Earlier today, the Senate voted 84-13 to pass the National Defense Authorization Act (NDAA), which includes a number of changes to the anti-money laundering (AML) regime. Specifically, it requires companies to disclose their “ultimate beneficial owners” (i.e., those who own at least 25% or exercise significant control over the company) to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN), which will develop a registry accessible by law enforcement or financial institutions (with customer consent). It contains a strong push to advance financial institution implementation of more innovative financial crime detection analytics and technologies, and it also requires that Treasury and FinCEN provide more transparency into their examination and supervision priorities.
The law also contains several provisions to expand FinCEN’s reach and strengthen its enforcement. Foreign financial institutions (FFIs) will be required to comply with subpoenas to produce and authenticate customer records, even if their home country law prohibits them from doing so. Banks that run afoul of this requirement will be subject to increased penalties and potentially being cut off from dealing with their US correspondent bank. The law also contains a whistleblower program that would provide those that report wrongdoing with up to 30% of the enforcement penalties and expands FinCEN’s scope to include digital currencies as well as art and antiquities dealers. While the law does not include any adjustment to the dollar amounts that trigger reporting thresholds, it does call for Treasury to allow for more streamlined reporting of certain information and to examine whether to raise the thresholds going forward. Notably, it requires that FinCEN establish automated processes for firms to file “noncomplex” suspicious activity reports and currency transaction reports.
Before becoming law, the NDAA must be signed by the President, who has threatened to veto it for reasons unrelated to its AML provisions.
While the NDAA passed with enough votes to overturn a potential veto, it remains unclear whether Congress would vote to do so. If signed into law, it will represent the most significant set of changes to the AML framework since the 2001 USA PATRIOT Act. The beneficial ownership registry will mandate more corporate transparency and prevent bad actors from hiding behind a web of shell companies, a common practice exposed by the Panama Papers in 2016. It will also significantly ease the operational burden for many banks as they will be able to rely on the registry to collect and maintain customer information. However, banks should be aware that they are still subject to FinCEN requirements for ongoing customer monitoring and that they will still need to collect beneficial ownership information for their foreign clients that are not subject to registration.
Meanwhile, other provisions of the rule mean that FFIs and entities newly brought into scope have work to do. Digital currency platforms that are subject to New York Department of Financial Services registration will be able to leverage the work they have already done to comply with these new requirements, but other firms will have to begin developing or enhancing reporting programs. While many large art and antiquities dealers have some AML capabilities built into their overall compliance or risk programs, they generally would not satisfy regulatory expectations and many will have to begin building standalone programs from scratch. Chinese FFIs will need to develop new processes to approve client disclosures with their home regulators, but the possibility of getting the regulators to agree may be impacted by the status of the US-China geopolitical relationship.
One item on the industry’s wishlist left missing is an adjustment to reporting thresholds, which banks have long argued are out-of-date considering the significant amount of inflation since they were originally set in 1970. However, the potential for streamlined and automated reporting of less-complex reports could potentially result in a substantial reduction of the reporting burden depending on how it is ultimately implemented.
Stay tuned for our First take next week for more information on the AML reform provisions of the NDAA.
Today, the Fed, Harvard Law School, and the University of Pennsylvania’s Wharton School hosted a conference on bank supervision featuring speeches by FDIC Chairman Jelena McWilliams and Fed Vice Chair for Supervision Randal Quarles. McWilliams’ speech discussed the principles that guide the FDIC’s approach to supervision and key initiatives she has undertaken as Chairman including increasing transparency around examinations and appeals, clarifying the potential sources of supervisory criticism, and advancing technological adoption by the FDIC and the institutions it oversees.
In his speech, Quarles discussed the targeted changes the Fed has recently made to its regulatory framework before turning to what he described as the more difficult question of how to improve supervision. In particular, he focused on supervisory ratings due to their consequences and subjective components and discussed ways to make them more consistent and predictable. He raised the possibility of clarifying the Risk Management, Financial Condition, and Impact (RFI) rating system and CAMELS ratings1 similarly to the recently adopted three-component Large Financial Institution (LFI) rating system in terms of having clear weighting of the factors that go into the ratings. He also advocated for more study of the theory behind ratings in order to provide more consistency and empirical support for the factors that lead to a satisfactory or unsatisfactory rating. As related policy and procedural changes, he suggested the possibility of subjecting ratings to the scrutiny of a group of independent, diverse reviewers and providing clear weights to certain aspects of examinations that stem from concrete regulatory standards.
In response to questions, Quarles insisted that the suggestions in his speech are in no way intended to weaken supervision and defended the Fed’s decision to allow limited dividends by pointing out that banks have continued to accumulate capital throughout the crisis. He also noted that they are undergoing additional stress testing and confirmed that the Fed intends to allow banks to be flexible with their distributions within their stress capital buffers (SCB) after the pandemic.
In addition to the two speeches from regulators, this conference featured a breadth of diverse and thoughtful discussion about the nature of bank supervision. While there is certainly some disagreement about the best ways to improve supervision, it is clear that both Quarles and McWilliams intend to leave their mark on their respective agencies, particularly in terms of increasing transparency and accountability. As McWilliams noted, “talk is cheap” and her initiatives at the FDIC are intended to be codified as changes to procedures and regulations as much as possible. Similarly, if Quarles’ ideas get adopted as policy, he would affect bank supervision in fundamental ways. The industry would likely welcome more objectivity and consistency in their ratings but the devil is in the detail and ambitious changes like subjecting ratings to review by an independent panel could see some pushback. The looming potential for President Biden to appoint a new Vice Chair for Supervision in late 2021 may impede any drastic changes, especially if they are seen as potentially eroding the supervisory framework.
1The RFI rating system applies to bank holding companies and non-insurance and non-commercial savings and loanholding companies with less than $100 billion in total consolidated assets. It also comes with a Composite (C) and Depository Institution (D) rating. The CAMELS rating system confidentially assesses banks across capital adequacy, asset quality, management, earnings, liquidity, and sensitivity. The Fed and FDIC requested comments on the consistency and use of the CAMELS system last winter.
On Wednesday, the SEC unanimously voted to approve a final rule that would expand the pricing data available in the public data feed by securities information processors (SIP) for national market system (NMS) stocks. It would also allow new “competing consolidators” to provide alternatives to the two SIP operators: the New York Stock Exchange and Nasdaq. Significantly, the rule requires the SIP operators to disclose buying and selling interest at not just the best bid-offer price but the next five levels lower and higher for all NMS stocks. It also requires that they provide data on smaller sets of shares rather than sets of 100 shares for higher-valued stocks and expands information on auctions to include prices at opening and closing. The final rule provides a detailed transition plan that will go into effect in 2021.
The final rule will be welcomed by market participants who have long argued that there is a two tier model for obtaining access to market data, forcing them to decide between paying for premium feeds from the SIP operators or using the slower, less data rich public feeds. The final rule seeks to put an end to this two-tier model and create a more level playing field. The SIP operators are strongly opposed to the rule as they stand likely to lose revenue due to new competitors cutting into their market share and the enhanced public data resulting in some market participants canceling their subscriptions to premium feeds. Statements from the SIP operators that the rule violates federal law indicates that the final rule may be contested in court going forward.
On Tuesday, the CFTC released a series of final rules related to swap execution facilities (SEFs), margin requirements and electronic trading. The SEF reform rules eliminate a requirement that they include post-execution allocation information in their audit trail data and provide additional transparency and flexibility around certain financial calculations and annual compliance report requirements. They also withdraw a number of provisions that were included in the agency’s 2018 proposal, including registration requirements for interdealer brokers and aggregators of single-dealer platforms, disclosure-based trading and execution rules, and a limitation on the breadth of trading-related communications allowed for SEF participants while they are away from the trading system or platform.
The rules amending margin requirements revises the calculation period for the “average aggregate notional amount” to align with Basel Committee for Banking Supervision standards and allows nonbank swap dealers and major swap participants to use the risk-based model calculation of initial margin to determine the amount to be collected from the counterparty. For electronic trading, the CFTC sets out a principles-based framework for trading platforms, explaining that they must have rules to prevent electronic trading-related market disruptions, implement related controls, and notify the commission of significant market disruptions.
Two days after the announcement of these new rules, CFTC Chair Heath Tarbert announced that he intends to resign from his position “in early 2021.”
The various rule finalizations are largely non-controversial technical tweaks designed to increase flexibility and transparency while aligning thresholds with international standards. The more controversial aspects of the rules lie within what is omitted rather than the content itself. For example, the two Democratic Commissioners’ dissents note that while the electronic trading principles are helpful, they do not sufficiently change the status quo in light of past significant market volatility events. They also assert that the automated trading proposal containing prescriptive rules that the agency withdrew in June would have better addressed the issue. The withdrawal of many aspects of the 2018 SEF reform proposal may come as a relief to industry participants that objected to a broad overhaul of the regulatory framework considering the significant effort they have spent complying with the existing regime. Going forward, we could see some ideas from the proposal return, but they will likely come in the form of more targeted and incremental changes rather than sweeping reform.
These notable developments hit our radar over the past week:
1. Supervisors stress the importance of ending the use of LIBOR as soon as possible. Over the past week, supervisors made the following comments:
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2. Agencies announce resolution plan actions. On Wednesday, the Fed and FDIC announced the following resolution plan actions:
3. CFPB releases rulemaking agenda. Today, the CFPB released its Fall 2020 Rulemaking Agenda which includes a rule to address the LIBOR transition and possible revisions to the Home Mortgage Disclosure Act.
4. FDIC set to finalize new rules. Earlier today, the FDIC announced an open meeting to consider several final rules, including its brokered deposits rule and a rule regarding the parent companies of industrial loan companies.
Financial Services Leader, PwC US