CFTC Adopts Final Rules on Capital Requirements and Cross-Border Application of the Registration Thresholds for Swap Dealers and Major Swap Participants

At open meetings on Wednesday, July 22, and Thursday, July 23, the CFTC approved, by a 3-2 vote, two significant final rules implementing provisions in the Dodd-Frank Act.  The first rule imposes capital requirements on swap dealers (“SDs”) and major swap participants (“MSPs”) that are not subject to supervision by a banking regulator, as well as financial report requirements for all SDs and MSPs.  The second rule addresses the cross-border application of the SD and MSP registration thresholds and establishes a formal process for requesting comparability determinations for such requirements from the CFTC.  Each final rule is summarized below. Continue Reading

Judgement of the BVerfG dated 5 May 2020: ECB’s Public Sector Asset Purchase Program

I.    Judgement

On 5 May 2020, the German constitutional court (Bundesverfassungsgericht BVerfG“) decided in a landmark judgment about the compatibility of the Public Sector Asset Purchase Program launched by the European Central Bank (“ECB“) in March 2015 (“PSPP“)[1] with German constitutional law.

The BVerfG expressly excluded the EUR 750 billion Pandemic Emergency Purchase Program (“PEPP“) launched in March 2020 to mitigate the economic impact of the COVID-19 pandemic from its decision.

In brief, the BVerfG ruled that with the establishment of the PSPP in 2015 the ECB by far exceeded its competences and, therefore, acted ultra vires. The main reason is that the decision of the ECB lacks sufficient proportionality considerations due to insufficient balancing of the ECB’s monetary policy objective against potential effects on this policy.

More fundamentally, the judges of the BVerfG further ruled that they are not bound by the judgment of the Court of Justice of the European Union (“CJEU“)[2]. The CJEU decided upon submission by the BVerfG in 2018 that the ECB had the power to establish the PSPP. The BVerfG argues that while generally the interpretation and application of the laws of the European Union fall within the responsibility of the CJEU (so-called principle of uniformity and coherence of EU law), there are – under the established case law of the BVerfG – exceptional cases of substantiated ultra vires challenges where the BVerfG is not bound by judgments of the CJEU. According to the BVerfG, this follows from the legal structure of the European Union which has not yet passed the threshold to a federal state. The BVerfG rejects the principle according to which the Member States, via the acceptance of the EU Treaties, have given power to the EU institutions, in particular to the CJEU. According to the BVerfG, the Member States of the European Union are still “Masters of the Treaties”. The European Union does not have the power to determine its own competences (so-called ‘competence-competence’). As a consequence,  Member States are not bound by decisions of EU institutions which would effectively amount to a treaty amendment or an expansion of competences which would in turn imply the existence of a competence-competence of EU institutions.

The BVerfG also ruled that the decision of the ECB about the PSPP does not infringe the prohibition of monetary financing under Art. 123(1) of the Treaty of the Functioning of the European Union (TFEU).

The BVerfG defined the following legal consequences resulting from the ultra vires infringement:

  • As of the end of a three months period following the judgement of the BVerfG, Deutsche Bundesbank will no longer be allowed to participate in the implementation and execution of the ECB-Decision, unless the ECB describes by the end of that period in a comprehensible and substantiated manner that the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects.
  • The German government and the German parliament (Bundestag) must take active steps against the PSPP in its current form, e. they are required to take steps seeking to ensure that the ECB conducts an improved proportionality assessment.

By way of background, the BVerfG has no legal power over institutions of the European Union. Accordingly, the ECB is not bound by the judgment of the BVerfG and, thus, not legally bound to implement its orders. Only German institutions (such as Deutsche Bundesbank, the German government and the German parliament) must observe the judgement of the BVerfG.

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OCC Interpretation Paves Way for Banks to Custody Cryptocurrency

Today, the OCC released an interpretive letter concluding that national banks and federal savings associations (together, “banks”) may permissibly provide cryptocurrency custody services for customers.  The letter, written by Chief Counsel Jonathan Gould, describes custody of cryptocurrency as a modern form of the traditional banking activity of providing safekeeping and custody services, which the agency has previously permitted banks to conduct through electronic means.  The letter also “reaffirms the OCC’s position that national banks may provide permissible banking services to any lawful business they choose, including cryptocurrency businesses, so long as they effectively manage the risks and comply with applicable law.”

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A New Vision for Europe’s Capital Markets

 – Final Report of the High Level Forum on the Capital Markets Union –

I. Capital Markets Union

The Capital Markets Union seeks to remove regulatory and non-regulatory obstacles to the free movement of capital across borders, thus creating new opportunities across the Single Market for businesses, savers and investors and increasing the financial and economic resilience of the European Union. It is a cornerstone of Europe’s integration, a source of more sustainable economic growth and an important pre-condition for the strengthened role of the Euro.

Although significant progress has been made since the Capital Markets Union Action Plan of 2015, the Capital Markets Union has not been finalized yet. The European Union to a large extent still has 27 individual capital markets.

The Capital Markets Union is particularly needed to:

  • improve the resilience of the EU financial system;
  • diversify funding choices of European companies of all sizes and at all stages of their development;
  • improve the reach of retail investors;
  • foster cross-border investments and the provision of cross-border financial services;
  • build a unique competitive advantage globally as an efficient and well-functioning sustainable capital market; and
  • mobilize the private capital for a green Europe – notably supported by the European Green Deal – and a digital Europe.

The COVID-19 crisis as well as Brexit make the finalization of the Capital Markets Union even more urgent. In the aftermath of COVID-19, the Capital Markets Union should act as a catalyst for mobilizing private investments into companies to complement the unprecedented public support agreed on by EU authorities and Member States.

II. Final Report of the High Level Forum

A. Overview

The European Commission created a High Level Forum on Capital Markets to get the input from a broad range of stakeholders on how to finalize the Capital Markets Union. The High Level Forum published its Final Report on the Capital Markets Union in June 2020 (the “Report“). The Forum has brought together 28 experts from a wide spectrum of professional and national backgrounds to recommend an array of measures that should lead to the finalization of the capital Markets Union.

The Report does not contain abstract ideas or high level principles that should be achieved, but very precise and clear recommendations on what should be done in order to move Europe forward and create a Capital Markets Union. The 17 clusters of measures presented in the Report are mutually reinforcing and dependent on each other. A call for feedback is open for three weeks to gather the opinions from multiple stakeholders on the recommendations of the Forum.

The implementation of most of the measures is scheduled for 2021 or 2022, which seems to be – although not entirely unrealistic – at least a very ambitious timeline.

B. Recommendations

The High Level Forum proposes the following recommendations:

  • Setting up a European Single Access Point (ESAP) for company data in order to minimize fragmented and scattered company data;
  • Targeted review of the ELTIF framework and introduction of tax incentives as currently too few investment vehicles are available for late stage and long-term investment;
  • Targeted review of Solvency II in order to ease insurers’ investments in equity;
  • Implementation of Basel III rules in the prudential framework for banks to avoid banks’ withdrawal from market making activities and increase banks’ investments in equity;
  • Targeted review of the securitization framework to extend banks’ funding to SMEs;
  • Alleviation of listing rules as public listing is currently too burdensome and costly;
  • Implementing clear rules for the use of crypto/digital assets to raise the potential of this asset class;
  • Targeted changes to CSD passport, supervision and cross-currency rules in CSDR in order to facilitate cross-border trading;
  • Targeted review of SRD 2 to facilitate the exercise of ownership rights by investors;
  • Standardization of contractual terms for the provision and use of cloud services by EU financial operators;
  • Creation of a pension dashboard in Member States including pension tracking systems for individuals to make pensions more sustainable and adequate;
  • Establishing and implementing measures to foster financial literacy and engagement to strengthen retail investors’ trust in capital markets;
  • Targeted amendments to IDD, MiFID II and PRIIPs Regulation to improve disclosure, fairness and quality of financial advice as well as the creation of a voluntary pan-European quality mark (label) for financial advisors;
  • Creation of a regulatory framework for open finance by improving data sharing;
  • Legislative proposal to introduce a standardized system for WHT relief at source as well as a proposal to harmonize tax definitions, processes and forms as currently lengthy and costly WHT reclaim processes deter cross-border investments;
  • Targeted harmonization of central elements in corporate insolvency law;
  • Legislative amendments to strengthen governance, powers and toolkit of ESMA and EIOPA.

In the following we provide an overview of some of the above measures which are of particular relevance for the financial services industry.

1. Setting up a European Single Access Point (ESAP) for company data

The idea is to establish an EU-wide digital access platform (European Single Access Point, or “ESAP”) to companies’ public financial and non-financial information, as well as other financial product or activity-relevant public information, which shall be freely accessible to the public and free of fees or license use. The purpose of the creation of ESAP is to help investors in their investment decisions by providing easily accessible, reliable, understandable and comparable public information. To make investment decisions, investors in capital markets require information about issuers of securities. The availability and quality of such public information is a measure of the transparency of a capital market, which is itself a driver of investor confidence in capital markets.

2. Legislative proposal to introduce a standardized system for WHT relief at source

The proposal is to implement in EU law common definitions, common processes, and a single form, relating to withholding tax relief at source procedures and their streamlining. To achieve significant alleviations for stakeholders, it is recommended to introduce a standardized system for relief at source of withholding tax based on authorised information agents and withholding agents.

The main issue as regards the current WHT situation is its inefficient, prone to fraud/abuse refund procedures. While national laws of each individual Member States in principle allow for a refund of the tax withheld to nonresident investors, those refund procedures tend to be extremely resource-intensive, costly and lengthy for both tax administrations and taxpayers, leading to late refunds. This ultimately affects cross-border investment and fragments the single market.

3. Targeted amendments to MiFID II

Apart from proposals concerning the MiFID II inducements provisions and the creation of a voluntary European quality label for financial advisors, the High Level Forum suggests introducing a non-professional Qualified Investor (QI) category into MiFID II with the following characteristics:

  • Investment firms and credit institutions would have the option, but not an obligation, to apply the additional categorization to their clients.
  • Upon his/her explicit request and subject to meeting the eligibility criteria, a retail client may voluntarily opt in to become a QI.
  • The eligibility criteria should be cumulative and should include a proven track-record of trading different types of financial instruments over at least three years and financial assets of at least EUR 50,000 at the investor’s personal disposal.
  • Investment firms and credit institutions should not be under obligation to ensure continuous compliance of QI with the eligibility criteria.
  • A QI may revoke his/her QI-status at any point in time and upon his/her explicit request.
  • Information requirements to QI should be considerably reduced as compared to the requirements applicable to retail investors. A QI should have access to a wider range of investment products.

4. Implementing clear rules for the use of crypto/digital assets

Currently, there is no unique interpretation of the MiFID and E-Money Directive rules as regards the classification of crypto/digital assets as financial instruments/e-money in the European Union. Considering that the classification of an asset as financial instrument/e-money has far-reaching regulatory consequences (potential license requirements, applicability of the rules of conduct under MiFID II etc.), this discrepancy in national laws results not only in a distortion of competition in the various Member States but, more importantly, in a fragmentation of the European Market which is a huge hurdle for the distribution and marketing of crypto and digital assets within the European Union. In light of this, the High Level Forum suggests amending the relevant EU financial legislation, in particular elaborating a uniform and encompassing definition of crypto/digital assets as financial instruments/e-money and ensuring proper and uniform supervision in the Member States.

The Covington Financial Services team will continue to monitor the situation and update you on any new developments.


By John Ahern, Sophie Bertin, Alexis Lautenberg and Marco Brand

CFPB Finalizes Amendments to Payday Lending Rule

Today, July 7, 2020, the Consumer Financial Protection Bureau (“CFPB”) released final amendments to its small-dollar lending rule published in November 2017 (the “2017 Rule”), specifically repealing the mandatory underwriting provisions of the rule.  The CFPB did not rescind or alter the payments provisions of the 2017 Rule, and instead ratified those provisions and will move forward to implement those provisions.  We address each aspect of the final amendments below.

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Federal and State Regulators Issue Interagency Guidance Regarding Assessing Safety and Soundness During COVID-19

On June 23, 2020, the Federal Reserve, FDIC, OCC, NCUA, and state financial regulators (“the agencies”) issued guidance outlining the supervisory principles for assessing the safety and soundness of institutions amidst the COVID-19 pandemic. The guidance highlights that while examiners will consider the unique stresses caused by COVID-19 on financial institutions, the agencies will continue to assess institutions in accordance with existing policies and procedures and may provide supervisory feedback, or downgrade institutions’ composite or component ratings under the applicable rating system when conditions have deteriorated. Although an assessment may result in a lower rating, in determining the appropriate supervisory response, examiners will consider whether weaknesses were caused by external economic problems related to the pandemic or by intrinsic risk management and governance issues. Overall, the guidance suggests that while examiners will take into account the unique impact of the pandemic on financial institutions, ratings will depend on each individual institution’s ability to assess and manage risk appropriately, including taking appropriate action in response to stresses caused by the COVID-19 pandemic.

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FFIEC Releases Joint Statement on LIBOR Transition

Yesterday, July 1, the Federal Financial Institutions Examination Council released a Joint Statement on Managing the LIBOR Transition (the “Joint Statement”).  The Joint Statement discusses the LIBOR replacement issues at a high level and “does not establish new guidance or regulation.”  The Joint Statement does not mandate SOFR or any other rate as the replacement for LIBOR.

What the Joint Statement does do is lay out supervisory expectations for an insured depository institution’s plans for the LIBOR transition.  These plans will be reviewed at the institution’s next safety and soundness examination – which may occur well before LIBOR is discontinued.

For many institutions, the critical supervisory issue is likely to be how an institution plans to implement the fallback language in existing contracts.  Fallback or replacement language is typically not uniform in these contracts and may not address the permanent cessation of LIBOR.  Further, according to the Joint Statement, LIBOR transition plans should include the identification of LIBOR-related exposures, efforts to include fallback language or use alternative reference rates in new contracts, operational preparedness, and consumer protection considerations.

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NY DFS Launches Virtual Currency Initiatives

The New York State Department of Financial Services (DFS) launched a series of virtual currency initiatives last week meant to expand access to and clarify rules regarding the use of virtual currencies in the state. First, DFS has proposed a conditional licensing framework for virtual currency providers. In connection with this framework, DFS has signed an MOU with the State University of New York (“SUNY”) to launch a new virtual currency program. Second, DFS has issued final guidance regarding self-certification of new coins and the process by which DFS “Greenlists” coins. Third, DFS has issued new online virtual currency-related resources for the benefit of market participants.

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U.S. Supreme Court Holds that CFPB Director is Removable by the President

Earlier today, the U.S. Supreme Court released its long-awaited decision in the case of Seila Law LLC v. Consumer Financial Protection Bureau, a constitutional challenge to the structure of the CFPB.  The Court held that (i) the provision of the Dodd-Frank Act that protects the CFPB Director from removal by the President except for cause violates the constitutional separation of powers, and (ii) this provision is severable from the rest of the statute.  As a consequence of the decision, the CFPB Director is now removable by the President; the agency retains its full authority. Continue Reading

CFTC’s Civil Monetary Penalty Guidance: A Perspective from a Former CFTC Regulator

On May 20th the U.S. Commodities Futures Trading Commission (the “CFTC”) Division of Enforcement (the “Division”) announced new guidance for Division staff to consider when recommending civil monetary penalties in an enforcement action (the “CMP Guidance” or the “Guidance”).  As a former CFTC regulator who brought dozens of cases over a 13 year career in the Division of Enforcement, Anne Termine provides an explanation of both the art and science involved in the CFTC’s decision-making process for assessing penalties in enforcement actions. Utilizing her perspective and experience as a former CFTC regulator, the alert explains the background and reason for the CMP Guidance; deciphers the Guidance factors and how they can be used when negotiating a settlement or reviewing internal systems and controls; and examines the missing piece of the equation – the quantitative component in the Division’s penalty decision-making process and how this piece can be filled in by understanding how to interpret and distinguish precedent CFTC enforcement cases.

Click here to read our Covington Alert summarizing the key features of the final rule.