Our take: financial services regulatory update - October 16, 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 – October 16, 2020

Post-Brexit talks start, and then stop, at EU summit

At the EU summit this week, negotiators from the UK and EU continued trade deal talks in advance of the transition period expiration on December 31, 2020. The sides have so far failed to find common ground, reaching an impasse mainly around a “level playing field provision” limiting the UK from relaxing certain social, environmental and other regulatory standards as well as alignment on policies regarding state aid and competition. Other issues include the dispute resolution procedure and quotas for fisheries. Following the latest negotiations, the EU indicated that it wishes to continue talks in the coming weeks but urged its member states to step up preparations for no deal. Earlier today, UK Prime Minister Boris Johnson complained that the EU has refused to negotiate seriously and said the UK should get ready to trade with the EU without a new agreement but added that the UK is willing to listen if there is a fundamental change in approach from the EU.

Our take

With only two-and-a-half months until the end of the transition period, negotiations have stalled as both sides refuse to meaningfully budge on key issues. The UK has found itself on the ropes, with Prime Minister Johnson’s administration already struggling with dismal polling numbers regarding his handling of the current crisis. Now facing the undesirable prospect of adding a further economic hit, restrictions on movement and long customs lines at the border if a deal is not reached in time, the pressure is on to act. Further complicating the UK’s position is the fact that its plan B - a free trade agreement with the US - could be in jeopardy if Joe Biden wins the upcoming election as he may wish to strike a closer relationship with the EU and protect Ireland’s interest in avoiding a hard border. To reach a deal, both sides need to quickly reevaluate where they have room to move. For a deal to be ratified before the end of the year, the EU Parliament must review and approve it, so the ultimate deadline for the negotiations is likely early in December.

White House issues Hong Kong sanctions report and FAQs

On Wednesday, the White House submitted to Congress a report containing a list of individuals that have materially contributed to the “erosion of Hong Kong’s autonomy.” The Administration was required to produce the report by the Hong Kong Autonomy Act (HKAA), which was signed into law last July. The HKAA is intended to block individuals named in the report from participating in the US financial system and restricts them from obtaining visas to enter the US. Notably, the report is substantially similar to a previous list issued by the Treasury Department’s Office of Foreign Assets Control (OFAC) and does not impose any sanctions on new individuals.

Going forward, the White House now has 60 days under the HKAA to produce a second report identifying foreign financial institutions that have knowingly engaged in significant transactions with individuals sanctioned in the report after its publication. These financial institutions will be subject to “secondary sanctions,” which would cut them off from the US financial system as a result of dealing with prohibited entities. In a series of FAQs, Treasury explained that it will only identify foreign financial institutions that have entered into transactions with the sanctioned individuals after the report has been issued and that it does not consider transactions made to wind down relationships to be “significant.” They also explain that the Treasury will reach out to financial institutions to inquire about their conduct before making the decision to include them in the second report. For firms that have been added, the FAQs note that they can be removed depending on the overall impact of their transactions, whether they are likely to be repeated in the future, and whether the firm has implemented any mitigating countermeasures.

Our take

In contrast to the headline-grabbing actions taken this summer - implementing the HKAA, restricting certain Chinese social media apps and recommending the delisting of certain companies from US stock exchanges - this week’s report arrived with more of a whimper as it refrained from imposing any new sanctions. Further softening the blow is the FAQs’ explanation that the Treasury will liaise with foreign financial institutions and provide some flexibility around permissible transactions. While this may come as a relief to foreign financial institutions with significant China-related business, we would not read into these actions as long-term policy stances, especially given the unpredictability surrounding the Administration’s approach to sanctions policy and US-China relations as a whole. As such, considering the significant risk of being cut off from the US financial system due to secondary sanctions, financial institutions should carefully evaluate their customer network for any potential nexus to sanctioned individuals or entities owned 50% or more by them. Despite the apparent flexibility Treasury is offering, firms will need to tread carefully through the minefield of potential violations.

For more on the HKAA and other recent US-China issues, see PwC’s Policy on Demand: US-China relations and impact on financial institutions

On our radar

These notable developments hit our radar over the past week:

  1. Crisis response continues. Over the past week, the federal regulatory agencies continued to take steps to support the economy while Congress remained deadlocked on relief. Specifically:
    • Yesterday, Fed Vice Chair for Supervision Randal Quarles gave a speech explaining that the most severe stresses earlier in the crisis hit short-term funding markets; specifically, commercial paper and money market funds. He noted that “it is worth asking” whether federal agencies should take steps to provide further protections around these markets. He also said in a Wednesday speech that while banks remained resilient to crisis-related shocks, other areas experienced significant stress including money market funds, dealers' capacity and willingness to intermediate, leveraged investors, and fragilities in US dollar cross-border funding. He indicated that he will present a full report at the upcoming G20 Summit and provide a plan of concrete steps to be taken.
    • On Tuesday, the Small Business Administration (SBA) updated its FAQs on Paycheck Protection Program (PPP) loan forgiveness.
    • On Tuesday, the New York Fed released a report on consumer expectations, showing modest increases over the past month in expectations around employment, home prices, and household spending. Uncertainty around inflation continued an upward trend and expected earnings growth remained unchanged.
    • On Tuesday, the Treasury Department’s Financial Crimes Enforcement Network issued an advisory highlighting an increase in unemployment insurance-related fraud during the crisis and providing a list of associated red flags.
    • On Monday, House Financial Services Committee Chair Maxine Waters (D-CA) released a statement criticizing the Republicans’ relief proposals for having insufficient tenant protections and small business support.
    • On Sunday, Treasury Secretary Steven Mnuchin and White House Chief of Staff Mark Meadows sent a letter to Congress urging them to pass a compromise crisis relief package.
    • Last Friday, House Republicans sent a letter to the Fed asking the agency to temporarily provide flexibility in the calculation of the G-SIB surcharge and exclude bank participation in the Money Market Mutual Fund Liquidity Facility from the calculation as to ensure that banks do not face additional capital requirements throughout the crisis.
  2. LIBOR Transition: CCPs’ switch to SOFR PAI and discounting is in progress. Over the course of this weekend, both the London Clearing House (LCH) and Chicago Mercantile Exchange (CME) are switching the rate used for calculating price alignment interest (PAI, the interest paid on collateral) and discounting future cash flows for cleared USD derivatives from the effective federal funds rate (EFFR) to SOFR, the recommended alternative to USD LIBOR. While there are nuances in the approaches taken by the CCPs, both clearinghouses will issue basis swaps as a form of compensation for the change in discounting risk profile, while also facilitating an auction process for participants looking to contemporaneously unwind these swaps. In support of the auction process, the CFTC earlier this week issued a pair of no-action letters to the CCPs, providing relief from real-time reporting requirements for swaps related to the switch.

    Subscribe to PwC’s LIBOR Transition Market Update here to read more about these and other developments.
  3. FDIC to finalize Net Stable Funding Ratio next week. Next Tuesday, the FDIC is scheduled to vote on the Net Stable Funding Ratio (NSFR) rule, which requires that banks maintain an amount of liquidity that is at least equal to their funding needs over a one-year horizon. The final rule is expected to be consistent with the Basel Committee for Banking Supervision’s 2014 NSFR rule.
  4. CFTC finalizes position limits rule. Yesterday, the CFTC voted 3-2 to finalize a rule placing caps on speculative bets on 25 different commodities.

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Julien Courbe

Financial Services Leader, PwC US

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