FHFA Instructs Federal Home Loan Banks to Transition Away From Purchase of LIBOR-Tied Assets

 

On September 27, the Federal Housing Finance Agency (FHFA) instructed the Federal Home Loan Banks to stop practice of purchasing any investments with assets tied to LIBOR with maturities beyond December 31, 2021, as part of the transition away from LIBOR. As of March 31, 2020, according to the FHFA policy, Federal Home Loan Banks will be restricted from entering into all other LIBOR-based transactions, subject to certain limited exceptions. Release.

U.S. Treasury Issues Guidance on the Transition from Interbank Offered Rates to Other Reference Rates

 

The U.S. Department of the Treasury issued proposed regulations that provide guidance on the transition from LIBOR. One set of such regulations provides that substituting a “qualified rate,” such as the Secured Overnight Financing Rate (SOFR) published by the Federal Reserve Bank of New York, for an interbank offered rate in a debt instrument or certain other instruments will not result in a re-issuance under Section 1001 of the U.S. Internal Revenue Code. The proposed regulations can be viewed here. Comments and requests for a public hearing must be received by November 25.

SEC Announces Three New Rulemakings

 

On September 26, the Securities and Exchange Commission (SEC) announced three significant rulemakings. Summarized in a Public Statement by Chairman Jay Clayton, they are designed to achieve the following objectives.

  • The Modernization of the Approval Framework for ETFs. This new rule: “(1) sets forth a clear and consistent framework that will allow exchange-traded funds (ETFs) meeting certain standardized conditions to come to market without obtaining an individualized exemptive order, and (2) amends certain forms to enhance disclosures for investors.”
  • The Expansion of “Testing-the-Waters” Communications to All Issuers. This new rule: “will extend to all issuers the flexibility provided by the JOBS Act to communicate with institutional investors about potential IPOs and other registered offerings to better gauge market interest.”
  • The Enhancement of the Regulation of the OTC Markets. These proposed amendments to the rules governing the publication of quotations for over-the-counter (OTC) securities are “designed to better protect investors from fraud and manipulation, while at the same time facilitating more efficient OTC trading in certain well-capitalized issuers.”

Chairman Clayton emphasized that these rulemakings “share common themes.” Foremost, they “modernize decades-old regulations . . . taking account of our experience, advances in communications technology and changes in the operation of our markets.” Significantly, these “common sense actions better align our regulations with the preferences and investor protection interests of our long-term Main Street investors, while also facilitating capital formation.”

SEC Adopts New Rules and Amendments under Title VII of Dodd-Frank

 

On September 19, the SEC adopted new rules and amendments under Title VII of the Dodd-Frank Act establishing recordkeeping and reporting requirements for security-based swap dealers and major security-based swap participants, and amending those requirements for broker-dealers.  The new rules aim to allow the SEC to better monitor compliance and reduce risk to the market. Release.

Amendments to the Volcker Rule are Adopted but Leave Much to be Done

 

On September 18, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (the Board), the Federal Deposit Insurance Corporation, the Securities and Exchange Commission and the Commodity Futures Trading Commission  (collectively, the Agencies) adopted amendments to the 2013 rules (the 2013 Rules) under Section 13 of the Bank Holding Company Act (BHC), commonly known as the Volcker Rule (the 2019 Amendments).

The Volcker Rule and the 2019 Amendments.  The Volcker Rule imposes complex restrictions on the ability of a “banking entity” and a “nonbank financial company” supervised by the Board to engage in proprietary trading and to have certain interests in, or relationships with, non-registered, private funds, such as hedge funds and private equity funds (each, a Covered Fund).[i] As stated in the Release adopting the 2019 Amendments (the Release),[ii] the “amendments are intended to provide banking entities with clarity about what activities are prohibited and to improve supervision and implementation of section 13.”   The Release provides that banking entities must comply with the final amendments by January 1, 2021 and that the 2013 Rules will remain in effect until their compliance date. Alternatively, the Release provides that a banking entity may voluntarily comply, in whole or in part, with the 2019 Amendments prior to the compliance date, “subject to the agencies’ completion of necessary technological changes.”

The 2019 Amendments are based upon the amendments proposed by the Agencies in May 2018 (the 2018 Proposal). As was the case with respect to the 2018 Proposal, the most significant aspects of the 2019 Amendments relate to the proprietary trading provisions of the Volcker Rule, and specifically the definition of “trading account.”[iii]  An analysis of the trading provisions is beyond the scope of this overview. The following is a brief summary of the provisions of the 2019 Amendments that relate specifically to “Covered Funds.”

Covered Fund Provisions. As noted in the Release, the restrictions imposed on banking entities with respect to a Covered Fund are “designed to ensure that banking entities do not rescue investors in those funds from loss, and do not guarantee nor expose themselves to significant losses due to investments in or other relationships with these funds.”[iv] The 2019 Amendments, however, are a work-in-progress; they do not cover any aspects of the Covered Fund provisions of the 2018 Proposal for which specific rule text was not proposed.

The Release notes that: “the [A]gencies intend to issue an additional notice of proposed rulemaking that would propose additional, specific changes to the restrictions on covered fund investments and activities and other issues related to the treatment of investment funds under the regulations implementing section 13 of the BHC Act.”[v]

For example, the 2018 Proposal sought comment on the Volcker Rule’s general approach to defining the term “Covered Fund,” as well as the existing exclusions from the Covered Fund definition and potential new exclusions from this definition.” However, “[i]n light of the number and complexity of issues under consideration,” the Agencies did not take definitive action on those  issues and merely stated their intent “to address these and other comments received on the covered fund provisions in a subsequent proposed rulemaking.”[vi]

Notwithstanding this vacillation, the Agencies did adopt as proposed the few specific Covered Funds changes in the 2018 Proposal, including:

Risk-Mitigating Hedging: The 2019 Amendments permit banking entities to acquire and retain ownership interests in Covered Funds to hedge certain customer-driven transactions, including for fund-linked products. The Agencies also adopted without change the elimination of the requirement that a risk mitigating hedging transaction “demonstrably” reduces or otherwise significantly mitigates the relevant risks.[vii]

Market Making and Underwriting: The Agencies eliminated the aggregate fund limit and the capital deduction requirement for the value of ownership interests in third-party Covered Funds acquired or retained in accordance with the underwriting or market-making exemption (i.e., Covered Funds that the banking entity does not advise or organize and offer. The Agencies stated that they believe that this change will better align the compliance requirements for underwriting and market making involving Covered Funds with the risks those activities entail.[viii]

Solely Outside the United States: The 2013 Rule imposed several conditions on the availability of the exemption that permits foreign banking entities to acquire or retain an ownership interest in, or act as sponsor to, a Covered Fund, provided that those activities and investments occur solely outside of the United States and certain other conditions are met. Those conditions included that “no financing for the banking entity’s ownership or sponsorship is provided, directly or indirectly by any branch or affiliate that is located in the United States or organized under the laws of the United States or of any State.”  The Agencies adopted without change the proposal to remove the financing condition.[ix]

More to Come, But When? As noted above, the amendment of the Volcker Rule with respect to the Covered Fund issues is a work-in-progress without any deadline for completion. In the meantime, banking entities and their counterparties having relationships and holding interests in a Covered Fund must continue to proceed cautiously taking into consideration the complex provisions of the 2019 Amendments.

Please do not hesitate to contact Edward G. Eisert, Senior Counsel, at [email protected] with any questions that arise.


[i] As defined in the 2013 Rules, a “covered fund” includes:  “an issuer that would be an investment company, as defined in the Investment Company Act of 1940 . . . but for section 3(c)(1) or 3(c)(7) of that Act . . . .” and certain commodity pools under the Commodity Exchange Act.

[ii] A copy of the entire Release can be found here

[iii] As stated in the Release: “The definition of ‘trading account’ is a threshold definition that determines whether the purchase or sale of a financial instrument by a banking entity is subject to the restrictions and requirements of section 13 of the BHC Act and the 2013 rule.”  The BHC, in turn, provides a complex definition of “trading account” to mean: “any account used for acquiring or taking positions in [certain securities and instruments] principally for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short-term price movements), and any such other accounts as the [A]gencies, by rule determine.”  IV. Section by Section Summary of the Final Rule,  Subpart B—Proprietary Trading Restrictions.

[iv] Section I. Background.

[v] Section III.  Overview of the Final Rule and Modifications from the Proposal, A. The Final Rule.

[vi] IV. Section by Section Summary of the Final Rule, Subpart C – Covered Fund Activities and Investments, 1. Overview of Agencies’Approach to the Covered Fund Provisions.

[vii] IV. Section by Section Summary of the Final Rule, Subpart C – Covered Fund Activities and Investments,  3.  Section __.13:  Other Permitted Covered Fund Activities, a. Permitted Risk-Mitigating Hedges.

[viii] IV. Section by Section Summary of the Final Rule, Subpart C – Covered Fund Activities and Investments, 2.  Section _.11 Permitted Organizing and Offering, Undeerwriting and Market Making with Respect to a Covererd Fund.

[ix] IV. Section by Section Summary of the Final Rule, Subpart C – Covered Fund Activities and Investments, 3.  Section __.13:  Other Permitted Covered Fund Activities, b. Permitted Covered Fund Activities and Investments Outside the United States.

FDIC Finalizes Rules to Simplify Capital Calculation for Qualifying Community Banking Organizations

 

On September 17, the Federal Deposit Insurance Corporation (FDIC) finalized a rule that introduces an optional community bank leverage ratio (CBLR) framework for measuring capital adequacy of qualifying community banking organizations. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. Release. Final Rule.

Treasury Releases Proposed Regulations for CFIUS Reforms under FIRMMA

 

On September 17, the U.S. Department of the Treasury proposed regulations to implement provisions of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). Among other things, the proposed rules would provide the Committee on Foreign Investments in the United States (CFIUS) the ability to review non-controlling investments involving critical infrastructure and sensitive data, mandate certain filings by foreign government-affiliated investors, and codify certain exceptions and exclusions to CFIUS’s jurisdiction. A separate proposal would expand CFIUS’s jurisdiction to certain real estate transactions. Comments on each of the proposed rulemakings are due by October 17. Release. NPR (General). NPR (Real Estate).

Accenture Publishes Report on 2019 LIBOR Survey

 

Accenture recently published a report entitled “LIBORATION: A practical way to thrive in transition uncertainty.” The report, based on a survey of 177 firms across the financial services and corporate industries, found that although most market participants have LIBOR transition plans in place, there is still uncertainty and a lack of preparation among financial providers, who have expressed concern with a number of unresolved commercial and regulatory issues. The report outlines various recommendations for the transition process, including “10 No Regret Immediate Transition Actions.” Read the full report here.