plans in place for the most extreme outcome, which would involve updating their systems to prevent any transactions with either company, including the wide variety of subsidiaries such as WeChat’s payments platform and Tencent’s various games that are popular in the US. The uncertainty regarding the future of US-China relations means that such planning should involve both short term (e.g., the direct impact of the EOs) and long-term (e.g., the HKAA and possible further deterioration of relations) strategies. Going forward, we expect to see lawsuits challenging the President’s authority to restrict communications platforms via EO. If a new Administration were to take the White House after the upcoming election in November - or if US-China tensions cool down after the election - we could also see these recent actions reverse course.

Stay tuned for our joint survey with the China General Chamber of Commerce covering the outlook for US-China business relations.

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On our radar

These notable developments hit our radar over the past two weeks:

1. LIBOR transition: Several developments occurred related to the LIBOR transition including:

Market participants encouraged to adhere to ISDA’s upcoming fallback protocol. Last week, ISDA published a statement from its Board of Directors encouraging adherence to the upcoming IBOR Fallback Protocol, which will facilitate the transition of legacy LIBOR based derivative contracts to alternative reference rates upon LIBOR’s cessation. ISDA also published a letter previously sent to the risk-free rate working groups, in which it announced that the protocol would be made available for adherence to key market participants prior to its official launch. The goal is to demonstrate “a broad and comprehensive list of adherents at the time the IBOR Fallback Protocol launches,” indicating wide usage of the protocol.

ARRC publishes SOFR Starter Kit. Upon the conclusion of the SOFR Summer Series of educational webinars, the Alternative Reference Rates Committee (ARRC) today released the Secured Overnight Financing Rate (SOFR) Starter Kit, a collection of fact sheets on the background of LIBOR transition, details on SOFR and next steps in the transition from LIBOR to SOFR. SOFR is the ARRC’s recommended alternative to USD LIBOR.

Market participants prepare for price alignment interest (PAI) and discounting switch for cleared USD interest rate derivatives. The CFTC’s Market Risk Advisory Committee subcommittee on interest rate benchmark reform delivered a report summarizing the learnings from a recent tabletop exercise on the central counterparty (CCP) clearinghouses’ switch from the effective federal funds rate to SOFR as the rate for calculation of PAI (the interest paid on collateral) and discounting for cleared USD-denominated interest rate swaps, scheduled for October of this year. A similar switch from EONIA to €STR as PAI and discounting rate for EUR-denominated derivatives was completed on Monday last week.

Industry responses to CFPB’s proposal to amend Regulation Z. Earlier this week the CFPB made public comment letters it received on its proposed amendments to Regulation Z, which (among other changes) would explicitly include SOFR and the Prime Rate as comparable and acceptable replacements to USD LIBOR in certain consumer loans. Several market participants and industry groups requested additional flexibility in the type of rates that could be considered comparable. Some commenters specifically called for the inclusion of Ameribor, a benchmark rate favored by a number of smaller lending institutions.

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

2. Senate confirms SEC and NCUA nominees. Yesterday, the Senate approved Hester Peirce and Caroline Crenshaw as SEC commissioners and Kyle Hauptman to be on the NCUA board.

3. States sue OCC over valid-when-made rule. Attorneys General for California, Illinois and New York filed suit against the OCC over its recent valid-when-made rule, claiming that it would "dramatically expand" federal preemption and facilitate predatory lending by allowing lenders to circumvent state interest rate caps.

4. Fed provides details on faster payments launch. Yesterday, the Fed released a statement that its plans for its faster payments system is still on track to be launched in 2023 or 2024 and that it will be released in stages, with a more specific time frame to be announced at a later date.

5. SEC to simplify disclosure requirements for ETFs and mutual funds. On Wednesday, the SEC proposed amendments to its disclosure requirements to tailor ETF and mutual fund disclosures toward the needs of retail investors. Specifically, they would limit the length and complexity of shareholder reports, eliminate the requirement that retail investors receive annual prospectuses and provide investors with a simplified fee summary.

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Julien Courbe

Financial Services Leader, PwC US

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