Yesterday, Treasury Secretary Stephen Mnuchin sent a letter to Fed Chair Jerome Powell saying that the Treasury Department would not extend the Municipal Lending Facility (MLF), Primary and Secondary Corporate Credit Facilities (PMCCF and SMCCF), and the Main Street Lending Program (MSLP) beyond December 31, 2020. As of Wednesday, the MLF has seen two transactions totalling $1.7 billion (out of $500 billion available), the PMCCF and SMCCF have lent just over $13.7 billion of their $750 billion capacity, the MSLP $5.4 billion out of a potential $600 billion. In addition to declining to extend the facilities, Mnuchin also requested that the Fed return funds Treasury has invested in the facilities and indicated that Treasury ask Congress to reappropriate the allocated funding.
Powell responded that the Fed would prefer to keep all of its lending facilities operational beyond this year. Also disagreeing with Mnuchin’s decision was House Financial Services Committee Chair Maxine Waters (D-CA), while Senate Banking Committee Chairman Mike Crapo (R-ID) and Senator Pat Toomey (R-PA) agreed with Mnuchin’s assessment that the facilities were no longer needed.
While these lending facilities have been utilized well below their maximum capacities, they have served as backstops and calmed private lending markets just through their existence. With public health officials increasingly warning of a difficult several months ahead and several areas reinstituting restrictions, it does not appear to be a good time to remove options for businesses and local governments to obtain bridge funding. A new Treasury Secretary chosen by President Joe Biden could restart the programs but that would still leave them unavailable at least through January. The new Treasury Secretary could also find it extremely difficult to simply restart the programs if Mnuchin returns the funding allocated by Congress. In addition, the Paycheck Protection Program has been shut down since August and it appears unlikely that Congress will agree on fiscal stimulus before next year, making this a potentially dark winter for businesses even without the premature removal of emergency Fed lending.
On Tuesday, the Financial Stability Board (FSB) released a report that provides an overview of the market shock experienced by certain nonbank market participants in the early stages of the pandemic and outlines a work plan detailing steps it will take to further analyze and develop policy plans for nonbanks. The report explains that a surge in US dollar demand in the spring caused investors to withdraw from money market funds and some open-ended funds. It also notes that reductions in risk appetite, regulatory constraints and operational challenges held back supply in some funding markets. These stresses were amplified by large sales of US Treasury bonds by some leveraged nonbank investors.
In response, central banks intervened with asset purchases, liquidity operations and backstop facilities. The report notes that markets would likely have significantly worsened absent this support and stresses the danger of market participants not fully internalizing their own liquidity risk in anticipation of future central bank interventions in times of stress. As a result, it emphasizes the need to strengthen resilience in the nonbank sector and provides a work program over the next two years for steps the FSB will work with its member authorities to take in this regard. Specifically, next year it will set forth policy proposals to enhance the resilience of money market funds, examine the frameworks of margin calls in derivatives markets and hold a workshop on structural issues in nonbank financial intermediation. In 2022, the FSB will consider policies to address systemic risk related to nonbanks after examining liquidity risk management in open-ended funds and liquidity in core funding markets during stress.
The growth of nonbanks has been a key focus area for the FSB over the last several years with calls for increased monitoring and data collection, but until now it has stopped short of indicating the need for policy proposals. With Fed Vice Chair for Supervision Randal Quarles as the author of the report and the SEC recently releasing its own report highlighting vulnerabilities in the nonbank sector, the time for more prescriptive requirements has arrived. What form that will take - or how stringent any new requirements will be - remains to be seen, but what is clear is that the upcoming guard change due to the election is unlikely to slow this focus down. Vice Chair Quarles will likely remain in his position for at least another year, and considering that many Democrats have long pushed for regulation of nonbanks, his successor will be likely to carry the torch if not intensify the push. With both parties divided on many issues, enhancing resilience and addressing systemic risk of certain nonbanks is an area where at least some bipartisan consensus could emerge.
On Tuesday, SEC Chairman Jay Clayton testified before the Senate Banking Committee. He began by noting his decision to step down as head of the agency at the end of the year and highlighting key activities throughout his tenure as chair, which include issuing the best interest rule, promoting initiatives to provide investors with simplified disclosures, and harmonizing patchwork exempt offering rules. He also highlighted several areas that he believes the SEC should focus on going forward, including taking a closer look at how passive trading plans (i..e, 10b5-1 plans) and stock options pricing can be used to avoid insider trading requirements.
While many Senators offered Clayton words of appreciation on his last appearance before the Committee, others expressed disagreement with his policies and asked tough questions. Sen. Sherrod Brown (D-OH) criticized the SEC’s best interest rule as providing insufficient protections and not being adequately enforced, Sen. Elizabeth Warren (D-MA) expressed dissatisfaction at the agency’s lack of action on ESG disclosures, and Sen. Bob Menendez (D-NJ) asked about the status of the executive compensation rule that has not been issued despite being required by the 2010 Dodd-Frank Act. Meanwhile, Sen. Tom Cotton (D-AK) expressed that fines issued as a result of its share class selection disclosure initiative conflicted with the SEC’s statement that guidance does not contain the force of law and will not lead to enforcement actions.
Chairman Clayton’s departure announcement comes as no surprise as SEC Chairs traditionally step down when a new Administration takes the White House and Clayton had previously expressed a desire to return to New York. Clayton’s tenure has been primarily focused on capital formation, including by relaxing rules around private pools of capital. While we do not see his successor abandoning attention in these areas as they are consistent with the SEC’s core mission, we would expect additional priority around investor protection and attention to ESG issues, including by moving the best interest rule toward a fiduciary standard of care and mandating enhanced climate risk disclosures. A new Director could also renew the agency’s enforcement focus to emphasize areas that have dropped to lows under Clayton’s tenure such as actions against large public firms and insider trading.
For more, see our First take, Purple reign: Ten key points from the 2020 election.
On Wednesday, ICE Benchmark Administration (IBA), LIBOR’s administrator, announced that it will soon consult on its intention to cease publication of all tenors of GBP, EUR, CHF and JPY LIBOR after December 31, 2021. IBA notes that it has been engaged in discussions with panel banks regarding the potential continuation of certain LIBOR currency and tenor pairs beyond the end of 2021. While IBA’s announcement reiterates that the publication of USD LIBOR could not be guaranteed beyond the end of 2021, discussions between panel banks, the official sector and IBA itself are continuing with respect to USD LIBOR.
Any future statement on IBA’s voluntary cessation of LIBOR’s publication would not only depend on the outcome of the announced consultation but also on whether and how the Financial Conduct Authority (FCA) might use its new powers to create a so-called “synthetic LIBOR.” Coinciding with IBA’s statement, the FCA itself announced two initial consultations on its planned approach to apply these new powers, seeking market participants’ input on 1) the factors the FCA should take into consideration when deciding which benchmarks it should require to be continued and 2) the methodology it should employ in the continued publication of such a benchmark. To allow for the continued publication of a certain currency and tenor pair of LIBOR, the FCA would be able to direct a modification of the rate’s calculation methodology to end its reliance on panel bank submission. The use of the resulting synthetic LIBOR would be restricted to a narrowly defined set of tough legacy contracts that cannot be amended or transitioned away from LIBOR prior to LIBOR’s cessation.
In response to these announcements, ISDA promptly released a statement clarifying that neither the IBA’s nor the FCA’s announcement constituted an index cessation event for purposes of triggering fallbacks in standard derivative contracts.
IBA’s announcement provides some clarity on the likely LIBOR cessation timeline — at least with respect to GBP, EUR, CHF and JPY LIBOR. Given that IBA policies suggest a standard consultation period of one month, it seems rather unlikely that an announcement on the exact timing of LIBOR’s cessation would be made by year-end. Combined with its stated commitment to provide market participants with at least a year’s notice prior to discontinuation, early 2022 now appears a likely time frame for the cessation of all LIBOR tenors in currencies other than USD LIBOR.
The upcoming weeks are bound to provide much desired clarity on how the cessation of LIBOR will play out. With ISDA’s fallbacks protocol in place, IBA’s forthcoming consultation and continued progress on solutions to address tough legacy exposures, market participants will have a clearer picture of the financial impact of LIBOR’s cessation on their existing positions. In the case of USD LIBOR, firms should consider the risks of taking a wait-and-see approach. IBA’s statement by no means implies that market participants can count on its continued publication beyond 2021. But even in the case that the timing of USD LIBOR’s cessation should differ from other LIBOR currencies, we expect that firms will look to increase their efforts to proactively transition existing LIBOR-based instruments in order to minimize their exposure to LIBOR, including USD LIBOR.
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The OCC’s application bulletin publicized this week that a state-chartered cryptocurrency custodian filed an application to convert its state trust charter to a national bank. The company, which offers the crypto equivalent of traditional financial services such as exchange, custody, and lending, also offers more exotic crypto-specific services such as staking and governance. This follows statements made by Acting Comptroller Brian Brooks that the regulator is now prepared to accept payments charter applications, although its authority to do so is still pending litigation with several states.
While this is only one small step in the larger competition between the states and the OCC around the regulation of non-traditional financial services platforms, it’s a great leap forward for crypto. To date, digital asset firms have had to deal with piecemeal state-by-state regulation as money transmitters and trust companies, sometimes both. If successful, this conversion would blaze a path for a digital asset firm to become a national bank and therefore a “qualified custodian” able to hold assets for institutional investors. However, there are open questions remaining around the scope of the charter. For example, while the states have explicitly authorized a range of crypto services through their Trust or Trust-like charters, the OCC has only publicly declared safekeeping of assets as a core banking service and it’s unclear whether it is prepared to sanction trading and lending as well. Regardless, if successful, the granting of a banking charter to provide crypto services would likely trigger state parity statutes, which generally allow state-chartered banks to offer the same services that a similarly-chartered national bank may provide. If these efforts succeed, the OCC may open the door for all banks to enter the crypto space.
These notable developments hit our radar over the past week: