October 20, 2022
There was lots of big news coming out of the FDIC Board this week − an important Advanced Notice of Proposed Rulemaking on resolution requirements for large banking organizations (announced jointly with the Federal Reserve Board) and the announcement of a 2 basis point increase in deposit insurance assessment rates.
Also in the news, just yesterday, a three-judge panel of the 5th Circuit Court of Appeals ruled that the funding of the CFPB, as a bureau of the Federal Reserve, is unconstitutional. This is an important decision that is just the latest threat to the structure of the CFPB. We will have more to say on this decision in a forthcoming Client & Friends memo and in next week's Cabinet News and Views.
Finally, we thank our friends at Conyers in the Cayman Islands for their article on Russia-related financial sanctions.
For now, we welcome any comments or questions. Just drop me a note here.
Daniel Meade
Editor, Cabinet News and Views
The Federal Reserve Board (“FRB”) and Federal Deposit Insurance Corporation (“FDIC”) Board issued an Advanced Notice of Proposed Rulemaking (“ANPR”) titled “Resolution-Related Resource Requirements for Large Banking Organizations.” Separately, but relatedly (if for no other reason than the FRB put it in the same press release as the ANPR), the Office of the Comptroller of the Currency (“OCC”) and the FRB approved their respective applications for the merger of MUFG Union Bank into U.S. Bank.
The ANPR is seeking comment on possible changes to the resolution-related standards applicable to large banking organizations (“LBOs”) that are not global systemically important banks (“GSIBs”). Those possible changes that the FRB and FDIC are contemplating would bring some of what is required for GSIB resolution planning down to LBOs, particularly focusing on “Category III” firms with $250 billion to $700 billion in total assets. The main focus of the ANPR is on whether LBOs ought to be required to issue long-term debt similar to the total loss-absorbing capacity (“TLAC”) requirements for GSIBs. The ANPR notes that the Fed and FDIC are considering “whether an extra layer of loss-absorbing capacity could increase the FDIC’s optionality in resolving the insured depository institution,” but also costs associated with such a requirement.
The ANPR flows logically from remarks made by Acting Comptroller Hsu at the Wharton Conference on Financial Regulation in April (and which we discussed in a previous issue), and that Acting Comptroller Hsu noted in his statement when he voted in favor of the ANPR at the FDIC Board meeting.
As noted above, in the same press release announcing the ANPR, the FRB announced the approval of the application by U.S. Bancorp to acquire MUFG Union Bank. The FRB’s order noted that upon consummation, U.S. Bancorp’s consolidated assets would total approximately $698.7 billion, and noting the close proximity to becoming a “Category II” firm over $700 billion in assets imposed a unique commitment to give quarterly implementation plans for complying with Category II requirements. The commitment by U.S. Bancorp also could trigger a need for U.S. Bancorp to comply with Category II requirements by December 31, 2024, even if its asset size has not gone above the $700 billion threshold. FRB Governor Michelle Bowman issued a statement supporting both the issuance of the ANPR and the approval of U.S. Bancorp’s application, but questioned the appropriateness of imposing Category II requirements on a one-off basis. The OCC’s approval was conditioned, among other things, on U.S. Bank making plans for its possible operability in the event of a resolution in order to facilitate its sale to more than one acquiring institution.
The Federal Deposit Insurance Corporation (“FDIC”) Board had a busy Tuesday. In addition to the release of an ANPR on Resolution Requirements for large banking organizations that we also write about this week, the FDIC Board finalized its proposal to increase the assessment rates in initial base deposit insurance rates by 2 basis points.
The Final Rule is unchanged from the proposal. As we noted in June, the FDIC estimates that the increase in deposit insurance assessment rates should increase the likelihood that the Deposit Insurance Fund (“DIF”) will meet its statutory minimum ratio of 1.35% prior to the statutorily mandated date of September 2028. Notwithstanding the statutory minimum of 1.35% for the DIF’s designated reserve ratio (“DRR”), the FDIC has stated that its long-term goal is to maintain a 2% DRR. As of June 30, 2022, the DRR stood at 1.26%.
As we noted in August, several bank trade associations questioned the FDIC’s assumptions and projections for the DIF, and thus disagreed with the need for the 2 basis point increase in deposit insurance assessment rates. In response to the final rule, the bank trade associations that commented on the proposal issued a statement that they “are disappointed that the FDIC has chosen to increase assessment rates based on assumptions that are demonstrably incorrect.” The statement went on to note that the increase could hurt banks’ ability to support economic growth.
(This guest article comes to us from partners Derek Stenson and Michael O’Connor and associate Sarah Farquhar of Cayman Islands law firm Conyers. It was originally published last week in Cadwalader’s Fund Finance Friday newsletter.)
Russia’s invasion of Ukraine has demonstrated again how interconnected the political and financial worlds have become. For those of us in the private equity and finance worlds, it has also given rise to associated challenges posed by the Russia-related financial sanctions that have followed. In the fund finance market, these issues have arisen both for sponsors (who are now faced with issues around freezing the assets of sanctioned investors without being able to remove them) and lenders (some of whom have been faced with credit parties to their facilities who now have sanctioned investors in their LP roster).
Unfortunately for us, there is no easy way to address these issues as the war, and sanctions issues, continue to rumble on.
In response to the sanctions and the associated problems that have arisen for investment funds that have sanctioned investors, the Governor of the Cayman Islands last week issued a General Licence (GL/2022/0001) in respect of “Designated Persons – Redemption/Withdrawal of investment, basic needs, routine holding and maintenance and payment of legal fees” (the General Licence).
Spoiler Alert: While most industry participants hoped that the General Licence would provide welcome solutions to issues with sanctioned minority investors in Cayman funds, this is unfortunately not the case for the reasons set out below.
What is the current position?
In short, where a fund has a sanctioned investor (which has been identified by the fund/fund manager itself or by its administrator as part of a periodic check of investors, which is more often the case) it must: (i) freeze the assets and funds of the sanctioned investor; (ii) report the issue to the Cayman Islands Financial Reporting Authority; and (iii) not take any action that could be considered to be “dealing” with the assets of the sanctioned investor, nor make any funds or economic resources available to them. As the definition of “deals with” is very broad, it has led to a position whereby there are few, if any, actions a fund can take in respect of a sanctioned investor once it has frozen the assets – in particular, it cannot (without obtaining a licence, at least) redeem or involuntarily withdraw such an investor from the fund and place its assets in a blocked account or attempt to “sidepocket” the investor without potentially being seen to “deal” with the assets.
What permissions has the General Licence introduced and why does it not help with minority investors that are sanctioned?
The General Licence provides that a “Relevant Investment Fund” may redeem, withdraw or otherwise deal in an investment interest of a person that is not a designated person or owned/controlled by a designated person (a designated person being a sanctioned person).
A “Relevant Investment Fund” is defined as being an investment fund whose assets are frozen due to the investment fund being owned or controlled (e.g., 50%+) directly or indirectly by a designated person. We understand that this segment of the market is so small as to be negligible and covers only a handful of funds.
Accordingly, the General Licence is not very helpful to the most frequent issue (minority holdings in a fund by a sanctioned person and the ability to remove that investor from a fund). Even if the definition did cover funds with minority investors, the permissions in the General Licence would not be of obvious use to most funds, as it provides for the redemption/withdrawal of non-sanctioned investors. This, of course, is the opposite of what industry participants had hoped for – being that the fund would now be able to redeem out the problem/sanctioned investor and freeze their assets, allowing the fund to continue on with the non-sanctioned investors.
It’s also important to note that any action to withdraw/redeem an investor is only permitted provided the actions are also permitted by the fund’s constitutional and contractual documents. The licence does not override the contractual position of the fund’s LPA.
Any fund wishing to rely upon the General Licence also needs to be mindful of other applicable sanctions regimes that it may be subject to.
Are there any additional general licences anticipated?
At present, the existing General Licence expires in April 2023 (unless revoked/suspended earlier by the Governor), and so any action that relevant funds wish to take must be ahead of this timeline. It isn’t yet clear if further general licences are to be expected and, if so, whether they would advance the position and allow for the redemptions/withdrawal and subsequent freezing of sanctioned investors from Cayman Islands funds.
Registration will be closing soon for Cadwalader's annual Finance Forum at the JW Marriott in Charlotte next Thursday, October 27.
Programming will begin at 1:00 p.m. and continue throughout the afternoon, followed by a networking reception. Click here for a list of current panel topics and to register.