Welcome back to Cabinet News and Views. As the first month of 2024 is well underway, it is proving to be a busy start as global regulators look to tackle major challenges.

In this issue, we touch on a variety of topics including the latest developments from the financial services regulatory agencies, the UK's banking regulator priorities in 2024, the impact of the Retained EU Law and more. 

As always, your comments and questions are valued. Feel free to reach out to us anytime by dropping a note here. 

Mercedes Tunstall and Alix Prentice 
Partners and Co-Editors, Cabinet News and Views

By Mercedes Kelley Tunstall

Partner | Financial Regulation

From January 18th to 20th, the American Bar Association’s Banking Law Committee of the Business Law Section held its winter meeting in Washington, DC. This meeting not only provides an excellent retrospective of the previous year’s regulatory developments, but also tends to be a harbinger of what is on deck for the year to come. 

The opening address was given by the former General Counsel of the Federal Reserve Board ("Fed"), Scott Alvarez, and was focused on the issues he saw as being meaningful for 2024. Among those issues, he identified concerns regarding the state of deposit insurance, in light of the large bank failures in 2023 and the use of the systemic risk exception to insure all deposits of those large failed banks. He also discussed the impact an open banking system and real time payments functionality could have on depository institutions. And, finally, a big topic for all regulatory agencies and regulatory lawyers, the possibility that the Chevron standard of deference for agency decisions could be eroded by the Supreme Court’s decision in Chevron v. Natural Resources Defense Council. 

A panel of regulators from the agencies discussed enforcement priorities and happenings, during which the following observations were made regarding trends that are developing:

• BSA/AML concerns are trending up, which tends to go in cycles, and we seem to be in an era of increasing issues;
• Problem banks are also trending up;
• Increased focus upon institutions that are “repeat offenders”; and
• Continued focus upon third party management risk by financial institutions, especially those third parties that manage critical functions, including human resources.

The Fed, Office of the Comptroller of the Currency ("OCC"), the Federal Deposit Insurance Corporation ("FDIC") and the National Credit Union Association ("NCUA") all discussed their Rules of Practice updates, effective in April, indicating that practitioners should be prepared to adjust to those changes. And, the Consumer Financial Protection Bureau ("CFPB") identified that in addition to a focus on repeat offenders, they expected their enforcement activities to focus on junk fees, predatory lending and addressing the “surveillance economy” of big data being used to guide financial decisions by institutions.

The centerpiece of the winter meeting of the Banking Law Committee is the opportunity to hear thoughts from the General Counsel of the agencies. These discussions tend to be frank and informative, and to that end, these thoughts on the biggest challenges in our current environment, which were touched upon by each panelist, are useful to reflect upon as we proceed into 2024:

• The speed of change in terms of technology, in the economy and in regulation is extremely challenging just now and requires an extremely informed and engaged bar;
• Administrative law courts are under a great deal of pressure, due to various lawsuits that have been filed, which could dramatically slow the agencies’ ability to address harms in the marketplace;
• The rise of non-bank financial institutions, in the form of fintechs, shadow-banks, licensed lenders and money transmitters is providing a great deal of opportunity and flexibility in the financial services marketplace, but also is challenging to guide and properly risk-weight and control; and
• The specter of partisanship has begun to darken the doors of agencies more so than in years past, which can lead to uneven enforcement and regulatory guidance.

By Alix Prentice

Partner | Financial Regulation

Rebecca Jackson, Executive Director, Authorisations, Regulatory Technology, and International Supervision at the Prudential Regulation Authority ("PRA") has written to international banks on the PRA’s thematic supervision priorities for 2024. 

The context of this year’s letter is the events of 2023, and the consequences of sudden losses of customer, counterparty or market confidence and the subsequent need for regulatory intervention. A clear theme for supervisors in 2024 will be governance, risk management, and the ready availability of tools and controls to ensure the speedy identification of risks and appropriate mitigants in challenging market conditions. The PRA is going to be looking to senior management to promote an appropriate risk culture based on an environment of ‘cognitive diversity’ that encourages robust decision-making and takes into account new challenges such as novel technologies, including AI.

The PRA sets out clearly that their expectations remain that banks should cease considering risk in silos, and read risk across their business lines. Counterparty credit and secured financing risks remain priorities for the coming year, and the PRA will be looking to see how banks are capturing those risks and managing them. Unsurprisingly given 2023’s events, financial resilience is at the forefront, including robust treasury management and the monitoring of the interaction between capital and liquidity risks. The PRA is also reiterating its expectation that banks make progress in measuring and putting in place strategies to deal with climate risk in stressed scenarios.

The letter concludes by reminding banks that they have just over a year to meet the Operational Resilience expectations the PRA sets out in supervisory statement 1/21 and be in a position to demonstrate that they can deliver important business services in challenging situations involving disruption. Also on the PRA’s radar is their continuing scrutiny of the provision of regulatory data and the remediation of the deficiencies they have noted to date. 

By Mercedes Kelley Tunstall

Partner | Financial Regulation

The financial services regulatory agencies have rolled into 2024 as busy as ever.  This list hits on some quick takes of developments in the last month; a summit, a meeting and a symposium involving hot topics such as artificial intelligence ("AI"), tokenization and digital assets; and also the announcement of comment period extensions for proposed rules and guidance.

• The Commodity Futures Trading Commission ("CFTC") held a Technology Advisory Committee meeting on January 8th where they addressed several technology-related topics including “White House Executive Order on the Safe, Secure, and Trustworthy Development and Use of AI”, “U.S. Government Efforts to Modernize Federal Cyber Defenses”, “Understanding the Implications of AI on Financial Markets”, and a “Presentation by the Subcommittee on Digital Assets and Blockchain Technology.” The CFTC also typically prepares a report following these meetings, identifying their priorities on these topics, moving forward.
• The Federal Trade Commission ("FTC") is holding an FTC Tech Summit Thursday, January 25th, focused on AI. The summit features four panels including speakers from industry, government, academia and public interest on “AI & Chips and Cloud”, “AI & Data and Models”, and “AI & Consumer Applications.” Typically the FTC will prepare a report some months following these summits that summarizes their learnings from the event, and in the meantime, it is useful to read press coverage of the summit.
• The Office of the Comptroller of the Currency ("OCC") will be holding a symposium on the Tokenization of Real-World Assets and Liabilities on February 8th, which includes panels on “Legal Foundations for Digital Asset Tokens”, “Academic Papers on Tokenization”, “Tokenization Use Cases”, “Risk Management and Control Considerations”, and a Regulator Panel that includes speakers from the OCC, CFTC, Fed and SEC.  As with other conferences held by agencies, the OCC will typically prepare a report on this symposium some months afterwards, but it is useful to follow press coverage of the event, in the meantime. 
• The Securities and Exchange Commission ("SEC") on January 19th issued a “Staff Statement on Rule 6c-11(c)(1)(i)(C) Regarding Description of Foreign Currency Holdings” which provided views regarding exchange-traded funds ("ETFs") and how they should disclose foreign currency holdings on their websites, so that they can comply with the daily portfolio holdings disclosure requirements of the referenced rule. The statement states that hey are “requiring the ETF to provide a brief description of the investment to allow an investor to effectively hedge the ETF” whenever the foreign currency holding has not also been assigned a ticker, CUSIP or other identifier.  Finally, the staff commented that they believe that using the descriptor “cash” for these foreign currency holdings “is not an appropriate ‘description of [the] holding’ under the rule because it does not provide a retail investor or market participant with enough information to understand the ETF’s foreign currency holdings.”
• The SEC, on January 24th, also adopted final rules regarding IPOs conducted by special purpose acquisition companies (SPACs) and in subsequent business combination transactions between SPACs and target companies (de-SPAC transactions). While we will provide a more in-depth discussion of this final rule, the quick hits are that the final rules requires additional disclosures, may require the target company in a de-SPAC transaction to be a co-registrant with the SPAC, deems certain transactions involving reporting shell companies and SPACs to be a sale of securities, and makes certain changes such that the treatment of projections in de-SPAC transactions are better aligned with traditional IPOs. Commissioner Hester M. Peirce filed a vehement dissent. 
• The Federal Reserve announced on January 22nd that they would be extending the timeline for comments to be submitted regarding their interchange fee proposal to May 12, 2024.  The original deadline was February 12, 2024.
• The Fed and the Federal Deposit Insurance Corporation ("FDIC") announced on January 17th that they are extending the resolution plan submission deadline for certain large financial institutions until March 31, 2025, instead of July 1, 2024. This change is likely the result of the agencies’ review of comments received in response to their proposed guidance for how the resolution plans of these financial institutions should be written. While the comment period ended November 30, 2023, the agencies have not yet issued final guidance. 
• On December 22, 2023, the Department of the Treasury issued a request for information ("RFI") regarding public input on the issue of financial inclusion. Comments may be submitted in response to this RFI through February 20th. The RFI asks for responses on such questions as how organizations define financial inclusion, what parameters are used in the organization to define things that in or out of scope of financial inclusion, what features of the financial institution constitute barriers to financial inclusion, how financial inclusion efforts should be gauged and measured, and what actions could be taken to promote financial inclusion more broadly. 
• On January 8th, the OCC announced its inflation adjustments for civil money penalties, using the multiplier provided by the Office of Management and Budget, which was 1.03241.

By Juliette Mills

Associate | Financial Services

The Retained EU Law (Revocation and Reform) Act 2023 (the “Act”) addresses domestic law that originally derived from the European Union, known as “retained EU law”. “Retained EU law” continued to apply to the UK at the end of the Brexit transition period through the EU (Withdrawal) Act 2018, and came into effect the end of 2020. The purpose of the EU (Withdrawal) Act 2018 was to provide legal continuity by preserving the domestic legislation as it applied in the UK on 31 December 2020, including EU obligations by implementing certain EU laws into domestic legislation.

As of 1 January 2024, and as a result of the Act, any “retained EU law” which was not revoked at the end of 2023, will now be known as “assimilated law”. Among other things, the Act will:

• revoke approximately 600 EU-derived measures;
• change the way that EU-derived legislation is interpreted and applied;
• give the government additional powers to change retained EU legislation; and
• make it somewhat easier for UK courts to depart from retained EU caselaw.

Sunset Clause

In May 2023, the government abandoned their initial proposal of a sunset clause that would have automatically repealed a significant amount of “retained EU law” from 31 December 2023. Instead, Schedule 1 to the Act lists over 600 pieces of specific legislation that were automatically revoked on 31 December 2023 (most of which are defunct or of limited relevance particularly in relation to financial services).

Transitioning

Until 23 June 2026, the government will have the power to restate and to revoke and replace: (i) any “retained EU law” that is not primary legislation; and (ii) any “retained EU law” that is not primary legislation the text of which was inserted by subordinate legislation, including any “assimilated law”. Although there will be some limitations on how much change the government can immediately make for logistical and economic reasons, it is taking advantage of the opportunity to review its current regulatory frameworks, in particular with respect to the financial services section.

In the meantime, the government must periodically updated the retained EU law dashboard and publish and lay before Parliament a report on the revocation and reform of retained EU law under the Act.

By Alix Prentice

Partner | Financial Regulation

On 20 December 2023, the Financial Stability Board ("FSB") published revised policy recommendations to address structural vulnerabilities from liquidity mismatch in open-ended funds ("OEF"), concurrently with the publication by the International Organisation of Securities Commissions ("IOSCO") of its final Guidance on Anti-Dilution Liquidity Management Tools ("LMTs"). The aim of these two papers is to support regulatory and supervisory authorities to effect a framework that addresses vulnerabilities arising from liquidity mismatches and strengthens liquidity management in light of perceived deficiencies in current practices. Alongside recent publications by the FCA, the coming year looks to be one of a focus on liquidity management and resilience in the face of stressed market conditions.

FSB Recommendations

These are addressed to regulatory and supervisory authorities and set out key objectives for an effective regulatory and supervisory framework designed to address liquidity mismatches. The revisions build on the FSB’s 2017 Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, and updates focus on clarity of redemption terms and conditions linked to the liquidity of the OEF’s underlying assets through a categorisation approach (liquid, less liquid, illiquid, etc.) Also emphasised is the need for regulators to make sure that a broad set of anti-dilution and quantity-based LMTs are available to OEF managers and used consistently and with greater regularity in both normal and stressed market conditions, and that those anti-dilution LMTs are included in OEF constitutional documents. The Recommendations shift away from characterising LMTs as exceptional tools towards referring to them as quantity-based measures to be used in stressed market conditions. LMTs contemplated include suspensions, gates, in-kind redemptions and side pockets.

IOSCO Final Report

This sets out guidance to entities on the need for appropriate systems and controls to enable compliance with regulatory requirements for the design and use of anti-dilution LMTs as part of an overall liquidity risk management framework that can adapt to both normal and stressed market conditions. The activation of anti-dilution measures should take place in such a way as to avoid material dilution events for funds, and be subject to robust governance and decision-making tools. As with the FSB Recommendations, investor awareness is key to enable investors to factor in the cost of liquidity to their investment decisions.

Next Steps

The FSB and IOSCO plan to review the process, with that process beginning with a stocktake of measures and practices adopted in FSB member jurisdiction scheduled to complete by the end of 2026. IOSCO will also aim to coordinate a stocktake of its recommendations and guidance with the FSB’s. As mentioned above, the UK’s Financial Conduct Authority has also been in touch with UK managers about improvements they expect to see in liquidity management practices and techniques (see here for our note on this) and we anticipate significant regulatory scrutiny to be a feature of this year and into the next with a general emphasis on robust governance, investor awareness and risk management to smooth the effects of stressed market conditions.