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June 14, 2018 |
Revisions to the FFIEC BSA/AML Manual to Include the New CDD Regulation

Click for PDF On May 11, 2018, the federal bank regulators and the Financial Crimes Enforcement Network (“FinCEN”) published two new chapters of the Federal Financial Institution Examination Council Bank Secrecy Act/Anti-Money Laundering Examination Manual (“BSA/AML Manual”) to reflect changes made by FinCEN to the CDD regulation.[1]  One of the chapters replaces the current chapter “Customer Due Diligence – Overview and Examination Procedures” (“CDD Chapter”), and the other chapter is entirely new and contains an overview of and examination procedures for “Beneficial Ownership for Legal Entity Customers” to reflect the beneficial ownership requirements of the CDD regulation (“Beneficial Ownership Chapter”).[2] The new CDD Chapter builds upon the previous chapter, adds the requirements of the CDD regulation, and otherwise updates the chapter, which had not been revised since 2007.  The Beneficial Ownership Chapter largely repeats what is in the CDD Rule.  Both new chapters reference the regulatory guidance and clarifications from the Frequently Asked Questions issued by FinCEN on April 3, 2018 (the “FAQs”).[3]   Other Refinements to the CDD Regulation May Impact the BSA/AML Manual Implementation of the CDD regulation is a dynamic process and may require further refinement of these chapters as FinCEN issues further guidance.  For instance, in response to concerns of the banking industry, on May 16, 2018, FinCEN issued an administrative ruling imposing a 90-day moratorium on the requirement to recertify CDD information when certificates of deposit (“CDs”) are rolled over or loans renewed (if the CDs or loans were opened before May 11, 2018).  FinCEN will have further discussions with the banking industry and will make a decision whether to make this temporary exception permanent within this 90-day period (before August 9, 2018).[4] In his May 16, 2018, testimony at a House Financial Services Committee hearing on “Implementation of FinCEN’s Customer Due Diligence Rule,” FinCEN Director Kenneth Blanco suggested that FinCEN may be receptive to refinements as compliance experience is gained with the regulation.  Director Blanco also indicated that there will be a period of adjustment for compliance with the regulation and that FinCEN and the regulators will not engage in “gotcha” enforcement, but are seeking “good faith compliance.” Highlights from the New Chapters Periodic Reviews:  The BSA/AML Manual no longer expressly requires periodic CDD reviews, but suggests that regulators may still expect periodic reviews for higher risk customers.  The language in the previous CDD Chapter requiring periodic CDD refresh reviews has been eliminated.[5]Consistent with FAQ 14, the new CDD Chapter states that updating CDD information will be event driven and provides a list of possible event triggers, such as red flags identified through suspicious activity monitoring or receipt of a criminal subpoena.  Nevertheless, the CDD Chapter does not completely eliminate the expectation of periodic reviews for higher risk clients, stating:  “Information provided by higher profile customers and their transactions should be reviewed . . . more frequently throughout the term of the relationship with the bank.”Although this appears to be a relaxation of the expectation to conduct periodic reviews, we expect many banks will not change their current practices.  For a number of years, in addition to event driven reviews, many banks have conducted periodic CDD reviews at risk based intervals because they have understood periodic reviews to be a regulatory expectation. Lower Beneficial Ownership Thresholds:  Somewhat surprisingly, there is no expression in the new chapters that consideration should be given to obtaining beneficial ownership at a lower threshold than 25% for certain high risk business lines or customer types.  The new Beneficial Ownership Chapter simply repeats the regulatory requirement stating that:  “The beneficial ownership rule requires banks to collect beneficial ownership information at the 25 percent ownership threshold regardless of the customer’s risk profile.”  The FAQs (FAQ 6 and 7) refer to the fact that a financial institution may “choose” to apply a lower threshold and “there may be circumstances where a financial institution may determine a lower threshold may be warranted.”  We understand that specifying an expectation that there should be lower beneficial thresholds for certain higher risk customers was an issue that was debated among FinCEN and the bank regulators.For a number of years, many banks have obtained beneficial ownership at lower than 25% thresholds for high risk business lines and customers (e.g., private banking for non-resident aliens).  Banks that have previously applied a lower threshold, however, should carefully evaluate any decision to raise thresholds to the 25% level in the regulation.  If a bank currently applies a lower threshold, raising the threshold may attract regulatory scrutiny about whether the move was justified from a risk standpoint.  Moreover, a risk-based program should address not only regulatory risk, but also money laundering risk.  Therefore, banks should consider reviewing beneficial ownership at lower thresholds for certain customers and business lines and when a legal entity customer has an unusually complex or opaque ownership structure for the type of customer regardless of the business line or risk rating of the customer. New Accounts:  The new chapters do not discuss one of the most controversial and challenging requirements of the CDD rule, the requirement to verify CDD information when a customer previously subject to CDD opens a new account, including when CDs are rolled over or loans renewed.  This most likely may be because application of the requirement to CD rollovers and loan renewals is still under consideration by FinCEN, as discussed above. Enhanced Due Diligence:  The requirement to maintain enhanced due diligence (“EDD”) policies, procedures, and processes for higher risk customers remains with no new suggested categories of customers that should be subject to EDD. Risk Rating:  The new CDD Chapter seems to articulate an expectation to risk rate customers:  “The bank should have an understanding of the money laundering and terrorist financing risk of its customers, referred to in the rule as the customer risk profile.  This concept is also commonly referred to as the customer risk rating.”  The CDD Chapter, therefore, could be read as expressing for banks an expectation that goes beyond FinCEN’s expectation for all covered financial institutions in FAQ 35, which states that a customer profile “may, but need not, include a system of risk ratings or categories of customers.”  It appears that banks that do not currently risk rate customers should consider doing so.  Since the CDD section was first drafted in 2006 and amended in 2007, customer risk rating based on an established method with weighted risk factors has become a best and almost universal practice for banks to facilitate the AML risk assessment, CDD/EDD, and the identification of suspicious activity. Enterprise-Wide CDD:  The new CDD Chapter recognizes the CDD approach of many complex organizations that have CDD requirements and functions that cross financial institution legal entities and the general enterprise-wide approach to BSA/AML long referenced in the BSA/AML Manual.  See BSA/AML Manual, BSA/AML Compliance Program Structures Overview, at p. 155.  The CDD Chapter states that a bank “may choose to implement CDD policies, procedures and processes on an enterprise-wide basis to the extent permitted by law sharing across business lines, legal entities, and with affiliate support units.” Conclusion Despite the CDD regulation, at its core CDD compliance is still risk based and regulatory risk remains a concern.  Every bank must carefully and continually review its CDD program against the regulatory requirements and expectations articulated in the BSA/AML Manual, as well as recent regulatory enforcement actions, the institution’s past examination and independent and compliance testing issues, and best practices of peer institutions.  This review will help anticipate whether there are aspects of its CDD/EDD program that could be subject to criticism in the examination process.  As the U.S. Court of Appeals for the Ninth Circuit recently recognized, detailed manuals issued by agencies with enforcement authority like the BSA/AML Manual “can put regulated banks on notice of expected conduct.”  California Pacific Bank v. Federal Deposit Insurance Corporation, 885 F.3d 560, 572 (9th Cir. 2018).  The BSA/AML Manual is an important and welcome roadmap although not always as up to date, clear or detailed as banks would like it to be. These were the first revisions to the BSA/AML Manual since 2014.  We understand that additional revisions to other chapters are under consideration.    [1]   May 11, 2018 also was the compliance date for the CDD regulations.  The Notice of Final Rulemaking for the CDD regulation, which was published on May 11, 2016, provided a two-year implementation period.  81 Fed. Reg. 29,398 (May 11, 2016).  https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf. For banks, the new regulation is set forth in the BSA regulations at 31 C.F.R. § 1010.230 (beneficial ownership requirements) and 31 C.F.R. § 1020.210(a)(5).    [2]   The new chapters can be found at: https://www.ffiec.gov/press/pdf/Customer%20Due%20Diligence%20-%20Overview%20and%20Exam%20Procedures-FINAL.pdfw  (CDD Chapter) and https://www.ffiec.gov/press/pdf/Beneficial%20Ownership%20Requirements%20for %20Legal%20Entity%20CustomersOverview-FINAL.pdf (Beneficial Ownership Chapter).    [3]   Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions, FIN-2018-G001.  https://www.fincen.gov/resources/statutes-regulations/guidance/frequently-asked-questions-regarding-customer-due-0.  On April 23, 2018, Gibson Dunn published a client alert on these FAQs.  FinCEN Issues FAQs on Customer Due Diligence Regulation.  https://www.gibsondunn.com/fincen-issues-faqs-on-customer-due-diligence-regulation/. FinCEN also issued FAQs on the regulation on September 29, 2017. https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.    [4]   Beneficial Ownership Requirements for Legal Entity Customers of Certain Financial Products and Services with Automatic Rollovers or Renewals, FIN-2018-R002.  https://www.fincen.gov/sites/default/files/2018-05/FinCEN%20Ruling%20CD%20and%20Loan%20Rollover%20Relief_FINAL%20508-revised.pdf    [5]   The BSA/AML Manual previously stated at p. 57:  “CDD processes should include periodic risk-based monitoring of the customer relationship to determine if there are substantive changes to the original CDD information. . . .” Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the authors: Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 24, 2018 |
Dodd Frank 2.0: Reforming U.S. HVCRE Capital Treatment

Click for PDF On Tuesday, May 22, 2018, the U.S. House of Representatives passed the Economic Growth, Regulatory Relief, and Consumer Protection Act (Reform Bill), which had already passed the Senate on a bipartisan basis.  President Trump signed the Reform Bill into law today.  Among the Reform Bill’s more important provisions is a section reforming the current capital treatment of so-called High Volatility Commercial Real Estate (HVCRE) loans.  The Reform Bill, in provisions that are now effective, overrides certain highly conservative provisions in both the federal banking agencies’ (Banking Agencies) Basel III capital rule and their interpretations of it. HVCRE Capital Treatment Under the Basel III Capital Rule and the Banking Agencies’ Interpretations Current HVCRE treatment is a purely American phenomenon; it was not included in the international Basel III framework.  A form of capital “gold plating,” it imposes a 50% heightened capital treatment on certain commercial real estate loans that are characterized as HVCRE loans. The current Basel III capital rule defines an HVCRE loan as follows: A credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances: One- to four-family residential properties; Certain community development properties The purchase or development of agricultural land, provided that the valuation of the agricultural land is based on its value for agricultural purposes and the valuation does not take into consideration any potential use of the land for non-agricultural commercial development or residential development; or Commercial real estate projects in which: The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio under Banking Agency standards – e.g., 80% for a commercial construction loan; The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15% of the real estate’s appraised ”as completed” value; and The borrower contributed the amount of capital required  before the bank advances funds under the credit facility, and the capital contributed by the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project.[1] Under the current Basel III capital rule, the life of a project concludes only when the credit facility is converted to permanent financing or is sold or paid in full.[2] The current Basel III capital rule has raised many interpretative questions; however, many of the important ones have not been answered by the Banking Agencies, and others have been answered in a non-intuitive, unduly conservative manner.  In particular, the Banking Agencies interpreted the requirement relating to internally generated capital as foreclosing distributions of such capital even if the amount of capital in the project exceeds 15% of “as completed” value post-distribution.[3]  The Banking Agencies also have not permitted appreciated land value to be taken into account for purposes of the borrower’s capital contribution. The Reform Bill’s Principal Provisions The Reform Bill overrides the current Basel III capital rule.[4]  Specifically, it states that the Banking Agencies may impose a heightened capital charge on an HVCRE loan (as currently defined) only if the loan is also an HVCRE ADC loan.  Such a loan is defined as: A credit facility secured by land or improved real property that, prior to being reclassified by the depository institution as a non-HVCRE ADC loan— (A) primarily finances, has financed, or refinances the acquisition, development, or construction of real property; (B) has the purpose of providing financing to acquire, develop, or improve such real property into income-producing real property; and (C) is dependent upon future income or sales proceeds from, or refinancing of, such real property for the repayment of such credit facility. Thus the loan must not only finance or refinance the acquisition, development, or construction of real property, it must “primarily” do so, must have a development purpose, and must be dependent on future income, sales proceeds or refinancing – not current income.  The “HVCRE ADC” loan definition also corrects some of the unduly conservative regulatory interpretations described above.  It permits appreciated land value, as determined by a qualifying appraisal, to be taken into account for purposes of the 15% test, and it permits capital to be withdrawn as long as the 15% test continues to be met. In addition, the Reform Bill overrides the current Basel III capital rule by stating that HVCRE status may end prior to the replacement of the ADC loan with permanent financing, upon: the substantial completion of the development or construction of the real property being financed by the credit facility; and cash flow being generated by the real property being sufficient to support the debt service and expenses of the real property, in accordance with the bank’s applicable loan underwriting criteria for permanent financings.[5] Additional exemptions from HVCRE treatment apply to loans for: the acquisition or refinance of existing income-producing real property secured by a mortgage on such property, if the cash flow being generated by the real property is sufficient to support the debt service and expenses of the real property, in accordance with the institution’s applicable loan underwriting criteria for permanent financings; and improvements to existing income-producing improved real property secured by a mortgage on such property, if the cash flow being generated by the real property is sufficient to support the debt service and expenses of the real property, in accordance with the institution’s applicable loan underwriting criteria for permanent financings. Finally, loans made prior to January 1, 2015 may not be classified as HVCRE loans. Conclusion The Reform Bill’s HVCRE ADC provisions are a welcome development.  They do not answer every question relating to HVCRE treatment, but they do purge regulatory interpretations that led to heightened capital treatment for many ADC loans in the absence of persuasive risk justifications.  It is to be hoped that the Banking Agencies further the legislation’s intent of aligning gold plated capital treatment more closely to risk when interpreting the new law.    [1]   See, e.g., 12 C.F.R. § 3.2.    [2]   Id.    [3]   See Interagency HVCRE FAQ Response 15.  It remains unclear how this interpretation squares with the text of the HVCRE regulation itself.    [4]   The original version of the Senate bill, which was passed first, did not include this provision.  Senator Tom Cotton, R-Ark, proposed the relevant amendment while the Senate was considering the bill.    [5]   The Reform Bill retains the current exemptions for loans financing one- to four-family residential properties, certain community development properties, and the purchase or development of agricultural land. The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and James Springer. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions or Real Estate practice groups, or any of the following: Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) Real Estate and Finance Groups: Jesse Sharf – Los Angeles (+1 310-552-8512, jsharf@gibsondunn.com) Eric M. Feuerstein – New York (+1 212-351-2323, efeuerstein@gibsondunn.com) Erin Rothfuss – San Francisco (+1 415-393-8218, erothfuss@gibsondunn.com) Aaron Beim – New York (+1 212-351-2451, abeim@gibsondunn.com) Linda L. Curtis – Los Angeles (+1 213-229-7582, lcurtis@gibsondunn.com) Drew C. Flowers – Los Angeles (+1 213-229-7885, dflowers@gibsondunn.com) Noam I. Haberman – New York (+1 212-351-2318, nhaberman@gibsondunn.com) Victoria Shusterman – New York (+1 212-351-5386, vshusterman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 15, 2018 |
CFTC Chairman and Chief Economist Co-Author “Swaps Reg Reform 2.0”

Click for PDF On April 26, 2018, Commodity Futures Trading Commission (“CFTC”) Chairman J. Christopher Giancarlo and the CFTC’s Chief Economist Bruce Tuckman released a co-authored white paper titled Swaps Regulation Version 2.0: An Assessment of the Current Implementation of Reform and Proposals for Next Steps (“White Paper”),[1] which analyzes and assesses the CFTC’s current implementation of the swaps reforms promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).[2]  The White Paper focuses on the following five specific areas of Dodd-Frank swaps reform:  clearing and central counterparties (“CCPs”); swaps data reporting; swaps execution rules; swap dealer capital requirements; and the end-user exception.  The paper’s title is intended to draw an analogy between the need to further refine the CFTC’s swaps regulatory reform under Dodd-Frank and the process undertaken by technology companies when updating or upgrading their software applications.  Indeed, the authors suggest that the CFTC—like a technology company—needs to assess where its Dodd-Frank swaps regulations are working, where those regulations require “updates” and where they require an upgrade or a complete overhaul. As part of its analysis and assessment, the White Paper primarily cites to academic research and market activity in reaching certain conclusions regarding the progress made to date and areas for improvement in the CFTC’s implementation of Dodd-Frank swaps reform.  The authors also cite to the CFTC’s four years of regulatory experience in implementing Dodd-Frank swaps reform in the United States as the basis upon which they make certain recommendations “to recognize success, address flaws, recalibrate imprecision and optimize measures. . . .”[3] Although the White Paper is comprehensive in its scope, it is noteworthy what the paper does not cover.  For instance, while the White Paper includes the authors’ recommendations for further changes to the CFTC’s swaps regulations and guidance, the paper does not propose detailed or prescriptive modifications to specific CFTC rules.  Thus, the paper describes at a high level what the authors envision would result in regulations that are more “economy-focused” and “what’s in the best interest of the markets.”[4] Additionally, the authors make clear that the White Paper does not express the views of the full commission.  Interestingly, however, the White Paper does include significant input from CFTC senior staff across all operating divisions (i.e., the directors of the CFTC’s Division of Market Oversight, the Division of Swap Dealer and Intermediary Oversight, and the Division of Clearing and Risk). Further, the White Paper does not discuss other important Dodd-Frank swaps reform topics such as position limits, the CFTC’s swap dealer de minimis threshold, the bounds of the CFTC’s cross border authority or how best to harmonize the CFTC’s swaps ruleset with the security-based swaps ruleset of its sister agency, the Securities and Exchange Commission. Lastly, the White Paper does not outline the timetable for any proposed changes to the CFTC’s swaps regulations.  In unveiling the White Paper at an industry conference, Chairman Giancarlo noted that the CFTC will likely begin issuing proposals in the areas of trading and swaps data reporting in the early part of the summer of 2018.  Chairman Giancarlo further noted with respect to timing that, “We’re not in the wake of a crisis right now — we need to take the time to get this right.  We have an ambitious timetable, and we will get this done, but we will do this right.”[5] In this client alert, we have summarized below some of the key takeaways from each of the five topical areas covered in the White Paper. Please contact us if you have any questions regarding the White Paper or the CFTC’s widely anticipated reforms to its swaps regulations. Clearing and CCPs The White Paper notes that swaps clearing is probably the most far-reaching and consequential of the swaps reforms adopted under Title VII of Dodd-Frank.  The authors cite data collected by the CFTC in finding that the CFTC’s implementation of Dodd-Frank’s clearing mandate was highly successful based on the increasing volumes of cleared swaps when compared to before the enactment of Dodd-Frank.[6] This section of the White Paper then focuses on the topics of CCP resources to maintain viability under extreme but plausible conditions, CCP recovery when those resources prove insufficient and CCP resolution in the highly unlikely event that a CCP fails.  In short, the authors applaud the substantial progress that CCPs and the CFTC have made in order to ensure that CCPs are safe and sound under extreme but plausible scenarios and the work that CCPs have undertaken to develop credible recovery plans to remain viable without government assistance. In terms of their recommendations to address continuing challenges in this space, the authors assert—without picking winners or losers as between CCPs and their clearing members—that further market-wide discussions are necessary regarding: (1) the development of potential solutions to ensure the liquidity of prefunded resources; (2) the network and systemic effects of defaults; (3) the liquidation costs of defaulted positions; and (4) improving transparency and predictability of CCP recovery plans.  Lastly, the authors note that the CFTC must continue to coordinate with the Federal Deposit Insurance Corporation (“FDIC”) in formulating resolution plans, which would guide the authority vested in the FDIC under Dodd-Frank to intervene upon the highly unlikely event that a CCP fails. Swaps Data Reporting In the section of the White Paper covering swaps data reporting, the authors note that, while the state of data reporting has improved considerably, the CFTC’s current swaps reporting regime is “suboptimal” and “imperfect.”  They cite the lack of uniform data standards and nomenclature as the biggest problems with the regime.  Another cited problem is the fact that the CFTC has not provided sufficient technical specifications to swap data repositories (“SDRs”) in collecting data from reporting parties. The authors then discuss a number of steps that the CFTC has taken within the last few years to improve the effectiveness of its swaps reporting regime, including the CFTC’s cooperation with the global regulatory community, SDRs and reporting counterparties to harmonize uniform data standards, nomenclature and technical guidance.  The paper also mentions the work that CFTC staff has begun as outlined in the CFTC’s 2017 Roadmap to Achieve High Quality Swaps Data (“Roadmap”).[7]  Through the Roadmap consultation process, CFTC staff has heard from a wide range of market participants and interested parties.  Under consideration in the Roadmap are changes to the CFTC’s reporting rules with the goal of making available to the CFTC and to the public more complete, more accurate and higher quality data. Finally, in this section, the authors urge the CFTC to ensure that its swaps reporting reforms will remain technologically neutral in order to allow for technological advancement (e.g., through the use of distributed ledger technology) to make reporting systems more reliable, more automated and less expensive.  They also urge CFTC staff and market participants to continue to collaborate in order to recalibrate the trade data reporting regime so that it is specific, accurate, and useful enough to:  (1) capture systemic risk, market abuse and market manipulation; (2) harmonize with globally accepted risk data fields; and (3) achieve transparency while promoting healthy trading liquidity. Swaps Execution Rules In the section covering swaps execution, the authors repeat many of the same concerns and arguments made by Chairman Giancarlo in his 2015 White Paper on swap trading reforms, which was titled Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank, White Paper.[8]  Essentially, they assert that Congress did not mandate that swap execution facilities (“SEFs”) utilize any particular method of trading and execution.  In its final swaps execution rules, however, the CFTC determined that swaps which are “made available to trade” should be subject to the CFTC’s mandatory trade execution requirement and must be traded through specified execution protocols (i.e., an order book or a request-for-quote system to three).  The authors cite to comprehensive industry research in noting that the CFTC’s current swaps execution requirements have stunted swaps trading in the United States, fragmented global trading liquidity, increased market liquidity risk, restricted technological innovation and incentivized a significant amount of price discovery and liquidity to take place off-exchange. To correct these ills, the authors recommend that the CFTC eliminate the requirement that SEFs maintain an order book and permit SEFs to offer any means of interstate commerce for the trading or execution of swaps subject to the CFTC’s mandatory trade execution requirement.  Additionally, they argue that the CFTC also should expand the category of swaps subject to the trading mandate to include all swaps that are subject to the CFTC’s clearing mandate, unless no SEF or designated contract market lists the swap for trading.  Finally, they suggest that the CFTC’s regulatory focus should be on enhancing the professional conduct of swaps execution through licensure, testing and the adoption of professional conduct principles. Swap Dealer Capital In the section covering swap dealer capital, the authors note that while current bank capital rules are extremely relevant to the swaps dealing business and the efficiency of swap markets, there are aspects of the current regime that result in an unintended bias against risk taken through swaps markets.  To correct this bias, the White Paper argues that bank capital rules need to allow firms to rely on internal models instead of a standardized approach.  The paper also argues that the current standardized approach and industry-developed models inappropriately rely on swap notional amounts to measure risk.[9] The authors do not offer one specific recommended approach to correct these concerns.  Instead, the paper offers a couple of remedial approaches.  One approach suggested by the authors to correct these concerns is for regulators to continue to refine—and by necessity complicate—the standardized models imposed on market participants.  Another suggested approach is for regulators to improve their capabilities with respect to approving and monitoring the use of bank internal models. End-User Exception In the last section of the White Paper, the authors assert that Congress intended a robust end-user exception from Dodd-Frank clearing and margin requirements for entities that are unlikely sources of systemic risk.  They further assert that there are a number of entities that currently fall within the Dodd-Frank definition of “financial entity” (and thus are ineligible to elect an exception from those requirements) but should not be captured under the definition because those entities are not sources of systemic risk.  Specifically, the paper identifies bank holding companies, savings and loan holding companies and certain relatively small financial institutions as being broadly and unnecessarily captured under the definition. To reduce the burdens on these categories of end-users, the authors offer a few recommendations.  First, the authors recommend that the CFTC codify into regulation relief for bank holding companies and savings and loan holding companies that is currently provided in CFTC staff no-action relief.[10] Second, the authors recommend that the CFTC exempt certain small financial institutions including pension funds and small insurance companies from clearing and margin requirements through a “material swaps exposure” test, which is similar to the test set forth in the CFTC’s final uncleared margin rules.  Related to their second recommendation, the authors further assert that the CFTC and prudential regulators should consider exempting small financial end-users from uncleared margin requirements by tweaking the material swaps exposure thresholds to address real risk as opposed to risk based on swap notional amounts.  Interestingly, the authors cite to studies suggesting that pension funds and insurance companies should not broadly be excluded from the definition because larger entities might still pose significant risks. Finally, the authors argue that the CFTC should amend the calculation of initial margin for uncleared swaps in the CFTC’s uncleared margin rules so that those rules do not promote a bias against the trading of uncleared swaps.  On this point, the authors argue that Congress did not intend for the CFTC’s and prudential regulators’ uncleared margin rules to favor cleared products.    [1]   J. Christopher Giancarlo and Bruce Tuckman, Swaps Regulation Version 2.0: An Assessment of the Current Implementation of Reform and Proposals for Next Steps (Apr. 26, 2018), available at https://www.cftc.gov/sites/default/files/2018-04/oce_chairman_swapregversion2whitepaper_042618.pdf.    [2]   Dodd-Frank Wall Street Reform and Consumer Protection Act, 124 Stat. 1376, Pub. Law 111-203 (July 21, 2010), as amended.    [3]   White Paper at p.i.    [4]   CFTC Press Release, No. 7719-18, CFTC Chairman Unveils Reg Reform 2.0 Agenda (Apr. 26, 2018), available at https://www.cftc.gov/PressRoom/PressReleases/7719-18.    [5]   Id.    [6]   See White Paper, p.7 (“According to data collected by the CFTC on U.S. reporting entities, about 85% of both new interest rate swaps and new credit default swaps were cleared in 2017. Precise data as far back as 2010 are not available, but the Bank for International Settlements (BIS) estimated minimum global clearing rates at that time of about 40% for interest rate swaps and 8% for credit default swaps.”).    [7]   Staff Advisory, Division of Market Oversight, Roadmap to Achieve High Quality Swaps Data, U.S. Commodity Futures Trading Commission, July 10, 2017, available at http://www.cftc.gov/idc/groups/public/@newsroom /documents/file/dmo_swapdataplan071017.pdf.    [8]   J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank, Jan. 29, 2015, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom /documents/file/sefwhitepaper012915.pdf.    [9]   The CFTC’s Chief Economist and others have published a paper proposing an alternative approach to measuring swaps risk.  See Richard Haynes, John Roberts, Rajiv Sharma and Bruce Tuckman, Introducing ENNs: A Measure of the Size of Interest Rate Swap Markets (Jan. 2018), available at https://www.cftc.gov/ sites/default/files/idc/groups/public/@economicanalysis/documents/file/oce_enns0118.pdf. [10]   See CFTC Letter 16-01 (Jan. 8, 2016). The following Gibson Dunn lawyers assisted in preparing this client update: Carl Kennedy and Jeffrey Steiner. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or any of the following: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 3, 2018 |
Webcast: Anti-Money Laundering and Sanctions Enforcement and Compliance in 2018 and Beyond

Gibson Dunn partners provide an overview of significant trends and key issues in Bank Secrecy Act (BSA)/Anti-Money Laundering (AML) and sanctions enforcement and compliance. Topics covered: BSA/AML Overview Recent trends in BSA/AML enforcement Recent trends in BSA/AML compliance BSA/AML Reform Efforts Sanctions Overview Key OFAC sanctions program developments Recent trends in sanctions enforcement The future of sanctions under the Trump Administration (and beyond) View Slides [PDF] PANELISTS M. Kendall Day was a white collar prosecutor for 15 years, serving most recently as an Acting Deputy Assistant Attorney General with the U.S. Department of Justice’s Criminal Division, where he supervised Bank Secrecy Act investigations, enforcement of anti-money laundering and sanctions laws, deferred prosecution agreements and non-prosecution agreements involving all types of financial institutions. He previously served in a variety of leadership and line attorney roles, including as Chief of the DOJ Money Laundering and Asset Recovery Section. Mr. Day will join Gibson Dunn’s Washington, D.C. office as a partner effective May 1, 2018. Stephanie L. Brooker is co-chair of Gibson Dunn’s Financial Institutions Practice Group. She is former Director of the Enforcement Division at the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN), and previously served as the Chief of the Asset Forfeiture and Money Laundering Section in the U.S. Attorney’s Office for the District of Columbia and as a trial attorney for several years. Stephanie represents financial institutions, multi-national companies, and individuals in connection with criminal, regulatory, and civil enforcement actions involving BSA/AML, sanctions, anti-corruption, securities, tax, wire fraud, and sensitive employee matters. Her practice also includes BSA/AML compliance counseling and due diligence and significant criminal and civil asset forfeiture matters. Adam M. Smith is an experienced international trade lawyer who previously served in the Obama Administration as the Senior Advisor to the Director of OFAC and as the Director for Multilateral Affairs on the National Security Council. Adam focuses on international trade compliance and white collar investigations, including with respect to federal and state economic sanctions enforcement, the FCPA, embargoes, and export controls. F. Joseph Warin is co-chair of Gibson Dunn’s White Collar Defense and Investigations Practice Group, and chair of the Washington, D.C. office’s Litigation Department.  He is a former Assistant United States Attorney in Washington, D.C., one of only ten lawyers in the United States with Chambers rankings in five categories, was named by Best Lawyers® as 2016 Lawyer of the Year for White Collar Criminal Defense in the District of Columbia, and recognized by Benchmark Litigation as a U.S. White Collar Crime Litigator Star for seven consecutive years (2011–2017). In 2017, Chambers honored Mr. Warin with the Outstanding Contribution to the Legal Profession Award. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.50 credit hours, of which 1.50 credit hours may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.50 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

April 23, 2018 |
FinCEN Issues FAQs on Customer Due Diligence Regulation

Click for PDF On April 3, 2018, FinCEN issued its long-awaited Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions, FIN-2018-G001. https://www.fincen.gov/resources/statutes-regulations/guidance/frequently-asked-questions-regarding-customer-due-0.[1]  The timing of this guidance is very controversial, issued five weeks before the new Customer Due Diligence (“CDD”) regulation goes into effect on May 11, 2018.[2]  Most covered financial institutions (banks, broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities) already have drafted policies, procedures, and internal controls and made IT systems changes to comply with the new regulation.  Covered financial institutions will need to review these FAQs carefully to ensure that their proposed CDD rule compliance measures are consistent with FinCEN’s guidance. The guidance is set forth in 37 questions.  As discussed below, some of the information is helpful, allaying financial institutions’ most significant concerns.  Other FAQs confirm what FinCEN has said in recent months informally to industry groups and at conferences.  A few FAQs raise additional questions, and others, particularly the FAQ on rollovers of certifications of deposit and loan renewals, are not responsive to industry concerns and may raise significant compliance burdens for covered financial institutions.  The guidance reflects FinCEN’s regulatory interpretations based on discussions within the government and with financial institutions and their trade associations.  The need for such extensive guidance on so many issues in the regulation illustrates the complexity of compliance and suggests that FinCEN should consider whether clarifications and technical corrections to the regulation should be made.  We provide below discussion of highlights from the FAQs, including areas of continued ambiguity and uncertainty in the regulation and FAQs. Highlights from the FAQs FAQ 1 and 2 discuss the threshold for obtaining and verifying beneficial ownership.  FinCEN states that financial institutions can “choose” to collect beneficial ownership information at a lower threshold than required under the regulation (25%), but does not acknowledge that financial institution regulators may expect a lower threshold for certain business lines or customer types or that there may be regulatory concerns if financial institutions adjust thresholds upward to meet the BSA regulatory threshold.  A covered financial institution may be in compliance with the regulatory threshold, but fall short of regulatory expectations. FAQ 7 states that a financial institution need not re-verify the identity of a beneficial owner of a legal entity customer if that beneficial owner is an existing customer of the financial institution on whom CIP has been conducted previously provided that the existing information is “up-to-date, accurate, and the legal entity’s customer’s representative certifies or confirms (verbally or in writing) the accuracy of the pre-existing CIP information.”  The example given suggests that no steps are expected to verify that the information is up-to-date and accurate beyond the representative’s confirmation or certification.  The beneficial ownership records must cross reference the individual’s CIP record. FAQs 9-12 address one of the most controversial aspects of the regulation, about which there has been much confusion: the requirement that, when an existing customer opens a new account, a financial institution must identify and verify beneficial ownership information.  FinCEN provides further clarity on what must be updated and how:Under FAQ 10, if a legal entity customer, for which the required beneficial ownership information has been obtained for an existing account, opens a new account, the financial institution can rely on the information obtained and verified previously “provided the customer certifies or confirms (verbally or in writing) that such information is up-to-date and accurate at the time each subsequent new account is opened,” and the financial institution has no knowledge that would “reasonably call into question” the reliability of the information.  The financial institution also would need to maintain a record of the certification or confirmation by the customer.There is no grace period.  If an account is opened on Tuesday, and a new account is opened on Thursday, the certification or confirmation is still required.  In advance planning for compliance, many financial institutions had included a grace period in their procedures. FAQ 11 provides that, when the financial institution opens a new account or subaccount for an existing legal entity customer whose beneficial ownership has been verified for the institution’s own recordkeeping and operational purposes and not at the customer’s request, there is no requirement to update the beneficial ownership information for the new account.  This is because the account would be considered opened by the financial institution and the requirement to update only applies to each new account opened by a customer.  This is consistent with what FinCEN representatives have said at recent conferences.The FAQ specifies that this would not apply to (1) accounts or subaccounts set up to accommodate a trading strategy of a different legal entity, e.g., a subsidiary of the customer, or (2) accounts of a customer of the existing legal entity customer, “i.e., accounts (or subaccounts) through which a customer of a financial institution’s existing legal entity carries out trading activity through the financial institution without intermediation from the existing legal entity customer.”  We believe the FAQ may fall far short of addressing all the concerns expressed to FinCEN on this issue by the securities industry. FAQ 12 addresses an issue which has been a major concern to the banking industry:  whether beneficial ownership information must be updated when a certificate of deposit (“CD”) is rolled over or a loan is renewed.  These actions are generally not considered opening of new accounts by banks.FinCEN continues to maintain that CD rollovers or loan renewals are openings of new accounts for purposes of the CDD regulation.  Therefore, the first time a CD or loan renewal for a legal entity customer occurs after May 11, 2018, the effective date of the CDD regulation, beneficial ownership information must be obtained and verified, and at each subsequent rollover or renewal, there must be confirmation that the information is current and accurate (consistent with FAQ 10) as for any other new account for an existing customer.  There is an exception or alternative approach authorized in FAQ 12 “because the risk of money laundering is very low”:  If, at the time of the rollover or renewal, the customer certifies its beneficial ownership information, and also agrees to notify the financial institution of any change in information in the future, no action will be required at subsequent renewals or rollovers.The response in FAQ 12 is not responsive to the concerns that have been expressed by the banking industry and will be burdensome for banks to administer.  Obtaining a certification in time, without disrupting the rollover or renewal, will be challenging, and it appears that if it the certification or promise to update is not obtained in time, the account may have to be closed. FAQs 13 through 17 address another aspect of the regulation that has generated extensive discussion: When (1) must beneficial ownership be obtained for an account opened before the effective date of the regulation, or (2) beneficial ownership information updated on existing accounts whose beneficial ownership has been obtained and verified.Following closely what was said in the preamble to the final rule, FAQ 13 states that the obligation is triggered when a financial institution “becomes aware of information about the customer during the course of normal monitoring relevant to assessing or reassessing the risk posed by the customer, and such information indicates a possible change in beneficial ownership.”FAQ 14 clarifies somewhat what is considered normal monitoring but is not perfectly clear what triggers obtaining and verifying beneficial ownership.  It is clear that there is no obligation to obtain or update beneficial ownership information in routine periodic CDD reviews (CDD refresh reviews) “absent specific risk-based concerns.” We would assume that means, following FAQ 13, concerns about the ownership of the customer.  Beyond that FAQ 14  is less clear.  It states that the obligation is triggered “when, in the course of normal monitoring a financial institution becomes aware of information about a customer or an account, including a possible change of beneficial ownership information, relevant to assessing or reassessing the customer’s overall risk profile.  Absent such a risk-related trigger or event, collecting or updating of beneficial ownership information is at the discretion of the covered financial institution.”The trigger or event may mean in the course of SAR monitoring or when conducting event-driven CDD reviews, e.g., when a subpoena is received or material negative news is identified – something that may change a risk profile.  Does the obligation then arise only if the risk profile change includes a concern about whether the financial institution has accurate ownership information?  That may be the intent, but is not clearly stated.  If the account is being considered for closure because of the change in risk profile, would the financial institution be released from the obligation to obtain beneficial ownership?   That would make sense, but is not stated.  This FAQ is in need of clarification and examples would be helpful.On another note, the language in FAQ 14 also is of interest because it may suggest, in FinCEN’s view, that periodic CDD reviews should be conducted on a risk basis, and CDD refresh reviews may not be expected for lower risk customers, as is the practice for some banks. FAQ 18 seems to address at least partially a technical issue with the regulation that arises because SEC-registered investment advisers are excluded from the definition of legal entity customer in the regulation, but U.S. pooled investment vehicles advised by them are not excluded.[3]  FAQ 18 states that, if the operator or adviser of a pooled investment vehicle is not excluded from the definition of legal entity customer, under the regulation, e.g., like a foreign bank, no beneficial ownership information is required to be obtained on the pooled investment vehicle under the ownership prong, but there must be compliance with beneficial ownership control party prong, i.e., verification of identity of a control party.  A control party could be a “portfolio manager” in these situations.FinCEN describes why no ownership information is required as follows:  “Because of the way the ownership of a pooled investment vehicle fluctuates, it would be impractical for covered financial institutions to collect and verify ownership identity for this type of entity.”  Thus, in the case where the operator or adviser of the pooled investment vehicle is excluded from the definition of legal entity, like an SEC-registered investment adviser, it would seem not to be an expectation to obtain beneficial ownership information under the ownership prong.  Nevertheless, the question of whether you need to obtain and verify the identity of a control party for a pooled investment vehicle advised by a SEC registered investment adviser is not squarely answered in the FAQ.  A technical correction to the regulation is still needed, but it is unlikely there would be regulatory or audit criticism for following the FAQ guidance at least with respect to the ownership prong. FAQ 19 clarifies that, when a beneficial owner is a trust (where the legal entity customer is owned more than 25% by a trust), the financial institution is only required to verify the identity of one trustee if there are multiple trustees. FAQ 20 deals with what to do if a trust holds more than a 25% beneficial interest in a legal entity customers and the trustee is not an individual, but a legal entity, like a bank or law firm.  Under the regulation, if a trust holds more than 25% beneficial ownership of a legal entity customer, the financial institution must verify the identity of the trustee to satisfy the ownership prong of the beneficial ownership requirement.  The ownership prong references identification of “individuals.”  Consequently, the language of the regulation does not seem to contemplate the situation where the trustee was a legal entity.FAQ 20 seems to suggest that, despite this issue with the regulation, CIP should be conducted on the legal entity trustee, but apparently, on a risk basis, not in every case:  “In circumstances where a natural person does not exist for purposes of the ownership/equity prong, a natural person would not be identified.  However, a covered financial institution should collect identification information on the legal entity trustee as part of its CIP, consistent with the covered institution’s risk assessment and customer risk profile.”  (Emphasis added.)More clarification is needed on this issue, and perhaps an amendment to the regulation to address this specific situation.  Pending additional guidance, the safest course appears to be to verify the identity of legal entity trustee consistent with CIP requirements, which may pose practical difficulties, e.g., will a law firm trustee easily provide its TIN?  Presumably, CIP would not be required on any legal entity trustee that is excepted from the definition of legal entity under 31 C.F.R. § 1010.230(e)(2). FAQ 21 addresses the question of how does a financial institution verify that a legal entity comes within one of the regulatory exceptions to the definition of legal entity customer in 31 C.F.R. § 1010.230(e)(2).  The answer is that the financial institution generally can rely on information provided by the customer if it has no knowledge of facts that would reasonably call into question the reliability of the information.  Nevertheless, that is not the end of the story.  The FAQ provides that the financial institution also must have risk-based policies and procedures that specify the type of information they will obtain and reasonably rely on to determine eligibility for exclusions. FAQ 24 may resolve another technical issue in the regulation.  The exceptions to the definition of legal entity in the regulation refer back to the BSA CIP exemption provisions, which in turn, cross reference the Currency Transaction Reporting (CTR) exemption for banks when granting so-called Tier One exemptions.  One category for the CTR exemption is “listed” entities, which includes NASDAQ listed entities, but excludes NASDAQ Capital Markets Companies, i.e., this category of NASDAQ listed entity is not subject to CIP or CTR Tier One exemptions.  31 C.F.R. § 1020.315(b)(4).  This carve out was not discussed in the preamble to the CDD final regulation or in FAQ 24.The FAQ simply states:  “[A]ny company (other than a bank) whose common stock or analogous equity interests are listed on the New York Stock Exchange, the American Stock Exchange (currently known as the NYSE American), or NASDAQ stock exchange” is excepted from the definition of legal entity.  In any event, as with the FAQ 18 issue, it would appear that a technical correction is needed on this point, but, given the FAQ, it is unlikely that a financial institution would be criticized if it treated NASDAQ Capital Markets Companies as excepted legal entities. FAQs 32 and 33 end the speculation that the CDD regulation impacts CTR compliance.  Consistent with FinCEN CTR guidance, under FAQ 32, the rule remains that, for purposes of CTR aggregation, the fact that two businesses share a common owner does not mean that a financial institution must aggregate the currency transactions of the two businesses for CTR reporting, except in the narrow situation where there is a reason to believe businesses are not being operated separately. Conclusion Financial institutions and their industry groups will likely continue to seek further guidance on the most problematic issues in the CDD regulation.  It is our understanding that FinCEN and the bank regulators also will address compliance with the CDD regulation in the upcoming update to the FFIEC Bank Secrecy Act/Anti-Money Laundering Examination Manual. Covered financial institutions already have spent, and will continue to spend, significant time and resources to meet the complex regulatory requirements and anticipated regulatory expectations.  In this flurry of activity to address regulatory risk, it is essential for financial institutions to continue to consider any money laundering risk of legal entity clients and that CDD not become simply mechanical.  It is not only a matter of documenting and updating all of the right information about beneficial ownership and control, but financial institutions should continue to assess whether the ownership structure makes sense for the business or whether it is overly complex for the business type and purposely opaque.  Also, it is important to consider whether it makes sense for a particular legal entity to be seeking a relationship with your financial institution and whether the legal entity is changing financial institutions voluntarily.  CDD measures to address regulatory risk and money laundering risk overlap but are not equivalent.    [1]   FinCEN also issued FAQs on the regulation on July 19, 2016. https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.   FINRA issued guidance on the CDD regulation in FINRA Notice to Members 17-40 (Nov. 21, 2017). http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-40.pdf.    [2]   The Notice of Final Rulemaking was published on May 11, 2016 and provided a two-year implementation period.  81 Fed. Reg. 29,398 (May 11, 2016). https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf.  FinCEN made some slight amendments to the rule on September 29, 2017.  https://www.fincen.gov/sites/default/files/federal_register_notices/2017-09-29/CDD_Technical_Amendement_17-20777.pdf The new regulations are set forth in the BSA regulations at 31 C.F.R. § 1010.230 (beneficial ownership requirements); 31 C.F.R. § 1020.210(a)(5) (banks); 31 C.F.R. § 1023.210(b)(5) (broker-dealers); 31 C.F.R. § 1024.210(b)(4) (mutual funds); and 31 C.F.R. § 1026.210(b)(5) (future commission merchants and introducing brokers in commodities).    [3]   The regulation does not clearly address the beneficial ownership requirements for a U.S. pooled investment vehicle operated or controlled by a registered SEC investment adviser.  Pooled investment vehicles operated or advised by a “financial institution” regulated by a Federal functional regulator are not considered legal entities under the regulation.  31 C.F.R. § 1010.230(e)(2)(xi).  An SEC registered investment adviser, however, is not yet a financial institution under the BSA.  Under 31 C.F.R. § 1010.230(e)(3), a pooled investment vehicle that is operated or advised by a “financial institution” not excluded from the definition of legal entity is subject to the beneficial ownership control party prong. Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the authors: Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

April 19, 2018 |
The Federal Reserve’s New Take on Bank Capital: Two Modest, but Thoughtful, Proposals

Click for PDF Last week, the Board of Governors of the Federal Reserve System (Federal Reserve) issued two proposals relating to capital requirements for large banking organizations that provide a glimpse into its thinking on recalibrating post-Financial Crisis regulation.  Not at all radical, they appear driven by two principal, and beneficial, goals – simplifying the complex maze of regulations that grew out of the Dodd-Frank Act, and seeking to tailor regulation more closely to the risks posed by particular organizations.  At the same time, however, the “new” Federal Reserve’s approach shows more continuity with the Yellen Federal Reserve than a drastic departure. The first proposal (Stress Buffer Proposal) would simplify the capital rules that are applicable to bank holding companies (BHCs), including intermediate holding companies of non-U.S. banks, that have $50 billion or more in total consolidated assets.  The second proposal (eSLR Proposal) would lower the enhanced supplementary leverage ratio (eSLR) that is applicable only to U.S. globally systemically important BHCs (G-SIBs) and their insured bank subsidiaries. The Federal Reserve will be taking comments on the Stress Buffer Proposal for 60 days, and on the eSLR Proposal for 30 days, in each case after publication in the Federal Register. Stress Buffer Proposal:  Simplifying Capital Rules Applicable to Large Banking Organizations At the heart of the Financial Crisis lay a very significant capital problem:  there was an insufficient amount of capital in the banking system to absorb losses, and certain capital instruments did not end up having the loss absorbency that regulators originally contemplated.  As a reaction, the Basel III capital regime and the Federal Reserve, acting under its authority to adopt enhanced prudential standards under Section 165 of the Dodd-Frank Act, substantially increased the amount of capital that large banking organizations are required to hold – but the rules that were adopted did not take into account their cumulative effects. The result of multiple rulemakings was therefore a hodgepodge of requirements, described with some flair earlier this year by the Federal Reserve’s Vice Chairman for Supervision, Governor Randal Quarles: There are different ways to count the number of loss absorbency constraints that our large banking firms face – which is perhaps in itself an indication of a surfeit of complexity if we can’t be perfectly sure of how to count them – but the number I come up with is 24 total requirements in the framework.  While I do not know precisely the socially optimal number of loss absorbency requirements for large banking firms, I am reasonably certain that 24 is too many.[1] The Stress Buffer Proposal addresses this concern and would reduce the number of loss absorbency requirements to 14 – which still may be above a “socially optimal” number – by tying minimum capital requirements into the Federal Reserve’s CCAR and stress testing process. Under the proposal, the results of the Federal Reserve’s annual supervisory stress test would be used to size specific buffer requirements above minimum capital requirements for particular firms – that is, there would be tailoring based on the stress test result for each firm.  The Stress Buffer Proposal would replace the current static 2.5 percent capital conservation buffer under the Basel III standardized approach with a “stress capital buffer requirement.”  In addition, the proposal would also establish a “stress leverage buffer requirement” in addition to the Basel III minimum 4 percent Tier 1 leverage ratio requirement.  Firms subject to the rules would be required to maintain capital ratios above minimum requirements plus the buffer requirements in order to avoid restrictions on capital distributions and discretionary bonus payments. The stress capital buffer would be determined as the difference between a firm’s starting and lowest projected Common Equity Tier 1 (CET1) capital ratios under the severely adverse scenario in the stress test, calculated under the Basel III standardized approach, plus the sum of the ratios of the dollar amount of the firm’s planned common stock dividends to projected risk-weighted assets for each of the fourth through seventh quarters of the test’s planning horizon.  The stress capital buffer could not, however, be less than the current 2.5 percent capital conservation buffer.  The eight U.S. G-SIBs would be required to add on their current G-SIB surcharges to the buffer amount.  The stress leverage buffer would be calculated in a similar manner – that is, looking at the lowest projected Tier 1 leverage ratio under the severely adverse scenario in the stress test and considering the effects of a year of dividends. To give an example of how the stress capital buffer would operate, if a firm has a CET1 ratio of 9 percent and it declined to 6 percent under the severely adverse scenario, the firm’s stress capital buffer for the coming year would be 3 percent.  This would be added to the minimum 4.5 percent CET1 requirement, and therefore the firm would be required to maintain a 7.5 percent CET1 ratio for the coming year in order to avoid restrictions on dividends and bonus payments.  If the firm was a G-SIB, its minimum CET1 ratio could be as much as 11 percent. In addition, the Stress Buffer Proposal would remove certain very conservative assumptions that are currently used in the CCAR post-stress capital assessment.  The current assumption that firms would make all planned capital distributions over the nine-quarter stress planning horizon – one that appears to be questionable at best – would be removed, and replaced with an assumption that firms would cease all repurchases, and make four quarters of dividend payments.  On this score, the Federal Reserve noted that, in the Financial Crisis, large BHCs ceased repurchases early, but continued to pay dividends at the pre-Crisis rate through 2008.  Similarly, the counterintuitive assumption that firms would grow their balance sheets in periods of financial stress would be removed, and replaced with a more realistic one that firms would maintain asset levels for the planning horizon.  In addition, the Federal Reserve would eliminate the 30 percent dividend payout ratio as a criterion for heightened scrutiny of a firm’s capital plan.  The Stress Buffer Proposal would remove CCAR’s quantitative objection as redundant, and, as is the case now, the qualitative objection in CCAR would apply only to large and complex firms.[2] The new requirements would come into effect on October 1, 2019. Proposed Reduction in the Enhanced Supplementary Leverage Ratio The Federal Reserve’s second proposal, which was issued jointly with the Office of the Comptroller of the Currency, relates to reducing the eSLR, which is applicable only to G-SIBs and their insured bank subsidiaries.  Traditionally, a leverage ratio, which does not take into account the particular risks of a bank’s assets – or, in supplementary form, a bank’s off-balance sheet exposures – has been thought of as a “backstop” to risk-weighted capital ratios.  That is, the leverage ratio has not been intended to be the ultimate determinant of how much capital a bank must hold.  If, by contrast, the leverage ratio becomes that determinant – the binding capital constraint – it may encourage a bank to engage in riskier activities because the same amount of capital is required for such activities, which promise greater rewards, than safer, less profitable activities. The eSLR is currently set a 5 percent for G-SIBs, and at 6 percent for their insured depository institution subsidiaries – in contrast to 3 percent for non-G-SIBs.[3]  As a result, certain institutions have commented that the eSLR is likely to be the binding capital constraint, and the Federal Reserve noted that, based on third quarter 2017 data, the current eSLR was a binding constraint for four of the eight U.S. G-SIBs and all of their lead insured bank subsidiaries. The eSLR Proposal does not seek to change the current manner in which the eSLR is calculated – which itself has not insubstantial complexity in terms of certain off-balance sheet exposures.  Rather, it proposes reducing the overall ratio by replacing the current 2- and 3-percent supplements with a supplement equal to one-half of a particular BHC’s G-SIB surcharge.  The maximum G-SIB surcharge is currently 3.5 percent, and so for such a G-SIB, the eSLR would be reduced from 5 percent to 4.75 percent at the holding company level, and from 6 percent to 4.75 percent at the bank level.  BHCs with lower G-SIB surcharges would have lower required eSLRs – thus, as with the Stress Buffer Proposal, there would be tailoring of the amount of required capital to the overall perceived risk of a particular BHC. The Federal Reserve estimated that the eSLR Proposal would reduce the amount of required capital only marginally at the holding company level, $400 million across all eight G-SIBs.  The effects would be more pronounced at the bank level, where the eSLR Proposal was estimated to reduce required capital by a total of $121 billion. Perhaps for this reason, the eSLR Proposal was more controversial.  Federal Reserve Governor Brainerd voted against it, and so it passed 2-1,[4] and outgoing FDIC Chair Gruenberg issued a statement noting his disagreement with it. Conclusion Taken together, the proposals appear to be a prudent course change given what are perhaps the two most significant issues with 2010-2016 Dodd-Frank implementation – multiple regulatory requirements adopted without an overall consideration of their cumulative effects, and a failure fully to heed the statutory policy that enhanced prudential standards should be tailored to the quantity of risk created by particular financial firms.  Given the effects of the Financial Crisis and the obligations that the Dodd-Frank Act imposed on bank regulatory agencies, these issues are not surprising.  It is nonetheless welcome to see a broader and more nuanced view. For those expecting significant change, the two proposals may surprise.  Indeed, the concept of a stress capital buffer was previewed by Governor Daniel Tarullo.[5]  And the Stress Buffer Proposal contains the concept that it is appropriate to add on the G-SIB surcharge during stress (also previewed by Governors Tarullo),[6] even though the stress tests themselves include certain tests only for G-SIBs – the result being that the Stress Buffer Proposal is likely to result in more capital being held by G-SIBs even as it is likely to reduce, modestly, the amount of capital to be held by large banks that are not G-SIBs. Because the U.S. banking system is currently strongly capitalized, it is difficult to see the proposals as increasing systemic risk:  the Federal Reserve noted that the common equity capital ratio of the BHCs in the 2017 CCAR was 12.1 percent in the fourth quarter of 2017, more than double 2009 levels.  The increase was the result of these BHCs having increased their common equity – the most dependable form of capital – more than $720 billion.  For this reason, the dissenting positions of Governor Brainerd and FDIC Chair Gruenberg are difficult to justify. Notwithstanding this simplification effort, capital regulation remains highly complex, as may be seen in the eSLR Proposal itself.  The proposal would need to amend the Total Loss Absorbing Capacity (TLAC) rule to conform the TLAC leverage buffer with the proposed revised eSLR standard and to recalibrate the TLAC rule’s minimum Long Term Debt requirement, which itself is calibrated off of the eSLR.  For those who agree with the proposition that “the [c]onfusion and compliance burden that results from overly complex regulation does not advance the goal of a safe financial system,”[7] the two proposals are a step in the right direction, but there is more work to be done.    [1]   “Early Observations on Improving the Effectiveness of Post-Crisis Regulation,” Speech by Vice Chairman for Supervision Randal K. Quarles, January 19, 2018.  .    [2]   These are any BHC with average total assets or at least $250 billion or average total nonbank assets of at least $75 billion.    [3]   As an example of the current over-complexity of capital regulation, the minimum eSLR is a requirement to avoid limitations on capital distributions and bonus payments at the G-SIB level, but it is a requirement for “well capitalized” status at the insured bank level.  The eSLR requests comments on whether such an approach should continue to be followed.    [4]   Although President Trump has nominated three other persons to fill Federal Reserve vacancies, none has been confirmed, and so there are only three of seven Governors currently serving.    [5]   “Departing Thoughts,” Speech by Governor Daniel K. Tarullo, April 4, 2017.    [6]   Id.    [7]   Vice Chairman for Supervision, Randal K. Quarles, Semiannual Supervision and Regulation Testimony, Committee on Financial Services, U.S. House of Representatives, April 17, 2018. The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and James Springer. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or any of the following: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

April 12, 2018 |
Trump Administration Imposes Unprecedented Russia Sanctions

Click for PDF On April 6, 2018, the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) significantly enhanced the impact of sanctions against Russia by blacklisting almost 40 Russian oligarchs, officials, and their affiliated companies pursuant to Obama-era sanctions, as modified by the Countering America’s Adversaries Through Sanctions Act (“CAATSA”) of 2017.  In announcing the sanctions, Treasury Secretary Steven Mnuchin cited Russia’s involvement in “a range of malign activity around the globe,” including the continued occupation of Crimea, instigation of violence in Ukraine, support of the Bashal al-Assad regime in Syria, attempts to subvert Western democracies, and malicious cyber activities.[1]  Russian stocks fell sharply in response to the new measures, and the ruble depreciated almost 5 percent against the dollar.[2] Although this is not the first time that the Trump administration imposed sanctions against Russia, it is the most significant action taken to date.  In June 2017, OFAC added 38 individuals and entities involved in the Ukraine conflict to OFAC’s list of Specially Designated Nationals (“SDNs”).[3]  The April 6 sanctions added seven Russian oligarchs and 12 companies they own or control, 17 senior Russian government officials, the primary state-owned Russian weapons trading company and its subsidiary, a Russian bank, to the SDN List.[4]  These designations include major, publicly-traded companies that have been listed on the London and Hong Kong exchanges and that have thousands of customers and tens of thousands of investors throughout the world. OFAC has never designated similar companies, and the potential challenges for global companies seeking to comply with OFAC measures are substantial.  An SDN designation prohibits U.S. persons—including U.S. companies, U.S. financial institutions, and their foreign branches—from engaging in any transactions with the designees or with entities in which they hold an aggregate ownership of 50 percent or more.  The designation of a small company in a regional market can be devastating for the company, but rarely would it impose meaningful collateral consequences on global markets or investors.  In this case, sanctions on companies such as EN+ and RUSAL (amongst others) have already impacted a substantial portion of a core global commodity (the aluminum market) while also preventing further trades in their shares, a move that could harm pension funds, mutual funds, and other investors that have long held stakes worth billions of dollars. To minimize the immediate disruptions, OFAC issued two time-limited general licenses (regulatory exemptions) permitting companies and individuals to undertake certain transactions to “wind down” business dealings related to the designated parties.[5]  However, our assessment is that disruptions are inevitable and the size of the sanctions targets in this case means that the general licenses will have potentially limited effect in reducing dislocations. Background OFAC’s April 6 designations mark a clear change in tone from the Trump administration, which had initially resisted imposing the full force of CAATSA’s sanctions.  For example, as we wrote in our 2017 Year-End Sanctions Update, CAATSA required the imposition of secondary sanctions on any person the President determined to have been engaging in “a significant transaction with a person that is part, or operates for or on behalf of, the defense or intelligence sectors of the Government Russia.”[6]  On the day such sanctions were to be imposed, State Department representatives provided classified briefings to Congressional leaders to explain their decision not to impose any such sanctions under CAATSA, namely because the Trump administration felt that CAATSA was already having an deterrent effect which removed any immediate need to impose sanctions.[7] Section 241 of CAATSA also required OFAC to publish a report on January 29, 2018 identifying “the most significant senior foreign political figures and oligarchs in the Russian Federation,”[8] (the “Section 241 List”).  The Treasury Department issued the report shortly before midnight on the due date, publicly naming 114 senior Russian political figures and 96 oligarchs.[9]  Although the report did not result in any sanctions or legal repercussions, the public naming of such persons did cause confusion for those who sought to engage with them in compliance with U.S. law.[10]  However, most observers were highly critical of the list, claiming that it demonstrated that the Trump administration was failing to adequately address Congressional intent to punish Moscow.  Interestingly, almost all of the oligarchs designated on April 6 originally appeared on the Section 241 List.[11] Designations Included among the list of sanctioned parties were seven Russian oligarchs designated for being a Russian government official or operating in the energy sector of the Russian Federation economy, and 12 companies they own or control.  In its press release, OFAC warned that the 12 companies identified as owned or controlled by the designated Russian oligarchs “should not be viewed as exhaustive, and the regulated community remains responsible for compliance with OFAC’s 50 percent rule.”  This rule extends U.S. sanctions prohibitions to entities owned 50 percent or more, even if those companies are not themselves listed by OFAC.  The opacity of ownership in the Russian economy makes the 50 percent rule very difficult to operationalize. In addition, OFAC designated 17 senior Russian government officials, a state-owned company and its subsidiary.  The sanctioned individuals and entities, as described by OFAC, are provided in the following table. SDN Description Designated Russian Oligarchs 1. Vladimir Bogdanov Bogdanov is the Director General and Vice Chairman of the Board of Directors of Surgutneftegaz, a vertically integrated oil company operating in Russia. OFAC imposed sectoral sanctions on Surgutneftegaz pursuant to Directive 4 issued under E.O. 13662 in September 2014. 2. Oleg Deripaska Deripaska has said that he does not separate himself from the Russian state.  He has also acknowledged possessing a Russian diplomatic passport, and claims to have represented the Russian government in other countries.  Deripaska has been investigated for money laundering, and has been accused of threatening the lives of business rivals, illegally wiretapping a government official, and taking part in extortion and racketeering.  There are also allegations that Deripaska bribed a government official, ordered the murder of a businessman, and had links to a Russian organized crime group. 3. Suleiman Kerimov Kerimov is a member of the Russian Federation Council.  On November 20, 2017, Kerimov was detained in France and held for two days. He is alleged to have brought hundreds of millions of euros into France – transporting as much as 20 million euros at a time in suitcases, in addition to conducting more conventional funds transfers – without reporting the money to French tax authorities.  Kerimov allegedly launders the funds through the purchase of villas.  Kerimov was also accused of failing to pay 400 million euros in taxes. 4. Kirill Shamalov Shamalov married Putin’s daughter Katerina Tikhonova in February 2013 and his fortunes drastically improved following the marriage; within 18 months, he acquired a large portion of shares of Sibur, a Russia-based company involved in oil and gas exploration, production, processing, and refining.  A year later, he was able to borrow more than one $1 billion through a loan from Gazprombank, a state-owned entity subject to sectoral sanctions pursuant to E.O. 13662.  That same year, long-time Putin associate Gennady Timchenko, who is himself designated pursuant to E.O. 13661, sold an additional 17 percent of Sibur’s shares to Shamalov.  Shortly thereafter, Kirill Shamalov joined the ranks of the billionaire elite around Putin. 5. Andrei Skoch Skoch is a deputy of the Russian Federation’s State Duma.  Skoch has longstanding ties to Russian organized criminal groups, including time spent leading one such enterprise. 6. Viktor Vekselberg Vekselberg is the founder and Chairman of the Board of Directors of the Renova Group.  The Renova Group is comprised of asset management companies and investment funds that own and manage assets in several sectors of the Russian economy, including energy.  In 2016, Russian prosecutors raided Renova’s offices and arrested two associates of Vekselberg, including the company’s chief managing director and another top executive, for bribing officials connected to a power generation project in Russia. Designated Oligarch-Owned Companies 7. B-Finance Ltd. British Virgin Islands company owned or controlled by, directly or indirectly, Oleg Deripaska. 8. Basic Element Limited Basic Element Limited is based in Jersey and is the private investment and management company for Deripaska’s various business interests. 9. EN+ Group Owned or controlled by, directly or indirectly, Oleg Deripaska, B-Finance Ltd., and Basic Element Limited.  EN+ Group is located in Jersey and is a leading international vertically integrated aluminum and power producer.  This is a publicly traded company that has been listed, inter alia, on the London Stock Exchange. 10. EuroSibEnergo Owned or controlled by, directly or indirectly, Oleg Deripaska and EN+ Group. EuroSibEnergo is one of the largest independent power companies in Russia, operating power plants across Russia and producing around nine percent of Russia’s total electricity. 11. United Company RUSAL PLC Owned or controlled by, directly or indirectly, EN+ Group.  United Company RUSAL PLC is based in Jersey and is one of the world’s largest aluminum producers, responsible for seven percent of global aluminum production.  This is a publicly traded company that has been listed, inter alia¸ on the Hong Kong Stock Exchange. 12. Russian Machines Owned or controlled by, directly or indirectly, Oleg Deripaska and Basic Element Limited.  Russian Machines was established to manage the machinery assets of Basic Element Limited. 13. GAZ Group Owned or controlled by, directly or indirectly, Oleg Deripaska and Russian Machines.  GAZ Group is Russia’s leading manufacturer of commercial vehicles. 14. Agroholding Kuban Owned or controlled by, directly or indirectly, Oleg Deripaska and Basic Element Limited. 15. Gazprom Burenie, OOO Owned or controlled by Igor Rotenberg.  Gazprom Burenie, OOO provides oil and gas exploration services in Russia. 16. NPV Engineering Open Joint Stock Company Owned or controlled by Igor Rotenberg.  NPV Engineering Open Joint Stock Company provides management and consulting services in Russia. 17. Ladoga Menedzhment, OOO Owned or controlled by Kirill Shamalov.  Ladoga Menedzhment, OOO is located in Russia and engaged in deposit banking. 18. Renova Group Owned or controlled by Viktor Vekselberg.  Renova Group, based in Russia, is comprised of investment funds and management companies operating in the energy sector, among others, in Russia’s economy. Designated Russian State-Owned Firms 19. Rosoboroneksport State-owned Russian weapons trading company with longstanding and ongoing ties to the Government of Syria, with billions of dollars’ worth of weapons sales over more than a decade.  Rosoboroneksport is being designated under E.O. 13582 for having materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services in support of, the Government of Syria. 20. Russian Financial Corporation Bank (RFC Bank) Owned by Rosoboroneksport.  RFC Bank incorporated is in Moscow, Russia and its operations include deposit banking activities. Designated Russian Government Officials 21. Andrey Akimov Chairman of the Management Board of state-owned Gazprombank 22. Mikhail Fradkov President of the Russian Institute for Strategic Studies (RISS), a major research and analytical center established by the President of the Russian Federation, which provides information support to the Presidential Administration, Federation Council, State Duma, and Security Council. 23. Sergey Fursenko Member of the board of directors of Gazprom Neft, a subsidiary of state-owned Gazprom 24. Oleg Govorun Head of the Presidential Directorate for Social and Economic Cooperation with the Commonwealth of Independent States Member Countries.  Govorun is being designated pursuant to E.O. 13661 for being an official of the Government of the Russian Federation. 25. Alexey Dyumin Governor of the Tula region of Russia.  He previously headed the Special Operations Forces, which played a key role in Russia’s purported annexation of Crimea. 26. Vladimir Kolokoltsev Minister of Internal Affairs and General Police of the Russian Federation 27. Konstantin Kosachev Chairperson of the Council of the Federation Committee on Foreign Affairs 28. Andrey Kostin President, Chairman of the Management Board, and Member of the Supervisory Council of state-owned VTB Bank 29. Alexey Miller Chairman of the Management Committee and Deputy Chairman of the Board of Directors of state-owned company Gazprom 30. Nikolai Patrushev Secretary of the Russian Federation Security Council 31. Vladislav Reznik Member of the Russian State Duma 32. Evgeniy Shkolov Aide to the President of the Russian Federation 33. Alexander Torshin State Secretary – Deputy Governor of the Central Bank of the Russian Federation 34. Vladimir Ustinov Plenipotentiary Envoy to Russia’s Southern Federal District 35. Timur Valiulin Head of the General Administration for Combatting Extremism within Russia’s Ministry of Interior 36. Alexander Zharov Head of Roskomnadzor (the Federal Service for the Supervision of Communications, Information Technology, and Mass Media) 37. Viktor Zolotov Director of the Federal Service of National Guard Troops and Commander of the National Guard Troops of the Russian Federation All assets subject to U.S. jurisdiction of the designated individuals and entities, and of any other entities blocked by operation of law as a result of their ownership by a sanctioned party, are frozen, and U.S. persons are generally prohibited from dealings with them.  OFAC’s Frequently Asked Questions (“FAQs”) make clear that if a blocked person owns less than 50 percent of a U.S. company, the U.S. company will not be blocked.  However, the U.S. company (1) must block all property and interests in property in which the blocked person has an interest and (2) cannot make any payments, dividends, or disbursement of profits to the blocked person and must place them in a blocked account at a U.S. financial institution.[12] Non-U.S. persons could face secondary sanctions for knowingly facilitating significant transactions for or on behalf of the designated individuals or entities.  CAATSA strengthened the secondary sanctions measures that could be used to target such persons, although such measures typically carry less risk because as a matter of implementation OFAC traditionally warns those who may be transacting with parties that could subject them to secondary sanctions and provides them with an opportunity to cure.  While this outreach and deterrence model of imposing secondary sanctions was developed under the Obama administration (and resulted in very few impositions of secondary sanctions), the Trump administration could theoretically change it and impose secondary sanctions without the traditional warning.  However, that appears unlikely and the Trump administration has indicated that it will continue to provide warnings before imposing secondary sanctions. Two CAATSA provisions bear particular note as they are implicated by Friday’s actions:  section 226, which authorizes sanctions on foreign financial institutions for facilitating a transaction on behalf of a Russian person on the SDN List, and section 228, which seeks to impose sanction on a person who “facilitates a significant transaction…for or on behalf of any person subject to sanctions imposed by the United States with respect to the Russian Federation.”[13]  OFAC has clarified that the section 228 provision extends to persons listed on either the SDN or the Sectoral Sanctions Identifications (“SSI”) List, as well as persons they may own or control pursuant to OFAC’s 50 percent rule.[14]  As we noted when CAATSA was passed, despite the mandatory nature of these sections, the President appears to retain the discretion to impose restrictions based upon whether he finds certain transaction significant or for other reasons.  With the increase in the SDN list to include major players in global commodities such as EN+ or RUSAL, more companies around the world that rely on these companies could find themselves at least theoretically at risk of being sanctioned themselves.  Companies should also consider this risk where there is reliance on material produced by any company in the Russian military establishment and sold by the Russian state arms company such as Rosoboronexport, which was also sanctioned. General Licenses In an effort to minimize the immediate disruptions to U.S. persons and global markets (especially given the sanctioning of major publicly traded corporations that have thousands of clients and investors throughout the world), OFAC issued General Licenses 12 and 13, permitting companies to undertake certain transactions and activities to “wind down” certain business dealings related to certain, listed designated parties.  These General Licenses only cover U.S. persons, which has led some non-U.S. companies to inquire whether their ability to wind down operations with respect to the SDN companies would place them at risk for secondary sanctions (as they would be engaging with sanctioned parties and perhaps trigger the CAATSA provisions above).  OFAC has noted in its FAQs that the U.S. Government would not find a transaction “significant” if a U.S. person would not need a specific license to undertake it.[15]  That is, it would seem that at least for the duration of the General Licenses a non-U.S. party can engage in similar wind down operations without risking secondary sanctions. General License 12, which expires June 5, 2018, authorizes U.S. persons to engage in transactions and activities with the 12 oligarch-owned designated entities that are “ordinarily incident and necessary to the maintenance or wind down of operations, contracts, or other agreements” related to these 12 entities (as well as those entities impacted by operation of OFAC’s 50 percent rule).  This is a broader wind down provision than OFAC has issued in the past in that it allows not just “wind down” activities but also non-defined “maintenance” activities.  Despite this breadth it is already uncertain how this General License will actually work in practice.  Permissible transactions and activities include importation from blocked entities and broader dealings with them.  However, no payments are allowed to be made to blocked entities–rather such payments can only be made to the blocked entities listed in General License 12 into blocked, interest-bearing accounts and reported to OFAC by June 18, 2018 (10 business days after the expiration of the license).[16]  It is not clear why a sanctioned party would wish to deliver goods and services to parties if the sanctioned party cannot be paid.  In line with the FAQ noted above, for non-U.S. companies it would seem that in order to avoid secondary sanctions implications the same restrictions would apply–that is, continued transactions are permitted on a wind down basis, but transfer of funds to the SDN companies could be viewed as “significant” or otherwise sanctionable. Recognizing how broad the sanctions are and how far they may implicate subsidiaries of SDN companies inside the United States, OFAC’s FAQs clarify that General License 12 generally permits the blocked entities listed to pay U.S. persons their salaries, pension payments, or other benefits due during the wind down period.  U.S. persons employed by entities that are not explicitly listed in General License 12—principally the designated Russian state-owned entities—do not have the benefit of this wind down period.  OFAC FAQs note that such U.S. persons may seek authorization from OFAC to maintain or wind down their relationships with any such blocked entity, but make clear that continued employment or board membership related to these entities is prohibited.[17]  The implications of these restrictions are significant where, as is the case with the blocked entities listed in General License 12, U.S. subsidiaries exist and U.S. persons are involved throughout company operations. General License 13, which expires May 7, 2018, similarly allows transactions and activities otherwise prohibited under the April 6 sanctions.  This license allows transactions and activities necessary to “divest or transfer debt, equity, or other holdings” in three designated Russia entities:  EN+ Group PLC, GAZ Group, and United Company RUSAL PLC.  Permitted transactions include facilitating, clearing, and settling transactions.  General License 13, however, does not permit any divestment or transfer to a blocked person, including the three entities listed in General License 13.[18]  As with General License 12, transactions permitted under General License 13 must be reported to OFAC within 10 business days after the expiration of the license. Once again, it is uncertain how the General License will work in practice.  Given the designations which have depressed the share prices of the sanctions parties it is unknown who might be willing to purchase the shares even if U.S. holders are permitted to sell them. Other Ramifications for Investors, Supply Chains, and Customers The April 6 sanctions raise other significant questions and practical challenges for U.S. and non-U.S. companies, with particular risks for investors as well as the manufacturers, suppliers, and customers of the SDN companies. Investors and fund managers will need to conduct significant diligence into the participants and ownership structures of their funds, including fund limited partners, to determine whether sanctioned persons or entities are involved.  Moreover, for those who have seen the value of any assets tied to these companies decline significantly, they are allowed to continue to try sell their assets to non-U.S. persons.  However, given the challenge in finding buyers and evidence that certain financial institutions and brokers are already refusing to engage in any trades (even during the wind down period), the investment community needs to potentially prepare for long-term holding of blocked assets (by setting up sequestered accounts). For those within the supply chains of sanctioned companies, from suppliers of commodities to finished goods, as well as customers of sanctioned companies, the concern will be to potentially replace key commercial relationships which will become increasingly difficult (if not prohibited) to maintain.  For companies that have relied on RUSAL, for example, as a source of aluminum or as a customer for their goods they will potentially need to find replacements.  While aluminum is not in short supply globally, in certain jurisdictions RUSAL has a commanding position and even a monopoly.  It is unclear how companies that seek to be compliant with OFAC regulations will navigate a world in which RUSAL has been a primary or secondary supplier (and there is no clear way to avoid such engagement so long as the company seeks to be active in that jurisdiction and in need of aluminum).  Moreover, it is not just U.S. person counterparties that are likely to be affected by prohibitions on dealing with sanctioned parties.  In line with the FAQ noted above, if non-U.S. companies were to make payments to the sanctioned companies for deliveries, these could be deemed “significant transactions” and could make the non-U.S. companies, themselves, the target of OFAC designations and/or secondary sanctions.  One option—reportedly pursued by one major trading company—is to declare force majeure on contracts with Rusal. As noted above, relief contemplated by General Licenses 12 and 13 may be operationally difficult to implement.  The sanctions apply to companies 50 percent owned or controlled by blocked parties.  Companies will need to undertake, under a short time line, significant due diligence to determine whether any such companies are involved in its operations.  The wind down process may be further complicated by any Russian response to the U.S. sanctions. What Happens Next? The April 6 sanctions are likely not the end of the story.  The next steps to watch include: 1.)    Potential Russian Retaliation:  During an address to the State Duma on April 11, Prime Minister Dmitry Medvedev said, for example, that Russia should consider targeting U.S. goods or goods produced in Russia by U.S. companies when considering a possible response.[19]  Any such measures could implicate further U.S. business dealings with Russian entities, including the blocked entities. 2.)    Changing Ownership and Structure of Sanctioned Parties:  Given that the sanctioned companies were listed due to their ownership/control by sanctioned persons (pursuant to the 50 percent rule) there have already been moves to dilute their ownership and thus potentially have the companies de-listed.  While possible, it is important to note that because the companies were explicitly listed by OFAC (and now appear on the SDN list), any reduction in ownership or control will not result in an automatic de-listing.  Rather, OFAC will need to process these changes and formally de-list the entities before they can be treated as non-sanctioned.  OFAC could opt not to de-list, or could decide to list the companies on other bases.  Regardless the process will undoubtedly take some time.  We note that at least one engineering firm whose stock was held by a designated entity has already obtained a license to complete the transfer of these shares; this is helpful precedent for any company impacted but only tangentially related to the designated entities.  Sanctioned entities have also changed their board membership in response to the U.S. sanctions.  On Monday, April 11, for example, the entire board at Renova Management AG, the Swiss subsidiary of the Renova Group, was dismissed after Renova Group’s designation.[20] 3.)    European Follow On Restrictions:  The shock of many of Europe’s major powers following the poisoning of Sergei and Yulia Skripal in Salisbury in early March and the resulting mass expulsion of Russian diplomats from European capitals suggests that sanctions may be next.  Core European U.S. allies were likely notified in advance of the April 6 measures.  In the run up to sanctions in 2014, Washington and Brussels worked very closely to institute parallel measures against Moscow.  While that unity has broken down under the Trump administration, especially since CAATSA was passed in August, it would appear as though some European sanctions are liking in the offing. 4.)    OFAC FAQs/Licenses and Potentially New Measures:  Due to the complexity of the April 6 measures, we expect that OFAC will issue additional FAQs and potentially revisions to General Licenses 12 and 13 (or new General Licenses) in the near term to clear up questions and further calibrate response.  Depending upon next steps from Russia and Europe we may see additional sanctions as well.  Secretary of State-designate Mike Pompeo’s statement that the United States “soft” policy toward Russia is over suggests as much.[21] Unfortunately, there is no clear path towards a de-escalation in Washington-Moscow tensions.  When the U.S. first issued sanctions against Russia in response to the Crimea incursion in 2014 the sanctions “off-ramp” was very clearly defined: if Russia altered its behavior in Crimea/Ukraine there was a way that sanctions could be removed.  Since 2014, as Secretary Mnuchin noted, Russia’s activities have exacerbated in scope and territory to include support for the Bashar regime in Syria, election meddling, cyber-attacks, and the nerve agent attack in the United Kingdom.  The breadth and boldness of this activity makes it even more unlikely that Russia will comply with the West’s wishes and thus even less likely that the sanctions would be removed or even reduced at any point in the near term.  For its part, bipartisan Congressional leadership expressed broad support for the Trump administration’s actions—however, Congress will likely demand more from the President in the near term.  Perhaps eager to placate Congress and dispel any notion that he is “soft” on Russia and buffeted by external circumstances ranging from any potential attack in Syria to the investigation by Robert Mueller, the President may impose still harsher measures on Moscow. [1]      Press Release, U.S. Department of the Treasury, Treasury Designates Russian Oligarchs, Officials, and Entities in Response to Worldwide Malign Activity (Apr. 6, 2018), available at https://home.treasury.gov/news/featured-stories/treasury-designates-russian-oligarchs-officials-and-entities-in-response-to. [2]      Natasha Turak, US sanctions are finally proving a ‘major game changer’ for Russia, CNBC, (Apr. 10, 2018) available at https://www.cnbc.com/2018/04/10/us-moscow-sanctions-finally-proving-a-major-game-changer-for-russia.html. [3]      Press Release, U.S. Dep’t of the Treasury, Treasury Designates Individuals and Entities Involved in the Ongoing Conflict in Ukraine (June 20, 2017), available at https://www.treasury.gov/press-center/press-releases/Pages/sm0114.aspx.  Designated persons and entities included separatists and their supporters; entities operating in and connected to the Russian annexation of Crimea; entities owned or controlled by, or which have provided support to, persons operating in the Russian arms or materiel sector; and Russian government officials. [4]      U.S. Department of the Treasury, supra, n. 1. [5]      Id. [6]      CAATSA, Title II, § 231 (a). Specifically, CAATSA Section 231(a) specified that the President shall impose five or more of the secondary sanctions described in Section 235 with respect to a person the President determines knowingly “engages in a significant transaction with a person that is part of, or operates for or on behalf of, the defense or intelligence sectors of the Government of the Russian Federation, including the Main Intelligence Agency of the General Staff of the Armed Forces of the Russian Federation or the Federal Security Service of the Russian Federation.”  The measures that could be imposed under Section 231 are discretionary in nature.  The language of the legislation is somewhat misleading in this regard.  Section 231 is written as a mandatory requirement—providing that the President “shall impose” various restrictions.  However, the legislation itself—and the October 27, 2017 guidance provided by the State Department—makes clear that secondary sanctions are only imposed after the President makes a determination that a party “knowingly” engaged in “significant” transactions with a listed party.  The terms “knowingly” and “significant” have imprecise meanings, even under the State Department guidance.  OFAC Ukraine-/Russia-related Sanctions FAQs (“OFAC FAQs”), OFAQ No. 545, available at https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_other.aspx#567. [7]      Press Release, U.S. Dep’t of State, Background Briefing on the Countering America’s Adversaries Through Sanctions Act (CAATSA) Section 231 (Jan. 30, 2018), available at https://www.state.gov/r/pa/prs/ps/2018/01/277775.htm. [8]      CAATSA, Title II, § 241. [9]      See U.S. Dep’t of the Treasury, Report to Congress Pursuant to Section 241 of the Countering America’s Adversaries Through Sanctions Act of 2017 Regarding Senior Foreign Political Figures and Oligarchs in the Russian Federation and Russian Parastatal Entities (Unclassified) (Jan. 29, 2018), available at https://www.scribd.com/document/370313106/2018-01-29-Treasury-Caatsa-241-Final. [10]     See, e.g., Press Release, U.S. Dep’t of the Treasury, Treasury Releases CAATSA Reports, Including on Senior Foreign Political Figures and Oligarchs in the Russian Federation (Jan. 29, 2018), available at https://home.treasury.gov/news/press-releases/sm0271. [11]     The one exception is Igor Rotenberg.  Although Igor Rotenberg did not appear on the Section 241 List, his father and uncle were included.  According to the April 6 OFAC announcement, Igor Rotenberg acquired significant assets from his father, Arkady Rotenberg, after OFAC designated the latter in March 2014.  Specifically Arkady Rotenberg sold Igor Rotenberg 79 percent of the Russian oil and gas drilling company Gazprom Burenie.  Igor Rotenberg’s uncle, Boris Rotenberg, owns 16 percent of the company.  Like his brother Arkady Rotenberg, Boris Rotenberg was designated in March 2014. [12]     OFAC FAQ No. 573. [13]     CAATSA, Title II, §228. [14]     OFAC FAQ No. 546.  In its implementing guidance, OFAC confirmed that Section 228 extends to SDNs and SSI entities but clarified that it would not deem a transaction “significant” if U.S. persons could engage in the transaction without the need for a specific license from OFAC.  In other words, only transactions prohibited by OFAC—specifically, transactions with SDNs and/or transactions with SSI entities that are prohibited by the sectoral sanctions—will “count” as significant for purposes of Section 228.  OFAC also noted that even a transaction with an SSI that involves prohibited debt or equity would not automatically be deemed “significant”—it would need to also involve “deceptive practices” and OFAC would assess this criteria on a “totality of the circumstances” basis. [15]     OFAC FAQ No. 574. [16]     General License 12; OFAC FAQ No. 569. [17]     See also OFAC FAQ Nos. 567-568. [18]     See also OFAC FAQ Nos. 570-571. [19]     Russia’s Renova says board at its Swiss subsidiary dismissed due to sanctions, Reuters (Apr. 11, 2018), available at https://uk.reuters.com/article/usa-russia-sanctions-renova/russias-renova-says-board-at-its-swiss-subsidiary-dismissed-due-to-sanctions-idUKR4N1NE02P. [20]     Russia ready to prop Up Deripaska’s Rusal as US sanctions bite, Financial Times (Apr. 11, 2018), available at https://www.ft.com/content/4904f6d4-3d97-11e8-b7e0-52972418fec4. [21]     Patricia Zengerle, Lesley Wroughton, As Pompeo signals hard Russia line, lawmakers want him to stand on his own, Reuters (Apr. 12, 2018), available at https://www.reuters.com/article/us-usa-trump-pompeo/as-pompeo-signals-hard-russia-line-lawmakers-want-him-to-stand-on-his-own-idUSKBN1HJ0HO. The following Gibson Dunn lawyers assisted in preparing this client update: Adam Smith, Judith Alison Lee, Christopher Timura, Stephanie Connor, and Courtney Brown. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade Group: United States: Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com) Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com) Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com) Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com) Daniel P. Chung – Washington, D.C. (+1 202-887-3729, dchung@gibsondunn.com) Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com) Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com) Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com) Kamola Kobildjanova – Palo Alto (+1 650-849-5291, kkobildjanova@gibsondunn.com) Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com) Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com) Europe: Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com) Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com) Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com) Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com) Mark Handley – London (+44 (0)207 071 4277, mhandley@gibsondunn.com) Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com) Richard Roeder – Munich (+49 89 189 33-160, rroeder@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 24, 2018 |
Webcast – Challenges in Compliance and Corporate Governance -14th Annual Briefing

Our constantly-evolving regulatory landscape expands existing obligations while creating new compliance risks for companies big and small. Join our panel of experts as they review key developments in 2017 and offer valuable insight on how to address challenges forecasted for 2018. Topics discussed include: Global Enforcement and Regulatory Developments Change and Continuity in the New Administration Key Tips for Identifying and Addressing Top Areas of Compliance Risk Practical Recommendations for Improving Corporate Compliance DOJ and SEC Priorities, Policies, and Penalties Update on Key Governance Issues and Regulatory Requirements View Slides [PDF] PANELISTS: This year’s presentation assembles a deep bench of experts with broad expertise. The following panelists join moderator Joe Warin for the 14th annual installment of ‘Challenges in Compliance and Corporate Governance’: Gibson Dunn partner Stephanie L. Brooker, Co-Chair of the firm’s Financial Institutions Practice Group, is former Director of the Enforcement Division at the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN). As a federal prosecutor, Stephanie served as the Chief of the Asset Forfeiture and Money Laundering Section in the U.S. Attorney’s Office for the District of Columbia. She represents financial institutions, multi-national companies, and individuals in connection with criminal, regulatory, and civil enforcement actions involving anti-money laundering (AML)/Bank Secrecy Act (BSA), sanctions, anti-corruption, securities, tax, and wire fraud New Gibson Dunn partner Avi S. Garbow, the former EPA General Counsel and co-chair of Gibson Dunn’s Environmental Litigation and Mass Tort Practice Group. As General Counsel, he successfully managed one of the most active regulatory and defensive litigation dockets among large federal agencies. Avi previously held positions in EPA’s enforcement office and served as a distinguished prosecutor in DOJ’s Environmental Crimes Section New Gibson Dunn partner Caroline Krass, the former CIA General Counsel and chair of Gibson Dunn’s National Security Practice Group. As General Counsel, Caroline oversaw more than 150 attorneys and advised on complex, highly sensitive issues, including cybersecurity, foreign investment in the U.S. and export controls, government investigations and litigation, and crisis management.  Previously, Caroline served as Acting Assistant Attorney General at the Department of Justice, as Special Counsel to the President for National Security Affairs, as a federal prosecutor, at the National Security Council, and at the Treasury and State Departments. Gibson Dunn partner Stuart Delery, the former Acting Associate Attorney General, the No. 3 position in the Justice Department. In that role, Stuart was a member of DOJ’s senior management and oversaw the civil and criminal work of five litigating divisions — Antitrust, Civil, Tax, Civil Rights, and Environment and Natural Resources — as well as other components. Previously, Stuart led the Civil Division, overseeing litigation involving the False Claims Act among other matters. Gibson Dunn partner Adam M. Smith, an experienced international trade lawyer who previously served in the Obama Administration as the Senior Advisor to the Director of OFAC and as the Director for Multilateral Affairs on the National Security Council. Adam focuses on international trade compliance and white collar investigations, including with respect to federal and state economic sanctions enforcement, the FCPA, embargoes, and export controls. Gibson Dunn partner Lori Zyskowski, a member of the firm’s Securities Regulation and Corporate Governance Practice Group who was previously Executive Counsel, Corporate, Securities & Finance at GE. Lori advises clients on a wide array of securities, compliance and corporate governance issues, and provides a unique perspective gained from over 12 years working in-house at S&P 500 corporations. Gibson Dunn partner F. Joseph Warin, Co-Chair of the firm’s White Collar Defense and Investigations practice and former Assistant United States Attorney in Washington, D.C. Joe is one of only ten lawyers in the United States with Chambers rankings in five categories. Chambers recently honored him with the Outstanding Contribution to the Legal Profession Award in 2017. Chambers Global 2017 ranked Mr. Warin a “Star” in USA – FCPA “with exceptional expertise across all aspects of anti-corruption law”. Chambers USA 2017 ranked him a “Star” in Nationwide FCPA and D.C. Litigation: White Collar Crime & Government Investigations. Chambers USA 2017 also selected him as a Leading Lawyer in the nation in the areas of Securities Regulation Enforcement and Securities Litigation, as well as in D.C. Securities Litigation. From 2015–2017, he has been selected by Chambers Latin America as a top-tier lawyer in Latin America-wide, Fraud & Corporate Investigations. In 2017, Who’s Who Legal selected him as a “Thought Leader: Investigations,” including “only the best of the best” of those listed in their guides and who obtained the biggest number of nominations from peers, corporate counsel and other market sources. In 2016, Who’s Who Legal and Global Investigations Review also named Mr. Warin to their list of World’s Ten-Most Highly Regarded Investigations Lawyers. He has been listed in The Best Lawyers in America® every year from 2006 – 2017 for White Collar Criminal Defense. BTI Consulting named Mr. Warin to its 2017 BTI Client Service All-Stars list, recognizing lawyers who “truly stand out as delivering the absolute best client service.” Best Lawyers® also named Mr. Warin 2016 Lawyer of the Year for White Collar Criminal Defense in the District of Columbia. In 2016, he was named among the Lawdragon 500 Leading Lawyers in America. Mr. Warin also was recognized by Latinvex as one of its 2017 Latin America’s Top 100 Lawyers. He was selected as a 2015 Top Lawyer for Criminal Defense by Washingtonian magazine. U.S. Legal 500 has repeatedly named Mr. Warin a Leading Lawyer for White Collar Criminal Defense Litigation. Benchmark Litigation has recognized him as a U.S. White Collar Crime Litigator Star for seven consecutive years (2011–2017). MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 3.0 credit hours, of which 3.00 credit hours may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 2.50 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

December 1, 2017 |
Sentiment Analysis & Natural Language: Processing Techniques for Capital Markets & Disclosure

New York counsel Nicolas H.R. Dumont is the author of “Sentiment Analysis & Natural Language: Processing Techniques for Capital Markets & Disclosure,” [PDF] published by The Corporate Governance Advisor in December 2017.

November 14, 2017 |
U.S. Treasury’s Capital Markets Report Gives Market Regulators Green Light to Streamline Derivatives Regulations

This alert examines the derivatives policy recommendations set forth in the U.S. Department of Treasury’s (“Treasury”) report titled A Financial System That Creates Economic Opportunities: Capital Markets[1] (the “Report” or the “Capital Markets Report”), which Treasury released on October 6, 2017.  The Capital Markets Report is the second in a series of reports that Treasury has released or is expected to release in accordance with President Trump’s February 3, 2017, Executive Order on Core Principles for Regulating the United States Financial System[2] (the “Order”). The Report is particularly relevant to derivatives market participants because it reflects the Trump Administration’s policies on Federal regulation and oversight of derivatives-related activities, bank capital standards, the regulation and supervision of financial market utilities, international aspects of the capital markets’ regulations, and various administrative matters relating to agency rulemaking processes.  Although Treasury’s policy recommendations will not result in wholesale reforms in the immediate term, the Report urges Congress to consider certain legislative proposals and empowers financial regulators to begin the rulemaking process to amend existing regulations with the goal of reducing burdensome compliance obligations. Section I of this alert provides background on the Capital Markets Report.  Section II discusses key takeaways from the Report that we believe are most pertinent to our clients.  Section III reviews the Report’s policy recommendations related to derivatives markets.  The alert concludes with Section IV, reiterating themes and takeaways from the Report’s recommendations.  Although the Report also includes several other capital markets recommendations that focus on regulatory issues beyond derivatives reform, those recommendations are outside the scope of this alert. I.     Background Under the Order, the Secretary of the Treasury is directed to consult with member agencies of the Financial Stability Oversight Council and to report on how existing laws, regulations, and other Government policies promote, support, or inhibit the seven core principles outlined in the Order.[3]  The Order has signaled to financial regulators that the Trump Administration wants a reappraisal of a number of Obama-era regulations imposed on financial institutions and derivatives end users. To meet its directive under the Order, Treasury has organized its recommendations into a series of reports.  The first report, on banks and credit unions, was released on June 12, 2017.  The second report, and the focus of this alert, was released on October 6, 2017.  Treasury released a report on asset management and insurance companies on October 26, 2017.  Treasury is expected to release a fourth report on non-banks, financial technology, and cybersecurity in financial markets sometime in the first quarter of 2018. The Capital Markets Report serves as an agenda for many of the issues that the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”, together with the SEC, the “Commissions”) are expected to address in the coming years.  The content of the Report, the range of topics discussed, and the level of detail in the Report’s recommendations demonstrate Treasury’s close collaboration with the Commissions and engagement with industry stakeholders.[4]  Indeed, the Chairmen of both Commissions indicated that staff from their respective agencies engaged with Treasury in preparing the Report.  SEC Chairman Jay Clayton expressed appreciation for “Treasury’s willingness to seek the SEC’s input during the drafting process[,]” and that the Report “will be of immediate and lasting value.”[5]  Similarly, CFTC Chairman J. Christopher Giancarlo indicated that the CFTC “was actively engaged with Treasury in the preparation of this [R]eport,” and that the CFTC was “pleased to see our perspective incorporated in the final product.”[6]  He further stated that “if implemented, the recommendations provided within this [R]eport will help foster financially sound markets in a way that encourages broad-based economic growth and American prosperity and respects the American taxpayer.”[7] II.     Key Takeaways We believe that there are four key takeaways from the Capital Markets Report of which derivatives market participants should be cognizant.  First, the Capital Markets Report outlines an ambitious agenda for the Commissions with a focus on streamlining and harmonizing regulations to lower costs for market participants, promoting capital formation, keeping U.S. markets competitive, and fostering economic growth.  In the near term, we anticipate that the CFTC may quickly propose rulemakings in the spirit of the Report’s recommendations.  In fact, there has already been momentum in that regard.  The CFTC has taken steps towards modernizing existing rules, regulations, and practices through soliciting comments as part of Project KISS,[8] and improving reporting rules for products and swap data responsibilities through its reform efforts.[9]  These proposals and efforts to modernize existing rules, regulations, and practices, however, will take some time to be finalized and implemented by the industry.  In contrast, the SEC has not been as focused on Title VII reforms given the volume of additional non-derivatives related recommendations for the SEC to consider.  It is unclear therefore how quickly the SEC will focus on derivatives reforms. Second, we anticipate that the Commissions will begin more fully addressing some of the rulemaking procedural criticisms raised in the Report, such as the recommendation that the Commissions perform more robust cost-benefit and economic analyses for their rulemakings and the recommendation to rely less heavily on staff action.  With respect to cost-benefit and economic analyses, we have observed that the CFTC has recently taken steps to address this criticism.  The CFTC’s Chief Economist, Bruce Tuckman—who was appointed to the position last August—stated that he looked forward to working with Chairman Giancarlo on “increasingly guiding CFTC rule-making and risk monitoring with cutting-edge economic analysis and empirical work.”[10]  Chairman Giancarlo has spoken publicly about the need for the CFTC to apply “rigorous cost benefit analysis” in its rulemaking,[11] and recently requested additional funds from Congress for fiscal year 2018 so the Commission can “enhance economic cost benefit analysis capabilities.”[12]  With respect to the Commissions’ reliance on staff action, the Chairmen of the Commissions have made public statements to the effect that the agencies will work more collaboratively with the industry during the rulemaking consultation process and rely less heavily on the issuance of staff no-action letters and interpretations.  Indeed, Chairman Giancarlo has emphasized the need to ensure that market participants and affected parties do not experience significant implementation issues when complying with the CFTC’s rulemakings.[13] Third, market participants should expect the Commissions to engage in efforts to harmonize their derivatives regulations and to cooperate with international regulators.  With respect to the rulesets of the two agencies, the Report clearly favors domestic harmonization over merging the Commissions.  With respect to international cooperation, the Commissions already have engaged in two examples following the issuance of the Report.  The first example is the SEC’s adoption of measures to facilitate the cross-border implementation of the European Union’s Markets in Financial Instruments Directive II (“MiFID II”) research provisions.[14]  The second example, discussed below in Section III(2) of this alert, is the CFTC’s two recent actions on harmonization with the European Commission (“EC”).[15] Fourth and finally, market participants should expect Congress to consider legislative proposals that would, if adopted, result in targeted amendments to Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) in order to address some of its more over-bearing provisions.  While most of Treasury’s recommendations call for regulatory action, there are certain areas in the Report where Treasury acknowledges the need for Congress to take action, in particular with respect to the definition of “financial entity” as well as harmonizing rulemaking among agencies.  Because Congress currently is focused on legislative matters such as tax reform, health care, and infrastructure, the timing and vehicles for implementing the Report’s legislative recommendations remain unclear. III.     Capital Markets Report Derivatives-Related Recommendations The Capital Markets Report makes ninety-one recommendations in nine topic areas.[16]  The derivatives-related topic areas include: (1) derivatives legislative recommendations; (2) derivatives regulatory recommendations; (3) bank capital and margin; (4) financial market utilities; and (5) administrative matters (i.e., regulatory structure and process).  Across those topic areas, we discuss below the most important recommendations to derivatives market participants and derivatives market reform. (1)  Legislative Recommendations In its preparation of the Capital Markets Report, Treasury generally expressed widespread support for the broad derivatives regulatory changes enacted under Title VII of Dodd-Frank.  The Report recommends, however, three legislative amendments relating to the derivatives title of Dodd-Frank. Definition of “Financial Entity.”  The Report recommends a legislative amendment to finally address the numerous proposals since Dodd-Frank’s passage to modify the definition of “financial entity” and clarify the scope of the exception for nonfinancial end users’ affiliates.  It recommends that Congress amend the Commodity Exchange Act (“CEA”) Section 2(h)(7) to provide the CFTC with rulemaking authority to modify and clarify the scope of the financial entity definition and the treatment of affiliates, and provide the SEC analogous rulemaking authority under the Securities Exchange Act of 1934 (“Exchange Act”) Section 3C(g) for security-based swaps. Harmonization.  The Report focuses heavily on the harmonization of existing and forthcoming rules among the agencies and recommends that Congress consider further action to aid in this goal, particularly in relation to the regulation of swaps and security-based swaps. Streamline and Formalize Rulemakings.  The Report recommends that the Commissions streamline regulation by avoiding imposing substantive new requirements by interpretation or other guidance.  However, it suggests that Congress restore the Commissions’ authority to provide exemptions to requirements when necessary to facilitate market innovation.  The Report says that regulators should also conduct reviews of existing agency rules in order to decrease regulatory burdens and ensure relevance, and should fully solicit comments and input from the public. (2)  Significant Regulatory Recommendations Most of Treasury’s recommendations are regulatory in nature and come under the rulemaking authority of the Commissions.  Following Treasury’s release of the Report, the CFTC issued a comprehensive statement explaining what it views as the Report’s key recommendations on derivatives.[17]  The CFTC’s statement emphasizes recommendations on capital treatment in support of central clearing; swap execution facilities; the SEC-CFTC merger debate; SEC-CFTC harmonization; cross-border issues; economic analysis; swap data reporting; and central counterparties’ (“CCPs”) “skin in the game.”  We highlight seven of the most significant regulatory recommendations on derivatives below. Swap Dealer De Minimis Threshold.  The Report recommends that CFTC maintain the swap dealer de minimis threshold calculation at $8 billion and establish that any future changes to the threshold will be subject to a formal rulemaking.  The Report found that lowering the threshold to a $3 billion level would result in a tremendous increase in the number of regulated entities but would only capture less than 1 percent of notional activity.  The Report indicates that market participants strongly support maintaining the $8 billion level and that clarification on the topic will reassure markets.On October 26, the CFTC voted to extend the sunset date  of the exception threshold by one year, ensuring that the threshold will stay at $8 billion until December 31, 2019, instead of decreasing to $3 billion on December 31, 2018.[18]  This action was the CFTC’s second order providing such relief.  The CFTC explained in the current order that it needed additional time to complete its analysis of swap data and consider appropriate further action, including potential amendments to the de minimis exception.  It further noted that any such amendments, if implemented, would not become effective until some point in 2018 because the CFTC would have to follow its normal rulemaking process under the Administrative Procedure Act. Formalize Staff Guidance.  In relation to the implementation of the swaps regulatory framework under Title VII of Dodd-Frank, the Report recommends that regulators rely less on no-action letters and take steps to simplify and formalize staff guidance where necessary.  The CFTC has already begun its efforts in this regard by soliciting comments from the public on Project KISS and CFTC staff’s Roadmap to Achieve High Quality Swaps Data (the “Roadmap”), which is discussed below. Finalize Position Limits.  The Report notes that progress on establishing position limits has been a challenge.  The CFTC finalized a position limits rule in November 2011, which was vacated in September 2012 by the U.S. District Court for the District of Columbia after a legal challenge.  The Commission has since had multiple re-proposals of the position limits rules but has not taken final action.  The Report urges the CFTC to finalize its position limits rulemaking as contemplated by the statutory mandate, taking into account, among other things, the appropriate availability of bona fide hedging exemptions for end-users, and finally bring clarity to this important issue.  We anticipate that yet another position limits re-proposal is forthcoming from the CFTC. Swap Data Reporting Reform. The Report supports the CFTC’s Roadmap efforts to standardize and harmonize reporting rules for products and swap data repositories.  The Roadmap effort is directed by the CFTC’s Division of Market Oversight and lays out the tranches of changes to the CFTC’s swap data reporting rules.  The Report recommends the CFTC commit adequate resources to the Roadmap effort, amend its rules through a formal rulemaking process, and implement the new standards within the timeframe outlined in the Roadmap. Cross-Border Jurisdiction. On cross-border issues, the Report highlights the need for U.S. regulators to continue to engage and cooperate with international counterparts and seek notice and comment for rulemakings in an effort to avoid market fragmentation, redundancies, undue complexity, and conflicts of law.  Treasury recommends that the Commissions:  (1) make their swaps and security-based swaps rules compatible with non-U.S. jurisdictions; (2) adopt outcomes-based substituted compliance regimes that minimize redundancies and conflicts by considering the rules of other jurisdictions; and (3) reconsider their approaches to transactions that are arranged, negotiated, or executed by personnel in the United States for applying transaction-level swap requirements.  The CFTC indicated preliminary steps to comply with these recommendations through its October 13, 2017 joint announcement with the EC on harmonizing two key derivatives regulatory requirements.[19] Harmonize Margin Requirements for Uncleared Swaps. The Report recommends that the CFTC and U.S. banking regulators harmonize margin requirements for uncleared swaps domestically and cooperate with non-U.S. jurisdictions so that U.S. bank swap dealers and U.S. firms are not at a disadvantage to domestic and international competitors.  The Report recommends that regulators consider amendments to their rules to allow for more realistic time frames for collecting and posting margin on uncleared swaps; reconsider treating end users all the same for the purposes of margin on uncleared swaps; and that the SEC re-propose its proposed margin rule for uncleared security-based swaps in a manner that is aligned with the margin rules of the CFTC and U.S. prudential regulators.The CFTC and the EC announced on October 13, 2017 that they had adopted substituted compliance uncleared margin determinations for each other’s uncleared margin requirements.[20]  As a result, swap dealers subject to both CFTC’s and European’s uncleared margin rules now have more certainty that they will not have to establish duplicative compliance programs.[21] SEF Execution Methods and MAT Process.  Due to market participants’ concerns that the CFTC’s current mandatory trading protocols (i.e., order book and “RFQ-to-3” requirements) are overly restrictive—a concern also expressed by CFTC Chairman Giancarlo—the Report recommends that the CFTC:  (1) consider rule changes to permit swap execution facilities (“SEFs”) to use any means of interstate commerce to execute swaps subject to trade execution mandates; (2) reevaluate the made available to trade (“MAT”) determination process to ensure liquidity; and (3) consider clarifying or eliminating footnote 88 of the June 2013 CFTC SEF final rules that triggered the exclusion of U.S. participants by most non-U.S. trading platforms and that ultimately has led to a bifurcation of the global interest rate swaps market.[22]One recent step that the CFTC has taken to ameliorate the effects of footnote 88 is the agency’s October 13 joint announcement with the EC regarding an agreement to recognize each other’s authorized trading venues.  Once the terms of their agreement is finalized, European firms operating in the United States will be able to trade derivatives on authorized U.S. trading venues while still complying with EU law in advance of the trading obligation go-live date of Markets in Financial Instruments Directive II.[23]  The agreement, once finalized, also will allow U.S. firms to comply with the CFTC’s trade execution requirement by executing swaps on EU-authorized trading venues.  Since the announcement sets forth only a common plan, both regulators must take additional steps to effectuate recognition of each other’s trading venues.  The timing of the EC’s and the CFTC’s actions to finalize their agreement is uncertain. (3)  Bank Capital and Margin Recommendations U.S. banking agencies and the CFTC finalized their respective margin rules for the uncleared swaps and bank-affiliated swap dealers in November 2015 and nonbank swap dealers in January 2016.  The Report recommends that U.S. regulators take steps to harmonize their margin requirements for uncleared swaps domestically and cooperate with non-U.S. jurisdictions to promote a level playing field for U.S. firms. Treasury’s recommendations of particular importance to derivatives market participants are highlighted below. Capital Treatment in Support of Central Clearing.  Treasury reiterates its recommendation in the Banking Report that initial margin for centrally-cleared derivatives should be deducted from the supplementary leverage ratio denominator, thereby reducing the cost for banks to provide clearing services and ending the penalization of entities for clearing their swaps.  Additionally, the Report recommends a risk-adjusted approach for valuing options under capital rules, and that banking regulators conduct regular assessments on how capital and liquidity rules impact the incentives to centrally clear derivatives. Exemption from Initial Margin Requirements.  The Report notes that market participants hold the view that U.S. regulators have taken a stricter approach than non-U.S. jurisdictions with respect to many of the particular requirements of the uncleared margin rules.  Accordingly, the Report recommends that U.S. prudential regulators consider providing an exemption to initial margin requirements for derivatives trades between affiliates of the same bank (i.e., inter-affiliate transactions), harmonizing the requirements with those of the CFTC and corresponding non-U.S. requirements, and promoting a level playing field for U.S. firms. (4)  Financial Market Utilities Recommendations CCPs, trade repositories, and exchanges are an essential part of the Dodd-Frank derivatives market infrastructure.  The Report states these financial market utilities (“FMUs”) are critical financial infrastructures that are also highly interconnected with other U.S. financial institutions and, therefore, pose a threat of systemic risk. Strengthen Oversight.  To address concerns regarding systemic risk, Treasury recommends additional oversight of FMUs and finalizing strong resolution regimens for these entities in order to limit potential taxpayer-funded bailouts and moral hazard, especially important because FMUs may have access to the Federal Reserve System’s (“Federal Reserve”) discount window. Increase Resources for Regulators.  The Report further recommends that more resources be devoted to the regulators that supervise systemically-important FMUs, in particular for the CFTC to enhance supervision of CCPs, and for the Federal Reserve to review risks related to  account access, strengthen stress testing exercises, and coordinate and complete the development of resolution plans for FMUs. CCP “Skin in the Game.”  The Report also recommends that CCPs and their members work together to strike an appropriate balance between the CCPs’ resources and mutualized resources of clearing members. (5)  Administrative Recommendations The Report makes a number of recommendations that are focused on the administrative procedures followed by the Commissions rather than on specific substantive requirements.  Each of the key recommendations in this regard are discussed below. SEC-CFTC Merger Debate.  The Report highlights the need for harmony and cooperation between regulators.  However, Treasury stops short of recommending a merger between the SEC and CFTC, citing the key differences in their underlying regulatory purposes—capital formation and investment versus hedging and risk transfer—and insignificant cost savings of five percent.  Instead, the Report recommends that the Commissions better harmonize rules to avoid increased compliance cost and complexity for market participants.  Specifically, the Report notes that where the CFTC has finalized most of the rulemakings required under Dodd-Frank, there are several “critical rulemakings” that the SEC has not yet finalized or implemented.  Treasury recommends that the Commissions harmonize Title VII of Dodd-Frank reform rules with an eye towards reducing burdens on market participants. Enhance Cost Benefit Analyses.  The Report stresses that the Commissions continue to perform more, and heightened, economic analysis of costs and benefits in rulemaking, including an updated consideration of the effects on small entities, and that the Commissions publish this information where appropriate. Comprehensive Reviews of Self-Regulatory Organizations.  The Report finds that, while self-regulatory organizations (“SROs”) offer many benefits to the capital market, over time they have grown larger, their members have less control, and many have become for-profit publicly traded companies.  As a result, some constituencies told Treasury that SROs have become less transparent while their rules and costs continue to increase, and have created a potential for regulatory duplication with Commissions or other SROs.  Thus, Treasury recommends the Commissions conduct comprehensive reviews of the SROs and make recommendations for operational, structural, and governance improvements of the SRO framework to include, among other things, controlling for conflicts of interest; transparency regarding fee structures; and limitations on regulatory, surveillance, and enforcement responsibilities.  If enhanced oversight of SROs is required, the regulators should take action in this regard. Definition of “Small Entity.”  Under the Regulatory Flexibility Act (“RFA”), Federal agencies are required to consider the impact of rulemaking on small entities.  Rules regarding which entities are considered a “small entity” by the Commissions, however, can be overbroad in some instances and too narrow in others.  The Report recommends that the Commissions review and update these definitions so that the RFA analysis appropriately considers the impact on persons who should be considered small entities. IV.     Conclusion  Each of the derivatives-related recommendations in the Capital Markets Report conform with the Order’s seven core principles, which essentially seek to foster U.S. economic growth through right-sizing regulatory obligations.  To reach this goal, Treasury urges regulatory agencies and Congress to focus on streamlining and harmonizing regulations, something we anticipate the Commissions—whose input was incorporated into the Report—will address by making procedural changes to rulemaking and working more closely with each other and international regulators.  Legislative amendments to some provisions of Title VII of Dodd-Frank should also be expected.  Ultimately,  Treasury’s proposed agenda will take a significant amount of time to develop and implement, so the impact of these recommendations likely will not be felt by market participants in the near term.    [1]   U.S. Dep’t of the Treas., A Financial System That Creates Economic Opportunities: Capital Markets (2017), available at https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf.    [2]   Exec. Order No. 13,772, 82 Fed. Reg. 9965 (Feb. 8, 2017).    [3]   The seven core principles in the Order are: (a) empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth; (b) prevent taxpayer-funded bailouts; (c) foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry; (d) enable American companies to be competitive with foreign firms in domestic and foreign markets; (e) advance American interests in international financial regulatory negotiations and meetings; (f) make regulation efficient, effective, and appropriately tailored; and (g) restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework. For further information, see our Client Alert, President Trump Issues Executive Order on Financial Regulation, and Memorandum on Department of Labor Fiduciary Rule (Feb. 6, 2017), available at http://www.gibsondunn.‌com‌‌‌‌/publications/Pages/President-Trump-Issues-Executive-Order-on-Financial%20Regulation–DOL-Fiduciary-Rule.aspx.    [4]   In addition to collaborating with the Commissions, Appendix A to the Report contains a list of market participants, think tanks, trade groups, regulators, consumer advocates, and academics that engaged with Treasury in preparing the recommendations in the Report.    [5]   Statement attributed to Chairman Jay Clayton (Oct. 6, 2017) (on file with U.S. Sec. & Exch. Comm’n).    [6]   U.S. Commodity Futures Trading Comm’n, Statement of Chairman Giancarlo on Treasury Report on Capital Markets (Oct. 6, 2017), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/‌giancarlostatement100617.    [7]   Id.    [8]   Project KISS is the CFTC’s initiative to seek public input on simplifying and modifying the CFTC’s rules.  In particular, the CFTC requested comments on five key initiatives:  (1) Registration; (2) Reporting; (3) Clearing; (4) Executing; and (5) Miscellaneous.  The comment period for providing comments on these initiatives closed on September 30, 2017.  See U.S. Commodity Futures Trading Comm’n, CFTC Requests Public Input on Simplifying Rules (May 3, 2017), available at http://www.cftc.gov/PressRoom/PressReleases/pr7555-17.    [9]   See Section III(2) Swap Data Reporting Reform. [10]   U.S. Commodity Futures Trading Comm’n, Chairman Giancarlo Appoints Bruce Tuckman CFTC’s Chief Economist (Aug. 21, 2017), available at http://www.cftc.gov/PressRoom/PressReleases/pr7604-17. [11]   See, e.g., U.S. Commodity Futures Trading Comm’n, Remarks of CFTC Commissioner J. Christopher Giancarlo before the U.S. Chamber of Commerce (Nov. 20, 2014), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlos-2.   [12]   U.S. Commodity Futures Trading Comm’n, Testimony of J. Christopher Giancarlo, Acting Chairman, Commodity Futures Trading Commission, before the U.S. Senate Committee on Appropriations Subcommittee on Financial Services and General Government (June 27, 2017), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-26. [13]   U.S. Commodity Futures Trading Comm’n, Testimony of J. Christopher Giancarlo, Chairman, Commodity Futures Trading Commission, before the U.S. House Committee on Agriculture (Oct. 11, 2017), available at https://agriculture.house.gov/uploadedfiles/testimony_for_j._chris_giancarlo_before_house_ag__10.11.17.pdf. [14]   U.S. Securities and Exchange Comm’n, SEC Announces Measures to Facilitate Cross-Border Implementation of the European Union’s MiFID II’s Research Provisions (Oct. 26, 2017), available at https://www.sec.gov/news/press-release/2017-200-0. [15]   For further information, see our Client Alert, Ready? Set? Harmonize: The CFTC and EC Announce Two Actions to Harmonize Their Derivatives Regulations ( Oct. 27, 2017), available at http://gibsondunn.com/publications/Pages/CFTC-and-EC-Announce-Two-Actions-to-Harmonize-Their-Derivatives-Regulations.aspx. [16]   Appendix B of the Report contains a table of recommendations outlining in detail each recommendation, the branch or regulator responsible for the related policy, and the core principle that applies. [17]   U.S. Commodity Futures Trading Comm’n, CFTC Backgrounder on the Department of Treasury’s Report on Capital Markets, available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/ treasuryreport100617.pdf. [18]     U.S. Commodity Futures Trading Comm’n, CFTC Issues Order Extending Current Swap Dealer De Minimis Threshold to December 2019 (Oct. 26, 2017), available at http://www.cftc.gov/PressRoom/PressReleases/pr7632-17. [19]   For further information, see our Client Alert, Ready? Set? Harmonize: The CFTC and EC Announce Two Actions to Harmonize Their Derivatives Regulations ( Oct. 27, 2017), available at http://gibsondunn.com/publications/Pages/CFTC-and-EC-Announce-Two-Actions-to-Harmonize-Their-Derivatives-Regulations.aspx. [20]   Id. [21]   Swap dealers that are subject to the U.S. prudential regulators’ uncleared margin rules, however, are not covered by the Uncleared Margin Determinations and, as a result, are unable to rely on this substituted compliance relief. [22]   See CFTC, Final Rule, Core Principles and Other Requirements for Swap Execution Facilities, 78 Fed. Reg. 33476 (June 4, 2013). [23]   For further information, see our Client Alert, Ready? Set? Harmonize: The CFTC and EC Announce Two Actions to Harmonize Their Derivatives Regulations (Oct. 27, 2017), available at http://gibsondunn.com/publications/Pages/CFTC-and-EC-Announce-Two-Actions-to-Harmonize-Their-Derivatives-Regulations.aspx Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the following: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Amy Kennedy – London (+44 (0)20 7071 4283, akennedy@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 1, 2017 |
Webcast: IPO and Public Company Readiness: Regulatory Compliance Issues

​Public companies face unique challenges as they confront and seek to manage OFAC, AML and FCPA compliance risk. Disclosure obligations and market reactions can intensify the pressures arising from alleged or actual violations of these laws. Companies preparing to go public must assess their compliance programs in order to avoid or mitigate incidents that could harm their business, disrupt the IPO process or damage their reputation as a newly public company. Companies also must be prepared to successfully respond to the scrutiny regarding compliance issues in the diligence and disclosure process associated with an IPO. Our highly experienced and distinguished panel of Gibson Dunn partners from the Capital Markets, Financial Institutions and White Collar Defense and Investigations Practice Groups will provide invaluable and practical advice and tips on how companies can prepare for public company reporting and scrutiny of their compliance programs. View Slides [PDF] PANELISTS Stephanie L. Brooker is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher where she is Co-Chair of Gibson Dunn’s Financial Institutions Practice Group and a member of the White Collar Defense and Investigations Practice Group. Ms. Brooker is a former Director of the Enforcement Division at the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) and a former federal prosecutor, where she served as the Chief of the Asset Forfeiture and Money Laundering Section in the U.S. Attorney’s Office for the District of Columbia, tried 32 criminal trials, and briefed and argued criminal appeals. Ms. Brooker’s practice focuses on internal investigations, regulatory enforcement, white collar criminal defense, and compliance counseling involving anti-money laundering (AML)/Bank Secrecy Act (BSA), sanctions, anti-corruption, securities, tax, and wire fraud. Joel M. Cohen is a partner in the New York office of Gibson, Dunn & Crutcher where he is Co-Chair of Gibson Dunn’s White Collar Defense and Investigations Practice Group and a member of its Securities Litigation, Class Actions and Antitrust and Competition Practice Groups. Mr. Cohen’s experience includes all aspects of FCPA/anti-corruption issues, insider trading, securities and financial institution litigation, class actions, sanctions, money laundering and asset recovery, with a particular focus on international disputes and discovery. Mr. Cohen was the prosecutor of Jordan Belfort and Stratton Oakmont, which is the focus of “The Wolf of Wall Street” film by Martin Scorsese. He was an adviser to OECD in connection with the effort to prohibit corruption in international transactions and was the first Department of Justice legal liaison advisor to the French Ministry of Justice. Andrew L. Fabens is a partner in the New York office of Gibson, Dunn & Crutcher where he is Co-Chair of Gibson Dunn’s Capital Markets Practice Group and a member of the Securities Regulation and Corporate Governance Practice Group. Mr. Fabens advises companies on long-term and strategic capital planning, disclosure and reporting obligations under U.S. federal securities laws, corporate governance issues and stock exchange listing obligations. He represents issuers and underwriters in public and private corporate finance transactions, both in the United States and internationally. Stewart L. McDowell is a partner in the San Francisco office of Gibson, Dunn & Crutcher where she is Co-Chair of Gibson Dunn’s Capital Markets Practice Group and a member of the Steering Committee of the Securities Regulation and Corporate Governance Practice Group. Ms. McDowell’s represents business organizations as to capital markets transactions, mergers and acquisitions, SEC reporting, corporate governance and general corporate matters. She represents both underwriters and issuers in a broad range of both debt and equity securities offerings, in addition to buyers and sellers in connection with U.S. and cross-border mergers, acquisitions and strategic investments. Adam M. Smith is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher where his practice focuses on international trade compliance and white collar investigations with a focus on economic sanctions and export controls. Mr. Smith served as Senior Advisor to the Director of the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) and as the Director for Multilateral Affairs on the National Security Council. While at OFAC he played a primary role in all aspects of the agency’s work, including briefing Congressional and private sector leadership on sanctions matters, shaping new Executive Orders, regulations, and policy guidance for both strengthening sanctions and easing measures. Mr. Smith counsels a global roster of clients in the financial, services, manufacturing and technology sectors to help them understand, navigate and comply with increasingly complex financial regulations. Peter W. Wardle is a partner in the Los Angeles office of Gibson, Dunn & Crutcher where he is Co-Chair of Gibson Dunn’s Capital Markets Practice Group. Mr. Wardle represents issuers and underwriters in equity and debt offerings, in addition to both public and private companies in mergers and acquisitions, including private equity, cross border, leveraged buy-out, distressed and going private transactions. He also advises clients on a wide variety of general corporate and securities law matters, including corporate governance issues. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.50 credit hours, of which 1.50 credit hours may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.50 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

October 27, 2017 |
Ready? Set? Harmonize. The CFTC and EC Announce Two Actions to Harmonize Their Derivatives Regulations

This alert discusses the U.S. Commodity Futures Trading Commission’s (“CFTC“) and European Commission’s (“EC“, together with the CFTC, the “Commissions“) announcements on October 13, 2017 regarding the international harmonization on two key derivatives regulatory requirements.[1]  The Commissions first announced that they had separately adopted comparability and equivalence determinations related to their respective uncleared swap margin regulations (“Uncleared Margin Determinations“).[2]  The Commissions then announced that they had reached a common plan to recognize each other’s authorized derivatives trading venues as comparable and equivalent (“Common Plan on Trading Venues“).[3]  Ultimately, both of these actions will have positive impacts on cross-border swap trading for both U.S. and European market participants once fully implemented.  The most significant of these impacts is the avoidance of potential market disruption and fragmentation resulting from the implementation of the European Union’s (“EU“) cornerstone financial markets legislation and regulation—the Markets in Financial Instruments Directive (“MiFID II“)[4] and the European Market Infrastructure Regulation (“EMIR“), respectively—which go into force on January 3, 2018. To present these two important announcements, CFTC Chairman J. Christopher Giancarlo and EC Vice President for Financial Stability, Financial Services and Capital Markets Union, Valdis Dombrovskis, held a joint press conference and issued statements emphasizing their commitment to international coordination and cooperation on derivatives regulation.  The unprecedented manner of these announcements demonstrates that the tone and approach under CFTC Chairman Giancarlo on matters relating to cross-border swap regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank” or “Dodd-Frank Act“)[5] will be quite different from that of his predecessors.  Indeed, when commenting on the Commissions’ two actions, Giancarlo noted that, “Today marks a significant milestone in cross-border harmonization between the EC and the CFTC.  These cross-border measures will provide certainty to market participants and also ensure that our global markets are not stifled by fragmentation, inefficiencies, and higher costs.”[6] In the days and weeks following the Commissions’ adoption of these two actions, while U.S. and European swap market participants subject to the CFTC and EU’s uncleared swap margin rules can breathe a sigh of relief in terms of their compliance with requirements under those rules, U.S. and European market participants should not become too comfortable since the Commissions must take further actions in order to implement the Common Plan on Trading Venues before the MiFID II implementation deadline on January 3, 2018.  While Giancarlo and Dombrovskis indicated that their respective staffs are working collaboratively and extensively to meet this deadline, the exact timing and details of the Commissions’ actions to effectuate their plan remain uncertain. In the sections that follow, we first summarize the impact of the Uncleared Margin Determinations and then outline and discuss the known elements of the Commissions’ Common Plan on Trading Venues.  Please feel free to contact Gibson Dunn’s Derivatives Team if you have any questions. 1.     Uncleared Margin Determinations Shortly before making their announcements on October 13, the Commissions adopted the Uncleared Margin Determinations for each other’s uncleared margin requirements.   As a result, swap dealers subject to both CFTC and European uncleared margin rules now have more certainty that they will not have to establish duplicative compliance programs.  In contrast, swap dealers that are subject to the U.S. prudential regulators’ uncleared margin rules are not covered by the Uncleared Margin Determinations and, as a result, are unable to rely on this substituted compliance relief.  The U.S. prudential regulators have not yet issued a comparability determination relating to the EC’s uncleared derivatives margin rules. Background and a discussion of the implications of the CFTC’s and the EC’s determinations are provided in more detail separately below. a.     CFTC’s Comparability Determination On the morning of the announcements, the CFTC unanimously voted to approve its comparability determination,[7] affirmatively finding that the EU’s uncleared derivatives margin rules are comparable in outcome to the CFTC’s uncleared swap margin rules under the Commodity Exchange Act (“CEA“)[8] and CFTC regulations.[9]  The prelude to the CFTC’s vote on October 13 started on December 16, 2015, when the CFTC adopted its final uncleared swap margin rules.  Those rules required non-prudentially-regulated swap dealers to post and collect initial and daily variation margin for their uncleared swaps entered into with other swap dealers and “financial end-users” (e.g., insurance companies, private funds and securitization vehicles) by March 1, 2017.[10]   Those rules also required that non-prudentially-regulated swap dealers post and collect initial margin subject to a phased-in compliance schedule, with various compliance dates extending into the year 2020.   Following its December 2015 vote, the CFTC adopted a final rule in May 2016, setting forth the manner in which its uncleared swap margin rules would apply to cross-border transactions.  This subsequent rulemaking provided that certain foreign swap dealers subject to both the jurisdiction of the CFTC and the foreign regulator through substituted compliance could elect to comply with the applicable foreign jurisdiction’s uncleared margin rules (instead of the CFTC’s rules) once the CFTC issued a comparability determination for the foreign jurisdiction.  To begin the CFTC’s comparability determination process, the EC filed a submission with the CFTC on November 22, 2016, requesting that the CFTC make such a determination for the EU’s uncleared derivatives margin rules. The CFTC’s comparability determination for the EU’s uncleared derivatives margin rules analyzed several principles, including  the scope and objectives of the EU’s uncleared swap margin requirements and whether the EU’s requirements achieve comparable outcomes to the CFTC’s corresponding requirements.[11]  In short, the CFTC’s analysis primarily stressed the importance of the EU’s uncleared derivatives margin rules aligning with the Basel Committee on Banking Supervision’s (”BCBS”) and the International Organization of Securities Commissions’ (”IOSCO”) principles for uncleared derivatives margin rules.[12]  Based on its analysis, the CFTC’s determination deemed any swap dealer that is subject to both CFTC jurisdiction and EU law and complies with the EU’s uncleared derivatives margin requirements to be in compliance with the CFTC’s uncleared swap margin rules, effective immediately.  The CFTC’s comparability determination noted, however, that the swap dealer’s dually-regulated swap positions would remain subject to the CFTC’s examination and enforcement authority. In effect, the CFTC’s adoption of its comparability determination should not result in any material change to impacted swap dealers’ existing compliance programs since CFTC staff took action earlier this year specifically to address any differences between the CFTC’s and EU’s requirements.  In particular, the CFTC’s October 13 comparability determination effectively supersedes CFTC Staff No-Action Letter 17-22 (“Letter 17-22“), which the CFTC’s Division of Swap Dealer and Intermediary Oversight issued on April 18, 2017.[13]   That letter—and a previously issued, but now expired staff letter—were intended to specifically address concerns related to the differences between the CFTC’s and EU’s variation margin requirements around the types of transactions and counterparties subject to margin requirements, the types of eligible collateral required, margin transfer timing and valuation methods.  Letter 17-22 extended the previously-issued no-action relief to swap dealers subject to the CFTC’s uncleared swap margin rules from having to comply with certain provisions in the CFTC’s rules when those swap dealers entered into swaps with counterparties that are subject to the EU’s uncleared derivatives margin rules.  Letter 17-22 was set to expire on November 7, 2017.  Swap dealers subject to the CFTC’s uncleared swap margin rules now can rely on the more permanent relief provided by the CFTC’s comparability determination. b.     EC’s Equivalence Determination As noted above, the EC similarly adopted a determination on October 13 before its formal announcement recognizing the CFTC’s uncleared swap margin regulations as equivalent to similar requirements under EMIR.  EMIR sets forth requirements for the exchange of margin for uncleared, over-the-counter (“OTC“) derivatives contracts entered into by financial counterparties and non-financial counterparties above the EU’s clearing threshold.[14]  The EU’s uncleared derivatives margin rules entered into force on January 4, 2017, and from March 1 2017, certain counterparties begun posting both variation margin and initial margin (with a phase-in of the initial margin requirements through the year 2020). In the cross-border context, the EU’s margin requirements also apply to OTC derivative contracts entered into with third-country entities that would be subject to the EU’s uncleared margin requirements if they were established in the EU where the contract has a direct, substantial and foreseeable effect within the EU or such obligation is necessary or appropriate to prevent the evasion of any provision of EMIR.   The EC has authority under EMIR, however, to allow substituted compliance to third-country entities if the EC determines that a third country has a legal supervisory and enforcement regime that is equivalent to EMIR.  Under this authority, the EC concluded that the CFTC’s uncleared swap margin rules were equivalent in substance to the EU’s uncleared derivatives margin rules and in terms of the CFTC’s legal supervision and enforcement regime. 2.     Common Plan on Trading Venues During the same press conference, the Commissions also announced their Common Plan on Trading Venues, which lays out the Commissions’ agreement regarding the recognition of each other’s authorized trading venues.[15]  The Common Plan on Trading Venues was modeled after the Commissions’ common approach adopted in 2016 to address cross-border recognition issues dealing with derivatives clearinghouses.[16]  In effect, the Common Plan on Trading Venues importantly aims to allow European firms operating in the United States to trade derivatives on authorized U.S. trading venues while still complying with the EU’s Markets in Financial Instruments Regulation (“MiFIR“)[17] trading obligation in advance of MiFID II’s expected implementation date on January 3, 2018.  By that date, any market participant that is subject to the EU’s trading obligation will be required to execute certain swap transactions on regulated markets, multilateral trading facilities (“MTFs“), organized trading facilities (“OTFs“) or certain third-country trading venues.[18] Once the Commissions’ finalize and issue comparability and equivalence determinations for each other’s authorized derivatives trading venues, U.S. firms will be able to comply with the CFTC’s trade execution mandate under the CEA and CFTC regulations[19] by executing swaps on EU-authorized MTFs and OTFs that are exempted from registration as a swap execution facility (“SEF“).[20]  Conversely, European firms will be able to comply with the EU’s trading obligation by executing swaps on authorized CFTC-authorized SEFs and DCMs. Notably, the Commissions’ announcement of the Common Plan on Trading Venues only sets forth the Commissions’ intentions to take further action and the key elements of the Commissions’ approaches.  Thus, both regulators must take further steps in order to effectuate recognition of each other’s authorized trading venues. The Common Plan on Trading Venues outlines some of the actions that the Commissions must undertake.  In particular, it provides that Vice President Dombrovskis intends to propose an equivalence decision covering CFTC-authorized SEFs and DCMs operating the United States, which comply with relevant requirements under MiFID II, MiFIR and the Market Abuse Regulation (“MAR“).[21]  The Common Plan on Trading Venues also noted that CFTC staff in the Division of Market Oversight—with the support of Chairman Giancarlo—intend to propose a single order exempting trading venues from the SEF registration requirement.  The CFTC would adopt the order through its exemption authority under CEA Section 5h(g), which allows the CFTC to grant an exemption where it determines that a foreign trading venue is subject to comparable, comprehensive supervision and regulation on a consolidated basis by its relevant home country regulator.[22]  In order to qualify for the CFTC’s exemption, a foreign trading venue would be required to (i) satisfy requirements under MiFIR and MiFID II, (ii) be identified to the CFTC by the EC, and (iii) in essence, meet such additional standards as the CFTC may determine under the CEA. In terms of the timing of their proposed actions, the Commissions have indicated that they are working as expeditiously as practicable to ensure that all necessary actions to achieve recognition are completed in a coordinated manner.  The CFTC is now preparing a list of eligible SEFs and DCMs that it will share with the EC.  The EC is similarly preparing a list of eligible MiFID II/MiFIR and MAR compliant trading venues to share with the CFTC.  In addition, the Commissions further noted that CFTC staff and the staffs of relevant national competent authorities (through coordination with the EC) will work towards concluding cooperation arrangements in order to ensure the effective exchange of information and coordination of supervisory activities. We are closely monitoring the Commissions’ implementation of the Common Plan on Trading Venues and will provide updates once the Commissions’ take final action.    [1]   See CFTC Press Release (PR 7629-17), CFTC Comparability Determination on EU Margin Requirements and a Common Approach on Trading Venues (Oct. 13, 2017).  See also EC Press Release, European Comm’n, Vice-President Valdis Dombrovkis’ Press Statement With the U.S. Commodity Futures Trading Comm’n (Oct. 13, 2017).    [2]   See CFTC, Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 Fed. 636 (Jan. 6, 2016); Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants – Cross-Border Application of the Margin Requirements, 81 Fed. Reg. 34818 (May 31, 2016).  See also EC, Council Regulation 648/2012, 2012 O.J. (L 201) 1(EU); Comm’n Delegated Regulation 2016/2251, 2016 O.J. (L 340) 9 (EU).    [3]   See CFTC, A Common Approach on Certain Derivatives Trading Venues (Oct. 13, 2017), available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dmo_cacdtv101317.pdf.    [4]   See Directive 2014/65/EU.    [5]   See Dodd-Frank Wall Street Reform and Consumer Protection Act, 124 Stat. 1376, Pub. Law 111-203 (July 21, 2010).    [6]   CFTC Chairman J. Christopher Giancarlo, Prepared Remarks at Press Conference to Announce comparability Determination on EU Margin Requirements and a Common Approach on Trading Venues (Oct. 13, 2017), available at:  http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-30.    [7]   See CFTC, Notification of Determination, Comparability Determination for the European Union: Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 82 Fed. Reg. 48394 (Oct. 18, 2017).    [8]   See 7 U.S.C. 1 et seq. (2017).    [9]   See 17 C.F.R. pt. 23, subpt. E. [10]   In light of widespread concern that the industry would be unable to meet the March 1, 2017 deadline, the CFTC, U.S. prudential regulators and some foreign regulators provide flexibility to swap dealers, which were unable achieve full compliance. [11]   The CFTC’s comparability determination analysis also examined the ability of the EC to supervise and enforce compliance with the EU’s uncleared derivatives margin requirements. [12]   See BCBS/IOSCO, Margin requirements for non-centrally cleared derivatives (updated March 2015), available at http://www.bis.org/bcbs/publ/d317.pdf. [13]   CFTC Staff No-Action Letter No. 17-22 (Apr. 18, 2017), which extends CFTC Staff No-Action Letter No. 17-05 (Feb. 1, 2017). [14]   The EU’s uncleared derivatives margin rules apply to a broader scope of financial instruments than the CFTC’s uncleared swaps margin rules.  The EU’s rules apply to all “OTC derivatives” as that term is defined in Annex I to the Markets in Financial Instruments Directive (“MiFID“).  In contrast, the CFTC’s rules do not apply to foreign exchange spot, foreign exchange forward and foreign exchange swap transactions. [15]   See Common Plan on Trading Venues, supra note 3. [16]   See CFTC Press Release, Common Approach for Transatlantic CCPs (Feb. 10, 2016), available at http://www.cftc.gov/PressRoom/PressReleases/cftc_euapproach021016. [17]   See Regulation (EU) No. 600/2014. [18]   See Council Regulation 600/2014, 2014 O.J. (L 173), 84, 122 Art. 28. [19]   The CFTC’s trading mandate under the CEA and CFTC regulations requires counterparties to execute certain swap transactions that are “made available to trade” on a SEF, a SEF that is exempt from registration, or a designated contract market (“DCM“).  See CEA Section 2(h)(8) and 17 C.F.R. Parts 37 and 38. [20]   Note that the EC has not authorized any entities as OTFs to date. [21]   See Regulation (EU) No 596/2014. [22]   See 7 U.S.C. § 7b-3(g).   Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the following: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Amy Kennedy – London (+44 (0)20 7071 4283, akennedy@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 23, 2017 |
Webcast: 2017 Mid-Year Update: The False Claims Act and Financial Services

​The False Claims Act (FCA) is well-known as one of the most powerful tools in the government’s arsenal to combat fraud, waste and abuse anywhere government funds are implicated. The U.S. Department of Justice has made clear that vigorous FCA enforcement is here to stay,  with newly filed cases remaining at historical peak levels and the DOJ  on pace to recover more than $3 billion from FCA cases for the seventh straight year.  More than ever, any company that deals in government funds—including companies in the education, health care and life sciences, government contracting and financial services sectors—needs to stay abreast of how the government and private whistleblowers alike are wielding this tool, and how they can prepare and defend themselves. Please join Gibson Dunn for a 90-minute discussion of the latest developments in FCA, including: The latest trends in FCA enforcement actions and associated litigation involving Financial Services; Updates on the Trump Administration’s approach to FCA enforcement; Notable legislative and administrative developments affecting the FCA’s statutory framework and application; and The latest developments in FCA case law following the Supreme Court’s Escobar decision. View Slides [PDF] PANELISTS: F. Joseph Warin is a partner in the Washington, D.C. office, Chair of the office’s Litigation Department, and Co-Chair of the firm’s White Collar Defense and Investigations practice group. His practice focuses on complex civil litigation, white collar crime, and regulatory and securities enforcement – including FCPA investigations, FCA cases, special committee representations, compliance counseling and class action civil litigation Stuart Delery is a partner in the Washington, D.C. office. He represents corporations and individuals in high-stakes litigation and investigations that involve the federal government across the spectrum of regulatory litigation and enforcement. Previously, as the Acting Associate Attorney General of the United States (the third-ranking position at the Department of Justice) and as Assistant Attorney General for the Civil Division, he supervised the DOJ’s enforcement efforts under the FCA, FIRREA and the Food, Drug and Cosmetic Act. Mylan Denerstein is a partner in the New York office. She is Co-Chair of the firm’s Public Policy practice group, and a member of the White Collar Defense and Investigations, Securities Litigation, Appellate, and Crisis Management practice groups. She handles a broad range of complex litigation, as well as white collar, legislative and investigation matters. She is former Counsel to New York State Governor Andrew Cuomo, and previously served as Deputy Chief of the Criminal Division of the U.S. Attorney’s Office in the Southern District of New York. James Zelenay is a partner in the Los Angeles office and a member of the firm’s Litigation Department. He is experienced in federal and state FCA matters and whistleblower litigation, in which he has represented a breadth of industries and clients, including educational institutions.   MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.80 credit hours, of which 1.80 credit hours may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit only. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondun.com  to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.50 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

July 20, 2017 |
French Market Update – July 2017

France is great again? Many of you have read positive articles on the new government in France and its freshly elected President, Emmanuel Macron. Is it real? First, one needs to understand the context: a quasi-unknown individual a year ago, Mr. Macron has stunned all by winning the first, then second, round of the presidential election, as an "anti-populist", pro-European, candidate. Almost as surprisingly, his party (called "Republic on the Move!"), which has been in existence for less than a year, won an absolute majority (with 350 seats over 577) in the subsequent parliamentary election, held on June 11 and 18, 2017, reducing, for example, the Socialist representatives to 28 from 280 in 2012. This, in turn, means that for the next five years, Mr. Macron has both a mandate and an ability to implement his program. France, in electing him with such latitude, rejected the extreme right (with a Frexit program) and the extreme left (with a very high taxation program). One of Mr. Macron’s key strengths has been his "extreme centrist" positioning, based on the simple concept that necessary policies are neither leftist or rightist ones; they are just common sense and should be supported by all reasonable politicians regardless of their original party. He also promoted a very large number of non-politicians to political positions, thus considerably altering the political landscape. Being an ex-Rothschild banker, Mr. Macron is guided by a resolute desire to "open the country for business" and eliminate the disincentives to investment in France, particularly at a time when Brexit causes potential issues for businesses based in the UK. He also understands the need to act fast, and intends to pass his most emblematic promises, aiming at triggering a supply-side shock and boosting confidence, before the end of 2017. What are these promises? An extensive labor reform to "move the rules of the game" aiming at lowering the unemployment rate to 7% at the end of his term in 2022. Proposed measures include caps on financial penalties for companies sued for firing employees, allowing businesses more flexibility to define internal working rules, merging the various employee representative bodies currently existing in French business organizations to improve social dialogue. To achieve this reform expeditiously, the French Government wants to use a special procedure to pass the measures this Summer without extended debate in parliament. The details of the reform are expected to be announced at the end of August. Strong workers antagonism is likely, but the climate has changed and popular support for movements has weakened.  Tax reform aimed at restoring France’s attractiveness: Among the key signals sent to the business community: a decrease of the corporate income tax (from 34.3% today to 25% in 2022), and, as from 2019, the replacement of the tax credit for competitiveness and employment (CICE) by a substantial reduction in the employers’ social contributions.     Another aspect of the proposed tax reform will be the replacement of the general wealth tax by a special wealth tax limited to real estate and the creation of a "flat tax" on capital gains and dividends at a rate of about 30%. The purpose of this proposal is to favor financial investments over real estate ones.  These long-awaited measures will kick-in as soon as 2018. A 50-billion euro investment program: Although not yet fully financed, this plan will likely rely on the existing program "Investing for the Future" launched by President Sarkozy and on a new wave of privatizations. This program embraces huge investments in training (up to €15bn), supports to the ecological transition, the digitalization of the healthcare system, investments in infrastructures (such as transports) and modernization of the State services, all of which will favor future business fluidity. A large number of these projects will be open for bidding to non-French entities. An additional 10 billion euro "innovation program" is planned to invest into Cleantech, Greentech, AI, all in order to attract and retain start-ups. A new momentum for foreign investments in France After seven years of profound economic crisis, and five years of French bashing due to the former president’s administration, his tax increases and anti-business stance, France now benefits a true shift in perception. These changes have the effect to make France a desirable investment target, especially for business and real estate. Opportunities for foreign investors are relatively cheap, especially given the quality of the administration, education, health and infrastructure and the stability of the political system. France has numerous fundamental strengths including its central location in Europe, excellent communication and transport infrastructure, significant industrial achievements in a wide range of sectors, high productivity, and a well-qualified workforce. All these strengths support opportunities for foreign investments, from the United States and elsewhere. 2017 marks Gibson Dunn’s 50th year in France.  With 45 lawyers, whose expertise covers all aspects of business law, such as corporate transactions, restructuring/insolvency, private equity, litigation, compliance, public law and regulatory, technology and innovation, and finance, as well as tax and real estate, our Paris office,  is well-positioned to assist all the Firm’s clients as their strategy shifts towards France. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyers with whom you usually work, or the following authors in the firm’s Paris office: Bernard Grinspan (+33 1 56 43 13 00, bgrinspan@gibsondunn.com) Judith Raoul-Bardy (+33 1 56 43 13 00, jraoulbardy@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 5, 2017 |
Office of Comptroller of Currency Provides More Guidance on Third-Party Business Relationships, Including Fintech Firms

In June, the Office of the Comptroller of the Currency (OCC), the regulator of national banks, federal savings associations and federal savings banks, issued additional guidance on the oversight and risk management of third-party relationships (Bulletin 2017-21).  The guidance takes the form of responses to fourteen “frequently asked questions” about the OCC’s prior guidance in its Bulletin 2013-29.  In that Bulletin, the OCC required banks to adopt risk management and oversight procedures for third-party relationships based on the level of risk and complexity of the applicable relationship.  OCC Bulletin 2013-29 also outlined a recommended risk management process consisting of:  (i) management planning, (ii) due diligence on third-party service providers, (iii) effective contract negotiation, (iv) ongoing monitoring, (v) contingency planning, (vi) oversight and accountability, (vii) proper documentation and reporting, and (viii) independent reviews. In issuing the updated guidance, the OCC wished to call attention to the increased frequency and complexity of bank third-party relationships, including developments involving financial technology (Fintech) companies, and it addressed several areas of focus.  The OCC’s guidance focuses on the responsibilities of bank boards and senior management in undertaking and overseeing risk management, special issues posed by Fintech companies, the ability of banks – particularly, community banks – to collaborate with respect to risk management and oversight obligations, and outsourcing compliance obligations. Board and Senior Management Duties Bulletin 2013-29 stressed the importance of a bank’s board and senior management implementing a comprehensive and rigorous risk management and oversight program for third-party service providers that support “critical activities” – defined as significant bank functions, shared services, or other bank activities that could cause significant risks or customer effects, require significant investments, or have a major impact on bank operations on termination of the relationship.  A key portion of such programs is robust due diligence and ongoing monitoring, reviewed by both senior management and the board. Noting the difficulty certain banks have had in receiving all information necessary to conduct the type of due diligence review necessary when critical activities are at issue, particularly for new companies, Bulletin 2017-21 states that, in such a situation, the OCC expects a bank’s board and management to: develop alternative ways to assess such critical third-party service providers; establish appropriate mitigating controls; make appropriate preparations for potential interruptions in service; make risk-based decisions that such service providers are the correct choice notwithstanding the unavailability of certain information; retain appropriate documentation regarding the efforts to obtain relevant information and related decisions; and ensure that the contracts with the service providers appropriately address the bank’s needs. In terms of how banks should structure their risk-management process, the OCC reiterated that there was no one way to do so, and the process should be commensurate with the level of risk and complexity of the particular relationship.  The OCC noted that some banks have dispersed accountability for the process among business lines, whereas others had centralized the process under compliance, information security, procurement, or risk management functions.  The OCC did state, however, that “personnel in control functions such as audit, risk management, and compliance programs” should be involved.  Moreover, the OCC emphasized that a bank’s board is ultimately responsible for the development of an effective risk management process, and that “periodic board reporting is essential to ensure that board responsibilities are fulfilled.” Fintech Companies Due to increased collaboration between Fintech companies and banks, Bulletin 2017-21 addresses the applicability of the OCC’s third-party risk management guidance to such companies.  It states that Fintech companies (including third-party service providers in mobile payment environments) performing services for or on behalf of a bank are considered third-party service providers under Bulletin 2013-19 and, accordingly, subject to the third-party risk management process. In complying with Bulletin 2013-19, banks should ensure that they are appropriately assessing the financial condition of Fintech companies, including, in certain circumstances, by an evaluation of such companies’ earnings, cash flow, access to funding sources, expected growth and potential borrowing capacity.  The OCC also stated that, due to the limited financial information that may be available for certain Fintech companies, banks should ensure that appropriate contingency plans are developed to address interruptions or failures in service.  In addition, if a bank’s board and management determine that a relationship with a Fintech company involves “critical activities,” the board and management should ensure that the bank complies with the comprehensive risk management process put in place for such critical activities.  The OCC did indicate, however, that there is no express prohibition on entering relationships with Fintech companies that do not meet a bank’s lending criteria. Bulletin 2017-21 also includes a lengthy response to a FAQ on banks’ relationships with marketplace lenders.  The response states that a bank’s board and management should understand the relationships among the bank, the marketplace lender and borrowers, as well as the variety of risks – legal, strategic, reputational, operational – posed by the arrangements, and also evaluate  the lender’s practices for compliance with applicable laws and regulations.  The Bulletin warns that banks should have in place adequate loan underwriting guidelines, and that management should ensure that loans are underwritten to those guidelines.  To address risks, banks’ due diligence on marketplace lenders should include consulting with appropriate business units – credit, compliance, finance, audit, operations, accounting, legal and information technology. Bank Collaboration Recognizing the challenges that community banks face when complying with Bulletin 2013-29, Bulletin 2017-21 clarifies that banks may collaborate to meet certain risk management expectations including due diligence, contract negotiation and ongoing monitoring if such banks are using the same service providers for similar products or services.  This collaboration can include alliances to create standardized contracts with common third-party service providers or standardized approaches to due diligence and monitoring, such as common security, privacy, and internal controls questionnaires. Although the OCC does not intend to discourage collaboration, it stated that certain products and services may pose different levels of risk for individual banks and, accordingly, collaboration should not viewed as sufficient to meet the totality of a bank’s responsibilities under Bulletin 2013-29.  Individual bank-specific responsibilities include defining the requirements for planning and termination (e.g., plans to manage the third-party service provider relationship and development of contingency plans in response to a termination of service), as well as: integrating the use of product and delivery channels into the bank’s strategic planning process and ensuring consistency with the bank’s internal controls, corporate governance, business plan, and risk appetite; assessing the quantity of risk posed to the bank through the third-party service provider and the ability of the bank to monitor and control the risk; implementing information technology controls at the bank; ongoing benchmarking of service provider performance against the contract or service-level agreement; evaluating the third party’s fee structure to determine if it creates incentives that encourage inappropriate risk taking; monitoring the third party’s actions on behalf of the bank for compliance with applicable laws and regulations; and monitoring the third party’s disaster recovery and business continuity time frames for resuming activities and recovering data for consistency with the bank’s disaster recovery and business continuity plans. In addition, the OCC stated that any bank collaboration should be conducted in accordance with the antitrust laws. Outsourcing Compliance Finally, Bulletin 2017-21 provides that banks may use third-parties to assist with their compliance obligations by outsourcing aspects of their compliance programs to third-parties.  Although outsourcing can be valuable, banks are required to monitor and ensure that the third-parties comply with applicable consumer laws and regulations.  Banks may use third-party service organization control reports prepared in accordance with AICPA’s SSAE 18 to evaluate the internal controls and policies of a third-party’s risk management program; at the same time, however, they should independently determine whether such reports are sufficient. Conclusion The issuance of Bulletin 2017-21 demonstrates that the OCC is attaching increased significance to the risk management issues created by third-party relationships – matching the increased use of third-parties by banks themselves.  In keeping with the general post-Financial Crisis emphasis on risk governance, the OCC is showing that in this context, too, it expects bank management and boards of directors to manage risk proactively.  National banks, federal savings associations and federal savings banks that do find the use of third-parties and Fintech companies advantageous as a business matter should not forget that the OCC will expect them to identify clearly and manage prudently the risks created by such relationships. Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions or Securities Regulation and Corporate Governance practice groups, or the authors: Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Christopher O. Lang – New York (+1 212-351-2660, clang@gibsondunn.com) Please also feel free to contact any of the following practice group members: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 10, 2017 |
House Financial Services Committee Financial Choice Act 2.0: Key Banking, Derivatives and Rulemaking Reforms

On May 4, 2017, by a vote of 34 to 26, the House Financial Services Committee ordered reported H.R. 10,[1] the Financial CHOICE Act of 2017 (CHOICE Act 2.0 or the Bill), which had been introduced previously by Chairman Representative Jeb Hensarling (R-TX) and seven other Republican members of Congress.  The Bill, which is a revised and expanded version of similar legislation introduced by Representative Hensarling in 2016,[2] seeks to overhaul the administrative state as much as it does the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The Bill focuses on the following principal themes: Under Dodd-Frank, financial regulation improperly balanced the costs of regulations against their perceived benefits; Congress and the federal courts should have greater control over the regulatory process; Dodd-Frank’s systemic risk provisions produced substantial regulatory overreach; Heightened capital standards alone are sufficient to replace much of Dodd-Frank’s prudential regulatory structure; and Dodd-Frank did not go far enough in restraining the ability of government to “bail out” and play favorites among failing financial firms. Politically, CHOICE Act 2.0 has a challenging road ahead.  The Bill did not attract Democratic support in committee.  It was ordered reported on a party-line vote, and 19 Democratic amendments were rejected, also on party lines.  Highlighting the level of partisan rancor, one Democratic amendment that was defeated on party lines would have prevented the Bill from taking effect until the Office of Government Ethics certified that the Bill would not directly benefit the President or any of his advisors who are in a position to influence federal regulation. This Alert summarizes the Bill’s key provisions relating to bank regulation, derivatives regulation, and rulemakings by federal financial regulators. I.     BANK REGULATORY REFORMS A.     Reforms Independent of the “Off Ramp” from Dodd-Frank Demonstrating a desire to roll back excessive regulation generally, the Bill would eliminate many key features of the Dodd-Frank regulatory regime for all banks and nonbank financial companies.  These changes include: End to Nonbank SIFI designation:  The ability of the Financial Stability Oversight Council (FSOC) to designate nonbank financial companies as “systemically significant” (Nonbank SIFIs) and the ability of the Board of Governors of the Federal Reserve System (Federal Reserve) to apply enhanced prudential standards to such institutions would be repealed. As a result, Federal Reserve supervision and regulation of the two currently designated Nonbank SIFIs, American International Group, Inc. and Prudential, Inc.[3] would end, as well as the prospect of future supervision and regulation for all other nonbank financial companies. The FSOC would retain, however, certain of its current authority; for example, its authority to identify risks to the financial system and report on those to Congress. End to Designation of Systemically Significant Financial Market Utilities:  Similarly, the ability of the FSOC to designate financial market utilities (FMUs) as “systemically significant” would be repealed. As a result, Dodd-Frank supervision and regulation of the eight currently designated FMUs would cease, and these FMUs would lose their ability to borrow from the Federal Reserve discount window.[4] Repeal of FSOC “Break-Up” and Related Authority:  The so-called “Kanjorski Amendment” that gave the FSOC the authority, among other permitted actions, to break up Nonbank SIFIs and bank holding companies (BHCs) with total consolidated assets of $50 billion or more upon a finding of a “grave threat” to financial stability would be repealed. The Federal Reserve would retain its authority contained in Regulation Y to require a BHC to terminate a business activity or terminate control of a nonbank subsidiary whenever it believes that the activity or control constitutes a serious risk to the financial safety, soundness, or stability of a subsidiary bank of the BHC and is inconsistent with sound banking principles or the purposes of the BHC Act.[5] Repeal of the Volcker Rule:  The Volcker Rule’s restrictions on proprietary trading and private fund activities would be repealed for all banking institutions, regardless of size. Repeal of the “Hotel California” Provision:  As a result, $50 billion or greater BHCs that received TARP money could “debank”–that is, close down or sell their BHC Act “banks”–without the consequence of being subject to Federal Reserve supervision and enhanced prudential standards. Repeal of the Orderly Liquidation Authority:  Title II of Dodd-Frank, which established the Orderly Liquidation Authority (OLA) an alternative to the Bankruptcy Code for resolving a failing Nonbank SIFI or $50 billion or greater BHC, would be repealed. As a result, resolution under the Bankruptcy Code would be the only means of resolving such companies, not an FDIC receivership. The FDIC would lose its most significant source of current regulatory authority, and be relegated to its traditional role of resolving failed banks and thrifts. CHOICE 2.0 Act would add a new Subchapter V to Chapter 11 of the Bankruptcy Code, discussed below, for financial companies Changes to the “Living Will” Process:  The “living will” process would be transformed for $50 billion or greater BHCs. The FDIC would no longer review the living wills of $50 billion or greater BHCs; only the Federal Reserve would.  The FDIC would review the living wills of insured depository institutions that were required to submit them. Living wills would be required to be updated only every two years, not every year, and the relevant agency would be required to provide its feedback within six months after a submission. The relevant agencies would be required to make public the framework by which they assessed BHC and insured depository institution living wills, and subject that framework to notice and comment before finalizing it. Changes to the CCAR/DFAST Process:  The Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) would become a two-year process, as opposed to being conducted every year; and it would not include a “qualitative component,” regardless of the size or complexity of the BHC. In addition, responding to concerns that the Federal Reserve’s stress testing process (DFAST) was based on “black box” models, CHOICE Act 2.0 would require the Federal Reserve to promulgate regulations under notice and comment setting forth its three stress testing scenarios, as well as models used to estimate certain losses under those scenarios. Changes to Company Run Stress Testing Process:  For $50 billion or greater BHCs, only one annual BHC-run “stress test” would be required, as opposed to the two tests required currently. Restriction on Operational Risk Capital Requirements:  The Bill would prohibit the adoption of a capital requirement for operational risk unless the requirement was based on the risks posed by a banking organization’s current activities and businesses, was appropriately risk sensitive, was based on a forward-looking assessment of potential losses, and permitted adjustments based on qualifying risk mitigants.  Large BHCs have been highly vocal in their criticism of the burdens of current operational risk requirements. Repeal of Securities Holding Company Regulation by the Federal Reserve:  The Bill would repeal the current authority of the Federal Reserve to regulate a “securities holding company”–that is, a broker dealer that did not own a bank or thrift but was required to demonstrate to foreign supervisors that it was subject to consolidated supervision in the United States. Repeal of “Early Remediation” Authority:  The Bill would repeal the Dodd-Frank provision authorizing the Federal Reserve to issue regulations requiring early remediation requirements for Nonbank SIFIs and $50 billion or greater BHCs.  The Federal Reserve has proposed regulations under that provision, but such regulations have not been finalized. Repeal of the Durbin Amendment:  Viewed by the Bill’s sponsors as an inappropriate price control mechanism, the Durbin Amendment to Dodd-Frank, which limits the amount of debit card interchange fees that may be charged by banks with $10 billion or more in total consolidated assets, would be repealed. FIRREA Reform:  The Bill would amend the civil money penalty provisions of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 so that violations of federal statutes like those punishing wire and mail fraud would be required to be carried out either “against” a federally insured financial institution or “by a federally insured financial institution against an unaffiliated third person,” rather than merely “affect” such an institution, to give rise to liability. Bank Examination Reforms:  The Bill would set mandatory time periods for the federal banking agencies to issue examination reports and create in the Federal Financial Institutions Examination Council an Office of Independent Examination Review to which material supervisory determinations in examinations could be appealed. Override of Madden Decision:  The Bill would override the controversial decision of the United States Court of Appeals for the Second Circuit in Madden v. Midland Funding, LLC[6] and impose a uniform federal rule that a loan that did not violate state usury laws when made due to federal preemption would also not violate such laws when acquired by or transferred to a third party. Bank Regulations to Take Into Account Business Models.  The Bill would require each federal banking agency, when taking regulatory action, to take into consideration the risk profile and business models of each type of institution or class of institutions subject to the regulatory action; determine the necessity, appropriateness, and impact of applying such regulatory action to such institutions or classes of institutions; and tailor such regulatory action in a manner that limits the regulatory compliance impact, cost, liability risk, and other burdens, as appropriate, for the risk profile and business model of the institution or class of institutions involved. Several key points may be taken from these general reforms.  First, enactment of CHOICE 2.0 Act would return Nonbank SIFI regulation to where it was before the Financial Crisis:  if a large, interconnected company engaged in financial activities (securities, derivatives, commodities, insurance) did not control a BHC Act “bank” or a thrift, it would not be subject to supervision and regulation by the Federal Reserve or any other prudential bank regulator. Second, although there would be a significant reduction in bank holding company regulation, the Dodd-Frank Section 165 enhanced prudential standards, amended in the manner above, would continue to apply at the $50 billion total consolidated asset threshold.  This would be the case even though there is a consensus that the $50 billion threshold was set too low, as well as strong beliefs that the Federal Reserve could have tailored its enhanced prudential standards much more effectively based on size and complexity in its regulations implementing Section 165. Third, other than as described above, many Section 165 prudential standards and other Dodd-Frank regulations would remain:  the Basel III capital standards (including the standardized approach capital floor imposed by the Collins Amendment and certain U.S. gold-plating, such as the heightened capital charge for High Volatility Commercial Real Estate loans); the liquidity coverage ratio; and heightened risk governance requirements, among others. In order to escape these aspects of Dodd-Frank, a BHC would be required to make use of the Bill’s so-called “Off Ramp.” B.     Reforms for Banks and BHCs Qualifying for the “Off Ramp” A principal aspect of the “choice” in CHOICE Act 2.0 refers to the fact that additional regulation under Dodd-Frank would disappear for BHCs and banks that are “qualifying banking organizations.”  Such banking organizations include: Insured depository institutions Insured credit unions[7] Depository institution holding companies Non-U.S. banks treated as U.S. BHCs U.S. intermediate holding companies (IHCs) of non-U.S. banks established under Dodd-Frank To qualify, the organization must have an average leverage ratio of at least 10 percent (i.e., the average of its leverage ratios for the four most recently completed calendar quarters); if the organization is a holding company, its subsidiary insured depository institutions must also meet the 10 percent test, and if the organization is an insured depository institution, any parent holding company must also meet the 10 percent test.  This is the only requirement. How the leverage ratio is measured depends on the type of banking organization.  If the banking organization limits itself to “traditional” activities–that is, it has zero trading assets and liabilities, has no swap activities other than swaps/securities-based swaps referencing interest rates and foreign exchange, and its total notional exposure of swaps and securities-based swaps is not more than $8 billion, then the ratio is: the sum of common equity Tier 1 capital, plus additional Tier 1 capital instruments issued on or before the date of enactment, plus, for certain holding companies, outstanding trust preferred securities that qualify as Tier 1 capital, divided by: total assets minus any items deducted from common equity Tier 1 capital. For other organizations, the numerator is the same, but the denominator is total leverage exposure–that is, the denominator is a supplementary leverage ratio (SLR) including off-balance sheet components. Maintaining such a high tangible leverage ratio has substantial benefits.  These include: Being exempt from “any” federal law, rule or regulation addressing capital or liquidity requirements or standards Being exempt from “any” federal law, rule or regulation that permits a federal banking agency to object to a capital distribution Being exempt from the consideration of Dodd-Frank “financial stability” factors in mergers, acquisitions, and the conduct of new activities Being exempt from Section 165 enhanced prudential standards and their implementing regulations Being exempt from laws placing limitations on mergers and acquisitions relating to capital and  liquidity standards, and concentrations of deposits and assets[8] Because for more complex banking organizations the leverage ratio is an SLR, it not clear that such organizations would make use of the off-ramp:  the amount of tangible capital that would be required is significantly more than under current capital requirements.  This said, the off-ramp could provide small and medium-sized institutions (including certain non-U.S. bank IHCs with a retail banking focus) with an intriguing manner of significantly avoiding the current web of Dodd-Frank regulation.  Many community banks, moreover, currently do meet the 10 percent leverage threshold, and such banks would clearly benefit from enactment of the “off-ramp.” C.     A New Bankruptcy Regime for Failing Financial Companies As noted above, CHOICE Act 2.0 would repeal the OLA, which means that a significant bank or financial firm that failed could only be resolved–like Lehman Brothers–in a Bankruptcy Code proceeding. Many commenters on the Financial Crisis believed that the Bankruptcy Code as in effect at the time of Lehman Brothers’ insolvency was ill-suited to the resolution of financial firm, and so CHOICE Act 2.0 would enact a new Subchapter V in Chapter 11 of the Bankruptcy Code in an attempt to fix the perceived flaws.[9] Subchapter V would be available for “covered financial corporations,” a term defined as follows: Any corporation incorporated or organized under any Federal or State law, other than a stockbroker, commodity broker, depository institution or insurance company, that is: a bank holding company, or a holding company that has total consolidated assets of $50 billion or greater, and for which, in its most recently completed fiscal year, had annual gross revenues or consolidated assets that were at least 85 percent financial in nature (including related to the ownership or control of insured depository institutions) Subchapter V takes from the OLA the concept of the transfer of estate property, assignment of executory contracts, unexpired leases, and qualified financial contracts (QFCs) to a bridge company; upon an order approving such a transfer, such property would no longer be property of the estate.  The purpose of such a transfer is similar to that in the OLA–effectively to wipe out the equity and unsecured debt of the failed firm, which would be required to remain in the estate, while permitting healthy operating subsidiaries to continue their business as subsidiaries of the bridge company. Equity in the bridge company would be owned by a trust overseen by a “special trustee” appointed by the bankruptcy court (the Federal Reserve would be permitted to consult regarding the identity of the special trustee).  Ultimately securities of the bridge company could be sold–that is, if the transferred business stabilized under the bridge company such that it could be sold to new investors or another financial firm–but the special trustee would be required to consult with the Federal Reserve and FDIC regarding such sales and disclose the result of that consultation to the bankruptcy court.  Proceeds from such sales would be held in trust for the benefit or, or otherwise transferred to, the bankruptcy estate for distribution to creditors. Subchapter V thus seeks to preserve enterprise value of the failed firm as the OLA does.  To that end, if contains amendments to the Bankruptcy Code regarding provisions for “qualified financial contracts” (QFCs)–that is, swaps and other derivative agreements–that seek to ensure a transfer of QFCs to the bridge company, without permitting counterparties to the failed firm, or counterparties of the firm’s affiliates, to avoid such agreements due to the commencement of the case. Although Subchapter V borrows many concepts from the OLA, it differs in one significant way.  Because CHOICE Act 2.0 seeks to end any possibility of a government bailout, there is no provision for the extension of government liquidity funding to the bridge company as in the case of the OLA.  The bridge company will therefore be required to rely on the available liquidity of the failed firm’s subsidiaries transferred to it, and any liquidity funding that it can obtain from private sources. One logical result of the repeal of the OLA and enactment of Subchapter V, therefore, would be continued increased focus on pre-positioning of available liquidity throughout a BHC’s structure as part of the BHC “living wills” process. D.     Reforms to the Federal Bank Regulators                         1.        Federal Reserve The Bill makes significant changes to the Federal Reserve’s emergency lending authority,[10] including: Amending Section 13(3) of the Federal Reserve Act to require the affirmative vote of at least nine Federal Reserve Bank presidents for the Federal Reserve to grant an emergency funding request; Requiring that the “unusual and exigent circumstances” in Section 13(3) that permit such emergency funding also “pose a threat the financial stability of the United States”; Prohibiting the acceptance of equity securities issued by the borrower as collateral for emergency loans under Section 13(3); Requiring that borrowers under Section 13(3) be financial institutions, and that, as a condition to an emergency loan, all federal banking regulators with jurisdiction over a borrower certify that the borrower was not insolvent; and The Federal Reserve would be required to promulgate regulations regarding the types of acceptable collateral (including collateral haircuts) for Section 13(3) loans and the penalty rate of interest that would be applied to such loans; the Bill itself sets a minimum penalty rate.                         2.        Consumer Financial Protection Bureau Under the Bill, the CFPB would be radically transformed.  Among the more important reforms are the following: The CFPB would be renamed the Consumer Financial Opportunity Agency; It would be an executive agency whose Director would be removable at will by the President, and it would be subject to the congressional appropriations process; It would be a rulemaking and enforcement agency only (it would not have supervisory or examination authority); it would be limited in enforcing enumerated federal consumer laws only, and not “unfair, deceptive or abusive acts and practices” (UDAAP); It would have a “dual mandate” of enforcing laws to strengthen participation in financial markets, increase competition, and enhance consumer choice; The federal banking agencies, and not it, would have authority to promulgate regulations addressing unfair or deceptive, but not abusive, acts and practices (UDAP); and It would be stripped from taking regulatory action where its actions to date have been controversial, such as payday and small dollar loans, arbitration clauses, and automobile finance.                         3.        Reforms to the Other Bank Regulators The Bill would significantly alter the structure of the FSOC, which would be enlarged so that each member of a multi-member commission, agency or board would be a member of the FSOC.  The number of FSOC votes, however, would not be increased, so that a multi-member commission, agency or board would determine its vote by its normal voting processes, meaning that a Chair could be outvoted.  To add transparency to FSOC meetings, agency staff could attend FSOC meetings if selected by an FSOC member; meetings would also be open to attendance by members of the House Financial Services Committee and Senate Banking Committee; and they would be subject to the Government in the Sunshine Act.  The FSOC would receive a set amount of congressionally authorized funding each fiscal year, rather than its current practice of assessing Nonbank SIFIs and $50 billion or greater BHCs.  In a response to widespread criticism of its work, the FSOC’s Office of Financial Research would be abolished.  Dodd-Frank’s Federal Insurance Office would be replaced by the Office of the Independent Insurance Advocate (IIA), a bureau in the Department of the Treasury; the IIA would replace the so-called “independent member with insurance expertise” as an FSOC voting member. As for the FDIC, the Bill would remove the Comptroller of the Currency and the Director of the CFPB from its board of directors; they would be replaced by specific Presidential appointees.  In addition, the Bill would strip the FDIC of the ability to establish a guarantee program of general applicability like the Temporary Liquidity Guarantee Facility established during the Financial Crisis and repeal the provision of current law that permits the FDIC to select a means of resolution of a failing bank that is not the least costly to government if the FDIC makes a systemic risk finding. The effects of the changes to the federal bank regulators seem threefold.  First, the ability of the Federal Reserve and FDIC to use their discretion in the event of a new financial crisis, which was already constrained by Dodd-Frank, would be further channeled–the animating principle is to end government “bailouts” in the broadest sense of the term.  With respect to the CFPB, CHOICE Act 2.0 would transform its mission and make it less independent of the political branches of government.  The other significant Dodd-Frank administrative creation, the FSOC, would see its powers cut back, greater transparency brought to its meetings, and the ability of Chairs of regulatory agencies to influence FSOC decision-making reduced. II.     DERIVATIVES REFORMS           Largely unaffected by CHOICE Act 2.0, derivatives regulation would be subject to only two new, specific provisions.  One would require harmonization of rules promulgated by the securities-based swap regulator, the SEC, and the swaps regulator, the CFTC.  The other is a measure to exempt swaps and securities-based swaps transactions between certain affiliates from certain regulatory requirements intended to be applied to third-party transactions. A.     Title VIII, Subtitle B, Section 871: Commission Review and Harmonization of Rules Relating to the Regulation of Over-the-Counter Swaps Markets Similar to aspects of President Trump’s Executive Order 13777 to Executive agencies,[11] Section 871 of the Bill would instruct the SEC and CFTC to streamline their current governance framework.  In particular, the SEC and CFTC would be required to review all rules, orders, and guidance issued pursuant to Title VII of Dodd-Frank with the goal of resolving inconsistencies between such rules, orders and interpretive guidance by issuing new joint regulations, orders and guidance. In the Title VII implementation process, harmonization between the CFTC’s rules for swaps and the SEC’s rules for security-based swaps has been recognized as an area for improvement.  For example, market participants have raised concerns that proposals from the SEC would require duplicative registration and other requirements for entities that engage in both swaps and security-based swaps activities.  In that regard, Section 871 would aim to eliminate such inconsistencies. B.     Title VIII, Subtitle B, Section 872: Treatment of Transactions Between Affiliates Dodd-Frank does not distinguish between internal swaps between affiliates and those with third parties, ignoring the fact that former does not create systemic risk, as such transactions do not create additional counterparty exposure outside of the corporate group and do not increase interconnectedness between third parties.[12]  Notwithstanding the lack of clarity in the statute, the CFTC has provided significant relief for inter-affiliate swaps from margin, clearing and reporting requirements.[13]  Similar to the inter-affiliate language that passed the House earlier this year as part of the CFTC Reauthorization Bill (H.R. 238),[14] Section 872 would serve to codify current CFTC relief, and add a parallel SEC provision.  The amendment would remove transactions between majority-owned affiliates from the definition of “swap” and “security-based swap” if those affiliates are on a company’s consolidated financial statements.  It would also subject those exempted swaps or security-based swaps to certain requirements: if one counterparty is either a swap dealer or major swap participant if regulated by the CFTC, or a security-based swap dealer or major security-based swap participant if regulated by the SEC, it would be required to report the transaction and have a centralized risk management program; and the inter-affiliate swaps cannot be structured to evade Dodd-Frank requirements.[15] III.     ADMINISTRATIVE LAW REFORMS    Title III of the Bill would significantly change the financial rulemaking process.  It would do so through imposing new cost-benefit analysis requirements, granting Congress oversight and veto powers over new regulations, and putting an end to federal court deference when reviewing agency action.  Moreover, Title III applies to a wide range of agencies, including all the principal bank regulatory agencies: Federal Reserve Consumer Law Enforcement Agency (i.e., the agency replacing the CFPB) Commodity Futures Trading Commission (CFTC) Federal Deposit Insurance Corporation (FDIC) Federal Housing Finance Agency (FHFA) Office of the Comptroller of the Currency (OCC) National Credit Union Administration  (NCUA) Securities and Exchange Commission (SEC, and together with the foregoing, the Agencies) A.     Title III, Subtitle A–Cost-Benefit Requirements Subtitle A of Title III sets forth heightened cost-benefit requirements with which Agencies must comply in rulemakings.  In addition, the Bill would require the SEC to submit to Congress a plan for subjecting the Public Company Accounting Oversight Board, the Municipal Securities Rulemaking Board, and registered national securities exchanges to these requirements.                         1.        Expansion of Subject Agencies and Increased  Requirements Although cost-benefit analyses are currently undertaken by certain federal financial agencies, the Bill would expand the number of Agencies that would generally be required to conduct such analyses–e.g., the Federal Reserve, the OCC, and the FDIC[16]–and impose uniform heightened standards for all Agencies.[17] When issuing a proposed rule, an Agency would be required to complete a detailed analysis, including on the following principal subjects: General Justifications:  The Agencies would be required to identify the need for the regulation, including the nature and significance of the market, regulatory or other failure necessitating Agency action. Private Market and Local Solutions:  The Agencies would also be required to address and explain why the private market or state and local authorities could not adequately address the market failure or need for the regulation. Method of Regulation:  If a proposed regulation would specify the behavior or manner of compliance (i.e., how to do something), rather than specify the performance objective (i.e., what an activity should result in), the Agency must provide an appropriate justification for the use of the former. Adverse Effects Analysis:  The Agencies would be specifically required to analyze the adverse effects of the proposed regulation on regulated entities, market participants, economic activity, and Agency effectiveness. Cost-Benefit Analysis:  The Agencies would be required to undertake a quantitative and qualitative cost-benefit analysis of all anticipated direct and indirect costs and benefits, including: (i) compliance costs; (ii) costs on economic activity, job creation, efficiency, competition, and capital formation; and (iii) regulatory administrative costs and other costs to state and local government.  An analysis would be required to include an assessment of the degree to which key assumptions used are subject to uncertainty, as well as a description of data or studies used.[18] Alternatives:  The Agencies would be required to identify and assess all available alternatives to the regulation, including why modifications to existing regulations or laws were not adequate. Conflicts and Overlap:  The Agencies would be required to assess any inconsistencies or duplication with other domestic or international regulations.  This provision echoes many of the principles contained in recent executive orders. Market Behavior:  The Agencies would need to provide a prediction of expected changes in market structure and behavior, assuming that market actors pursue their economic interests. The Bill would subject proposed rules to a comment period of at least 90 days from the date of publication in the Federal Register, or an Agency would be required to include in its final rulemaking an explanation of why such a comment period had not been provided.  Before issuing a final rule, an Agency would be required to conduct an analysis of the elements required in the notice of proposed rulemaking, and also include regulatory impact metrics under which the rule would be analyzed five years after promulgation.  Notably, Section 312(b) of the Bill would prevent an Agency from issuing a final rule if its quantified costs outweighed its quantified benefits, absent a joint House and Senate waiver.                         2.        Increased Rulemaking Transparency Section 314 of the Bill would require the Agencies to increase transparency in the rulemaking process, mandating that they make available the underlying data, methodologies and assumptions of the various analyses required under Section 312 at or prior to the commencement of the comment period.  The information provided should be “sufficient . . . so that the analytical results of the Agency are capable of being substantially reproduced.”  Although Section 314 expressly does allow agencies to deny disclosure of data and documents in order to “preserve the confidentiality of nonpublic information, including confidential trade secrets, confidential commercial or financial information, and confidential information about positions, transactions, or business practices,” this permission is not as broad as under the Freedom of Information Act (FOIA) generally.[19]                         3.        Mandated Agency Reviews To ensure that new Agency regulations were consistent with the statute’s objectives, Sections 315 and 316 of the Bill would require the following: Five Year Analysis of Each Rule:  Each final Agency rule would be subject to a comprehensive economic impact review five years after implementation by the Agency’s chief economist; the review would be required to address the regulatory impact metrics identified in final rulemaking.  The chief economist would then issue a report on the rule to the House Financial Services Committee and the Senate Banking Committee and post it on the Agency’s public website; if a CFTC rule were involved, the report would be issued to the House and Senate Agriculture Committees as well. Retrospective Review:  Each Agency would be required to undergo Agency-wide assessments to “to make the regulatory program of the Agency more effective [and] less burdensome in achieving the regulatory objectives.”  As part of the assessments, the Agencies would submit an implementation plan to the above Committees, and post it on their public websites, within one year of the Bill’s enactment and every five years thereafter.  A progress report on the plan would be required to be submitted within two years of each plan submission. 4.         Judicial Review of Compliance with Title III Requirements Section 317 would permit any person adversely affected or aggrieved by a final rule to seek relief from the Agency action within one year of publication of a final rule.  It would empower the U.S. Court of Appeals for the District of Columbia Circuit to vacate the regulation upon a showing that the Agency failed to comply with Section 312’s requirements; an Agency could avoid vacatur if it demonstrated by clear and convincing evidence that vacatur would result in irreparable harm.  Section 317 would not, however, affect other limitations on judicial review or the ability of the federal courts to dismiss actions on appropriate legal or equitable grounds. Because Section 312’s requirements are more specific and detailed than existing law, this provision would impose more robust constraints than currently exist on insufficiently substantiated agency decisionmaking. B.     Title III, Subtitle B–Congressional Review of Federal Financial Agency Rulemaking Title III, Subtitle B of the Bill would grant Congress new broad veto and consent powers over most final Agency rulemakings.[20]  Upon publication of a final rule in the Federal Register, Agencies would be required to submit to Congress and the Comptroller General a detailed report on the regulation, including the cost-benefit analysis.  For final rules designated as “major,” such rules would be required to obtain the joint consent of both chambers of Congress in order to become law.  For all other rules, Congress would be permitted to reject finalization via a joint resolution. For all “major rules”–those that would likely result in (i) an annual effect on the economy of $100 million or more, (ii) a “major increase” in costs or prices for consumers, individual industries, domestic governments, or geographic regions, or (iii) have significant adverse effects on competition, employment, investment, productivity, innovation, or the ability of U.S. business to compete with foreign business[21]–Congress would be required to enact a joint resolution within 70 days of receiving the Agency report.  Absent such a joint resolution or overriding determination by the President,[22] major rules would be prevented from coming into effect. To assist Congress in making a decision, the Comptroller General would be required to submit a report to each chamber of Congress within 15 calendar days of the Agency’s submission, assessing whether the major rule imposes any new limits or mandates on private sector activity, as well as whether the Agency complied with the administrative requirements of Subtitle B (including providing a complete version of the cost-benefit analysis). Non-major rules would not require the affirmative vote of Congress to become effective.  Congress, however, would be afforded 60 days from publication of a final rule in the Federal Register to formally reject the rule. If enacted, Subtitle B would alter significantly the administrative process for regulations that qualify as “major” rules and give Congress substantially more influence over Agency action, particularly when Congress and the White House are controlled by different political parties.  But even when Congress and the Administration were of the same political party, the provision could make it more difficult for major rules to become effective. C.     Title III, Subtitle C–Restrictions on Judicial Review of Agency Actions Section 341 of the Bill would end the application of Chevron[23] and Auer[24] deference to Agency decision-making in court actions challenging administrative action.   The Bill would instead require courts to apply de novo review on “all relevant questions of law, including the interpretation of constitutional and statutory provisions, and rules made by an [A]gency.” Notably, a similar provision in the Regulatory Accountability Act of 2017[25] passed the House earlier this year.  Given the broader scope of that bill–it applied to all administrative agencies–it appears that a majority of the House believes that the deference currently given to agency interpretations of law is misplaced. D.     Title III, Subtitle E–Subjecting Bank Regulators to Congressional Appropriations The Bill would implement a significant change to the funding of the FDIC, OCC, and the non-monetary-policy-related functions of the Federal Reserve, as well as the FHFA and NCUA.  Whereas currently, these Agencies generally fund themselves with assessments on the banking industry, if the Bill becomes law, Congress would set, and thereby be able to limit, Agency funding; industry assessments would serve only to reimburse the federal government for its spending.  The impetus for this change is, once again, a desire to exert more congressional control over the financial regulatory process. E.     Title III, Subtitle F – International Processes Section 371 of the Bill would, among other things, subject each Agency’s involvement in international harmonization and rulemaking efforts to public oversight and comment.  Prior to engaging in “processes”[26] to establish standards as part of any foreign or multinational entity, Agencies would be required to issue a formal public notice at least 30 to 90 days in advance.  The notice would describe the subject matter, scope and goals of the process and be subject to public comment. After the conclusion of such international efforts, Agencies would be required to issue a public report summarizing the discussions and efforts, including any new or revised rulemaking or policy changes that the Agency might pursue.  Section 371 thus seeks to bring greater transparency to U.S. regulators’ international co-ordination activities, such as participation in the Financial Stability Board and Basel Committee.  *         *          *          *          * CHOICE Act 2.0, like the statute it seeks to reform, Dodd-Frank, is an extremely ambitious piece of legislation.  It is also extremely unlikely to pass both chambers of Congress in its entirety.  This said, there is considerable desire on the part of the Administration and members of Congress to prune away those portions of Dodd-Frank that are seen as inhibiting economic growth, and so particular provisions of the Bill may ultimately be enacted as separate measures.  It is clear, moreover, from both the administrative law and federal banking law provisions of the Bill that the regulatory implementation of Dodd-Frank over the past six years has generated significant congressional opposition, opposition that is unlikely to subside in the near term. [1]   H.R. 10, 115th Cong. (2017), available at https://financialservices.house.gov/uploadedfiles/crpt-115-hr10-h001036-amdt-001.pdf.    [2]   H.R. 5983, 114th Cong. (2016), available at https://www.congress.gov/114/bills/hr5983/BILLS-114hr5983rh.pdf.    [3]   The FSOC is currently appealing the adverse decision of the U.S. District Court for the District of Columbia voiding its Nonbank SIFI designation of MetLife, Inc. to the U.S. Court of Appeals for the District of Columbia Circuit.    [4]   The eight designated FMUs are:  The Clearing House Payments Company, L.L.C., as operator of the Clearing House Interbank Payments System, CLS Bank International, the Chicago Mercantile Exchange, Inc., the Depository Trust Company, the Fixed Income Clearing Corporation, ICE Clear Credit L.L.C., the National Securities Clearing Corporation, and the Options Clearing Corporation.    [5]   12 C.F.R. § 225.4(a)(2).    [6]   Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015).    [7]   The following discussion focuses on non-credit union banking organizations.    [8]   If a banking organization fails to meet the tangible leverage ratio test at a particular financial quarter, the Bill provides a cure period during which capital distributions may be prohibited.  If the failure is not cured after one year, the status of a qualifying banking organization is lost, and may not be claimed until the banking organization has maintained a quarterly leverage ratio of at least 10 percent for eight consecutive calendar quarters.  Qualifying status is lost immediately if the leverage ratio falls below 6 percent at the end of any financial quarter.    [9]   In order to have a specialized bankruptcy judge hear a case under Subchapter V, the Bill requires the Chief Justice of the United States to designate at least 10 bankruptcy judges to be available to hear such cases; bankruptcy judges may apply for consideration to the Chief Justice.  If a case is commenced, the bankruptcy judge hearing the case will be randomly assigned by the chief judge of the court of appeals for the district in which the case is pending; that judge is not required to be assigned to the district but may receive a temporary assignment. [10]   This Alert does not discuss the Bill’s significant amendments to existing provisions governing the Federal Reserve’s conduct of monetary policy, nor its Federal Reserve audit provisions. [11]   President Donald J. Trump, Executive Order 13777: Enforcing the Regulatory Reform Agenda, 82 Fed. Reg. 12285 (Feb. 24, 2017), available at https://www.federalregister.gov/documents/2017/03/01/2017-04107/enforcing-the-regulatory-reform-agenda (Designated officers of agencies shall “make recommendations to the agency head regarding their repeal, replacement, or modification [or regulation that] create[s] a serious inconsistency or otherwise interfere[s] with regulatory reform initiatives and policies.”). [12]   For example, commercial businesses engage in inter-affiliate transactions in order to reduce costs, reduce risk, and increase efficiency.  Rather than having each affiliate face the market to execute swaps, it is a common for commercial businesses to operate a single market-facing entity within a corporate group in order to centralize hedging expertise. [13]   See, e.g., 17 CFR § 50.52(a); CFTC No-Action Letter 13-09 (Apr. 5, 2013), available at http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-09.pdf. [14]   H.R. 238, 115th Cong. (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/238. [15]   Notably, Section 872 removes the requirement for swap dealers and major swap participants to exchange variation margin with respect to their inter-affiliate swaps, which was included in H.R. 238. [16]   The final regulation under Dodd-Frank’s Volcker Rule, for example, was promulgated without any effective cost-benefit analysis, because it is a regulation under the Bank Holding Company Act, which does not require that such an analysis be conducted. [17]   There would be limited exceptions to this general approach; for example, regulations promulgated pursuant to a statutory authority expressly prohibiting compliance with Title III, and regulations certified by an Agency to be emergency action, if the certification were published in the Federal Register. [18]   Indeed, calls from market participants for greater transparency and justification of underlying Agency assumptions have been made consistently during recent rulemakings.  See, e.g., Comment Letter Submitted by the International Swaps and Derivatives Association in response to the Federal Reserve’s 2016 Proposed Physical Commodities Rule (Docket No. R-1547, RIN 7100 AE-58), available at https://www.federalreserve.gov/SECRS/2017/February/20170222/R-1547/R-1547_021717_131734_316074629957_1.pdf (noting that the Federal Reserve’s justification for imposing heightened capital standards on banks’ physical commodities activities–as a result of perceived legal, reputational and financial risks–“provides no empirical support or analysis for these positions and does not cite any instance in which this type of liability was imposed on a banking organization or where a banking organization suffered material financial losses with respect to these activities.”); Comment Letter Submitted by the Coalition for Derivatives End-Users in response to the CFTC’s 2016 Proposed Cross-Border Rule (RIN 3038-AE54), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61067&SearchText (“Particularly troubling with this proposed expansion is that no exigent market events have occurred and no new risks have arisen that would necessitate the CFTC supplanting its Final Cross-Border Guidance with a different and more ‘maximalist’ regulatory approach.”). [19]   FOIA allows government agencies to deny disclosure of, inter alia, documents related solely to the internal personnel rules and practices of an agency; documents “specifically exempted from disclosure by statute” other than FOIA if the other statute’s disclosure prohibition is absolute; documents that are “inter-agency or intra-agency memorandum or letters” that would be privileged in civil litigation; documents that are “personnel . . . and similar files the disclosure of which would constitute a clearly unwarranted invasion of personal privacy;” and documents related to specified reports prepared by, on behalf of, or for the use of agencies, such as examination, operating, or condition reports. [20]   Subtitle B would not apply to a non-major rule if the Agency for good cause found (and incorporated the finding and a brief statement therefor in the issued rule) that notice and public procedure on the rule were impracticable, unnecessary or contrary to the public interest. [21]   President Ronald Regan used precisely this definition in his Executive Order 12291, directing each agency to prepare impact analyses for every new “major rule” proposal.  President Regan, Executive Order 12291: Federal Regulation, Sec. 3, 46 Fed. Reg. 13193 (Feb. 17, 1981), available at https://www.archives.gov/federal-register/codification/executive-order/12291.html. [22]   The President would be able to override Congresses’ determination and allow the rule to go into effect for a 90-day period if he or she determines that the rule is: (i) necessary because of an imminent threat to health or safety or other emergency, (ii) necessary for the enforcement of criminal laws, (iii) necessary for national security or (iv) issued pursuant to any statute implementing an international trade agreement. [23]   Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 US 837 (1984). [24]   Auer v. Robbins, 519 US 452 (1997). [25]   H.R. 5, 115th Cong. (2017). [26]   The Bill defines a “process” as “includ[ing] any official proceeding or meeting on financial regulation of a recognized international organization with authority to set financial standards on a global or regional level.” Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Eugene Scalia – Washington, D.C. (+1 202-955-8206, escalia@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com)   © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

April 28, 2017 |
The Commodities Activities of Banks: Comments on the Federal Reserve’s Notice of Proposed Rulemaking Reveal Key Concerns and Divides

One of the remaining significant issues facing the Board of Governors of the Federal Reserve System (Board) is its Notice of Proposed Rulemaking (Proposed Rule) relating to the physical commodities activities of U.S. and non-U.S. financial holding companies (FHCs).[1]  The public comment period for the Proposed Rule closed in February 2017, and like the Board’s 2014 Advanced Notice of Proposed Rulemaking (ANPR),[2] the Proposed Rule drew comments from a diverse group of parties, including members of Congress, academics, interest groups, the banking industry, and end-users of commodities and commodity-based derivatives. Commentary:  Key Points 44 end-users, comprising individual businesses, municipal end-users, and related trade groups and associations, reacted to the Proposed Rule with concern, citing issues including risk mitigation, market liquidity, transaction costs, and counterparty credit risk. Proponents, comprised of interest groups, academics and certain U.S. Senators, filed 11 submissions. They echoed the Board’s concern over perceived environmental risks and, in addition, noted the importance of restricting the potential for market manipulation. The comments filed by participants in the commodities markets show serious concerns with the Board’s approach to the Proposed Rule and disbelief that the costs of the regulation will be outweighed by market benefits.  Market participants argued that the Board failed to connect the proposed restrictions on commodities activities to the Board’s perceived risks, and that the Board did not sufficiently acknowledge the tangible commercial benefits that FHCs provide to U.S. counterparties.[3]  Market participants further contended that existing laws and regulations adequately constrain potential adverse effects. In particular, the commercial end-user community expressed strong concerns with the limitations that the Board proposed.  24 comment letters were filed by end-users and municipal end-users of commodities and commodities-based derivatives, and their related associations and industry groups,[4] including a letter from the National Association of Corporate Treasurers, on to which 18 additional end-users signed.[5]  These comment letters generally expressed a strong preference to transact with sophisticated, well-capitalized, and well-regulated FHC counterparties, as well as fear that FHCs will continue to exit commodities markets. Background The current legal authority for FHCs to engage in physical commodities activities is derived from several provisions of the Gramm-Leach-Bliley Act of 1999 (GLB Act),[6] which amended the U.S. Bank Holding Company Act of 1956 (BHC Act) to expand the permissible business activities of bank holding companies. The GLB Act permitted expanded financial activities to be carried out by a subset of bank holding companies – those whose insured depository institution subsidiaries met heightened capital and management standards[7] and had “satisfactory” or better ratings under the U.S. Community Reinvestment Act.  This subset of bank holding companies could elect “financial holding company” status; under a new section of the BHC Act, Section 4(k), FHCs could engage not only in the “closely related to banking” activities that had been permissible for all bank holding companies, but also activities that were “financial in nature” and “incidental to a financial activity,” and, on receiving a specific Federal Reserve approval, activities “complementary” to a financial activity as well.[8] Under Section 4(k)’s complementary authority, the Federal Reserve was required to find that the activity did not pose “a substantial risk to the safety or soundness of depository institutions or the financial system generally,” and that the public benefits from the activity outweighed any adverse effects.[9] In addition to Section 4(k), the GLB Act added a new Section 4(o) to the BHC Act. Section 4(o) provided that a company that was not a bank holding company when the GLB Act was enacted but that became an FHC after November 12, 1999, could “continue to engage in, or directly or indirectly own or control shares of a company engaged in, activities related to the trading, sale, or investment in commodities and underlying physical properties that were not permissible for bank holding companies to conduct in the United States as of September 30, 1997, if . . . the holding company, or any subsidiary of the holding company, lawfully was engaged, directly or indirectly, in any of such activities as of September 30, 1997, in the United States.”[10] In 2003, the Federal Reserve made its first interpretation under Section 4(k)’s complementary authority, and determined that certain physical commodities activities were “complementary” to financial activities and thus permissible for FHCs.  It did so in permitting Citigroup to retain its subsidiary Phibro, which had been a subsidiary of Travelers Group before the Citigroup-Travelers merger.[11] Following the Citigroup approval, a number of other domestic and foreign FHCs received approval to engage in physical commodities trading activities.[12]  In other orders, the Board declared energy tolling and energy management activities to be complementary to financial activities.[13] During the 2008 Financial Crisis, Morgan Stanley and Goldman Sachs became FHCs and subject to Board supervision and regulation. Both companies had been engaged in physical commodities activities in 1997 and therefore came under the legal authority contained in Section 4(o) of the BHC Act. For more information on the legal authorities that permit FHCs to engage in commodities-related activities, please see Appendix B. The ANPR In July 2013, the Board surprised most observers by announcing that it was re-evaluating its determination that physical commodities activities were complementary to financial activities.  Commodities activities had not been identified as contributing to the Financial Crisis, and Congress had specifically excluded spot commodities from the Volcker Rule’s proprietary trading prohibition, thus indicating a degree of comfort with the risks posed by commodities trading.[14] In January 2014, the Board issued its ANPR, requesting public comment with respect to three specific GLB Act authorities relevant to physical commodities activities: Section 4(k)’s complementary authority, Section 4(k)’s merchant banking authority, and The grandfather authority contained in Section 4(o) of the BHC Act. The ANPR also posed twenty-four questions that fall into the following three categories: Whether commodity-related activities by FHCs pose unacceptable systemic risk; What other costs and benefits are created by FHC engagement in commodity-related activities; and What other regulation of FHC activities in this area is necessary. Our Client Alert summarizing the ANPR and public comment is available here. The Proposed Rule On September 8, 2016, the Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued a study required by Section 620 of the Dodd-Frank Act (Section 620 Study).[15]  In it, the Board recommended that Congress repeal both Section 4(k)’s merchant banking authority and Section 4(o)’s grandfather provision. A little over two weeks later, the Board issued the Proposed Rule, premised on concerns over environmental risks such activities could pose.  Notably, the Board did not address allegations of market manipulation as a reason for the Proposed Rule.  Seen largely as a “de-risking” mechanism, the Proposed Rule was issued notwithstanding that many FHCs, for business reasons, have actively reduced commodity-related activities. The Proposed Rule would restrict FHC commodities activities in several ways: It would tighten the conditions for finding certain commodity activities to be “complementary” to a financial activity – most notably, by counting the value of commodities held in bank subsidiaries towards the 5 percent of Tier 1 capital limit; It would impose a 300% risk weighting on certain physical commodities held under Section 4(k) authority, and a 1,250% risk weighting on certain commodities and related assets held under Section 4(o) and the merchant banking authority; It would rescind the findings underlying the Federal Reserve orders that permitted certain FHCs to engage in energy tolling and energy management services; It would revise Regulation Y to provide that the owning and storing of copper is not an activity closely related to banking, which would remove the ability of bank holding companies to own and store copper absent a Section 4(k) complementary determination, which would be available only to FHCs; and It would impose new public reporting requirements in the form of a new Schedule HC-W, Physical Commodities and Related Activities, which would collect more specific information on the covered physical commodities holdings and activities of FHCs. In particular, the Proposed Rule’s increased risk-weights would apply to commodities defined: As a “hazardous substance” under section 104 of the Comprehensive Environmental Response, Compensation, and Liability Act (42 U.S.C. 9601) and interpreting regulations; As “oil” under section 1001 of the Oil Pollution Act of 1990 (33 U.S.C. 2701) or section 311 of the Clean Water Act (33 U.S.C. 1321) and interpreting regulations; As a “hazardous air pollutant” under section 112 of the Clean Air Act (42 U.S.C. 7412) and interpreting regulations; or In a state statute, or regulation promulgated thereunder, that makes a party other than a governmental entity or fund responsible for removal or remediation efforts related to the unauthorized release of the substance or for costs incurred as a result of the unauthorized release; provided that the Board-regulated institution owned the commodity in the state that promulgated the law imposing such liability during the last reporting period. Comments on the Proposed Rule were originally due on December 22, 2016, but the Board agreed to extend the comment period through February 20, 2017. Scope of Comments to the Proposed Rule As of the close of business on April 26, 2017, the Board had posted 43 unique comment letters on its website.[16]  We have categorized commenters based on the following: End-Users 27 end-user companies submitted their own letter or joined a trade association letter; 8 municipal utility districts submitted their own or joint letters; 8 end-user trade associations submitted their own or joint letters; and 1 private equity firm with end-user operating companies submitted its own letter. Financial Holding Companies 1 FHC submitted a letter; 9 trade associations from the financial services industry submitted their own or joint letters; and 2 other financial companies submitted their own letters. Others 4 U.S. Senators and Representatives submitted their own or joint letters; 6 academics submitted their own or joint letters; and 9 interest groups submitted their own or joint letters. We summarize below the key points made by end-users, banks, and their trade associations as well as the arguments raised by certain U.S. Senators, interest groups, and academics.  For a list of commenters and a breakdown of certain key points raised in the comment letters, please see Appendix A. Comments to the Proposed Rule:  Key Points The end-user community focused on how the proposed rule could impact commodities markets.  They fear that the proposed rule could cause additional FHCs to exit commodities markets and identified the following concerns: End-users could be denied the ability to trade with the counterparties of their choosing. FHCs are market-makers and necessary counterparties that provide economies of scale, creditworthiness, and sophistication, which in turn provide affordable financing, risk mitigation, and other business solutions for end-user businesses. Non-bank financial institutions lack the institutional knowledge, capital, creditworthiness, transparency, and regulatory oversight necessary to serve as market makers and price commodities-related products as efficiently. With a departure of additional FHCs, the commodities markets generally would suffer from diminished liquidity and greater risk concentration. There would be fewer counterparties with the ability to enter into long-term transactions and to offer a range of financial solutions, as certain products essential to end-user operations were generally not available from non-FHCs; as a result, costs for end-user businesses and consumers would increase. Comments from an FHC commenter and industry trade groups made the following principal contentions: FHCs provide substantial benefits to consumers, commodity producers, investors, financial markets, and the broader economy by their participation in physical commodities markets and making merchant banking investments. FHC physical commodity activities are already subject to extensive regulation by the Federal Reserve and other government agencies, and Basel III has imposed additional capital requirements for certain of these activities.  Risks identified by the Board as justification for additional capital levies may already be captured under current regulatory requirements, such as requirements for FHCs to account for the credit risk of subsidiaries. Section 4(o) authority is an explicit recognition by Congress of the importance of the expertise and risk management provided by grandfathered companies in the physical commodity markets.  The Proposed Rule undermines this statutory grant and is a direct contradiction of the authority outlined in the GLB Act.  Such fundamental changes are contrary to well-recognized limits to administrative powers and, as suggested by the Board in its Section 620 Study, are solely within the purview of Congress. Before imposing punitive risk-weights, the Board should conduct in-depth empirical and qualitative studies to assess the potential effects that increased capital requirements and the related departure of FHCs would have on the physical commodities markets. The environmental risks cited by the Board are exaggerated and speculative.  In addition to the Board’s failure to point to a material environmental liability borne by an FHC since the inception of the GLB Act, generally accepted principles of corporate separateness prevent enterprise-wide liability of FHCs.  Moreover, the parties legally responsible for environmental liabilities are often the facility owners and operators, not the underlying commodity owners. The lack of empirical data supporting the Proposed Rule and acknowledgment of its failure to consider unforeseen consequences warrants further caution.  The Board should present data to support its claim that additional capital requirements improve the safety and soundness of FHCs and the U.S. financial markets.  Additionally, the Board should also consider the public benefits FHCs provide to the physical commodity markets and the potential downsides to their departure from such markets. Several U.S. Senators, interest groups like Public Citizen, Amazon Watch, and Americans for Financial Reform, and certain academics supported the Proposed Rule, making the following principal arguments: Physical commodities activities present risks that are wide-ranging and whose severity is unpredictable, therefore justifying new limitations and capital requirements. The Federal Reserve should narrowly construe the authority contained in Section 4(o) to pre-GLB Act activities due to the risks posed by commodities activities. The Board had interpreted Section 4(k)’s “complementary” authority in an expanded manner that did not accord with congressional intent. Additional disclosures of FHC commodities activities were required for the Federal Reserve to regulate such activities adequately. There have been and will continue to be conflicts of interest in the commodities markets when FHCs are allowed both to own physical commodities and trade their financial equivalents. Potentially adverse effects on the commodities markets are not outweighed by the benefits of reducing risk to particular FHCs and to the financial system generally. Comments to the Proposed Rule:  Key Themes and Contentions The debate over the appropriate extent of bank commodities activities in the comment letters shows four principal issues at play: Conflicting Viewpoints:  Market Participants vs. Interest Groups and Academics There was a clear delineation in the views of market participants, on the one hand, and representatives of interest groups and academia, on the other.  Outnumbering all other commenters nearly [three-to-one], end-users of physical commodities, including municipal end-users, noted their reliance on FHCs as counterparties to finance their businesses and engage in risk mitigation.  End-users expressed concern that the Proposed Rule could force more FHCs out of the commodities markets, which they argued could lead to (1) decreased market liquidity,[17] (2) increased counterparty risk,[18] (3) increased transaction costs,[19] (4) decreased counterparty sophistication,[20] and (5) greater price volatility.[21] In contrast, academics, several U.S. Senators, and various interest groups contended that the Proposed Rule should be strengthened in various ways in light of the risks that they claimed financial institutions pose to the commodity markets and the U.S. economy.  Suggested changes to the Proposed Rule included: (1) reinterpreting and limiting Section 4(o) authority to restrict permissible activities to pre-GLB Act activities;[22] (2) expanding the scope of commodities covered by the key provisions of the Proposed Rule (copper and aluminum, agricultural commodities, electricity);[23] (3) increasing FHC commodities disclosure requirements (such as by requiring FHCs to provide narrative disclosures detailing how their operations and assets related to physical commodities are interdependent);[24] and (4) redefining merchant banking authority (removing FHCs from business strategy formulation, decisionmaking, and employee overlap with boards of portfolio companies).[25] Authority:  Congress vs. the Board Relatedly, many commenters were divided on the scope of Section 4(o) authority and the Board’s authority to interpret it. As to the first issue, academics, interest group representatives, and several U.S. Senators suggested that the rulemaking should limit Section 4(o) activities to the actual activities in which the FHCs were engaged at the time that Section 4(o) was passed.[26]  Those concerned with the Proposed Rule noted that since Section 4(o) was enacted, there has been a steady decline in the number of FHC-eligible Section 4(o) institutions participating in physical commodity markets, and therefore that additional limitations on this provision could have economically adverse effects. Commenters also were divided on the question of the appropriate scope of Board rulemaking authority.  Those advocating for Board restrictions on the extent of Sections 4(k) and 4(o) argued that it was within the Board’s power, as it was when issuing its original interpretations, to reinterpret the scope of such authorities,[27] particularly in light of the environmental, market, and financial risks alleged.[28]  End-users, financial institutions, and trade associations countered that although the Board has the authority to issue capital standards as a general matter, the use of punitive risk weightings, which would make certain physical commodity activities economically unviable, amounted to agency legislation, and ignored the fact that Congress explicitly authorized additional financial activities without revising the attendant capital rules.[29] Public Benefits:  Healthy Markets vs. Systemic Effects Commenters also disagreed on whether perceived benefits to commodities markets or the broader financial system should be the priority in the Board’s analysis. End-users and financial entities urged the Board to focus on the “real-world” implications that the Proposed Rule would have on U.S. businesses and the physical commodity markets.  Central to their concern was the apparent lack of consideration in the ANPR and Proposed Rule in estimating the economic effects of additional FHC departures,[30] as well as a failure to consider the entities that would replace FHCs as market makers and counterparties.[31]  Similarly, Congressman Bradley Byrne of Alabama cautioned that the Board should postpone rulemaking until adequate consideration is given to “the potential adverse impact upon costs to the American public, the reduction in competition, the loss of markets, and the potential for fewer creditworthy and highly regulated bank counterparties with whom end-users may transact.”[32] Academics, interest group representatives, and certain U.S. Senators noted potential risks that FHCs pose to the market, and that the benefits considered by the Board should focus on overall market stability.[33]  Proponents cited past instances of manipulation in energy and aluminum markets and the potential for future abuses; however, the Board did not discuss, nor did it advance, past instances of market manipulation as a justification for the Proposed Rule.  Interestingly, Novelis, Inc., a major producer of aluminum, noted the substantial benefits that FHCs provide to its business.[34]  Subscribing to the belief of general de-risking and separation of commercial and investment banking, proponents urged the Board to consider the overall health of the U.S. financial system over the effects of FHC departures. Liability:  Environmental Risks vs. Principles of Corporate Separateness  Although the Board premised much of the Proposed Rule on the existence of serious environmental risks, there was a substantial debate in the public comments over the factual basis of the Board’s claims. Opponents of the Proposed Rule noted the Board’s lack of substantive discussion on the extent of environmental risks posed by FHC commodity activities.  They argued that, historically, FHC physical commodity activities have been conducted safely, without a major environmental incident since the inception of Section 4(k) and Section 4(o) authority.[35]  In addition, they contended that such speculative risks are already captured by capital requirements mandating that FHCs account for the credit risk of their subsidiaries, arguing that the larger capital reserves FHCs maintain to address institutional credit risk guard against environmental risks at the subsidiary level.[36]  Opponents further cited studies on legal principles of corporate separateness, which they stated demonstrated that most courts were not willing to pierce the corporate veil by reason of an environmental disaster alone.[37] Like the Board, supporters of the Proposed Rule focused on environmental disasters, albeit  disconnected to FHC activity, like the Deepwater Horizon disaster, as evidence of the potential for massive environmental liabilities; however, and also like the Board, they did not identify actual examples of material FHC liability stemming from physical commodity activities to date.  Instead, they referred to the specific holdings of large FHCs,[38] and cited disasters in related activities, such as oil exploration and energy projects,[39] in contending that such holdings pose unacceptable risks that should be divorced from banking activities. Conclusion Because many FHCs have retreated from the commodity markets since the Financial Crisis for other reasons, the concerns of market participants that further limitations on FHC activities will adversely affect their businesses and their customers—concerns expressed by numerous such participants during the comment period—appear justified.[40]  When weighed against the lack of concrete evidence of widespread veil piercing in environmental cases, these concerns justify a cautious approach in restricting commodity authority, particularly in the absence of congressional action.[41] Appendix A:  Summary of Key Points Raised by Commenters Commenter Type of Entity Key Points Raised in Comment Letter 1.      Alon USA Energy, Inc. End-User   Alon is an independent refinery owner and marketer of petroleum products in the United States that transacts with FHCs to hedge against normal and expected price volatilities. Relies on FHCs to timely access physical commodity markets to hedge against price volatilities and maintain stable funding. FHCs allow Alon to use excess inventory as collateral to hedge long- and short-term inventory needs.  FHCs further serve to bring better convergence between financial and physical assets which Alon uses to mitigate risks. Concerned that the departure of FHCs would force Alon to transact with counterparties in markets in which they do not operate. 2.      Barrick Gold End-User       Barrick is the largest gold-mining company in the world and a significant miner of copper. Argues that the Board has not and cannot demonstrate that the metals market poses a sufficient risk to warrant the proposed changes. It maintains that the proposal should be rescinded, but that if it is not, it should at least be modified so as to not cover the metals market. Concerned that risks to BHCs from metals activities are not substantial and that the oil and gas incidents that the Board cites are clearly distinguishable from any risks faced in the metals markets. Explains that there is no risk posed by metals since copper or precious metals are not released into the environment, mining activities are subject to rigorous safety and environmental controls and financial assurance requirements, mere owners of commodities are generally outside the scope of liability of environmental statues, and courts are very unlikely to pierce the corporate veil. Proposes the following revisions: excluding metals from the definition of “covered physical commodity”; reclassifying copper under the “closely related” authority only to the extent that it is in a form primarily suited for industrial or commercial use; and excluding non-covered physical commodities from the tighter Section 4(k) cap on assets held under the complementary authority (otherwise, this risks the possibility that FHCs will exit the metals market). 3.      Calpine Corporation End-User Calpine is the largest generator of electricity from natural gas and geothermal resources in the U.S. Opposes the rulemaking because it will hinder its ability to engage in risk-mitigation and could result in it having access to fewer credit-worthy counterparties. 4.      Cheniere Energy, Inc. End-User Cheniere is involved in the development and operations of liquefied natural gas terminals and transacts in the physical commodities markets to manage its risks. Argues that the Board’s analysis of the impact of the Proposed Rule is inconsistent with Cheniere’s experience in these markets.  Contests the Board’s assumption that FHCs only consist of 1% of the physical commodity markets and notes that companies like Cheniere transact with FHCs on a daily and monthly basis to address funding needs and mitigate risks. Concerned that increased regulation will cause FHCs to leave the markets.  Notes that they rely on FHCs to serve as market makers and facilitate liquid markets.  By contrast, commercial companies transact only to meet their acute needs. 5.      Cogentrix Energy Power Management, LLC End-User Cogentrix is a manager and operator of power generation facilities across the U.S. Concerned that the new rules will make it more difficult and expensive for it to achieve risk-mitigation through the use of commodity-related derivatives, will restrict competition and innovation, and will reduce market liquidity and result in higher prices for commodities and commodity-related production. Argues that this will ultimately result in higher prices for consumers. 6.      Delek US Holdings, Inc. End-User Delek is a diversified downstream energy company with operations in two primary business segments: petroleum refining and logistics. Notes that FHCs provide liquidity, offer customized solutions to meet its business needs, and provide important risk-mitigation opportunities.  Also asserts that it prefers to transact with financially sound and well-regulated counterparties such as FHCs. Economies of scale allow Delek to quickly sell and source inventory at market prices to FHCs to eliminate backlog and excess inventory.  Notes that arrangements like these eliminate the need for complex financing facilities and reduce exposures to price volatility given the short periods of ownership. FHCs allow access to lower crude oil prices even when Delek’s refinery does not have capacity, since FHCs will continue purchasing at advantageous prices and store the crude oil for Delek until Delek’s refinery has capacity for the oil. 7.      Novelis Inc. End-User Novelis is the world’s leading aluminum rolled products producer.  It produces aluminum sheet and light gauge products primarily for use in the beverage can, automotive, specialties (including transportation, consumer electronics, and architecture), and foil markets. Depends on FHCs to shift the metal price risk associated with aluminum to creditworthy third parties.  Argues that having multiple FHCs that participate in the aluminum futures market available to Novelis has helped keep hedging transactions costs relatively low and stable and given manufacturers in the aluminum industry improved liquidity. Notes that FHCs also allow Novelis to manage operational and business risks by engaging in repo transactions with excess inventory, acting as intermediaries between Novelis and related businesses, and carrying inventory on consignment. Concerned with the Proposed Rule because it will (1) reduce market liquidity, (2) increase costs and ultimately its costs to consumers, (3) increase price divergence, and (4) increase counterparty risks. 8.      Philadelphia Energy Solutions LLC End-User Philadelphia Energy Solutions LLC owns and operates a merchant fuel refinery (gasoline, ultra-low sulfur diesel, etc.). Argues that risk-mitigating derivatives make the commodity markets more stable and that increased capital requirements will make hedging risks more expensive and less effective.  Notes that many FHCs have already scaled back their physical commodity activities. Relies on expansive market knowledge of FHCs to tailor products to meet its needs. Asserts that high-risk weighting should be reserved for “the riskiest of bank exposures” and that physical commodities do not qualify. 9.      Black Belt Energy Gas District Municipal End-User Black Belt is a public corporation formed by three member municipalities in Alabama. It is a joint action gas supply agency that provides wholesale sales service to municipal gas systems both within and outside the State of Alabama. Black Belt also provides natural gas management services for certain large industrial customers. Argues that FHCs assist municipal end-users in financing and purchasing natural gas via long-term pre-paid purchase transactions.  By closing such a transaction with an FHC in 2016, more than 150 cities and towns spread across several southern states will have stable energy prices for the next 30 years. Further notes that given the nature of their business and transactions, FHCs are creditworthy counterparties that are necessary for small municipalities in securing long-term, stable natural gas prices. 10.  Central Plains Energy Project Municipal End-User CPEP is a joint action gas supply agency that provides wholesale sales service to its members and other municipal natural gas distribution systems in the states of Nebraska, Iowa, and South Dakota. Relies on prepayment transactions to meet the domestic and commercial needs of its customers.  Notes that the natural gas energy markets are primarily supported by FHCs and that their departure from this market would be hard to replicate with non-bank companies. Argues that the departure of FHCs from the physical natural gas marketplace would be highly adverse to the interests of municipal gas systems and gas consumers, while serving no countervailing public purpose. 11.  City of Rocky Mount, North Carolina, Richard H. Worsinger Municipal End-User As a community-owned electric and natural gas system, the goal of Energy Resources is to provide safe, efficient, and reliable electric and natural gas services to all customers. Argues that if FHCs stop participating in long-term municipal gas supply transactions, this will cause an increase in gas prices for its customers. Transactions with FHCs lead to discounted gas for its customers, and its customers have come to depend upon lower gas prices. 12.  Clarke-Mobile Counties Gas District Municipal End-User CMC is a public corporation formed by three member municipalities in Alabama. It is a municipal gas transmission and distribution system that provides natural gas transportation and sales service to retail gas customers in an eight-county area in southwestern Alabama. CMC also provides wholesale natural gas sales service to other municipal gas systems and their joint action agencies that it purchases in gas prepayment transactions. Relies on natural gas prepayments to serve Alabama counties.  Notes that FHCs play a critical role in providing stable and affordable supplies of natural gas.  For example, the use of prepayment transactions in 2016 are now serving gas consumers in Alabama, Louisiana, Florida, Georgia, Tennessee, and Kentucky. Concerned that the potential departure of FHCs would be replaced with less-liquid, less-capitalized, and less-efficient counterparties.  As a result, transaction costs would likely increase and it would not be able to provide services at their current rates. 13.  Greenville Utilities Commission Municipal End-User Electric utility company in Greenville, NC. Critical of the proposed requirements as increasing the likelihood that FHCs will be driven out of the commodities markets, which will result in a decrease in natural gas supply and an increase in natural gas prices. 14.  Public Utility District No. 1 of Chelan County, Washington Municipal End-User Consumer-owned electric utility that generates electricity and transacts in power markets.  Manages power needs, volatility, and exposure to price and volumetric risks by selling and buying wholesale power using short-, mid-, and long-term contracts. Cautions against new rulemaking because market access could become more difficult, more expensive, and less efficient without FHC participation.  Argues that reduced FHC participation will ultimately increase the cost and difficulty for end-users to serve customers. 15.  Tennessee Energy Acquisition Corporation Municipal End-User Tennessee Energy is an instrumentality of the State of Tennessee and certain Tennessee municipalities. It is a joint action natural gas supply agency that provides wholesale sales service to municipal gas distribution systems and to other joint action agencies within and outside the State of Tennessee. Tennessee Energy also provides natural gas supply, transportation, and storage management services for other municipal gas systems and joint action agencies, and supplies price-hedging services for its associated municipalities and others to whom it sells long-term gas supplies as part of its sales service to them. Relies on gas prepayment transactions (prepaid long-term natural gas contracts) which are offered by FHCs.  States that FHCs’ role in this regard could not and would not be replicated by other industry participants. Concerned that the Proposed Rule will force FHCs out of the natural gas marketplace by making it more expensive for them to participate.  Argues that this will result in the increase of natural gas prepayments and hedging services for Tennessee Energy, which would then increases costs for its customers. Suggests that FHCs are the most creditworthy counterparties with which they deal, and that they are more efficient and operate in a regulated environment. Notes that the fear of environmental catastrophe is completely misplaced in the natural gas industry. 16.  Town of Slaughter, Louisiana Municipal End-User Member of the Louisiana Municipal Gas Authority. FHC involvement in commodities activities provides their residents and retail and industrial consumers with affordable energy products. Argues that their Town has come to rely on FHC involvement and the economic savings involved. 17.  American Public Gas Association End-User Trade Association APGA is the national association for publicly owned, not-for-profit natural gas distribution systems, comprising over 700 public gas systems. Increased capital requirements threaten APGA members’ reliance on natural gas prepayment transactions—using swaps transactions and tax-exempt financing for the long-term purchase of natural gas—to provide affordable energy solutions. 18.  American Wind Energy Association End-UserTrade Association Trade association for a range of entities interested in encouraging the expansion of wind energy in the U.S. Notes wind industry reliance on FHC merchant banking authority investments to bring projects from development and construction into operation.  In 2015, over $14.7 billion was invested in new wind energy projects in the U.S. This included $5.9 billion from tax equity providers, including under the merchant banking authority. Concerned that some of the restrictions being considered by the Federal Reserve would unnecessarily limit or eliminate the ability of banking entities to help finance wind generation. Relies on FHCs to transact in stable, low-risk investment for long-term contracts to purchase their power at a set price.  Argues that this enables wind industry companies to reinvest money into growth rather than hedge against energy price fluctuations. 19.  Edison Electric Institute and the National Rural Electric Cooperative Association End-User Trade Associations Joint letter from the Edison Electric Institute (“EEI”) and the National Rural Electric Cooperative Association (“NRECA”). EEI is the association of U.S. shareholder-owned electric companies. EEI’s members comprise approximately 70% of the U.S. electric power industry, provide electricity for 220 million Americans, operate in all 50 states and the District of Columbia, and directly employ more than 500,000 workers. NRECA is the national service organization for more than 900 not-for-profit rural electric utilities that provide electric energy to more than 42 million people in 47 states or 12% of electric customers. Relies on banking entities and their affiliates as counterparties to customized energy commodity forward contracts and commodity trade options that can be physically settled to hedge and mitigate their commercial risks. Concerned that the proposed changes will make risk management more difficult and more expensive by disincentivizing banking entities from engaging in hedging transactions. Concerned that substantial increase in the regulatory capital requirements for FHCs’ holdings of certain commodities will have indirect cascading effects on the wholesale physical electric markets. 20.  National Association of Corporate Treasurers, et al.[42] End-User Trade Association NACT represents companies and trade associations (like its 18 co-signatories) that are end-users of physical commodities and commodity-related derivatives. Expresses concern that increased capital requirements would fuel the departure of FHCs from the commodities markets. Notes that FHCs provide affordable, well-tailored products and that non-bank financial replacements would likely be unable to address specific end-user needs. Notes that emerging and start-up end-users are likely to be the most affected as they will no longer be able to use their physical commodity assets as collateral to hedge risk, and would otherwise be unable to engage in risk management due to cash-flow and credit-rating constraints.  Further notes that without such benefits, such entities would have to enter into less-favorable, costly, and restrictive credit facilities. 21.  National Mining Association End-User Trade Association NMA is a national trade association that includes the producers of most of the nation’s metals, coal, industrial, and agricultural minerals; the manufacturers of mining and mineral processing machinery, equipment, and supplies; and the engineering and consulting firms, financial institutions, and other firms serving the mining industry. Notes that Mining is critical to the success of American manufacturers. Cites a 2014 Edelman Berland survey of 400 manufacturing executives, where more than 90% of respondents expressed their concern about supply disruptions outside of their control. FHCs enable mining companies to hedge risks associated with long-term investment projects.  A departure of FHCs would decrease liquidity in the commodities markets with no discernible corresponding benefit. Cites the robust federal and state environmental regulations applicable to mining operations, including those that require mining companies invest in and secure sites, as well as to post financial assurance instruments designed to cover potential unintended environmental releases. 22.  Natural Gas Supply Association End-User Trade Association Trade-association for the downstream natural gas industry. Argues that the Proposed Rule would reduce liquidity and efficiency in relevant markets, which will ultimately result in higher costs and increased credit risk for end-users, increased volatility in physical and financial markets, and a reduction in consumer choice for counterparties. Notes concern that increased capital requirements would also result in increased hedging costs. Argues that FHC financial products and market making activities have fostered growth within the natural gas industry.  Cites to overall reductions in CO2 emissions, increased technological breakthroughs, and job growth, all made possible with FHC backing. 23.  International Energy Credit Association End-User Trade Association The IECA is the leading global membership organization for credit professionals in the energy industry.  IECA is a not-for-profit association with over 1400 individual members who are involved in energy credit management. Urges the Board to reconsider issuing a final rule at all and also proposes a number of modifications that should be made to the rule before issuance. Argues that the Board does not present any evidence in support of its Proposal (“no precedent where financial entities involved in the physical commodities markets were held liable for environmental incidents”) and asserts that the Board is emphasizing hypothetical, potential risks (“possibility of a possibility of loss”) over the many positive effects of FHC activities.  Also notes that corporate separateness would shield FHCs from liability for environmental catastrophes. States that the definition for covered physical commodities is overly broad and the Board should provide a clear list of those commodities that are expressly covered by the definition (and those commodities should have evidence concerning the risks they post).  Also argues that the requirements should be proportional to the risks (e.g., natural gas activities do not pose the same risks as other commodities of concern). 24.  The Goldman Sachs Group, Inc. FHC Goldman Sachs has been a participant and market maker in the commodities and commodity derivatives markets since 1981. Argues that FHCs provide substantial benefits to consumers, commodity producers, investors, financial markets, and the broader economy by their participation in physical commodities markets and making merchant banking investments. Notes that FHCs enable end-users to obtain competitive pricing, manage their risks, and serve as stable, highly regulated counterparties. Argues that punitive capital requirements effectively pre-empt Congressional authority granted to FHCs under Section 4(k) and Section 4(o). Explains that the capital requirements do not reflect any change in the intrinsic risk of owning the physical commodities.  Further notes that an FHC engaged in a physically settled hedging transaction pursuant to Section 4(o) authority may be subject to the 1250% risk-weighting, while another FHC engaging in an identical transaction under Complementary Authority would only be subject to a 300% capital charge. 25.  The Clearing House Association, L.L.C., the American Bankers Association, the Financial Services Forum, the Financial Services Roundtable, and the Institute of International Bankers Financial Trade Associations Believes that limitations on FHC activities should be addressed by Congress, as suggested by the Board in its Section 620 study.  Notes that punitive rulemaking undermines current statutory authority. Concerned that additional capital charges are not commensurate with the environmental risks cited and that current capital standards already address the true risks.  Argues that corporate veil piercing standards are very difficult to overcome and such theories have not changed in recent years. FHCs are an efficient tool for providing capital to companies and industries.  Merchant banking authority affords FHCs flexibility to contribute capital at various stages in a company’s growth.  Notes that preliminary data to a Clearing House study suggests that FHCs provide ~40% of the renewable energy market’s financing needs. Argues that the Proposed Rule fails to address the impact it would have on the economy, small business, and the commodity markets.  Argues that further rulemaking in this area should take into account the impact on customers, markets, industries, and economic growth. 26.  The Futures Industry Association Financial Trade Association FIA is the leading trade organization for the global futures, options, and over-the-counter cleared derivatives markets.  Its mission is to support open, transparent, and competitive markets, protect and enhance the integrity of the financial system, and to promote high standards of professional conduct.  FlA’s members, their affiliates, and their customers are active users of physical commodities, futures, and over-the-counter derivatives. Urges the Board not to adopt restrictive regulatory measures or, at the very least, to conduct an analysis of the potential costs and benefits of the restrictions and to submit that analysis to the public for comment. Argues that FHCs provide many benefits to the physical commodities markets, including market depth, liquidity (serving as market-makers), and by offering a broad spectrum of financial services available to the market (e.g., risk-mitigating commodity-linked swaps and other derivatives).  Highlights the fact that commercial energy firms rely on inventory financing, which requires the FHC to take temporary title to the physical commodity.  This would now be subject to higher capital requirements, which would result in reduction of the practice. Makes the point that the Board does not support with any evidence its conclusion that any reduction in activity by FHCs in the commodities markets would not have a material impact on participants in those markets. 27.  International Swaps and Derivatives Association, Inc. Financial Trade Association Trade association for the global derivatives market with more than 850 member institutions in 67 countries.  Members comprise a broad range of derivatives market participants, including corporations, investment managers, government and supranational entities, insurance companies, energy and commodities firms, and international and regional banks. Requests that the Board revise the Proposed Rule so as not to: impose heightened capital requirements in the absence of supporting evidence; lower the cap of total value of physical commodities permitted under Section 4(k)’s “complementary authority”; rescind the previous authorizations of FHCs to engage in energy management services and energy tolling activities; and implement restrictions on copper trading, and to limit the reporting provisions. Concerned with the lack of empirical support for restricting the activities of FHCs, and the failure to cite any instances where FHCs were liable for the full extent of an environmental catastrophe. Argues that removing FHCs will decrease liquidity, increase volatility, and ultimately result in higher costs to consumers (also specifically points to the practice of providing inventory financing transactions). 28.  Securities Industry and Financial Markets Association and the Institute of International Bankers Financial Trade Association The associations believe that “the benefits of continuing to permit FHCs to engage in physical commodities activities should continue to produce public benefits that outweigh their potential risks.” Argues that the risks cited in the Proposed Rule are speculative and unsupported by facts and the law, and that the Board failed to point to a single instance where an FHC incurred a significant loss arising from environmental liability related to these activities.  Notes that case law and real-world examples demonstrate that FHC involvement in commodities-based activities do not pose a substantial risk to the safety and soundness of the institution or the financial system. Cites to a Joint Memorandum of Law, prepared by four law firms, which concludes that “appropriately limited investment and trading activities relating to environmentally sensitive commodities present limited environmental liability risk” to FHCs, and “well-established doctrines of corporate separateness protect FHC groups from liability for investments in enterprises that engage in environmentally sensitive activities.”[43] Argues that proposed capital charges would be duplicative of FHC requirements to maintain capital based on the credit risk (i.e., bankruptcy risk) of its subsidiaries engaged in commodities activities.  Argues that environmental risks are accounted for by credit risk capital requirements.  As a result, increased capital charges would force FHCs out of the market, causing adverse effects on competition, end-users, the liquidity of commodities markets, small- and medium-sized companies in the commodities sector, and the real economy. Concerned that the Proposed Rule ignores the substantial public benefits accruing from FHCs’ participation in these activities.  Notes that numerous public benefits flow from the participation by FHCs in the commodities markets, including greater competition, increased liquidity in commodities, increased price convergence between cash and derivatives markets and more economical financing for end-users, among many others.  Further notes that prior Federal Reserve determinations have found that FHC involvement in commodities activities provide: (1) greater convenience, (2) increased competition, and (3) enable efficient hedging. Counters the argument that the tail risks associated with FHCs’ current physical commodities activities pose unique and/or more significant risks than any of the other permissible banking and financial activities conducted by FHCs.  Notes that the scope of regulated commodities is overly broad and should be limited to substances defined by the EPA as “Extremely Hazardous Substances,” such as arsenic, hydrogen sulfide, and sulfuric acid.  Notes that the Proposed Rule captures commodities that present no meaningful risk of environmental harm (e.g., iron, vinegar, silver, silicon). 29.  U.S. Chamber of Commerce Center For Capital Markets Competitiveness End-User Trade Association The Chamber is the world’s largest federation of business and associations, representing the interests of more than three million U.S. businesses and professional organizations of every size and every economic sector. These members are users, preparers, and auditors of financial information. Argues that the Section 4(o) risk-weighting requirements and the new Section 4(k) thresholds will push FHCs out of the physical commodities markets.  This will result in reduced competition, which will ultimately lead to less liquidity and higher prices for the commodities on which end-users depend, and ultimately to higher prices for customers. Reasons that the regulation contradicts Congress’ intent when enacting Sections 4(k) and 4(o), as both Section 4(o) and 4(k) provide authority to facilitate efficient functioning of commodity markets and the efficient exchange of risk. Concerned that the Board has provided no evidence for hypothetical extreme circumstances where FHCs could be subject to massive liability.  Emphasizes that the risk-weighting requirements are particularly unjustified, as the Fed cannot and has not provided any evidence of material loss. Also notes that that the potential costs to FHCs are remote, and argues that there are no examples of “corporate veil piercing” occurring in the FHC context. Calls for the need to undertake a comprehensive study of various regulatory initiatives as well as the effects of those initiatives on the broader global economy and the capital formation system. 30.  Exante Regulatory Compliance Consultants Inc. Financial Services Company Exante is a financial services consulting firm specializing in regulatory compliance under SEC, CFTC, and FINRA. Urges the Federal Reserve to work with the Financial Stability Oversight Council to strengthen the Proposed Rule to prevent future instances of market manipulation by FHCs. 31.  TrailStone Group Financial Entity TrailStone is an asset-backed trading and logistics company with in-depth experience in mining, oil and gas investment and finance, energy asset management, energy logistics, and trading. Argues that new restrictions will force FHCs out of the market, thus reducing market depth (i.e., the number of sophisticated parties in which TrailStone relies on to efficiently hedge, finance, and otherwise transact in commodities), and liquidity of the commodities market. Concerned that lack of FHC activity will increase price divergence between physical and financial products.  Because TrailStone regularly makes use of both, it requires closely aligned pricing to prevent market arbitrage. Notes that its end-user subsidiaries need FHCs to take physical commodities as collateral to hedge and manage market risks. 32.  Elise J. Bean and Tyler E. Gellasch Academic Elise Bean is the former Staff Director and Chief Counsel of the U.S. Senate Permanent Subcommittee on Investigations, and Tyler Gellasch is the former Senior Counsel of the U.S. Senate Permanent Subcommittee on Investigations. Reaffirms the Board’s position to limit FHCs’ physical commodity holdings in order to mitigate the dangers associated with an overconcentration of assets, volatile price swings, and unexpected costs arising from catastrophic events.  Cites a 2012 Federal Reserve study supporting greater disclosure, reporting, capital requirements, and enhanced risk management measures for FHCs engaged in physical commodities activities. Supports stronger prohibitions on FHCs’ ability to own and operate facilities connected to the distribution of commodities through Section 4(k)’s complementary authority, as well as the prohibition of energy tolling, the reclassification of copper as an industrial metal, and increased capital requirements. Contends that the U.S. Senate Permanent Subcommittee’s investigation found evidence of market manipulation and conflicts of interest with respect to FHC commodity activities. Recommends strengthening the Proposed Rule as it relates to Section 4(k)’s complementary authority so that it also addresses catastrophes caused by safety violations; clarifying the definition of “covered physical commodities” by making use of a straightforward list (e.g., petroleum and petroleum products, natural gas, fertilizer), and clarifying the scope of Section 4(o) on whether or not the clause is confined to physical commodity activities the entities were engaged in prior to 1997. 33.  James D. Hanson Academic Supports removing copper and silver from lists of bank permissible precious metals. Expresses concern over the conflicts of interests banks may have when they both transact in financial products related to physical commodities and also hold physical commodity assets. 34.  Reid B. Stevens and Jeffery Y. Zhang Academic Reid Stevens is a Professor of Agriculture Economics at Texas A&M University; Jeffrey Zhang is a Professor of Economics at Yale and Harvard Law School. Presents a case study concerning alleged manipulation of the U.S. aluminum market from 2010 to 2014.  Argues that the Proposed Rule will improve the detection of manipulation, since it strengthens the prohibition on owning and operating storage facilities and increases reporting requirements for FHCs. 35.  Saule T. Omarova, Professor of Law, Cornell University Law School Academic Urges the Board to strengthen the Proposed Rule to expand the scope of covered commodities, tighten complementary authority, narrow Section 4(o) authority, and require additional quantitative and qualitative disclosures of FHC activity. Notes that even markets for “non-hazardous” commodities are subject to the distortive and manipulative effects of FHCs.  Cites examples in the aluminum, copper, and electricity markets. Argues for several changes to the Proposed Rule: The key operative provisions should apply to all physical commodities (e.g., copper and aluminum, agricultural commodities, electricity, etc.) as opposed to just hazardous substances that carry the greatest potential liability. The rule needs broader prohibitions on FHCs’ ability to manage, direct, conduct, or provide advice regarding business operations of entities engaged in the physical commodities business. Should restrict Section 4(o) activity to only those activities that were conducted before 1997. Should require from FHCs a detailed qualitative narrative of the entire complex of their operations and assets involving, or related to, physical commodities and how they are linked or interdependent. 36.  Aidenvironment, et al.[44] Interest Group Consortium of environmentally focused organizations and investors. Supports the Proposed Rule in order for FHCs to account for the material financial, environmental, and social risks associated with their physical commodities activities. Argues that Section 4(o) and Section 4(k) authority contribute to deforestation and other environmental effects. Cites independent research which suggests that asset impairment due to environmental and social degradation poses significant risk to FHCs holding physical assets.  For example, references a study which suggests that the Noble Group’s balance sheet was reduced by $400 million due to impairments of their palm oil and coal assets and receivables. 37.  Amazon Watch Interest Group Nonprofit organization for the protection of the rainforest and advancement of the rights of indigenous peoples in the Amazon Basin. Argues that FHCs should not have business financing or owning commodities and assets that harm the environment or indigenous communities. Contends that FHC holdings are problematic, including jet fuel supplies and the recent purchase, sale, transport, and storage of oil, natural gas, coal, metals, electricity, and agricultural products.  Further cites the extractive activities of FHC-owned or -backed entities, such as oil drilling in the Amazon. Argues that FHCs’ direct involvement in commodities financing and ownership creates layers of legal liability, as well as political, reputational, and financial risks. 38.  Americans for Financial Reform Interest Group AFR is a coalition of more than 200 national, state, and local groups who advocate for reform of the financial industry.  Their members include consumer, civil rights, investor, retiree, community, labor, faith-based and business groups along with prominent independent experts. Believes in the elimination or the significant reduction of commodity ownership from bank portfolios. Supports limitations and restrictions to FHCs commodity activities to limit exposures to both changes in commodity prices and commodity-related catastrophic events.  Notes that increased capital requirements would further serve as a stop-gap to such losses. Argues that FHC commodities activities concentrate economic power and pose potential market manipulation risks.  Cites the concerns related to energy and aluminum market manipulation. Urges the Board to interpret Section 4(o)’s grandfather provision more narrowly, such as by limiting activities to those permitted when the GLB Act was passed. 39.  Better Markets, Inc. Interest Group Better Markets is a non-profit, non-partisan, and independent organization founded in the wake of the 2008 financial crisis to promote the public interest in the financial markets and support financial reform. Supports the new requirements and offers a number of proposals and amendments to strengthen the rulemaking and its enforcement. Supports restrictions on commercial activities of banking entities, which aligns with the original intent of the GLB Act.  Also supports the proposals outlined in the Section 620 Study to (1) repeal the authority of FHCs to engage in merchant banking activities entirely, and (2) repeal the grandfather authority under Section 4(o).  Argues that this will result in “reduced institutional and systemic risk; more fair competition; and better fulfillment of original Congressional intent.” Recommends that the Board: engage in coordination with other regulatory agencies (e.g., CFTC, FERC, etc.) with regard to physical commodities trading, such as by establishing a mechanism for sharing the nature and percentage of commodities ownership among BHCs and FHCs; prevent evasion of other laws dealing with financial market oversight (e.g., FHCs that own commodity businesses have insider information, which can lead to insider trading and manipulation); ensure that non-banking business are not given an unfair advantage through Discount Window funding; and refrain from exempting FHCs from disclosure requirements (suggests that they should define the exemption from disclosure as narrowly as possible). 40.  Institute for Agriculture and Trade Policy Interest Group Nonprofit organization focused on ensuring fair and sustainable food, farm, and trade systems. Supportive of the proposed capital requirements but cautions that the Board has underestimated FHC and bank involvement and market share within the physical commodity markets, and therefore may underestimate the impact of commodity derivatives losses on the FHC trading losses in physical commodities. Skeptical of FHCs’ claims that their involvement in physical commodities trading benefits end-users.  Recommends that the Board require FHCs to divulge comprehensive and standardized data about their complementary commodity activities to verify their claims of harm from the Board’s action, and their claims of end-user and social benefits from those activities. Suggests that the Board should possibly broaden its understanding of what constitutes a catastrophe for the purposes of determining whether an FHC could be liable for a catastrophe involving its physical commodity activities. 41.  Public Citizen, Inc. Interest Group Non-profit consumer rights advocacy group and think tank. Supports the increased capital requirements, the prohibition of FHCs from entering into energy tolling agreements, and the copper amendment, but cautions that the Board should narrow the language for what it means to be “closely related” to banking. Proposes that the Board should modify the reporting requirements to require (1) disclosure of ownership or control over infrastructure assets and (2) restrictions on communications between a bank’s energy infrastructure and energy trading affiliates (otherwise they have an “insider’s peek” into the physical movements of energy products which is unavailable to other traders). 42.  Congressman Bradley Byrne U.S. House Requests an extension of the comment period until the 115th Congress has convened and has a chance to review the proposal. Notes that the Board needs to “consider the potential adverse impact upon costs to the American public, the reduction in competition, the loss of markets, and the potential for fewer creditworthy and highly regulated bank counterparties with whom end-users may transact.” 43.  Senators Sherrod Brown, Jeff Merkley, and Jack Reed U.S. Senate Argues that the recent departure of FHCs from the physical commodity markets demonstrates that FHCs are not pivotal intermediaries as they claim to be. Cites airline practices of engaging with non-financial companies for their fuel needs. Supports the expansion of covered physical commodities on the ground that volatility and sudden swings are not limited to those commodities enumerated in the Proposed Rule. Contends that the Proposed Rule fails to address additional environmental concerns related to international and other long-term liabilities.  The Senators note that reclamation and remediation of abandoned mines in the U.S. is problematic. Concerned with the ability of FHCs to utilize repo-style transactions to move commodities exposures off the balance sheet.  Argues that this would allow FHCs to continue to engage in commodity activities beyond the proposed 5% Tier 1 Capital cap. Supports a limitation of Section 4(o) activities to those permissible pre-1997.     Appendix B:  Physical Commodities Legal Authorities Type of Authority Covered Entities Applicable Statutes, Rules and Guidance Scope of Activities 1.   Banking and “Closely Related to Banking” Activities All BHCs and FHCs. 12 U.S.C. § 1843(a), (c)(8) 12 C.F.R. §§ 225.21(a), 225.28(a)-(b), 225.123, 225.126, 225.129, 225.131 Within two years of becoming a BHC (subject to three one-year extensions from the Board), a BHC may only own shares in banks, or engage in, or own companies that engage in, banking activities or activities that the Board has determined by regulation or order to be “so closely related to banking as to be incident thereto.”[45] The Board has determined that commodities derivatives activities are “closely related to banking” as long as the contract requires cash settlement or the BHC makes every reasonable effort to avoid physical delivery or receives and instantaneously transfers the asset by operation of contract and without taking physical delivery.[46] BHCs generally must file a notice with the Board and receive approval prior to engaging in any “closely related to banking” activities.[47]  FHCs and certain well- capitalized and well-managed BHCs may commence the activities and file a notice after the fact.[48] 2.   “Financial in Nature” Activities and Merchant Banking All FHCs. 12 U.S.C. §§ 1843(k)(1), (k)(4)(H), (k)(7); 12 C.F.R. 225 Subpart J (225.170-177) Fed. Res. Interp. Ltr. from J. Mattingly, Esq. to P. Grauer (Credit Suisse First Boston) (Dec. 21, 2001) All FHCs are permitted to engage in, and to acquire and own shares of any company engaged in, activities that are “financial in nature or incidental to such financial activity.”[49] Merchant banking is a permissible “financial in nature” activity for FHCs and their non-depository institution subsidiaries.[50] The merchant banking authority permits an FHC to: acquire an ownership interest in any company as “part of a bona fide underwriting or merchant or investment banking activity,”[51] so long as the FHC controls (i) a registered broker-dealer or (ii) an insurance company that is advised by a registered investment adviser;[52] hold such ownership interests “only for a period of time to enable the sale or disposition thereof,” which period generally may not exceed 10 years;[53] select all of the directors of a portfolio company;[54] enter into an agreement with a portfolio company giving it approval rights over non-routine matters;[55] and provide advice to officers and employees of a portfolio company.[56] The merchant banking authority does not permit FHCs to: own assets other than securities or other ownership interests in a portfolio company, unless the assets are held by a portfolio company that maintains a separate existence from the FHC and has separate management; or “routinely manage or operate a portfolio company”[57] other than for a limited period 3.   “Complementary” Activities FHCs that have applied to, and received approval from, the Board to engage in specific complementary activity. 12 U.S.C. § 1843(j), (k)(1)(B) 12 C.F.R. § 225.89 Board complementary activities orders, including Citigroup (2003), Barclays (2004), and RBS (2008)[58] FHCs are permitted to engage in, and to acquire and own shares of any company engaged in, any activity that the Board has determined by regulation or order “is complementary to a financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.”[59] A FHC must request approval from the Board to engage in a complementary activity, which the Board will evaluate as to whether the benefits to the public outweigh potential adverse effects.[60] In a series of orders beginning with the Citigroup order, the Board has determined that the purchase and sale of commodities in the spot market and taking physical delivery of commodities in connection with commodity derivatives activities—including owning and disposing of nonfinancial commodities (collectively, “Physical Trading Activities”)—are complementary to the financial activity of engaging as principal in BHC-permissible (i.e., cash settled) derivatives activities based on those commodities. As conditions to approval of its proposed Physical Trading Activities, Citigroup committed: that the market value of commodities held as a result of the activities would at no time exceed 5 percent of Citigroup’s consolidated Tier 1 capital; that it would notify its supervising Reserve Bank if the market value of commodities held by Citigroup as a result of its Physical Commodities Trading activities exceeded 4 percent of its Tier 1 capital; to only make and take delivery of physical commodities for which derivatives had been approved for trading on a U.S. futures exchange by the CFTC, unless explicitly excluded or approved by the Board.[61] 4.   “Grandfathered” Activities Any company that is not a BHC or foreign bank that becomes a FHC after November 12, 1999. 12 U.S.C. § 1843(o). Any company that is not a BHC or foreign bank that becomes a FHC after November 12, 1999 “may continue to engage in, or directly or indirectly own or control shares of a company engaged in, activities related to the trading, sale, or investment in commodities and underlying physical properties that were not permissible for bank holding companies to conduct in the United States as of September 30, 1997” if certain conditions are met.[62] These conditions are: that the FHC or one of its subsidiaries was engaged in any of such activities as of September 30, 1997; that the value of the assets of the company held by the FHC that are not otherwise permissible for a FHC are equal to or less than 5% of the total consolidated assets of the FHC (except as permitted by the Board); and that the FHC does not permit the company whose shares the FHC owns pursuant to section 4(o) to offer or market any product or service of an affiliated depository institution or vice versa. The Board, while not formally interpreting the extent of section 4(o) authority, has noted that the GLBA permits “FHCs that meet the criteria in section 4(o) to engage in a potentially broader set of physical commodity activities than generally authorized for BHCs and other FHCs.”[63] 5.   Sub-5% Investments All BHCs and FHCs. 12 U.S.C. § 1843(c) (6). BHCs are permitted to own “shares of any company which do not include more than 5 per centum of the outstanding voting shares of such company.”[64] BHCs may own more than 5% of the economic interest in such a company, but the size of such additional economic ownership may depend on the facts and circumstances. Sub-5% investments must be passive and non-controlling in nature.   [1]      Notice of Proposed Rulemaking, Regulations Q and Y; Risk-Based Capital and Other Regulatory Requirements for Activities of Financial Holding Companies Related to Physical Commodities and Risk-Based Capital Requirements for Merchant Banking Investments, 81 Fed. Reg. 67220 (Sept. 30, 2016) [hereinafter the “Proposed Rule”]. [2]      Complementary Activities, Merchant Banking Activities, and Other Activities of Financial Holding Companies Related to Physical Commodities, 79 Fed. Reg. 3329 (January 21, 2014); Complementary Activities, Merchant Banking Activities, and Other Activities of Financial Holding Companies Related to Physical Commodities, 79 Fed. Reg. 12414 (March 5, 2014) (extending the comment period to April 16, 2014). [3]      In previous Client Alerts, we analyzed public comments to the ANPR and the historical justifications for bank commodity activities in light of the enhanced regulatory framework existing after the passage of the Dodd-Frank Act, available at http://www.gibsondunn.com/publications/Pages/Commodities-Activities-of-Banks–Comments-on-Federal-Reserve-Advance-Notice-of-Proposed-Rulemaking.aspx and http://www.gibsondunn.com/publications/Pages/Federal-Reserve-to-Reevaluate-Permissibility-of-Physical-Commodities-Trading-Rationale-Historically-and-Today.aspx. [4]      In total, there were 44 individual end-users and municipal end-users signatories to the 24 letters. [5]      Trade associations and end-users that signed on to this letter include Accuride Corporation, Air Products and Chemicals, Inc., the American Investment Council, Apache Corporation, Ball Corporation, The Boeing Company, BP, Cummins Inc., FMC Corporation, General Electric Company, General Motors Company, Harley-Davidson, Inc., The Hershey Company, Honeywell International, NextEra Energy Resources LLC, Northern Virginia Electric Cooperative, Orbital ATK, Inc., and Southwest Airlines Co. [6]      Pub. L. 106-102, 113 Stat. 1338 (Nov. 12, 1999). [7]      The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required that such conditions be met at the bank holding company level as well.  12 U.S.C. § 1843(l)(1)(C). [8]      12 U.S.C. § 1843(k). [9]      Id. § 1843(j)-(k). Note that, under Section 4(k) of the BHC Act, making “merchant banking” investments in non-financial companies is an activity financial in nature. [10]     Id. § 1843(o). [11]     See Citigroup Inc., 89 Fed. Res. Bull. 508 (2003) (Citigroup Order). [12]     The FHCs other than Citigroup that received approval to engage in complementary physical commodities activities included UBS AG, 90 Fed. Res. Bull. 215, 216 (2004); Barclays Bank plc, 90 Fed. Res. Bull. 511, 512 (2004) (Barclays Order); Deutsche Bank AG, 92 Fed. Res. Bull. C54, C56 (2006); Société Générale, 91 Fed. Res. Bull. C113, C115 (2006); JPMorgan Chase & Co., 92 Fed. Res. Bull. C57, C58 (2006); Fortis S.A./N.V., 94 Fed. Res. Bull. C22 (2008) (Fortis Order); and The Royal Bank of Scotland Group plc, 94 Fed. Res. Bull. C60 (2008) (RBS Order). Beginning in 2006, many determinations were made by delegated authority to the Director of the Division of Banking Supervision and Regulation. See, e.g., Wachovia Co., Letter to Elizabeth T. Davy, Esq., dated Apr. 13, 2006; Credit Suisse Group, Letter to Paul E. Glotzer, Esq., dated Mar. 27, 2007; Bank of America, Letter to Gregory A. Baer, Esq., Apr. 24, 2007; BNP Paribas, Letter to Paul E. Glotzer, Esq., dated Aug. 31, 2007; Wells Fargo, Letter to John Shrewsberry, dated Apr. 10, 2008; Bank of Nova Scotia, Letter to Andrew S. Baer, Esq., dated Feb. 17, 2011. [13]     See RBS Order (energy tolling); Fortis Order (2008) (energy management). In an energy tolling arrangement, an FHC enters into an agreement with the owner of a power plant under which the FHC pays the plant owner a periodic payment that compensates the owner for its fixed costs in exchange for the right to all or part of the plant’s power output. Energy management services include acting as a financial intermediary for a power plant owner to facilitate transactions relating to the acquisition of fuel and the sale of power and advising on risk management. [14]     12 U.S.C. § 1851(h)(4) (definition of proprietary trading includes only commodity futures and derivatives). [15]     Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, Report to the Congress and Financial Stability Oversight Council Pursuant to Section 620 of the Dodd-Frank Act (Sept. 8, 2016).  For more information, please see our Client Alert, available at http://www.gibsondunn.com/publications/Pages/US-Bank-Regulators-Section-620-Study-Federal-Reserve-De-Risks-Merchant-Banking-Commodities.aspx. [16]     Comment letters are available at:  https://www.federalreserve.gov/apps/foia/ViewAllComments.aspx?doc_id=R-1547&doc_ver=1. For purpose of counting comment letters, we have removed instances where a commenter has submitted more than one letter. [17]     See, e.g., Comments submitted by the U.S. Chamber of Commerce Center for Capital Markets Competitiveness (“[M]arket liquidity would suffer because FHC affiliates are frequently the most knowledgeable participants and the most willing to enter into customized trades, and there are few potential new market entrants who can replace them.”); Comments submitted by Novelis Inc. (“Having multiple FHCs that participate in the aluminum futures market available to us has . . . given manufacturers in the aluminum industry improved liquidity.”). [18]    See, e.g., Comments submitted on behalf of end-users and end-user trade associations by the National Association of Corporate Treasurers (“[W]e will likely find ourselves having to transact with less-resilient and less-regulated non-bank counterparties, who offer a less-sophisticated and less-customized array of products, and who are often located outside the United States.”). [19]     See, e.g., Comments submitted by end-users and municipal end-users such as Alon USA Energy, Inc., the Town of Slaughter, Louisiana, and Cogentrix Energy Power Management, LLC. [20]     See, e.g., Comments submitted by the TrailStone Group (“[O]nly FHCs can provide practical market solutions to transparency, bid/ask pricing, and the tenor in which market participants need.”); Comments submitted by Delek US Holdings Inc. (“[W]we do not believe that the remaining intermediaries that exist in or could be expected to enter the market would be able to service our physical commodity and commodity derivatives needs as well as FHCs currently do because of FHCs’ unique combination of favorable characteristics”). [21]     See, e.g., Comments submitted by the International Swaps and Derivatives Association (“[L]limitations and restrictions in the Propos[ed] [Rule] on the ability of banking organizations to engage in certain activities relating to physical commodities may have negative effects on the physical and financial commodities markets, including less liquid and efficient markets, greater volatility and higher costs for end-users and consumers.”). [22]     See, e.g., Comments submitted by U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed. [23]     See, e.g., Comments submitted by Former Staff Director and Chief Counsel of the U.S. Senate Permanent Subcommittee on Investigations, Elise J. Bean, and Former Senior Counsel of the U.S. Senate Permanent Subcommittee on Investigations, Tyler E. Gellasch (suggesting that the definition of “covered physical commodities” be clarified by making use of a straightforward list). [24]     See, e.g., Comments submitted by Public Citizen, Inc. (“Given the critical role played by FHCs in the economy and in commodity trading markets, and considering the unique risks associated with energy infrastructure in our economy and national security, the public interest is best served by having the Board publically disclose limited aspects of FHC ownership and control over physical commodity assets such as pipelines, storage terminals and tankers.”); comments submitted by Professor Saule T. Omarova (“[T]the Board should require each FHC to provide a detailed qualitative narrative of the entire complex of its operations and assets involving, or related to, physical commodities. As part of this narrative, FHCs should be required to identify and discuss specific organizational, informational, and financial links and inter-dependencies between their specific physical commodities businesses and other business activities they conduct or seek to conduct.”). [25]     See, e.g., Comments submitted by U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed (citing to the U.S. Senate Permanent Subcommittee on Investigations’ findings with relation to Goldman Sachs’ activities within the aluminum markets, the Senators reasoned that “because FHCs have been found to exercise a high level of control over physical commodity portfolio companies, the proposal’s strengthened restrictions are necessary and important.”). [26]     See, e.g., Comments submitted by Americans for Financial Reform, U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed, and Professor Saule T. Omarova. [27]     See, e.g., Comments submitted by U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed (noting that “the Director of the Board’s Bank of Supervision and Regulation Division has acknowledged that ‘there are multiple possible interpretations of section 4(o) of the BHC Act.'”). [28]     See, e.g., Comments submitted by Professor Saule T. Omarova. [29]     See, e.g., Comments submitted by the Goldman Sachs Group, Inc. (“In enacting Section 4(o) Congress explicitly acknowledged the importance of the expertise and risk management provided by FHC intermediaries in the physical commodity markets.”). [30]     See, e.g., Comments submitted by the Natural Gas Supply Association (crediting the growth in the natural gas industry in part to the “unique role in facilitating physical commodity and related financial market counterparty diversity.”). [31]     See, e.g., Comments submitted on behalf of end-users and end-user trade associations by the National Association of Corporate Treasurers (“[W]e will likely find ourselves having to transact with less-resilient and less-regulated non-bank counterparties, who offer a less-sophisticated and less-customized array of products, and who are often located outside the United States.”). [32]     Comments submitted by U.S. Representative Bradley Byrne; see also Comments submitted by the Securities Industry and Financial Markets Association and the Institute of International Bankers (“The Federal Reserve’s failure to take into account the public benefits of FHCs’ physical commodities activities that would be lost if the requirements of the Proposed Rule were to become effective fails to satisfy its obligation under the Administrative Procedures Act to engage in reasoned decision-making in its rulemaking.”). [33]     See, e.g., Comments submitted by Professors Reid B. Stevens and Jeffery Y. Zhang (presenting their study of manipulation by financial entities of regional commodity markets); Comments submitted by Better Markets (FHC physical commodity activity “invites market manipulation and excessive commodity speculation.”); Comments submitted by Americans for Financial Reform (citing to federal studies noting market manipulation in the energy, aluminum, and copper markets). [34]     See Comments submitted by Novelis, Inc. (noting that FHCs enable Novelis to (1) efficiently manage surplus inventory through short-term repo transactions and (2) lock-in favorable pricing in instances where its business demands do not correspond with current market pricing). [35]     See, e.g., Comments submitted by the Securities Industry and Financial Markets Association and the Institute of International Bankers (“Despite the fact that Congress and the Federal Reserve have allowed FHCs to engage in physical commodity activities for over 15 years, the Federal Reserve has failed to point to a single instance where an FHC incurred a significant loss arising from environmental liability related to these activities.”). [36]     Id. (“FHCs are already subject to existing capital charges for credit risk, market risk and operational risk, which are designed to address, among other risks, legal liability risk.”). [37]     Id. (noting that associations attach a Joint Memorandum of Law, prepared by four law firms, which concludes that “appropriately limited investment and trading activities relating to environmentally sensitive commodities present limited environmental liability risk” to FHCs, and “well-established doctrines of corporate separateness protect FHC groups from liability for investments in enterprises that engage in environmentally sensitive activities”). Additionally, the Board acknowledged such safeguards in the Proposed Rule, stating that these laws “generally impose liability on owners and operators of facilities and vessels for the release of physical commodities. . . [and while] a company that directly owns an oil tanker or petroleum refinery that releases crude oil in a navigable waterway” may be liable for damages that result from a spill, the owner of the commodity often times is not liable except in instances where the underlying owner engages in activities in addition to mere ownership.  81 Fed. Reg. at 67221. [38]     See, e.g., Comments submitted by Amazon Watch (“In 2013, Morgan Stanley reported trading aluminum, copper, gold, lead, palladium, platinum, silver, rhodium, zinc, coal, crude oil, heating oil, ethanol, fuel oil, gasoline, jet kerosene, naphtha, and natural gas. It also reported maintaining physical inventories in 2012 that included 1.7 million barrels of crude oil, 5.8 million barrels of heating oil, and 6.2 million barrels of gasoline.”). [39]     See, e.g., Comments submitted by Amazon Watch (“As a new study from the Center for Biological Diversity shows, existing pipelines in North Dakota have spilled crude oil and other hazardous liquids at least 85 times since 1996—an average of four a year—and released over 3 million gallons into rivers, farmland, reservoirs, and more. Those 85 spills caused more than $40 million in property damage.”). [40]     See Catherine Ngai and Olivia Oran, Barclays’ exit from energy trading stirs concerns over liquidity, Reuters, Dec. 6, 2016, available at http://www.reuters.com/article/us-usa-oil-barclays-bk-idUSKBN 13U2MW. [41]     We note also that the Proposed Rule could face an uncertain future.  Board Governor Daniel Tarullo, the de facto Governor for bank supervision and regulation, has announced his resignation, effective in less than a month.  With two Board seats currently empty, the Trump Administration will be able to add at least three Governors to the Board.  Aspects of the Proposed Rule seem in tension with several Administration priorities, including lessening regulatory burden, making clear the economic costs of agency rulemakings, and constraining administrative action to adhere more closely to the expressed will of Congress. [42]     Trade associations and end-users that signed on to this letter include Accuride Corporation, Air Products and Chemicals, Inc., the American Investment Council, Apache Corporation, Ball Corporation, The Boeing Company, BP, Cummins Inc., FMC Corporation, General Electric Company, General Motors Company, Harley-Davidson, Inc., The Hershey Company, Honeywell International, NextEra Energy Resources LLC, Northern Virginia Electric Cooperative, Orbital ATK, Inc., and Southwest Airlines Co. [43]     See Covington & Burling LLP, Davis Polk & Wardwell LLP, Sullivan & Cromwell LLP and Vinson & Elkins LLP, Joint Memorandum of Law Prepared for SIFMA In Response to the Notice of Proposed Rulemaking on Risk-Based Capital and Other Regulatory Requirements for Activities of Financial Holding Companies Related to Physical Commodities and Risk-Based Capital Requirements for Merchant Banking Investments (Docket No. R-11547; RIN 7100AE-58), available at https://www.federalreserve.gov/SECRS/2017/February/20170228/R-1547/R-1547_021717_131733_608227617620_1.pdf (Appendix A). [44]     Aidenvironment was joined by Climate Advisers, Green Century Capital Management, and Profundo. [45]     12 U.S.C. § 1843(a)(2), (c)(8). [46]     12 C.F.R. § 225.28(b)(8)(ii).  FHCs are also permitted to own commodities that state member banks are permitted to own, such as gold and silver bullion.  Id. § 225.28(b)(8)(ii)(B)(1), (b)(8)(iii). [47]     12 U.S.C. § 1843(j)(1)(A). [48]     Id. § 1843(j)(3)-(4). [49]     Id. § 1843(k)(1)(A). [50]     Id. § 1843(k)(4)(H). [51]     Id. § 1843(k)(4)(H)(ii)(II). [52]     12 C.F.R. § 225.170(f). [53]     Id. § 225.172(b). [54]     Id. § 225.171(d)(1). [55]     Id. § 225.171(d)(2). [56]     Id. § 225.171(d)(3). [57]     Id. § 225.171(a).  The rule provides examples of what constitutes “routine management or operation” of a portfolio company.  “Routine management or operation” generally includes when any FHC director, officer or employee serves as an executive officer or employee of a portfolio company or when any portfolio company officer or employee is supervised by a director, officer or employee of the FHC (other than in its role as director of the portfolio company).  See id. § 225.171(b).  See also Fed. Res. Interp. Ltr. from J. Mattingly, Esq. to P. Grauer (Credit Suisse First Boston) (Dec. 21, 2001) (available at http://www.federalreserve.gov/boarddocs/legalint/bhc_changeincontrol/2001/20011221/) (providing a list of example covenants that would not involve an FHC routinely managing or operating a portfolio company). [58]     Citigroup Order; Barclays Order; RBS Order. [59]     12 U.S.C. § 1843(k)(1)(B). [60]     Id. § 1843(j)(1)(A), (j)(2). [61]     After the Citigroup Order, the Board permitted FHCs to make and take delivery of physical commodities for which the CFTC had not approved derivatives for trading on a U.S. futures exchange.  See RBS Order. [62]     12 U.S.C.  § 1843(o). [63]     Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation & Office of the Comptroller of the Currency, Report to Congress and the Financial Stability Oversight Council Pursuant to Section 620 of the Dodd-Frank Act (September 2016), available at https://www.fdic.gov/news/news/press/2016/pr16079a.pdf, at 16.  Former Governor Daniel K. Tarullo has also noted that “[i]n contrast to section 4(k) complementary authority, this authority is automatic–meaning no approval by or notice to the Board is required for a company to rely on this authority for its commodities activities. Also, unlike the firms conducting limited commodities activities found to be complementary to financial activities under section 4(k), the section 4(o) grandfathered firms are authorized to engage in the transportation, storage, extraction, and refining of commodities.”  Speech:  Former Governor Daniel K. Tarullo, Statement before the Permanent Subcommittee on Investigations, U.S. Senate, Washington, DC (Nov. 21, 2014), available at https://www.federalreserve.gov/newsevents/testimony/tarullo20141121a.htm. [64]     12 U.S.C. § 1843(c)(6). Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

April 20, 2017 |
Trump Administration’s Fintech policy remains unclear

​Washington, D.C. counsel Jeff Steiner and San Francisco associate Sean Sullivan are the authors of "Trump Administration’s Fintech Policy Remains Unclear," [PDF] published by The Daily Journal on April 20, 2017.

March 23, 2017 |
Alternative Capital Come Calling in the Region

​Dubai partner Richard Ernest and associate Aly Kassam are the authors of "Alternative Capital Come Calling in the Region," [PDF] published by Gulf News on March 23, 2017.

February 6, 2017 |
President Trump Issues Executive Order on Financial Regulation, and Memorandum on Department of Labor Fiduciary Rule

Last Friday, February 3, 2017, President Trump took two executive actions relating to U.S. financial markets and institutions.  First, the President issued an executive order titled “Core Principles for Regulating the United States Financial System.”[1]  The Executive Order articulates “core principles” with respect to financial regulation and directs the Secretary of the Treasury to advise the President within 120 days of actions being taken to promote those principles and to identify legal requirements that are inconsistent with the principles.  Second, the President issued a memorandum directing the Department of Labor to review its controversial “Fiduciary Rule” and to consider whether to revise or rescind it.[2] Together, these executive actions indicate that the new Administration is prepared to undertake a vigorous re-appraisal of a number of the restrictions imposed on financial institutions during the Obama Administration. Executive Order The Executive Order announces seven “core principles” to guide the regulation of the American financial system: “empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth”; “prevent taxpayer-funded bailouts”; “foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry”; “enable American companies to be competitive with foreign firms in domestic and foreign markets”; “advance American interests in international financial regulatory negotiations and meetings”; “make regulation efficient, effective, and appropriately tailored”; and “restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework.”[3] The Executive Order directs the Secretary of the Treasury to “consult with the heads of the member agencies of the Financial Stability Oversight Council”[4] and to report to the President within 120 days regarding the laws, treaties, regulations, other administrative requirements and guidance, and “other government policies” that “promote” or “inhibit” these core principles, and the steps being taken to “promote and support” the principles.[5] The Executive Order builds upon the prior order titled “Reducing Regulation and Controlling Regulatory Costs” that the President signed earlier last week.  As explained in our analysis of that order, the requirement that agencies offset the costs of any new regulations with reductions in existing regulatory burdens–and that two rules be repealed for every new rule adopted–“will provide a significant incentive for agencies to examine current regulations to identify those that may be rescinded or modified to reduce regulatory burdens.”[6]  The most recent Executive Order indicates that financial regulation will be an area of special focus as the Administration undertakes its general efforts to reduce federal regulation. Presidential Memorandum The Presidential Memorandum addresses a package of rules adopted by the Department of Labor in April 2016.  These rules vastly expanded the definition of who is a fiduciary for purposes of ERISA and tax-favored investment accounts such as IRAs, and placed a range of new requirements, restrictions, and liabilities on advisers, broker-dealers, insurance agents, and others who offer financial services and products to retirement savers.  Several lawsuits have been filed challenging this “Fiduciary Rule”–including one in which Gibson Dunn represents the challengers–and the Rule has been criticized by legislators, industry participants, and some experts as burdensome, costly, and harmful to retirement savers, whose investment options they contend would be limited by the Rule. The Presidential Memorandum takes heed of these criticisms and states that the Fiduciary Rule “may significantly alter the manner in which Americans can receive financial advice and may not be consistent with the policies of my Administration.”[7]  Accordingly, the Presidential Memorandum instructs the Department to review the Rule and “prepare an updated economic and legal analysis concerning the likely impact of” the Rule.[8]  The Department is to consider whether the Rule “has harmed or is likely to harm investors,” “has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees,” and “is likely to cause an increase in litigation, and an increase in the prices that investors and retirees must pay to gain access to retirement services.”[9]  If the Department makes an “affirmative determination” as to any of those considerations or finds that the Rule “is inconsistent with the priority identified” in the memorandum, the Department is directed to “publish for notice and comment a proposed rule rescinding or revising the Rule.”[10] Shortly after issuance of the President’s memorandum, the Acting Secretary of Labor released a statement that “[t]he Department of Labor will now consider its legal options to delay the applicability date as we comply with the President’s memorandum.”[11] *   *   * Reaction to the two actions on Capitol Hill has been mixed.  Rep. Jeb Hensarling (R – Tex.), Chairman of the House Financial Services Committee said that he was “very pleased” and that the President’s action “closely mirrors provisions” of his proposed Financial CHOICE Act, which is meant to “end and replace the Dodd-Frank mistake with legislation that holds Wall Street and Washington accountable.”[12]  Sen. Elizabeth Warren (D-Mass.) predicted that the President’s actions will result in “gutting the rules that protect [the public] from financial fraud and another economic meltdown.”[13] Both the Executive Order and the Presidential Memorandum portend significant changes to the executive branch’s approach to regulation of the financial services industry.  By directing the Department of Labor to re-evaluate its legal and economic justifications for the Fiduciary Rule, the Presidential Memorandum takes the first concrete steps toward a repeal of the Rule or a substantial reduction in its scope.  And the Acting Labor Secretary’s press statement indicates that the Department may take action soon to delay the current April 10 deadline for some of the Rule’s principal requirements to come into effect. Meanwhile, the Judge presiding over three of the pending lawsuits challenging the Rule issued an order on Thursday of last week indicating that she would issue her decision in the case by February 10, 2017.[14] Similarly, the Executive Order gives clear shape and impetus to the Trump Administration’s unfolding reconsideration of the Obama Administration’s implementation of the Dodd-Frank Act.  Aspects of Dodd-Frank that have been the subject of criticism since the bill’s passage now have the potential to be deemed by the Treasury Secretary as inconsistent with the Executive Order’s “core principles,”[15] including: the authority of the Financial Stability Oversight Council to designate particular companies as posing systemic risk; the Orderly Liquidation Authority contained in Title II of Dodd-Frank; U.S. implementation of Basel III capital requirements, particularly with respect to small institutions; the extent to which U.S. regulators’ participation in international forums like the Basel Committee affects rulemakings; banking agency enforcement of the Volcker Rule; the extent of regulatory transparency in the Dodd-Frank stress testing and CCAR processes; the regulations and enforcement approach of the Consumer Financial Protection Bureau; the extent to which regulations place direct and indirect burdens on commercial end-users’ ability to manage risks; the regulations and enforcement by U.S. banking agencies, the Commodity Futures Trading Commission, and the Securities and Exchange Commission of capital and margin rules related to derivatives; and the Commodity Futures Trading Commission’s rules and interpretive guidance related to cross-border regulation of derivatives transactions. Although the Executive Order does not itself pare back any regulations, it is another early signal of the Trump Administration’s intent to reduce the regulatory burdens on American businesses in general and the financial services industry in particular. Gibson Dunn will continue to monitor these developments and the effect they may have on our clients.     [1]  See Presidential Executive Order on Core Principles for Regulating the United States Financial System, WhiteHouse.gov, https://www.whitehouse.gov/the-press-office/2017/02/03/presidential-executive-order-core-principles-regulating-united-states (Feb. 3, 2017).     [2]  See Presidential Memorandum on Fiduciary Duty Rule, WhiteHouse.gov, https://www.WhiteHouse.gov/the-press-office/2017/02/03/presidential-memorandum-fiduciary-duty-rule (Feb. 3, 2017); Fiduciary Rule, 81 Fed. Reg. 20946 (Apr. 8, 2016).     [3]  Order § 1.     [4]  The FSOC member agencies are:  the Board of Governors of the Federal Reserve System; the Commodity Futures Trading Commission; the Federal Deposit Insurance Corporation; the Federal Housing Finance Agency; the National Credit Union Administration; the Office of the Comptroller of the Currency; the Securities and Exchange Commission; the Treasury Department; and the Consumer Financial Protection Bureau.     [5]  Order § 2.     [6]  Client Alert: President Trump Issues Executive Order on Reducing Regulation and Controlling Regulatory Costs, GibsonDunn.com, http://www.gibsondunn.com/publications/Pages/President-Trump-Issues-Executive-Order-on-Reducing-Regulation–Controlling-Regulatory-Costs.aspx (Feb. 3, 2017).     [7]  Memorandum.     [8]  Id. § 1(a).     [9]  Id.     [10] Id. § 1(b).     [11] Press Release, U.S. Department of Labor, US Department of Labor to Evaluate Fiduciary Rule (Feb. 3, 2017), available at https://www.dol.gov/newsroom/releases/opa/opa20170203.     [12] Press Release, Chairman Jeb Hensarling, House Financial Services Committee, President’s Executive Action Mirrors Financial CHOICE Act (Feb. 3, 2017), available at http://financialservices.house.gov/news/documentsingle.aspx?DocumentID=401457; see Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).     [13] Press Release, Senator Elizabeth Warren, Statement on President Trump’s Executive Orders to Roll Back Dodd-Frank, DOL Conflict-of-Interest Rule (Feb. 3, 2017), available at https://www.warren.senate.gov/?p=press_release&id=1431.     [14] Chamber of Commerce of the U.S. v. Hugler, 16-1476, dkt. 134 (N.D. Tex. Feb. 2, 2017).     [15] Order § 2.     The following Gibson Dunn lawyers assisted in the preparation of this client alert:   Eugene Scalia, Helgi Walker, Michael Bopp, Arthur Long, Jeffrey Steiner, Carl Kennedy, Catherine Conway, Jason Schwartz, Jason Mendro, James Springer and Russell Falconer. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Administrative Law and Regulatory, Financial Institutions, Labor and Employment, or Public Policy practice groups, or the following practice group leaders: Administrative Law and Regulatory Group: Eugene Scalia – Washington, D.C. (+1 202-955-8206, escalia@gibsondunn.com) Helgi C. Walker – Washington, D.C. (+1 202-887-3599, hwalker@gibsondunn.com) Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Labor and Employment Group: Catherine A. Conway – Los Angeles (+1 213-229-7822, cconway@gibsondunn.com) Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com) Public Policy Group: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)   © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.