U.S. Senate Votes to Block CFPB Arbitration Rule

The U.S. Senate voted on a resolution to overturn the Consumer Financial Protection Bureau’s (“CFPB”) arbitration rule. Republican senators Lindsey Graham of South Carolina and John Kennedy of Louisiana opposed the resolution, and Vice President Mike Pence cast the deciding vote in favor of striking down the rule to break a 50-50 tie.

The CFPB arbitration rule restricts mandatory arbitration clauses in certain consumer financial contracts. The rule has been subject to criticism from various sources who allege that the rule will greatly increase the number of class-action lawsuits, thereby benefiting the plaintiff’s bar and increasing costs to consumers. The U.S. Department of the Treasury recently released a report criticizing the rule and the CFPB’s review process in adopting the rule.

In July, Republicans in the House of Representatives and the Senate introduced joint resolutions to nullify the rule using the authority granted under the Congressional Review Act. Under the Congressional Review Act, a rule can be repealed by simple majority votes in both the House and the Senate within 60 legislative days of its finalization. The House promptly voted to block the rule in July and, by a narrow margin, the Senate has now voted to do the same. The resolution now will be put in front of President Trump, who is expected to sign it into law and block the rule from taking effect.

Lofchie Comment: The need for Congress and the President to undo the actions of the CFPB illustrates what an odd regulatory structure Dodd-Frank created in establishing the CFPB. The agency operates independently of, and now in opposition to, both the Executive and Legislative branches of government. While there are undoubtedly those who favor the rulemakings of the CFPB on a policy basis, that does not change the fact that the CFPB is, from a Constitutional standpoint, operationally unsound. Should a Democrat win in the next Presidential election, presumably the CFPB would be headed by a Republican and appointed by President Trump. Undoubtedly, such an appointee would seek to frustrate the goals of the next President. That is simply not the way that the government should work.

Senator Warren Warns Against Easing Oversight of Big Banks

In an op-ed published by Bloomberg, Senator Elizabeth Warren (D-MA) argued against any measures to reduce the regulation of banks with more than $50 billion in assets.

Senator Warren explained that Dodd-Frank mandates the Board of Governors of the Federal Reserve System (“FRB”) to impose stricter rules and apply more careful oversight to banks with more than $50 billion in assets. According to Senator Warren, the FRB has done a good job of “aggressively tailor[ing]” rules to ensure that banks with just over $50 billion in assets are not treated the same as banks with more than $250 billion in assets. This tailoring process is “ongoing,” and includes recent efforts to lower stress-testing requirements for banks with less than $250 billion in assets.

Senator Warren contended that big banks continue to advocate and lobby for raising the $50 billion threshold to $250 billion, or to have it replaced with a “multi-factor test.” She criticized both approaches, arguing that even banks at the lower end of the threshold pose significant risks to the financial system. Senator Warren posited that the correlated nature of these banks’ portfolios could lead to several of them failing at once. Lowering the threshold would only provide “negligible” benefit, she argued. Senator Warren suggested that changing the threshold would lead not to increased lending, but rather to “additional stock buybacks, mergers, and executive bonuses.”

Lofchie Comment: Senator Warren’s arguments might be more compelling if she tried to fit them more closely to particular facts or concerns. Because she chooses to argue in generalities, her claims have the appearance of generic political statements as opposed to attempts to discuss better financial regulation. As a result, the Senator remains consistent in her views on regulation: more is always better.

Given the authority that the Federal Reserve Board has over banks, it is an overstatement to suggest that banks might escape the Fed’s scrutiny. No one is suggesting that the Fed would not regulate bank holding companies. Further, the federal banking regulators have substantial authority over executive compensation and stock buybacks. That authority is not going to disappear. Lastly, it is not clear why Senator Warren believes that some reduction in regulation would lead to an increase in bank mergers. Heavy regulation results in increased fixed costs, which favors the very largest entities. One need not look far for proof. Since the adoption of Dodd-Frank, there has been increased financial industry consolidation (particularly in areas regulated by the CFTC, where the regulatory increases have been greatest; e.g., the number of FCMs is approximately halved).

Perhaps there are good arguments for maintaining the regulations that Senator Warren supports. If that is the case, Senator Warren would do better, to the extent that her interest is regulatory policy, to make those arguments with a good bit more specificity.

 

Treasury Criticizes CFPB Arbitration Rule

The U.S. Department of the Treasury (“Treasury”) released a report (“Report”) criticizing the Consumer Financial Protection Bureau’s (“CFPB”) arbitration rule (“Rule”). The Rule restricts mandatory arbitration clauses in certain consumer financial contracts. The Rule works by (i) restricting providers from using pre-dispute arbitration agreements that prohibit class action lawsuits, (ii) mandating that providers include language in their arbitration agreements that reflects this limitation, and (iii) imposing requirements that providers submit records related to pre-arbitration agreements to the CFPB for monitoring purposes.

Under the Rule, companies still would be able to include arbitration clauses in their contracts for the resolution of individual disputes. However, in contracts that are subject to the rule, the clauses would have to contain language stating explicitly that they could not be used to stop consumers from being part of class actions in court.

In the Report, Treasury claimed that the CFPB did not appropriately consider whether the Rule would promote customer protection or benefit the public. Instead, Treasury said, the review process undertaken by the CFPB to consider the potential effects of the rule was wholly inadequate. In particular, Treasury argued that:

  • the Rule is expected to generate more than 3,000 additional class action lawsuits that will impose heavy costs on businesses, and these costs will be passed on to consumers in the form of higher borrowing expenses;
  • class action lawsuits do not often result in recovery for most plaintiffs, and affected plaintiffs rarely claim settlement funds when awarded;
  • plaintiffs’ attorneys will receive a financial windfall from the resulting uptick in class-action suits;
  • the CFPB failed to consider whether an improved disclosure regime would benefit consumers more than an outright ban on mandatory arbitration clauses;
  • the CFPB failed to consider the amount of class-action suits that lack merit; and
  • the CFPB had no basis for its claim that the Rule would increase compliance with federal consumer finance laws.

Treasury contended that the CFPB Rule “would upend a century of federal policy favoring freedom of contract to provide for low-cost dispute resolution.” According to Treasury, the CFPB conducted a sub-standard analysis of the Rule before adopting it, and did not show that the Rule will have tangible benefits for consumers.

Lofchie Comment: This may be viewed as a dispute between Obama-holdover regulators who favor “retail” customers and the new Trump regulators who favor “institutions.” More cynically, this may be viewed not so much as protecting “retail” investors as it is throwing a potentially nice-sized bone to class-action lawyers.

The Treasury should be concerned with the risk to individual banks that is posed by class-action lawsuits. If small banks start getting hit with class-action lawsuits that are expensive to defend or settle, both Congress and the FDIC are likely to regret this rulemaking. Let’s see what happens when a small bank is put under real financial stress by being named in a class-action suit.

FRB Governor Describes Impact of FinTech on Banking and Payment Services

In remarks at the 41st Annual Central Banking Seminar in New York, Board of Governors of the Federal Reserve System (“FRB”) Governor Jerome H. Powell described the effect of FinTech on retail banking and payment services, and the role of the Federal Reserve in facilitating responsible innovation in those areas.

Governor Powell asserted that technological innovations, and the increased availability of data and analytics tools, have challenged traditional banking models. Governor Powell described the ability of FinTech to facilitate access to credit through alternative lending platforms that analyze non-traditional metrics to evaluate the financial health of a loan applicant. At the same time, he said, techniques such as “screen scraping” accentuate the necessity of heightened vigilance and raise questions about data security and consumer protection.

In the area of retail payments, FinTech developments now allow for instant payments via smartphone applications. Governor Powell said that enhancements such as integration with mobile messaging and increased security through two-factor authentication, biometrics, IP address verification, and geolocation data offer “tangible” benefits to consumers. He also examined the role of banks in payment innovations, noting that the ability to hold and transfer funds means that cooperation between banks and FinTech companies remains important. He encouraged a collaborative effort to ensure wide-scale improvement to retail payment systems.

Governor Powell suggested that the U.S. lags behind other countries in creating an advanced payment system, and emphasized the FRB’s role as a “leader and catalyst for change.” He explained that the Faster Payments Task Force recently made several recommendations for implementing “safe, ubiquitous, faster payments capabilities,” and that the FRB followed up on the recommendations by identifying several key strategies to achieve the stated goal. Governor Powell also said that the FRB formed a team to develop a proposal for a governance framework, and is considering providing settlement services for real-time retail payments. Finally, Governor Powell committed to the continued support of the Secure Payments Task Force. He shared that the FRB will (i) commission a study to analyze payment security vulnerabilities, and (ii) form work groups to explore approaches to reduce the cost of specific payment security vulnerabilities.

Lofchie Comment: On the one hand, Governor Powell insists that banks continue to be important to the financial system. On the other hand, he says that FinTech firms are racing ahead using technology to perform traditional banking tasks better and faster than banks (or most banks, at least).

These messages are not entirely contradictory. Banks, of course, are essential to the financial system. Individual banks, however, are not. Challenges from new technology providers, combined with materially increased regulatory costs, put individual banks in the midpoint of a rock and a hard place. Technology businesses tend to favor firms that can scale up. How will the banking regulators deal with the challenges to small banks? Proclaiming the significance of small banks in the payment system is well and good, but it won’t keep the doors open, as competition from nonbanks increases and the costs of being a regulated bank rise. How do the regulators think that banks, particularly small banks, will make money and survive? Should the regulators do more to relieve the cost pressure on small banks? Should regulators prepare for the possibility of bank closures?

Index Investing and Active Management…

The asset management industry has been disrupted by the trend toward increased index investing.  Over the years, CFS has explored this phenomenon.  As we look to dig deeper, we encourage members and friends to share insights, papers, or studies.

Although it is rare for us to distribute company research, BlackRock’s “Index Investing Supports Vibrant Capital Markets” is well worth a read.  The piece addresses many elements in the active versus passive debate as well as establishes useful concepts from a practitioners’ point of view.

Key themes include:

  • Index investing is still small or less than 20% of global equities,
  • Asset owners and managers sport different strategies and interests,
  • The balance between active and index management may ultimately be self regulating,
  • Passive owner corporate voting records are mixed between favoring both management versus activist investors.

As the trend will influence the future of the industry, many have raised questions regarding the impact of the move toward index investing in financial stability more broadly.

CFS welcomes and encourages view points and research on all sides of the discussion.  Please email any papers to Lauren Cooper, manager of communications (lcooper@the-cfs.org) or me.

“Index Investing Supports Vibrant Capital Markets” can be found at:
https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-index-investing-supports-vibrant-capital-markets-oct-2017.pdf

President Trump Signs FSOC Bill Assuring Insurance Regulator Continuity

President Donald J. Trump signed into law the Financial Stability Oversight Council Insurance Member Continuity Act (H.R. 3110) on September 27, 2017.

The bill, introduced by Representatives Randy Hultgren (R-IL) and Maxine Waters (D-CA), permits an FSOC independent member with insurance expertise to remain past his or her term for the earlier of (i) 18 months or (ii) when a successor is confirmed.

Representative Hultgren explained the importance of the bipartisan bill:

“[I]t is now extremely important that we have someone with a deep understanding of our insurance markets, and how they interact with our entire financial system, to continue serving as a voting member of FSOC. The Financial Stability Oversight Council Insurance Member Continuity Act ensures that this key regulatory body is able to benefit from the perspective of a voting member with insurance expertise without any unnecessary lapses.”

 

Lofchie Comment: The realization of the “importance” of industry participation in the FSOC designation process is welcome. When FSOC designated MetLife as being systemically important, it generally ignored the views of the FSOC member with insurance industry experience. See FSOC Proposes Preliminary Designation of MetLife as a Non-Bank Systematically Important Financial Institution (with Lofchie Comment).  See also D.C. District Court Calls FSOC’s Review of MetLife’s Status “Fatally Flawed”.

Senate Banking Committee Votes on Key Administration Nominees

The U.S. Senate Banking committee voted to advance the nominees for two prominent banking regulatory positions. The two nominations will now proceed to the Senate floor for a confirmation vote.

Joseph Otting was approved to serve as Comptroller of the Currency. Mr. Otting most recently was managing partner of Ocean Blvd LLC and Lake Blvd LLC. He previously held positions as President and CEO of OneWest Bank and Vice Chair of U.S. Bancorp. Keith Noreika has served as Acting Comptroller of the Currency since Thomas J. Curry stepped down in May 2017 (see previous coverage).

Randal Quarles was approved to serve as Vice Chair of the Board of Governors of the Federal Reserve System (“FRB”). Mr. Quarles had served as Under Secretary for Domestic Finance under President George W. Bush, Assistant Secretary of the Treasury for International Affairs and U.S. Executive Director of the International Monetary Fund. He is the founder and managing director of Cynosure, a private investment firm, and also was a partner at Davis Polk & Wardwell. Current FRB Vice Chair Stanley Fischer recently announced his intention to step down from his position in October 2017 (see previous coverage).

Stanley Fischer to Resign from Federal Reserve Board

Board of Governors of the Federal Reserve System (“FRB”) Vice Chair Stanley Fischer will resign from the FRB on or around October 13, 2017. Dr. Fischer announced his plans in a letter to President Donald J. Trump.

Dr. Fischer was appointed to the FRB by President Barack Obama in 2014 for an unexpired term set to end in 2020. Dr. Fischer’s term as Vice Chair was set to expire on June 12, 2018. During his tenure, Dr. Fischer served as chair of FRB Committees on (i) Financial Stability and (ii) Financial Monitoring and Research. He also represented the FRB internationally in various capacities.

NY Department of Financial Services Cybersecurity Regulation Now Effective

New York State’s “first-in-the-nation” cybersecurity regulation became effective on August 28, 2017.

The New York Department of Financial Services (“DFS”) cybersecurity regulation requires banks, insurance companies and other institutions regulated by the DFS (“covered entities”) to implement a cybersecurity program to protect consumer data (see previous coverage). A covered entity is required to have (i) a written cybersecurity policy or policies approved by the entity’s board of directors or a senior officer, (ii) a “Chief Information Security Officer” in place to protect data and systems, and (iii) other relevant “controls and plans” intended to fortify the safety of the financial services industry.

Firms also will be required to submit a Certification of Compliance annually that concerns the firm’s cybersecurity compliance program. The first such Certificate must be submitted by February 15, 2018. The DFS now requires covered entities to submit notices of certain cybersecurity events to the DFS Superintendent within 72 hours of any occurrence. Covered entities will be able to report cybersecurity events through the DFS online cybersecurity portal.  Institutions also will be able to use the portal to file notices of exemption.

DFS Superintendent Maria Vullo commented on the program:

“With cyber-attacks on the rise and comprehensive federal cybersecurity policy lacking for the financial services industry, New York is leading the nation with strong cybersecurity regulation requiring, among other protective measures, set minimum standards of a cybersecurity program based on the risk assessment of the entity, personnel, training and controls in place in order to protect data and information systems.”

 

Lofchie Comment: As if the life of a compliance officer trying to manage technology risk was not worrisome enough, the NY DFS has now added a state-wide regulatory burden to their job. On the positive side, there is a three-day weekend coming.

FRB Seeks Comments on Proposed Repo-Based Reference Rates

The Board of Governors of the Federal Reserve System (“FRB”) issued a request for public comment on a proposal to publish three new benchmark interest rates based on overnight repurchase agreement (“repo”) transactions backed by Treasuries.

According to the FRB, the following rates would be produced in coordination with the Office of Financial Research:

  • Secured Overnight Financing Rate, which would be the “broadest measure of rates on overnight Treasury financing transactions” by including tri-party repo data from Bank of New York Mellon (“BNYM”), as well as cleared bilateral and General Collateral Financing (“GCF”) repo data from the Depository Trust & Clearing Corporation (“DTCC”). This rate was recently chosen by the Alternative Reference Rates Committee to be used as the alternative to U.S. dollar LIBOR.
  • Tri-Party General Collateral Rate, which would be based only on tri-party repo data from BNYM only.
  • Broad General Collateral Rate, which would be based on tri-party repo data from BNYM, as well as cleared GCF repo data from DTCC.

The FRB noted that since these rates are based on Treasury-backed repo data, they are “essentially risk-free.” FRB is proposing to use a “volume-weighted median” as the “central tendency measure” for the aforementioned rates. The FRB is also proposing to publish the reference rates and accompanying summary statistics at 8:30 a.m. Eastern time, each morning beginning in mid-2018.

FRB is soliciting comments from the public, which must be submitted within 60 days of publication in the Federal Register.

Lofchie Comment: Note that these rates are for fully collateralized transactions, while LIBOR was (at least in theory) a rate for uncollateralized transactions. It would be informative to see how these rates perform in terms of financial stress. For example, would it be the case that a “flight to safety” results in the Secured Overnight Financing Rate declining when rates generally are rising to reflect a perception of increased risk?