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12.30.2022 | Legal Update

Headlines

1. Fed Adopts Rule to Mandate LIBOR-Replacement Benchmark Rates in Contracts
2. OCC Report on Risks to the Banking Industry Emphasizes Scrutiny of Crypto Activities
3. FDIC Implements Changes to the Rules Governing its Process for Supervisory Appeals
4. Banking Agencies Extend Regulation O No-Action Position for Certain Investment Funds
5. Other Developments: Advertising of Deposit Insurance and Intraday Credit
   
   

1. Fed Adopts Rule to Mandate LIBOR-Replacement Benchmark Rates in Contracts

The Federal Reserve has adopted a final rule that provides benchmark replacement rates based on SOFR (Secured Overnight Financing Rate) for contracts governed by U.S. law that reference the overnight and one-, three-, six-, and 12-month tenors of LIBOR (formerly known as the London Interbank Offered Rate), which will be discontinued after June 30, 2023. The final rule, released on December 16, implements the federal Adjustable Interest Rate (LIBOR) Act and applies to contracts that do not have terms that provide for the use of a clearly defined and practicable replacement benchmark rate for LIBOR. The final rule restates certain safe harbor protections contained in the LIBOR Act for selection or use of the replacement benchmark rate based on SOFR under the rule and clarifies who would be considered a “determining person” able to choose to use the replacement benchmark rate under a contract covered by the final rule. Specifically, the final rule defines a determining person to include a person with a contingent future right to select a replacement for LIBOR, so that such a person can select a replacement benchmark rate based on SOFR under the rule and benefit from the LIBOR Act’s safe harbor protections for that selection. Consistent with the LIBOR Act, the final rule also ensures that LIBOR contracts adopting a benchmark rate selected by the Board will not be interrupted or terminated following LIBOR's replacement. The final rule will be effective 30 days after it is published in the Federal Register, which is expected shortly. Click here for a copy of the final rule.

Nutter Notes:  The LIBOR Act was enacted on March 15, 2022, as part of the Consolidated Appropriations Act, 2022, and authorized the Federal Reserve to establish benchmark replacement rates that are based on SOFR to replace the overnight and one-, three-, six-, and 12-month LIBOR rates in existing contracts that do not provide for a LIBOR replacement. Consistent with the requirements of the LIBOR Act, all of the benchmark replacement rates incorporate spread adjustments for each specified tenor of LIBOR. According to the Federal Reserve, the spread adjustments are intended to address certain differences between SOFR and LIBOR, such as “the fact that LIBOR is unsecured and therefore includes an element of bank credit risk which may cause it to be higher than SOFR.” The final rule identifies different benchmark replacements based on SOFR for derivative transactions and for different types of cash transactions. In choosing different benchmark replacement rates for derivative and other transactions, the Federal Reserve adopted the view of the Alternative Reference Rates Committee (ARRC), a group of private-sector firms convened by the Federal Reserve Board and the Federal Reserve Bank of New York in 2014. ARRC previously identified SOFR as its recommended replacement for LIBOR and developed a plan to support the transition from LIBOR to SOFR.

2. OCC Report on Risks to the Banking Industry Emphasizes Scrutiny of Crypto Activities

Among key risks to the banking industry reported by the OCC in its Semiannual Risk Perspective for Fall 2022, the OCC highlighted crypto asset activities as an emerging risk for banks. The report published on December 8 specifically cautioned banks that risk management and governance practices in the crypto industry lack maturity, stablecoins remain susceptible to the risk of investor “runs,” and that there is a “high risk of contagion” among interconnected crypto businesses. The report warns that dislocations in crypto asset markets and the failures of crypto businesses during the last year illustrate why regulators expect banks to take “a careful and cautious approach to crypto activities and engagement with crypto-related firms.” In particular, the report concluded that recent market stresses revealed that crypto businesses may be engaging in highly leveraged trading, the associated risks of which may be difficult to assess because of the interconnectedness among certain crypto participants through “opaque lending and investing arrangements.” Click here for a copy of the OCC’s report.

Nutter Notes:  The OCC’s Semiannual Risk Perspective for Fall 2022 also underscored the national banks and federal savings associations should expect third-party risk management, including appropriate due diligence and change management, to continue receive heightened supervisory focus from OCC examiners. The report cited as an example the increased risk of consumer fraud associated with many peer-to-peer digital payment platforms. The report indicated that the OCC expects banks to help protect consumers by clearly communicating risks associated with such third-party products and services, educating customers about potential scams, and improving internal fraud monitoring capabilities. The report also discussed ways in which the adopting of innovative technology solutions may complicate a bank’s BSA/AML and OFAC compliance risks. The report advised banks that additional or different controls may be needed to safeguard against financial crimes or violations of federal anti-money laundering requirements as banks partner with, or implement new technologies to compete with, fintech companies.

3. FDIC Implements Changes to the Rules Governing its Process for Supervisory Appeals

The FDIC has adopted changes to its Guidelines for Appeals of Material Supervisory Determinations, including a requirement that materials considered by the Supervision Appeals Review Committee (SARC) be shared with both parties to the appeal (subject to applicable legal limitations on disclosure). The revised guidelines released on December 13 also allow banks to request a stay of a material supervisory determination while an appeal is pending. The revised guidelines expand and clarify the role of the FDIC’s Ombudsman in the appeals process, including by adding the Ombudsman to the SARC as a non-voting member. The Ombudsman will monitor the supervision process following a bank’s submission of an appeal and will periodically report to the FDIC Board of Directors on such matters according to the revised guidelines. Click here for a copy of the revised guidelines.

Nutter Notes: Among other changes, the revised guidelines require the appropriate FDIC Division Director, when deciding whether to issue a stay with respect to a material supervisory determination, to provide the institution with the reason(s) for his or her decision in writing. This requirement was added to the revisions first proposed in October 2022 in response to public comments. The revised guidelines also require that any materials that are required to be shared with parties to the appeal must be delivered on a timely basis, defined as sufficient time to prepare for a meeting with the SARC, which will be overseen by the Ombudsman. The SARC was first established as a new, independent office within the FDIC by the original guidelines adopted in 2021. SARC’s only function is to review and consider supervisory appeals.

4. Banking Agencies Extend Regulation O No-Action Position for Certain Investment Funds

The federal banking agencies have issued new interagency guidance on Regulation O (governing extensions of credit to bank insiders) and Part 363 of the FDIC’s regulations (related reporting requirements) that extend the expiration of a no-action position previously provided in 2021 interagency guidance concerning unintended consequences of the application of Regulation O to companies that sponsor, manage, or advise investment funds and institutional accounts that invest in voting securities of banking organizations. The agencies issued their decision to extend the no-action position on December 22 to continue to consider whether to amend Regulation O to address the treatment of extensions of credit to fund complex-controlled portfolio companies. The term “fund complex” refers to investment funds and institutional accounts that invest in voting securities of banking organizations, together with any company that sponsors, manages, or advises them. The no-action position described in the interagency guidance will now expire on January 1, 2024. Click here for a copy of the interagency guidance.

Nutter Notes:  The interagency guidance explains that, upon acquiring more than 10% of a class of voting securities of a banking organization, a fund complex would be considered a “principal shareholder” of the banking organization for purposes of Regulation O. In addition, any company in which a principal shareholder fund complex owns more than 10% of a class of voting securities could, in some circumstances, be considered a “related interest” of the fund complex (a “fund complex-controlled portfolio company”). In such cases, the principal shareholder fund complex and its controlled portfolio companies would be considered insiders of the banking organization under Regulation O, and loans by the banking organization to the principal shareholder fund complex and its fund-complex controlled portfolio companies would be subject to the lending limits and other restrictions and standards of Regulation O. The interagency guidance clarifies that the federal banking agencies will not take action against banking organizations or principal shareholder fund complexes with respect to extensions of credit by the banking organizations to fund complex-controlled portfolio companies that otherwise would violate Regulation O, provided the fund complexes and banking organizations satisfy certain criteria set forth in the interagency guidance.

5. Other Developments: Advertising of Deposit Insurance and Intraday Credit

• FDIC Proposes Amendments to Official Sign and Advertising Requirements

The FDIC has proposed amendments to Part 328 of its regulations to modernize the rules governing use of the official FDIC sign and banks’ advertising statements to reflect how depositors do business with banks, including through digital and mobile banking platforms. According to the FDIC, the proposed amendments would enable consumers to better understand when they are doing business with a federally insured bank and when their funds are protected by the FDIC’s deposit insurance coverage. Click here for a copy of the proposed amendments.

Nutter Notes: The proposed amendments also would clarify the FDIC’s regulations governing misrepresentations of deposit insurance coverage by addressing specific situations in which consumers may be misled as to whether they are doing business with an insured bank and whether their funds are protected by deposit insurance. For example, the proposed amendments would clarify that a non-bank’s use of the ‘‘Member FDIC’’ logo on its website or in marketing materials would be a misrepresentation unless that logo is next to the name of one or more federally insured banks. Comments on the proposed amendment are due by February 21, 2023.

• Federal Reserve Updates its Policy Governing Intraday Credit

On December 21^st, the Federal Reserve issued technical updates to its policy governing the provision of intraday credit in accounts at the Federal Reserve Banks. The updates include a new rule establishing settlement times for debits and credits to institutions’ Federal Reserve accounts for certain transactions subject to the Automated Claim Adjustment Process (ACAP). The changes will be implemented on January 30, 2023. Click here for a copy of the proposed amendments.

Nutter Notes:  According to the Federal Reserve, the updates are meant to streamline the settlement process and shorten the time needed for debits and credits to settle. Specifically, the federal reserve is adding a new posting rule to part II of its Policy on Payment System Risk to reflect the fact that ACAP adjustments will be made on a gross basis through Fedwire Securities throughout the business day.

Nutter Bank Report
Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, after interviewing our clients and our peers in the profession, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. Visit the U.S. rankings at Chambers.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Heather F. Merton. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich kehrlich@nutter.com Tel: (617) 439-2989	Matthew D. Hanaghan mhanaghan@nutter.com Tel: (617) 439-2583	Michael K. Krebs mkrebs@nutter.com Tel: (617) 439-2288

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.