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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.

Nearly All Claims Against U.S. Bank Dismissed in Ambac RMBS Trustee Suit

 

On July 16, Judge Schofield in the United States District Court for the Southern District of New York dismissed four out of five claims in a suit filed by Ambac Assurance Corp. (Ambac) against U.S. Bank National Association (U.S. Bank), challenging the Bank’s actions as trustee for a Harborview Mortgage Loan Trust. Ambac insured certain certificateholders against low cashflow from the Trust, which was backed by Countrywide-originated mortgages. In August 2011, U.S. Bank filed suit in New York state court against Countrywide and Bank of America, as its successor, alleging failure to comply with representations and warranties. When U.S. Bank agreed to stay the state suit after Countrywide proposed a $56.96 million settlement, Ambac sued U.S. Bank in the S.D.N.Y. to enjoin the settlement, alleging that the Bank breached its obligations to trust beneficiaries by accepting a low settlement amount. In March 2017, U.S. Bank initiated a trust instruction proceeding (TIP) in Minnesota to address its claims against Countrywide; meanwhile, Judge Stein in the S.D.N.Y. found in the Ambac-led suit that, because of the ongoing TIP, U.S. Bank had not yet breached its duties, and therefore Ambac’s claims were not yet ripe. On June 1, 2018, U.S. Bank disclosed its $94 million settlement with Countrywide, conditioned on approval by the Minnesota court.

In the case before Judge Schofield, Ambac alleged that U.S. Bank accepted an unreasonably low settlement, that it improperly released other lucrative claims, and that by agreeing to stay the New York state court action and bringing the TIP, U.S. Bank had wasted trust funds, harming trust beneficiaries. Judge Schofield dismissed four of Ambac’s five claims based on these facts, finding that any alleged injury was hypothetical and far too speculative, and that Ambac had not adequately alleged that U.S. Bank taking different actions would have resulted in a more favorable settlement or negotiation position. She also rejected Ambac’s counts for declaratory judgment, because such a finding would serve no useful purpose and would not resolve all of the outstanding cases. Judge Schofield let Ambac’s breach of contract claim continue, finding that Ambac sufficiently alleged that U.S. Bank’s improper accounting of recoveries under the Pooling and Servicing Agreement harmed Ambac, because it affected the amount and timing of the insurance payments that it made. Opinion and Order.

CFTC Adopts Final Rule Amending De Minimis Exception to Swap Dealer Definition

 

On March 25, the CFTC adopted a final rule amending the de minimis exception to the definition of “swap dealer.” Under the final rule, swaps entered into by Insured Depository Institutions (IDIs) in connection with loans to customers would not count towards the $8 billion aggregate notional amount threshold used in the de minimis exception. Release. Final Rule.

Alexander County Housing Authority Awards $1.9 Million Demolition Contract to RCRA Inc.

 

On March 19, the Alexander County Housing Authority awarded a demolition contract to RCRA Inc. to raze 278 housing units in Cairo. These housing developments experienced years of deferred maintenance such that they are unsafe for residents. The demolition will be completed by September 2019 and the land will be restored to green space. Press Release.

Second Circuit Upholds Dismissal of U.S. Bank’s Untimely Breach of Contract and Indemnity Claims

 

On February 6, the Second Circuit affirmed a trial court order dismissing repurchase and indemnification claims brought by the Federal Housing Finance Agency (“FHFA“), acting on behalf of U.S. Bank as Trustee, against GreenPoint Mortgage Funding Inc., predicated on allegations that mortgage loans sold by GreenPoint breached representations and warranties in the relevant loan purchase agreements. READ MORE

FINRA Requests Comment on Financial Technology Innovation in the Broker-Dealer Industry

 

On July 30, 2018, the Financial Industry Regulatory Authority (“FINRA“) published a Special Notice, in response to requests from the public, “seeking comments on how FINRA can support fintech development consistent with [its] mission.” In addition, FINRA requested “specific comment on certain fintech areas, including the provision of data aggregation services, supervisory processes concerning the use of artificial intelligence, and the development of a taxonomy-based machine-readable rulebook.” READ MORE

OTC Derivative Brexit Issues Considered by AFME and ISDA

 

A paper was jointly published by AFME and ISDA on July 30, 2018 which considered the potential contractual continuity issues which may influence OTC derivative contracts following Brexit.

As has been widely discussed, Brexit will bring an end to the single market passport. The passport currently allows regulated activities to be carried out by the UK in EU countries without additional local licenses. This however will no longer be in place following Brexit. Given that a number of contracts will have been entered into prior to Brexit and will continue thereafter, there is a risk that entities may be carrying out regulated activities in other jurisdictions without having the relevant local licensing requirements in place following Brexit.

The report, the full version of which is available here, looks at possible solutions both for UK entities, as well as regulators, in order to minimize disruption following Brexit.

ISDA Consultation Paper, “IBOR Fallbacks for 2006 ISDA Definitions: Consultation on Certain Aspects of Fallbacks for Derivatives Referencing GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW”

 

ISDA has launched a market-wide consultation on technical issues related to new benchmark fallbacks for derivatives contracts that reference certain interbank offered rates (“IBORs“). The consultation sets out options for adjustments that would apply to the fallback rate in the event an IBOR is permanently discontinued.

The ISDA consultation paper is here.

“The consultation sets out four options to account for the move from a term rate to an overnight rate: a spot overnight rate; a convexity adjusted overnight rate; a compounded setting in arrears rate; and a compound setting in advance rate. Three options are also proposed to calculate a spread adjustment: a forward approach; a historical mean/median approach; and a spot-spread approach. In each case, the spread adjustment will be fixed at the point the fallback is triggered.”