Compliance Insights – January 2017

Compliance Insights – January 2017

OCC Plans to Consider Special-Purpose National Bank Charters for Fintech Companies

In December 2016, the Office of the Comptroller of the Currency (OCC) announced its plan to grant special-purpose national bank charters to a broad range of business models, including fintech companies that engage in payment services, lending and other core banking functions, and that meet the OCC’s high standards and charter requirements. Concurrent with the announcement, the agency also released a white paper further describing the potential benefits of, the supervisory expectations for and the process for obtaining such charters.

Under the National Bank Act, the OCC has the authority to, among other things, grant national bank charters and supervise special purpose national banks. Accordingly, the OCC can grant special- purpose national bank charters to companies that receive deposits, pay checks or lend money. Currently, limited charters are issued for national banks that conduct trust or credit card activities. The OCC proposes to expand the scope of these qualifying activities to include bank-permissible, technology-based innovations in financial services, in support of its recent efforts to develop a supervisory framework to support responsible innovation in financial services.

As a special-purpose national bank, a fintech company would be required to meet the OCC’s supervisory standards related to safety and soundness; meet requirements to provide fair access to financial services and treat customers fairly; and comply with all applicable laws and regulations commensurate with its size, complexity and risks. Any entity seeking a national charter would need to demonstrate that it sufficiently meets each of these objectives by providing a detailed business plan, as well as its strategies for governance, capital and liquidity management, compliance risk management, financial inclusion, and recovery and resolution planning.

The OCC highlights that the potential benefits of such a charter include:

  • Ensuring that fintech companies operate in a safe and sound manner to effectively serve the needs of customers, businesses and communities;
  • Promoting consistency in the application of laws and regulations nationwide and ensuring that consumers are treated fairly; and Internal Audit, Risk, Business & Technology Consulting
  • Encouraging fintech companies to explore new ways to promote fair access and financial inclusion and innovate responsibly.

From a fintech company perspective, the charter also presents an opportunity to simplify the regulatory oversight framework it currently faces – the state-by-state licensing and other legal and regulatory requirements applicable to the products and services that it offers. And more broadly, the financial services industry views this charter as an opportunity to level the proverbial playing field with fintech start-ups that historically have not been subject to the same level of regulatory oversight and scrutiny.

By granting special-purpose national bank charters, the OCC could provide an avenue for certain companies, particularly those with well-established operating models and risk management frameworks, to enter the bank-regulated environment. Currently, however, it is unknown how many, if any, fintech companies will meet the OCC’s high standards. In addition, current opposition in Congress presents potential hurdles that are likely to impact not only the timing, but also the fate of the OCC’s proposed approach. As we progress into 2017, fintech companies should evaluate the potential regulatory burdens and benefits of the proposed charter and should closely monitor future developments, as the proposal could hold significant promise but likely will endure a challenging, and certainly unpredictable, path forward in the new political environment.

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CFPB Signals Upcoming Regulatory Activity

In November 2016, the Consumer Financial Protection Bureau (CFPB) released its semiannual rulemaking agenda, which highlights its upcoming activities regarding proposing and finalizing new regulations or changes to existing regulations. In the agenda, the CFPB provides an outline of both current and proposed initiatives, covering subjects ranging from arbitration to debt collection. In addition to its fall 2016 rulemaking agenda, the CFPB announced in December 2016 its fair lending- specific priorities for 2017. Both announcements provide insights to the financial services industry regarding the agency’s rulemaking and supervisory priorities for the coming year.

Noteworthy among the items in the fall 2016 rulemaking agenda are the following:

  • Arbitration. In May 2016, the CFPB issued a proposed rule in response to concerns that arbitration clauses prevent consumers from uniting to seek relief from wrongdoing by financial institutions. The proposed rule would prohibit class action waivers in consumer arbitration agreements and thereby eliminate restrictions on consumers filing or joining class action lawsuits. In its agenda, the CFPB indicates that it is reviewing commentary received on the proposal and intends to finalize a rule in February 2017.
  • Debt Collection. In July 2016, the CFPB issued a written outline of provisions it would likely include within a proposed debt collection regulation, specifically targeted at debt collection agencies that engage primarily in the collection of debts on the behalf of others, or that purchase debts from other creditors and then collect on their own behalf. It has been the CFPB’s contention that the primary statute applicable to debt collections, the Fair Debt Collection Practices Act (FDCPA), is insufficient to address modern day debt collection realities (as evidenced most recently by a January 2017 study published by the CFPB on these activities). Notably, the CFPB also indicated that in 2017 it expects to begin exploring regulations applicable to debt collection activities of financial institutions collecting debts on their own behalf.
  • Mortgages. In July 2016, the CFPB issued a proposed rule to clarify its TILA-RESPA Integrated Disclosure (TRID) rule, implemented in October 2015, including creating new tolerances/thresholds for certain figures on the required disclosures and providing guidance on sharing disclosures with various parties involved in the mortgage origination process. In its agenda, the CFPB indicated that it is currently reviewing public comments received on the proposal in preparation for issuing a final rule. Additionally, the CFPB continues to work on preparing for the implementation of the upcoming changes to the Home Mortgage Disclosure Act (HMDA), such as by working to streamline and modernize HMDA data reporting processes. Some components of the rule change will take effect in January 2017, but the majority of the new requirements are scheduled to take effect in January 2018.

Regarding its 2017 fair lending priorities, the CFPB stated it intends to increase its focus in the following three areas:

  • Redlining. Redlining-related enforcement activity has already been a prominent component of the CFPB’s enforcement actions and the agency stated it will continue to evaluate whether financial institutions avoid lending in minority neighborhoods.
  • Mortgage and Student Loan Servicing. The CFPB indicated that it will focus on whether a borrower’s race or ethnicity impacts the difficulty of working out a solution with mortgage owners and student loan servicers.
  • Small Business Lending. The CFPB indicated that it will evaluate fair lending risks related to women-owned and minority-owned small businesses.

Notably absent from the list of priorities are auto lending and credit cards, two areas that have been a focus of the CFPB since its inception. The CFPB stated that progress made to improve fairness in those markets has allowed for a shift into other areas of concern. And while this announcement signals where the CFPB’s fair lending resources may be targeted, financial institutions should not take this as an indication that other fair lending areas will not be scrutinized.
Considering this recent announcement, lenders should continue to strengthen their fair lending compliance management systems to provide broad coverage over fair lending risks and increase priority of monitoring and testing related to redlining, mortgage and student loan servicing, and small business lending.

There is much uncertainty regarding the state of the CFPB and the priorities that it has announced in light of the potential changes that may be implemented by the incoming administration. For instance, it has been contemplated that the new administration may place a hold on the implementation of any new rules not yet implemented, or place a moratorium on the proposal of new rules. Other potential leadership changes to the agenda may alter the supervision activities and priorities of the agency as well. In the meantime, however, financial institutions should monitor the CFPB’s current and projected rulemaking and supervision activities and assess the impact(s) on their businesses and risk management frameworks.

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FATF Praises U.S. Progress in Fighting Money Laundering but Identifies Vulnerabilities

In December 2016, the Financial Action Task Force (FATF), an international standards body designed to develop and promote policies to combat money laundering and terrorist financing, published its first Mutual Evaluation Report (MER) of the United States’ anti-money laundering and counterterrorist financing (AML/CTF) program since 2006. The MER provides an assessment of how the U.S. complied with the FATF’s 40 recommendations, a comprehensive set of measures intended to protect the global financial system against money laundering and terrorist financing. While the 2016 MER recognizes that the U.S. has excelled in many areas over the past decade and maintains a well-developed and robust AML/CTF regime, it also highlights areas of vulnerabilities.

In the 2016 MER, the FATF highlights several key developments since 2006, including improving international collaboration and domestic coordination and cooperation with a variety of agencies on AML/CTF issues. Additionally, the FATF reports that the financial services industry, the sector that bears a significant portion of the measures required by the Bank Secrecy Act (BSA), has evolved to better understand the processes, systems and tools available to mitigate against and prevent money laundering, such as effective transaction monitoring, effective onboarding, and identification and reporting of potentially suspicious activity. Further, the FATF notes that the U.S. AML/CTF regime is well supported by sound risk assessment processes, as evidenced by the 2015 National Money Laundering Risk Assessment (NMLRA) and the National Terrorism Financing Risk Assessment (NTFRA).

While lauding the U.S. for strengthening certain areas of its AML/CTF program, the FATF also identifies significant gaps in the U.S. framework:

  • The U.S. received the lowest possible rating for its poor efforts to prevent criminals from using legal entities to facilitate illicit schemes. This rating was driven by the inadequate and untimely access to comprehensive and accurate beneficial ownership information in the United States. Prior to the issuance of the MER, the U.S. Department of the Treasury finalized a customer due diligence (CDD) rule that, among other things, requires covered financial institutions to identify the beneficial ownership information of new legal entity customers and is effective in May 2018. With the passing of the CDD rule, the U.S. is taking steps to strengthen this sector of its AML/CTF program and enhance its ability to identify and trace illicit flows of money in a timely fashion.
  • The FATF noted that the U.S. lacks coverage of designated non-financial businesses and professions (DNFBPs), such as lawyers, accountants, real estate agents, and trust and company service providers, particularly related to CDD, recordkeeping, suspicious transaction reporting and internal controls.

Financial institutions should carefully review the MER and continue to monitor the U.S. AML/CTF regulatory framework as it enhances its efforts to protect the global financial system from abuse. To aid this effort, U.S. financial institutions should review internal controls specific to existing customer identification, verification, and ongoing monitoring policies and procedures. Further, financial institutions should perform know your customer (KYC) system assessments to evaluate the effectiveness of existing customer information collection practices and enhance the linkage among customer information collected, risk-rated profiles and transaction monitoring.

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India’s Demonetization Spawns Creative Money Laundering Networks and Encourages the Use of Online Payment Methods

In November 2016, India’s prime minister declared in an unscheduled televised speech that all 500- and 1,000-rupee notes (equivalent to approximately $7.50 and $15.00 in U.S. dollars, respectively) in circulation would cease to be considered as legal tender by the government. Citizens were given until Dec. 30, 2016, to deposit these notes into a bank account or to exchange them for newly designed 500- and 2,000-rupee notes. The government action to remove these notes from circulation (known as demonetization), voiding approximately 86 percent of cash in circulation, was intended to purge “black money,” or illegal cash holdings, from its financial system, improve tax collection, enhance surveillance of criminal networks and encourage broader acceptance of electronic payment methods.

This act is not without controversy, however. Long queues, limitations on the amount of currency that could be exchanged per day and the shortage of new bank notes have sent shockwaves through India’s economy. Questions abound as to whether this action will have any short- or long-term socioeconomic benefits and whether this effort to cleanse India’s financial system has instead worsened it by potentially spawning future generations of black money.
While Indians scrambled to convert their rupee notes, money laundering networks have reportedly prospered across the country by assisting people seeking to evade taxation and declaration. Money laundering networks, organized crime, corruption and alternative money transfer systems (such as hawala) appear to have found ways to circumvent the government oversight that the demonetization effort was intended to effectuate:

  • Money laundering networks and agents with creative means and legal exemptions offered services to convert banned rupee notes by connecting people seeking to avoid taxation with high-turnover and cash-intensive businesses, such as garment manufacturers and jewelers, many of which are exempt and can report the banned notes as revenue to the government.
  • It is expected that banned notes are being laundered through bank accounts of farmers and rural account holders, many of whom are exempt from paying taxes on income from any sources.
  • Axis Bank, the third largest of the private-sector banks in India, recently suspended several bank officers for assisting perpetrators and colluding with banking authorities to convert large amounts of illegal rupee notes into legal currency.

India’s government continues to take action to help transition India’s cash reliant society into a more cashless one. Early reports suggest that Indians are increasingly turning to electronic payment services. Digital payment companies are expanding their global footprint and are eager to find opportunities created by the abrupt change to India’s financial system. As the economic situation in India continues to unfold, U.S. financial institutions should continue to pay close attention to the potential growth of the use of electronic payments in this part of the world and monitor the infrastructure and tools utilized by India’s government to detect and deter black money.

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Alternatives to the LIBOR Rate in 2017

The London Interbank Offered Rate (LIBOR) is an index widely used by consumers and financial institutions as a benchmark for determining the interest rate on various debt instruments such as mortgages, credit cards, corporate loans and various types of derivatives. Over the last decade, several of the banks responsible for reporting into the LIBOR calculation process have been accused of colluding to report rates favorable to their trading positions as opposed to their good faith estimate of what interest rate they would pay in the money market. Such efforts to manipulate LIBOR have led to billions of dollars in fines for some of the largest global banks and have undermined consumers’ willingness to rely on LIBOR as a fair benchmark for debt instruments.

As a result, the Federal Reserve Bank of New York (FRBNY) established the Alternative Reference Rates Committee (ARRC), which is tasked with determining an alternative rate to LIBOR. The ARRC has narrowed its alternatives to two candidates:

  • The Overnight Bank Funding Rate (OBFR) is a rate calculated using federal funds transactions and certain eurodollar transactions. The primary drivers for why the ARRC is considering the OBFR include the size of the market, the diversity of counterparties and the potential robustness of transactions in the underlying market.
  • The Treasury’s overnight general collateral financing repurchase agreement (GCF Repo) rate is calculated by using the blended rate of short-term loans/repurchase agreements in the repo market created by the Fixed Income Clearing Corporation, JP Morgan and the Bank of New York. The ARRC is considering the GCF Repo rate as a possible alternative, as there are a high number of transactions in this market as well as a diverse range of financial market participants.

As per the ARRC’s Interim Report and Consultation, the FRBNY notes that these alternative approaches to LIBOR more accurately represent the conditions of the lending market for a given day and subsequently represent a more comprehensive cost of borrowing. The ARRC is expected to make its selection unilaterally later this year. Efforts by other central banks, including the Bank of England, to find an alternative to LIBOR are also underway.

The selection of either of these alternatives will have a deep and wide-ranging effect on money markets around the world. In response to these pending changes, banks and other financial institutions are encouraged to establish working groups and committees to determine the financial impact of transitioning from LIBOR to either of the alternatives under consideration by the ARRC. Important considerations for banks and financial institutions with this transition include determining strategic basis margins as the global banking system moves away from LIBOR, understanding the risks of benchmarking to an untested rate, and internalizing the reputational importance of using what is perceived to be a more equitable and prudential benchmark. Participants in the global financial system will have to establish forward-thinking policies and strategies in order to effectively navigate this significant change in the debt instruments they provide to millions of consumers globally.

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It is important to note that this newsletter is provided for general information purposes only and is not intended to serve as legal analysis or advice. Companies should seek the advice of legal counsel or other appropriate advisers on specific questions and practices as they relate to their unique circumstances.


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