1 January 2017 The Impact of the OCC’s Proposed FinTech Charter on Non-Bank Lenders On December 2, 2016, the Office of the Comptroller of the Currency (the “OCC”) issued a white paper proposing to grant a new federal “special purpose” national bank charter (the “Proposed Charter”) to financial technology (“FinTech”) companies operating in the United States. 1 The Proposed Charter would allow a company organized under it (a “Limited Purpose Bank”) to operate across multiple states with a single authorization, and could significantly reduce the complexities that the current patchwork of state laws on lending and money transmission has created. In particular, the Proposed Charter could greatly benefit non-bank businesses focused on lending (“Non-Bank Lenders”), such as credit funds and marketplace lenders. 2 The Proposed Charter has a number of potential drawbacks, and it will likely appeal only to Non-Bank Lenders willing to accept the substantial costs and oversight associated with being regulated as a national bank. Background In the wake of the 2008 financial crisis, as many banks curtailed their lending, Non-Bank Lenders stepped into the gap. Capital has flowed into the sector, with investment in Non-Bank Lenders increasing from US$1.8bn to more than US$24bn in the past five years. 3 The regulatory landscape in the United States has failed to evolve as quickly, however. Non-Bank Lenders face a patchwork of state licensing and other statutes governing their business. While many such laws are intended primarily to protect consumers or unsophisticated borrowers, 1 OCC, Exploring Special Purpose National Bank Charters for Fintech Companies (Dec. 2, 2016), available at https://www.occ.treas.gov/topics/bank-operations/innovation/special-purpose-nationalbank-charters-for-fintech.pdf (the “White Paper”). 2 We note that while certain Non-Bank Lenders may not necessarily be considered to be “FinTech,” the Proposed Charter nonetheless offers them potential benefits. While this Memorandum focuses on Non-Bank Lenders, a number of other types of FinTech companies, such as those that process payments between individuals, could find the Proposed Charter useful as well. 3 Thomas J. Curry, Special Purpose National Bank Charters for Fintech Companies, Address Before the Georgetown University Law Center at 1 (Dec. 2, 2016), available at https://occ.gov/newsissuances/speeches/2016/pub-speech-2016-152.pdf. Contents Background....................... 1 Benefits of the Proposed Charter.............................. 2 Potential drawbacks of the Proposed Charter ............. 2 What’s missing?................ 4 2 others are written more broadly.4 There is no meaningful harmony among the states’ laws on lender licensing, and they vary significantly on questions of what degree and types of activity trigger a licensing requirement and the rigor of supervision over licensed entities. This patchwork approach can be burdensome for Non-Bank Lenders, which need to understand and comply with several sets of regulatory requirements and potentially seek licenses in multiple states. Further, regulators and courts have, in recent years, scrutinized Non-Bank Lenders closely, thus ratcheting up legal risk. 5 Benefits of the Proposed Charter The Proposed Charter could address many of these concerns. First and foremost, the Proposed Charter would preempt state lender licensing laws. Just as a “full featured” national bank may lend to borrowers in every state without concern of a state license, so too would a Limited Purpose Bank. This would reduce the burden of surveying the licensing requirements of each state and the enforcement risk attendant with failing to obtain a license in a particular state. Further, like all other national banks, a Limited Purpose Bank would have the benefit of the preemption of state usury laws (save for that of its “home state”). A Limited Purpose Bank would be regulated by a single regulator, the OCC, which has expressed an interest in promoting financial innovation and has a sophisticated, experienced staff. A Limited Purpose Bank would therefore avoid the difficulties and cost of maintaining relationships with regulators scattered across multiple states. Like all national banks, Limited Purpose Banks would be required to become members of the Federal Reserve System. Among other things, this may potentially give a Limited Purpose Bank access to the Federal Reserve’s discount window, which could lower its short-term borrowing costs and help it address temporary liquidity shortages. Potential drawbacks of the Proposed Charter The Proposed Charter is not without potential downsides. Among them are: 4 Compare, e.g., N.Y. BANKING LAW § 340 (no lending license is required for loans of less than $50,000) with CAL. FINANCE LENDERS LAW § 22100(a) (no person shall engage in the business of lending without obtaining a license). 5 See Md. Commissioner of Financial Regulation v. CashCall, Inc., 225 Md. App. 313, 2015 BL 352784 (Md. Ct. Spec. App. Oct. 27, 2015) (upholding a $5.6 million sanction against a Non-Bank Lender that had made loans to Maryland consumers through an intermediating “fronting bank” for failure to obtain a license as a “credit services business” under Maryland law); Cal. Dep’t of Business Oversight, California DBO Announces Inquiry into ‘Marketplace’ Lending Industry (Dec. 11, 2015), available at http://www.dbo.ca.gov/Press/press_releases/2015/DBO%20Inquiry%20Announcement%2012-11- 15.pdf (describing California’s inquiry into online marketplace lending programs and its focus on consumer protection); see also Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015) (debt collection agency which had purchased distressed credit card debt from national banks was treated as an originating lender and did not enjoy the preemption of state usury laws that those national banks did). 3 > Complexity of federal supervision – While the OCC noted that it would tailor its supervisory standards based on a Limited Purpose Bank’s profile, it also emphasized that it would apply the same “rigorous standards of safety and soundness” as it does to all national banks.6 OCC supervision of Non-Bank Lenders, in most cases, would be more rigorous than that applied by individual state regulators. Further, while there are certain regulatory requirements, such as those under the Truth in Lending Act or the Bank Secrecy Act, that would apply to a Non-Bank Lender with a state license as well,7 federal chartering would give the OCC entrée to closely examine a Limited Purpose Bank’s compliance regime, which could increase compliance costs. Finally, there is some ambiguity as to how the Federal Reserve, which will also have supervisory oversight over Limited Purpose Banks, will approach that task. > Leveraged lending – One point, in particular, worth noting is that a Limited Purpose Bank will be subject to the U.S. banking agencies’ leveraged lending guidance, which requires institutions to carefully monitor, and in some cases limit, their leveraged lending. Non-Bank Lenders operating under state licenses generally are not subject to that guidance. > Capital requirements – The OCC has indicated that its Basel III capital adequacy standards would apply to Limited Purpose Banks. 8 While many state licensed lender statutes impose capital requirements, 9 a Limited Purpose Bank making loans would probably be more limited in its ability to acquire leverage than is the case under state law, which could impact its profitability. > Transactions with affiliates – Section 23A of the Federal Reserve Act (the “FRA”) would impose significant limitations on the ability of a Limited Purpose Bank to lend money to or transact with its affiliates. Such transactions would, among other things, need to be collateralized and would be subject to quantitative limits. Section 23B of the FRA would require all contracts and relationships between a Limited Purpose Bank 6 White Paper at 1, 5 and 8. 7 See 15 U.S.C. § 1602(g) (defining “creditor” to include various types of state-licensed entities); 31 U.S.C. § 5312(a)(2) (defining “financial institution” to include various types of state-licensed entities). Importantly, many state consumer protection laws would be applicable to a Limited Purpose Bank, just as they are to other national banks, notwithstanding the federal charter. 8 See White Paper at 9-10. Indeed, the OCC indicated that it may impose capital requirements on certain FinTech companies with relatively small balance sheets in excess of what would typically be required by its capital adequacy standards (much as it does for limited purpose trust national banks). 9 See, e.g., N.Y. BANKING LAW § 341(b)(5) (requiring liquid assets of at least $50,000); CAL. FINANCE LENDERS LAW § 22104 (requiring a net worth of at least $25,000 for all lenders and up to $250,000 for residential mortgage lenders). 4 and its affiliates, including, potentially, its controlling shareholders, to be on “arm’s length” terms.10 > Activities limitation – A Limited Purpose Bank could only engage in activities permissible for national banks. For instance, a Limited Purpose Bank could not engage in any non-banking business and even its ability to invest in securities would be significantly limited.11 While its affiliates could still engage in a wider variety of commercial activities,12 Sections 23A and 23B would limit the Limited Purpose Bank’s ability to fund such activities. The OCC stated that it may impose additional restrictions on Limited Purpose Banks beyond those applicable to all national banks, and that, as with other national banks, it would require a Limited Purpose Bank to obtain OCC approval prior to any changes in its business plan.13 What’s missing? The Proposed Charter is certainly a step in the right direction. Unlike some non-U.S. regulators, however, the OCC has not adopted a “regulatory sandbox” allowing early-stage companies to test their products and business models under a “light touch” supervisory regime before becoming fully licensed. As a result, the Proposed Charter would likely only be useful to relatively well-developed or well-resourced businesses, and early-stage businesses may have to continue navigating the thicket of divergent state laws. Nevertheless, the Proposed Charter is a promising development in an area in which regulation has not kept pace with market trends or technological innovation. Non-Bank Lenders and FinTech companies have the opportunity to utilize the public comment period, which ends on January 15, 2017, to push the OCC toward greater flexibility with respect to at least some of the potential drawbacks of the Proposed Charter. 10 We have glossed over the complexities of Sections 23A and 23B, and their implementing Regulation W. It is important, however, to note that these sections would likely significantly impact inter-affiliate transactions. 11 See 12 C.F.R. § 1.3 (limiting a national bank’s ability to deal in, underwrite, and purchase and sell securities). 12 Provided that a Limited Purpose Bank did not accept deposits, its affiliates should not be subject to the limitations on non-banking activities contained in Section 4 of the Bank Holding Company Act of 1956. 13 White Paper at 14. 5 A33085662 Authors: The persons listed at right. This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. 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