May 10, 2017
On May 4, 2017, by a vote of 34 to 26, the House Financial Services Committee ordered reported H.R. 10, 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, 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:
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.
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:
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.”
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:
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:
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:
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.”
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.
Subchapter V would be available for “covered financial corporations,” a term defined as follows:
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.
1. Federal Reserve
The Bill makes significant changes to the Federal Reserve’s emergency lending authority, including:
2. Consumer Financial Protection Bureau
Under the Bill, the CFPB would be radically transformed. Among the more important reforms are the following:
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.
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.
Similar to aspects of President Trump’s Executive Order 13777 to Executive agencies, 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.
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. Notwithstanding the lack of clarity in the statute, the CFTC has provided significant relief for inter-affiliate swaps from margin, clearing and reporting requirements. Similar to the inter-affiliate language that passed the House earlier this year as part of the CFTC Reauthorization Bill (H.R. 238), 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:
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:
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–and impose uniform heightened standards for all Agencies.
When issuing a proposed rule, an Agency would be required to complete a detailed analysis, including on the following principal subjects:
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.
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:
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.
Title III, Subtitle B of the Bill would grant Congress new broad veto and consent powers over most final Agency rulemakings. 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–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, 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.
Section 341 of the Bill would end the application of Chevron and Auer 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 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.
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.
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” 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.
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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.
 H.R. 10, 115th Cong. (2017), available at https://financialservices.house.gov/uploadedfiles/crpt-115-hr10-h001036-amdt-001.pdf.
 H.R. 5983, 114th Cong. (2016), available at https://www.congress.gov/114/bills/hr5983/BILLS-114hr5983rh.pdf.
 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.
 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.
 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.
 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.
 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.”).
 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.
 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.
 H.R. 238, 115th Cong. (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/238.
 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.
 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.
 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.
 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.”).
 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.
 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.
 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.
 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.
 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.”
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