Europe and American Financial Regulatory Outlooks Could Diverge

As reported by Law360, European Central Bank (“ECB”) Executive Board Member and Supervisory Board Vice-Chair Sabine Lautenschläger suggested in a February 19 interview that the ECB intends to keep “European [banking] institutions on a tighter rein” than the United States appears to intend to do with domestic banks. Ms. Lautenschläger noted “it is imperative that we do not take a leap backwards, especially not on an international scale, but rather ensure that we continue to provide the banking sector, which is indeed global, with a set of international rules.” While noting that potential regulatory changes in the United States might have little effect in Europe given that the “Dodd-Frank Act contains many national rules,” her comments suggested that Europe will not necessarily follow President Trump’s lead in contemplating financial deregulation. As we reported in a prior client alert, President Trump signed an executive order on February 3rd requiring a review of the current financial regulatory regime to determine the extent to which it promotes seven “Core Principles” articulated in the order.

Ms. Lautenschläger’s remarks are only the latest from high ranking European financial officials signaling that Europe will not back track in the face of potential changes in the United States. Speaking to the Committee on Economic and Monetary Affairs on February 6, just three days after President Trump’s executive order was signed, ECB President Mario Draghi noted that “the last thing we need at this point is a relaxation of regulation….[T]he idea of repeating the conditions that were in place before the crisis is something that is very worrisome.”

Still, if President Trump begins to roll back the Dodd-Frank Act and companion regulations, Europe may face competitive pressures to deregulate. And, it is no secret that member states have been critical over at least some ECB policies. For example, in the fall, reports (see here and here, for example) surfaced that some European regulators threatened not to accept heightened capital requirements as the Basel regime is revamped. Similar criticisms emerged from the industry, which expressed fear that Europe’s regulatory environment may be less competitive if the U.S. deregulates. In addition, Germany’s central bank has repeatedly criticized the ECB for keeping interest rates low, claiming that German banks’ profits have been squeezed as a result. (See, for example, this recent Financial Times article.) Indeed, Europe is facing nationalist movements akin to those that some contend contributed to President Trump’s victory in the 2016 U.S. Presidential election, which could pressure leaders to push back on continent-wide financial mandates.

Regulators Release Guidance for Compliance with Variation Margin Requirements for Non-Cleared Swaps

Today, both the Federal Reserve and the Office of the Comptroller of the Currency (“OCC”) published guidance addressing the agencies’ “expectations for compliance” with minimum variation margin requirements for non-cleared swaps that become effective March 1, 2017. The guidance is relevant to any swap dealer registered with the Commodity Futures Trading Commission (“CFTC”) for which the Federal Reserve or the OCC is the prudential regulator. The guidance advises examiners to consider the following principles in conducting initial examinations for compliance with minimum variation margin requirements for non-cleared swaps:

1. While covered entities should attempt to comply with the rule in a timely manner, the guidance suggests that examiners will first focus on covered entities’ compliance efforts with respect to the counterparties to which they have the most significant exposures beginning March 1, 2017. For other counterparties, the guidance directs examiners to focus on whether covered entities are making a good faith effort to comply with the rule as soon as possible, and by no later than September 1, 2017.

2. Examiners should recognize the “scope and scale of changes necessary for each covered swap entity to achieve effective compliance for each of its non-cleared swap transactions.”

3. Covered entities should have “governance processes” aimed at “asse[ssing] and manag[ing]” credit and market risk arising from non-cleared swap transactions.

4. Examiners should consider covered entities’ implementation of compliance initiatives, such as “documentation, policies, procedures, … processes,” and training programs.

The guidance comes shortly after the CFTC provided a similar grace period for swap dealers not subject to oversight by prudential regulators. As with the CFTC’s no-action “transition,” the Federal Reserve’s and the OCC’s guidance requires non-compliant covered entities to work toward full compliance during the period from March 1 to September 1, 2017.

In a similar vein, the European Supervisory Authorities have also acknowledged requests from EU-regulated market participants to delay the effective date of the EU’s variation margin exchange rules, and stated that while EU regulators still plan to enforce the variation margin exchange rules after March 1, they would also undertake “case-by-case” assessments of each covered entity’s compliance and progress.

The Federal Deposit Insurance Corporation also issued a press release supporting the Federal Reserve’s and the OCC’s guidance, but noted that it currently does not regulate swap entities affected by the guidance.

Getting Started Guide for Recovery Planning

On September 29, 2016, the Office of the Comptroller of the Currency issued final guidance for recovery planning.  The Guidance applies to insured national banks, federal savings associations and federal branches of foreign banks with average total consolidated assets of $50 billion or more.

We partnered with Ernst & Young LLP to prepare a getting started guide for banks that are subject to the OCC’s recovery planning guidance.

CFPB Issues Request for Information on Alternative Data and Modeling Techniques

On February 16, 2017, the Consumer Financial Protection Bureau issued a request for information (“RFI”) regarding the potential benefits and risks of relying on alternative data and modeling techniques in the consumer credit marketplace.

In contrast with information that has traditionally defined a consumer’s credit history—such as debt repayment history and the existence of current or past loans, mortgages, and debt collection actions—the RFI describes “alternative data” as encompassing an array of nontraditional sources that lenders might consider when assessing consumers, such as:

  • Payment data relating to non-loan products requiring regular payments, such as rent, insurance, utilities, or cell phone bills.
  • Information about a consumer’s assets, which could include the regularity of a consumer’s cash inflows and outflows or information about prior income or expense shocks.
  • Data that may be related to a consumer’s stability, such as the frequency of changes in residences, employment, phone numbers, or email addresses.
  • Information about a consumer’s educational or occupational attainment, such as schools attended, degrees obtained, and job positions held.
  • Behavioral data, such as how consumers interact with a web interface or answer specific questions, or data about how they shop, browse, use devices, or move about their daily lives.
  • Data about consumers’ social and professional connections, including on social media.

In terms of “alternative modeling techniques,” the RFI provides the following list of machine learning processes as examples: “decision trees, random forests, artificial neural networks, k-nearest neighbor, genetic programming, ‘boosting’ algorithms, etc.”

In remarks at a field hearing on alternative data, CFPB Director Richard Cordray stated that alternative data and modeling techniques could help expand access to financial products and services to some of the 26 million Americans the agency estimates are “credit invisible” due to a lack of credit history and to some of the additional 19 million Americans who lack sufficient traditional data for generating a credit score.

The RFI identifies the following as potential benefits from expanded use of alternative data and modeling techniques:

  • Greater credit access, particularly for the unbanked and underbanked.
  • Enhanced creditworthiness predictions, including for consumers who already have usable credit histories.
  • More timely information, lower costs, and better service and convenience, largely through the increased automation of credit-checking tasks.

As potential risks or challenges, the RFI highlights:

  • Discrimination risks, given that alternative data can potentially serve as proxies for groups protected by antidiscrimination laws.
  • Privacy issues, in terms of both data collection and sharing.
  • Data quality issues, due to the nature of the types of data used or due to a lack of the accuracy and quality obligations that are commonly expected for traditional data.
  • Issues with transparency, controlling and correcting data, and consumer education, particularly given the difficulty of explaining complex machine learning processes in consumer-friendly terms.
  • Increased difficulties in improving one’s credit standing, especially when the underlying calculation includes data outside the consumer’s control, such as data relating to behavior by peers or broader consumer segments.
  • Unintended or undesirable effects, such as the possibility of an algorithm mistaking a servicemember’s frequent changes in base assignments as a sign of residential instability.
  • Risks associated with other legal obligations, such as CRA requirements or UDAAP prohibitions.

TCH Report on Redesign of the AML/CFT Regulatory Framework

The Clearing House published this week a report that highlights potential anachronisms and inefficiencies in current U.S. anti-money laundering / counter-financing of terrorism regulation.  The report makes 8 core recommendations for reform, including the following:

  • Centralizing Regulatory Responsibility:  “The Department of Treasury, through its Office of Terrorism and Financial Intelligence (TFI), should take a more prominent role in coordinating AML/CFT policy across the government [and] FinCEN should reclaim sole supervisory responsibility for large, multinational financial institutions that present complex supervisory issues.”
  • Transparency in Beneficial Ownership:  “Congress should enact legislation, already pending in various forms, that requires the reporting of beneficial owner information at the time of incorporation, preventing the establishment of anonymous companies.”
  • Innovation and Big Data:  “Treasury TFI should strongly encourage innovation, and FinCEN should propose a safe harbor rule allowing financial institutions to innovate in a[] [financial intelligence unit] ‘sandbox’ without fear of examiner sanction.”  In addition, “Policymakers should further facilitate the flow of raw data from financial institutions to law enforcement to assist with the modernization of the current AML/CFT technological paradigm.”

Congress Mulling Proposals to Curb, Abolish CFPB

On February 14, 2017, U.S. Senator Ted Cruz (R-TX) and Rep. John Ratcliffe (R-TX) introduced a bill in the House and Senate to abolish the CFPB.

Excluding its introductory language, the bill reads in full: “The Consumer Financial Protection Act of 2010 (12 U.S.C. 5481 et seq.) is repealed, and the provisions of law amended or repealed by that Act are restored or revived as if the Act had not been enacted.” The legislation is largely symbolic, given that Senate Democrats intend to filibuster major changes to the Consumer Financial Protection Bureau and given the practical challenges involved in deconsolidating the Bureau’s functions back to the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Trade Commission, the Department of Housing and Urban Development, and the National Credit Union Administration.

Nonetheless, the proposal—which has four Republican cosponsors in the Senate and seventeen in the House—reflects a growing appetite among certain members to change the Bureau in substantial ways.

The bill comes on the heels of a leaked February 6, 2017, memorandum circulated by House Financial Services Committee Chairman Jeb Hensarling (R-TX) to the Financial Services Committee Leadership Team outlining changes expected to be made to the soon-to-be-reintroduced Financial CHOICE Act. Along with a package of other revisions to the Dodd-Frank Act, the legislation outlined in the memorandum would dramatically reduce the CFPB’s role by eliminating the Bureau’s UDAAP authority, supervisory authority, research and consumer education functions, and consumer complaint database.  It would also circumscribe the Bureau’s rulemaking and enforcement authority. Interestingly, the memorandum reverses the proposal in the most recent version of the CHOICE Act to replace the CFPB Director with a five-member bipartisan commission and would instead retain the single-director structure while allowing the President to replace the director at will.

D.C. Circuit Grants Rehearing En Banc in PHH

The D.C. Circuit today granted rehearing en banc in PHH Corp., et al. v. Consumer Financial Protection Bureau (“PHH”), vacating the prior order that, among other things, found the Consumer Financial Protection Bureau’s (“CFPB”) structure unconstitutional. The court directed the parties to brief a set of questions related to: the constitutionality of the Bureau’s structure; whether the court could resolve the case solely on statutory grounds;  and whether another case, involving the status of Administrative Law Judges (“ALJs”), should affect the outcome here.   Oral argument is set for May 24. Briefs for PHH (and any amici curiae in support of PHH) are due March 10.  Briefs for the CFPB (and any amici curiae in support of the CFPB) are due March 31.

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President Trump Signs First Congressional Review Act Disapproval Resolution in 16 Years

On February 14, 2017, President Donald Trump signed a resolution nullifying a Securities and Exchange Commission (“SEC”) regulation that required energy companies to disclose foreign payments. This marks the first successful use of the Congressional Review Act (“CRA”) procedure in 16 years, and only the second successful use since the statute passed in 1996.  Several more such resolutions are likely to follow, potentially including a resolution nullifying the Consumer Financial Protection Bureau’s (“CFPB”) prepaid card rule.

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CFTC Issues No-Action Position on Variation Margin Rules that Provides Swap Dealers with a Grace Period for the Completion of Documentation and the Implementation of Operational Processes

On February 13, 2017, the staff of the Division of Swap Dealer and Intermediary Oversight (“DSIO”) of the CFTC issued CFTC Letter No. 17-11 (the “Letter”) providing a time-limited no-action position with respect to swap dealers (“SDs”) who fail to collect and/or post variation margin in connection with uncleared swaps.

Acting Chair Christopher Giancarlo commented that such relief was necessary because “the facts on the ground cannot be ignored that as much as ninety percent of those end-users are not ready to meet the new requirements despite their best efforts to do so.” Acting Chair Giancarlo continued, stating “[t]his action by the CFTC does not change the scheduled time of arrival for the agreed margin implementation. It just foams the runway to ensure a safe landing.” (statement here)

Under CFTC Regulation 23.153, SDs and major swap participants (“MSPs”) that are not regulated by a Prudential Regulator are required to collect and post variation margin with respect to uncleared swaps with “swap entities” and “financial end users”. Many market participants have found the compliance process complicated and difficult, since such entities typically have a large number of credit support documents to amend to bring into comply with the variation margin requirements (defined in the Letter as the “March 1 VM Requirements”).

As a result of requests for transitional relief from numerous market participants, the CFTC issued a limited no-action position that DSIO will not recommend an enforcement action against an SD that does not comply with the March 1 VM Requirements prior to September 1, 2017, subject to the following conditions:

1. The SD does not comply with the March 1 VM Requirements with respect to a particular counterparty solely because it has not, despite good faith efforts, completed necessary credit support documentation (including custodial segregation documentation, if any) with such counterparty or, acting in good faith, requires additional time to implement operational processes to settle variation margin in accordance with the March 1 VM Requirements with such counterparty;

2. The SD uses its best efforts to continue to implement compliance with the March 1 VM Requirements without delay with each counterparty following March 1, 2017;

3. To the extent the SD has existing variation margin arrangements with a counterparty, it must continue to post and collect variation margin with such counterparty in accordance with such arrangements until such time as the SD is able to comply with the March 1 VM Requirements with respect to that counterparty; and

4. No later than September 1, 2017, the SD complies with the March 1 VM Requirements with respect to all swaps to which the March 1 VM Requirements are applicable entered on or after March 1, 2017.

Importantly, DSIO staff has stressed that the Letter does not “postpone” the compliance date, noting in the companion Q&A that it “simply affords market participants with a grace period to come into compliance.” In a similar vein, the Letter states that “SDs are expected to make continual, consistent, and quantifiable progress toward compliance with the March 1 VM Requirements with all counterparties on a rolling basis during the no-action period” and that the DSIO would be monitoring the progress of SDs relying on the Letter.

While this letter provides time for SDs to comply with the CFTC’s rules on margin, as of the date of this publication, the March 1, 2017 compliance date for entities subject to the Prudential Regulators’ rules on variation margin remains in place and cross-border coordination remains unclear.