Category: Financial Services Law

OCC Releases White Paper Discussing Plans For Understanding and Evaluating Financial Technology Innovations

The Office of the Comptroller of the Currency has released a White Paper that discusses the agency’s attitudes and approaches to developments in financial technology, and to the associated innovations that the fintech industry has brought, and continues to bring, at an ever-increasing pace, to banks and others in the financial-services industry.

Fintech innovations come both from within the financial-services industry and from nonbank companies, which may want to offer their products or services as vendors to financial institutions, or, instead, partner with such institutions in offering new services to bank customers.

The White Paper enumerates eight “guiding principles” that the agency says it has formulated “to guide the development of its framework for understanding and evaluating innovative products, services, and processes that OCC-regulated banks may offer or perform.” The term “responsible innovation” occurs throughout the principles, and, indeed, throughout the White Paper.

The principles reflect the OCC’s longstanding emphasis on the importance of such matters as assuring fair access to financial services and fair treatment of customers; giving due attention to effective risk management and preserving safe and sound operations; encouraging all banks to integrate responsible innovation into their strategic planning; promoting effective outreach; and collaborating with other regulators.

Speaking at the American Banker Retail Banking Conference in Las Vegas on April 7, Comptroller of the Currency Thomas J. Curry discussed the White Paper, the agency’s development of it, and some of what the agency hopes it will achieve: “We at the Office of the Comptroller of the Currency want to support efforts by federal banks to innovate, but we also want to be sure that they do so in a responsible way that doesn’t threaten the safety of the system or the financial well-being of bank customers.” He added: “Banks engaged in responsible innovation need to strike the right balance between providing benefits to consumers and businesses with sound risk management.”

The agency says it is considering several alternative structures and methods for understanding and evaluating the new products, services, and techniques, and the related innovations available through use of fintech devices and applications, and how the regulatory and supervisory framework administered by the OCC, and the business plans of the institutions that it supervises, most effectively and efficiently can assure that the benefits of these innovations can be made available to customers, while preserving safety and soundness, and without limiting or restricting the public’s access to financial services, or putting at undue risk the protection of privacy and data security that both commercial and consumer customers of banks now demand.

“Banks of all sizes will need to ensure appropriate risk management plans are in place when considering new products, services and technologies, using models and managing third-party relationships,” Curry said in his Las Vegas speech. “The OCC’s framework will describe ways that national banks and federal savings associations identify and address risks resulting from emerging technology.”

One proposal under consideration is the creation by the OCC of a centralized office on innovation. Presently, according to the paper, “banks and nonbanks use a variety of formal and informal entry points to communicate with the OCC”—one bank that’s interested in an innovative payments process may approach its examiners, for example, while another may seek guidance by inquiring of OCC legal staff whether it would need to obtain a legal opinion before offering or using a new process, and another may “contact one of the agency’s experts on credit, compliance, payments, cybersecurity, or modeling. While providing flexibility, the current process can result in some inconsistencies and inefficiencies.”

The White Paper concludes with a series of nine questions on which the OCC requests public comment, covering such areas as what steps the OCC can take to facilitate responsible innovation by banks and thrifts, what the agency can do to help community bankers better incorporate innovation into their strategic planning processes, and what forms of outreach and information-sharing are most effective.

The paper notes that some fintech innovations have been successful in expanding the access of underserved customers to financial services. Survey data indicate that underserved communities are more likely to use mobile banking technology than “fully banked” communities. Moreover, it adds: “Current innovations in the financial industry hold great promise for increasing financial inclusion of underserved consumers, who represent more than 68 million people and spend more than $78 billion annually.”

At the same time, the paper points out, “Brick-and-mortar branches are a stabilizing force in low-income neighborhoods, and innovative technology should not be seen as a substitute for a physical presence in those communities.” The paper says that the agency may issue guidance “on its expectations related to products and services designed to address the needs of low- to moderate-income individuals and communities,” including “promoting awareness of other activities that could qualify for Community Reinvestment Act consideration.”

ARTICLE BY George A. LeMaistre, Jr. of Jones Walker LLP
© 2016 Jones Walker LLP

SCOTUS Decision Affects Diversity Jurisdiction of Business Trusts

Many registered investment companies and real estate investment trusts are organized as business trusts. Certain states, such as Maryland, Delaware, and Massachusetts have been hospitable to such entities, and therefore are home to many of these entities. In some states, such as Massachusetts, the entities are formed as common-law trusts, while in others there is a statutory authorization for the formation of a business trust. However, unlike corporations which exist as “persons” for the purpose of legal actions, there have been questions raised as to whether business trusts have a separate legal existence.

The issue of whether a trust is a separate legal entity can impact how trusts access courts.  In a decision that could significantly impact the way in which business trusts determine the forum in which they sue or are sued, on March 7, 2016 the U.S. Supreme Court decided a case involving Americold Realty Trust. In that decision, the Court held that, unlike a corporation, a trust does not have a separate legal existence for the purpose of determining the citizenship of the entity.

The decision reaffirmed that a corporation is a citizen of the state in which it is organized (and the state in which it maintains its principal office, if different).  However, in an 8-0 decision, the Court held that trusts are not separate legal entities with a defined state of citizenship.  Rather, the citizenship of a business trust will be determined by where the beneficiaries of the trust are located.  For a large, publicly-owned business trust, such as a registered investment company or a REIT which have shareholders scattered in many or all of the states, that may effectively destroy any basis for such a trust to use diversity of citizenship to affect federal court jurisdiction.  If sued, this could force such entities to litigate in jurisdictions where the trust is not organized and does not maintain an office because an isolated shareholder resides in that jurisdiction.

While there may be little that investment companies or REITs can do to alter the impact of this decision, it will be interesting to see if the state laws authorizing such trusts can be revised in a way that may impact the consequences of this decision.

Article By Steven M. Felsenstein of Greenberg Traurig, LLP

©2016 Greenberg Traurig, LLP. All rights reserved.

Financial Services Sector Implications of ‘Brexit

Should Britain decide to leave both the EU and EEA as a result of a “Brexit” vote on 23 June 2016, the impact on UK and EU financial services firms could be significant.

The City of London is Europe’s key financial centre and one of the world’s leading financial centres. As such, asset managers, investment banks, retail banks, broker-dealers, corporate finance firms, and insurers choose the United Kingdom to headquarter their businesses, anchoring themselves in a convenient time zone and location from which to access the European and global markets.

A central plank of the European Union’s vision for a single market in financial services is that financial services firms authorised by their local member state regulators may carry on business in any other member state by establishing a local branch or by providing services on a cross-border basis without the need for separate authorisation in every host state. UK-based regulated asset managers (e.g., long-only, hedge fund, and private equity), banks, broker-dealers, insurers, Undertakings for Collective Investment in Transferable Securities Directive (UCITS) funds, UCITS management companies, and investment managers of non-UCITS (known as alternative investment funds or AIFs) have a passporting right to carry on business in any other state in the European Economic Area (EEA) in which they establish a branch or into which they provide cross-border services, without the need for further local registration. Passporting also facilitates the marketing of UCITS and AIFs established in the EEA (EEA AIFs) into other member states.

Members of the EEA (which comprises the 28 EU member states and Norway, Liechtenstein, and Iceland) are subject to the benefits and burdens of the financial services single market directives and regulations, including passporting rights. One outcome of a vote to leave the European Union in the UK referendum to be held on 23 June 2016, would be that the UK leaves the EU but decides to remain in the EEA (with a similar status to, say, Norway)—in which case the impact of a “Brexit” on the financial sector would likely be minimal. Another outcome would be that the UK finds it unpalatable politically to leave the EU whilst remaining in the EEA and therefore decides to leave both the EU and the EEA; it is this scenario that would have significant impact on both UK and EU financial services firms.

Effect on Passporting for UK Financial Services Firms

According to figures released by the European Banking Authority (EBA) in December 2015, more than 2,000 UK investment firms carrying on Markets in Financial Instruments Directive (MiFID) business (e.g., portfolio managers, investment advisers, and broker dealers) benefit from an outbound MiFID passport, and nearly 75% of all MiFID outbound passporting by firms across the EEA is undertaken by UK firms into the EEA. Notably, according to the EBA, 2,079 UK firms use the MiFID passport to access markets in other EEA countries, and the next two highest totals in the EBA list are Cyprus (148 firms) followed by Luxembourg (79 firms). EEA-wide, there are around 6,500 investment firms authorised under MiFID. The United Kingdom, Germany, and France are the main jurisdictions for more than 70% of the MiFID investment firm population of the EU; more than 50% are based in the UK.

We consider that these figures suggest that Continental consumers potentially stand to lose more than UK consumers in terms of the cross-border provision of financial services in the event of a Brexit, which could be a driver for the UK being given a special deal to permit access to continue, although this needs to be weighed against the political imperative that the remaining EU countries would likely feel against being seen as being too accommodating to a country leaving the EU.

In the event of a Brexit where the United Kingdom leaves the EEA, unless special arrangements for the UK were to be agreed between the UK and the EU, and subject to the more detailed comments below, UK firms would cease to be eligible for a passport to provide services cross-border into, or establish branches in, the remaining EEA countries (rEEA) and to market UCITS and AIFs across the rEEA. Instead, local licences would be required, and the use of relatively low-cost branches in multiple member states may have to be reassessed. UK-authorised firms no longer able to passport into the rEEA but wishing to do so would need to consider moving sufficient of their main operations to an rEEA jurisdiction in order to qualify for a passport.

Effect on UK Financial Services Regulatory Law

The EU is a major source of UK financial services regulatory law. Recent UK parliamentary research estimates that EU-related law constitutes one-sixth of the UK statute book. That figure does not include the deposit of more than 12,000 EU “regulations” which take direct effect in each member country (including the UK) in contrast to EU “directives” which must be implemented or “transposed” in local law by each country; EU regulations would cease to apply in the UK post-Brexit. In addition, it would be necessary for the UK to renegotiate or reconfirm a series of EU negotiated free-trade deals that would not automatically be inherited by the UK upon Brexit. Post-Brexit, the UK would need to legislate to “renationalise” voluminous laws rooted in the EU and fill any regulatory gaps in UK legislation once the EU treaties ceased to apply.

It would be open to the UK merely to incorporate directly applicable EU regulations into UK law. This might be the easiest course of action, given the volume and breadth of issues which would need to be addressed by the UK government in the event of a vote to leave the EU.

Accordingly, in contrast to the impact that the UK leaving the EEA would have on passporting, the UK regulatory environment for financial services firms may not change dramatically in the event of a Brexit, at least in the short-term. Furthermore, any subsequent changes to the UK regime are more likely than not to be deregulatory in nature and therefore favourable to UK firms. In relation to the AIFMD, to take one example, the UK government would have the option to introduce a more tailored and proportionate regime for fund managers managing AIFs with lower risk profiles.

Pre-Referendum Planning

Planning for a Brexit is difficult without knowing what a post-Brexit landscape would look like (as yet, this is a “known unknown”). However, in the run up to the UK referendum, it seems prudent for UK financial institutions to consider the impact of a Brexit on the terms of any new contracts being entered into and, if relevant, seek to make provision for a Brexit (e.g., by including Brexit in a force majeure provision; providing for termination rights in the event of a Brexit and adapting references to the EEA to continue to cover the UK, if appropriate).

Passporting aside, UK firms will also need to assess the practical issues that would arise in the event of a Brexit. For instance, investment strategies that permit investments in the EEA may need to be amended in order for investments in the UK to continue to be permitted. Similarly, a Brexit may impact the terms of product distribution agreements and other service agreements.

Alternative Investment Fund Managers Directive (AIFMD)

If the UK were to leave the EEA, then, potentially: UK AIFMs would be treated as non-rEEA AIFMs, marketing by UK AIFMs of AIFs to rEEA investors would have to be undertaken on the basis of member state private placement regimes, and UK AIFMs would no longer be able to manage (from the UK) an AIF established in an rEEA member state without being locally authorised in that member state to do so. Further, UK AIFMs that utilise AIFMD passports for MiFID investment services to provide segregated client portfolio management and/or advisory services on a cross-border basis would cease to be able to use those passports. Conversely, rEEA AIFMs that seek to manage or market AIFs in the UK or provide MiFID investment services to clients in the UK in reliance on AIFMD passports would no longer be able to do so.

However, unlike other single-market directives, the AIFMD provides for its regime to be extended to non-EEA managers, and this offers a potential “third way” should the UK not remain in the EEA. If the UK were to leave its current AIFMD compliant regime in place, it ought to be technically straightforward, following a Brexit, for the AIFMD to be extended to the UK. In this scenario, UK AIFMs could continue to be authorised under the regime and be entitled to use the AIF marketing and management passports (a non-rEEA manager passport). This possibility may influence the UK government to leave the current UK regime unchanged in the event of a vote to leave the EU. However, any such extension of the AIFMD would require a positive opinion from the European Securities and Markets Authority (ESMA) and a decision by the EU Commission, so there would be a political dimension to it that would likely introduce uncertainty.

It is important to note, though, that the use by a UK AIFM of a non-rEEA manager passport would be subject to a number of conditions prescribed by the AIFMD that would have material practical implications. In particular,

  • a UK AIFM would need to be authorised by the regulator in its rEEA “member state of reference” (this would be determined in accordance with the AIFMD by reference to where in the rEEA the manager is proposing to manage and/or market funds). This regulator could not be the Financial Conduct Authority (FCA), so the use of a non-rEEA manager passport would involve dual regulation and supervision—by the FCA in the UK and by a regulator in an rEEA country in relation to compliance with the directive for funds managed or marketed in rEEA countries (the guidance and approach to application and interpretation of the directive by the regulator and local rules in the member state of reference may well differ from that of the FCA);

  • it would be necessary to establish a legal representative in the member state of reference in order to be the contact point between the manager and rEEA regulators, and the manager and rEEA investors. The legal representative would be required to perform the compliance function relating to funds managed or marketed in rEEA countries; and

  • disputes with rEEA investors in a fund managed/marketed by a manager using a non-rEEA manager passport would need to be “settled in accordance with the law of and subject to the jurisdiction of a Member State”—this would preclude the use of UK courts as a forum for disputes with investors.

UK AIFMs should also note that the AIFMD does not provide for a non-rEEA manager passport to cover the provision of MiFID investment services on a cross-border basis. Accordingly, even if the AIFMD were to be extended to the UK so that UK AIFMs could use a non-rEEA manager passport to manage and/or market AIFs in the rEEA, in the event of the UK not remaining in the EEA, UK AIFMs providing cross-border MiFID investment services within the rEEA (e.g. discretionary management/advisory services for separate account clients) may need to think about where the services are in fact being provided and whether local authorisation would be required to continue the provision of those services. For the provision of MiFID investment services, this would re-establish the position prior to the implementation of the Investment Services Directive (the precursor of MiFID) in the mid-1990s.

Undertakings for Collective Investment in Transferable Securities Directive (UCITS)

A UCITS fund must by definition be EEA domiciled, as must its management company. Currently, both UCITS funds and their EEA managers benefit from the passport. UCITS funds are passportable into any other member state for the purposes of being marketed locally to the public and management companies can set up branches and/or provide services cross-border into other member states (e.g., a UK-based management company can provide management services to a UCITS fund based in any other EEA country such as, for example, Ireland or Luxembourg). UK UCITS funds and management companies established pre-Brexit would no longer qualify as UCITS post-Brexit. UK-based UCITS funds would no longer be automatically marketable to the public in the rEEA and would therefore become subject to local private placement regimes. Conversely, a UCITS fund established, say, in Ireland or Luxembourg, would no longer be marketable in the UK to the general public, and a management company based in Ireland or Dublin would no longer be entitled to provide management services to a UK-based UCITS fund.

Accordingly, consideration would need to be given to migrating UK UCITS funds to an rEEA country. Otherwise, UK UCITS funds would become subject to the AIFMD regime instead of the UCITS regime and would be subject to additional restrictions and unavailable to most types of retail investor. UK UCITS management companies would have to migrate to rEEA in order to continue to benefit from the passport.

The Markets in Financial Instruments Directive (MiFID)

MiFID gives EEA investment firms authorised in their home EEA country a passport to conduct cross-border business and to establish branches in other EEA countries, free from additional local authorisation requirements. MiFID prohibits member states from imposing any additional requirements in respect of MiFID-scope business on incoming firms that provide cross-border services within their territory, but does allow host territory regulators to regulate passported branches in areas such as conduct of business.

UK-regulated firms that undertake MiFID business would no longer be able to rely on the passport to undertake MiFID business in rEEA and might have to restructure accordingly. Conversely, rEEA firms that seek to undertake MiFID business in the UK would no longer be able to do so and might also have to restructure. However, in contrast to UCITS, that outcome is potentially leavened by the new third-country regime indicated by the recast Markets in Financial Instruments Directive (MiFID II).

The impact on the provision of cross-border MiFID investment services might be diluted by the regime under MiFID II permitting non-EEA firms to provide investment services to professional clients on a pan-EEA basis upon registration with ESMA, but this would not be an immediate solution, as it would be subject to ESMA making an equivalence determination under MiFID II in relation to the UK, and the timing would be highly uncertain (in particular, MiFID II seems unlikely to come into effect until January 2018, which will be 18 months after the UK referendum). The UK could implement an equivalent regime (in practice, largely by not repealing or amending its EU-generated legislative inheritance and “renationalising” it) to secure its status as an “equivalent” third country with which EEA firms can do business. However, it seems unlikely, given the technical difficulties and delays being experienced generally by ESMA in relation to MiFID II implementation, that an equivalence determination for any non-EEA firms will be high on the agenda until sometime following January 2018.
UK financial institutions would need to consider the regulatory perimeter in each rEEA country in which a financial institution wishes to undertake business. Conversely, rEEA financial institutions would need to consider the UK perimeter to identify what activities by them in the UK would engage a registration requirement locally in the UK.

On the other hand, equivalency considerations aside, the proposals under MiFID II for the unbundling of research and trading fees would fall away in the UK and remain in the rEEA. The unpopular cap on bonuses for systemically important banks and investment firms brought in by the Capital Requirements Directive (CRD) would also fall away in the UK but remain in the rEEA. Notably, the EBA has recently indicated that the bonus cap should be imposed on all firms subject to the CRD, which would implicate a huge increase in the number of banks and investment firms subject to the cap. On 29 February, it was announced that FCA and the Prudential Regulation Authority had decided to reject that advice on the basis of proportionality. Accordingly, even without a Brexit, the UK is already implementing a policy which should put it at a competitive advantage to other EEA countries that decide to follow the EBA’s guidelines.

Under MiFID, EEA countries must permit investment firms from other EEA countries to access regulated markets, clearing and settlement systems established in their country. Post-Brexit, UK investment firms would no longer be able to rely on those provisions, but nor would rEEA firms looking to access the UK. It is precisely this possibility of “mutually assured destruction”—combined with the UK’s status as Europe’s leading financial centre—that could drive some hard bargaining post-Brexit by both sides towards a constructive outcome in favour of continuing integrated financial markets and services.

The European Market Infrastructure Regulation (EMIR)

EMIR applies to undertakings established in the EEA (except in the case of AIFs, wherever established, where it is the regulatory status of the manager under AIFMD which is key) that qualify as “financial counterparties” or “non-financial counterparties.” Since, post-Brexit, a UK undertaking would no longer be established in the EEA, under EMIR, UK undertakings that are currently financial counterparties or non-financial counterparties would become third-country entities (TCEs) for EMIR purposes.

Post-Brexit, UK undertakings—along with other TCEs—would not be able to avoid EMIR altogether, as a number of its provisions have extraterritorial effect, including in relation to key requirements such as margin for uncleared trades and mandatory clearing. The trade reporting obligation, however, does not apply to TCEs. The UK government would need to consider whether to introduce similar reporting requirements domestically, particularly given the size and importance of the UK derivatives market. If UK undertakings became TCEs, they would be required to determine whether they would be financial counterparties or non-financial counterparties if they were established in the rEEA, an exercise which would be straightforward.

In any event, UK undertakings subject to the clearing and margin requirements of EMIR pre-Brexit would remain subject to such requirements when entering into derivatives transactions with rEEA firms post-Brexit. Importantly, the exemption from the forthcoming mandatory clearing requirement for UK pension scheme trustees would cease to apply post-Brexit. Accordingly, a UK pension scheme would no longer be able to rely on the EMIR exemption when entering an OTC derivative contract with an rEEA counterparty.

The City of London boasts some of the world’s largest clearing houses, and at least three of them are currently permitted under EMIR to provide clearing services to clearing members and trading venues throughout the EEA in their capacity as ESMA-authorised central counterparties (CCPs). Post-Brexit, however, a UK CCP would become a third-country CCP. Under EMIR, a third-country CCP can only provide clearing services to clearing members or trading venues established in the EEA where that CCP is specifically recognised by ESMA. This would require, among other things, clearing houses operating out of London to apply to ESMA for recognition, the European Commission to pass an implementing act on the equivalence of the UK’s regime to EMIR, and relevant cooperation arrangements to be put in place between the rEEA and the UK—a lengthy process overall. Financial institutions based in rEEA will certainly want to continue to access UK regulated markets and CCPs.

Article By Simon Currie & William Yonge of Morgan, Lewis & Bockius LLP

Copyright © 2016 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

EU Policy Update – February 2016 re: Dutch Presidency and Brexit, Digital Single Market Policy, Energy and Environment

Dutch Presidency and Brexit

In January, the Netherlands took over the Presidency of the Council of the European Union from Luxembourg.  In line with the political intentions of the Juncker Commission to be ‘big on the big issues but small on the small issues’, the Netherlands promises to focus on the essentials during its Presidency.  In particular, the Dutch Presidency would like to focus on migration and international security.  Another priority is to strengthen the free movement of services and the free movement of workers, where the Presidency would like to strengthen the protection of workers posted abroad.

Additionally, on February 2, the President of the European Council, Donald Tusk, presented his proposals for a ‘new settlement of the United Kingdom within the European Union’.  If accepted, they would allow David Cameron to campaign in the ‘Brexit’ referendum on the continuing membership of the UK in the bloc.  The Heads of State and Government will discuss and adopt the text in a meeting on February 18.  For Covington’s analysis of the proposals presented and the referendum, please see here.

Digital Single Market Policy

The formal adoption of the EU Network and Information Security (NIS) Directive is a step closer following a vote on January 14 by the European Parliament’s internal market and consumer protection (IMCO) committee.  The committee confirmed that the minimum harmonisation requirements under the Directive do not apply to digital service providers.  This means that Member States will not be able to impose any further security or notification requirements on digital service providers beyond those contained in the Directive, when transposing it into national law.  The NIS Directive will now be put forward for a plenary vote in the European Parliament.  Once it is published in the Official Journal of the European Union and enters into force later this year, Member States will have 21 months to transpose it into national law.  Member States will then have a further 6 months to apply criteria laid down in the Directive to identify specific operators of essential services covered by national rules.  These processes are likely to be complicated, and companies that may fall within scope should participate in consultations and monitor developments across the EU over the coming months.

On January 19, the European Parliament adopted a resolution on the Digital Single Market Strategy of the European Commission.  The parliamentarians called for ambitious and targeted actions to complete Europe’s digital single market.  Among other things, the MEPs support the end of geo-blocking practices across Europe, the setting of a single set of contract rules and consumer rights for online sales and for digital content, and the modernization of the copyright framework.

On February 2, the European Commission and U.S. Government reached a political agreement on the new framework for transatlantic data flows.  The new framework – the EU-U.S. Privacy Shield – succeeds the EU-U.S. Safe Harbor framework. The EU’s College of Commissioners has also mandated Vice-President Ansip, in charge of the Digital Single Market, and Commissioner Jourová, Commissioner for Justice, Consumers and Gender Equality, to prepare the necessary steps to put in place the new arrangement.  For Covington’s full analysis of the announcement of the EU-U.S. Privacy Shield, please see here.

Energy and Environment Policy

The European Commission published a proposal to update the approval requirements and market surveillance of new passenger cars and their respective systems and components.  The Commission’s proposal aims at strengthening the credibility and enforcement of the applicable safety and environmental requirements for cars, following the controversy regarding Volkswagen last year.

In a significant departure from past EU legislation, the proposal would empower the Commission to impose administrative fines on economic operators who are found not to have complied with the approval requirements, of up to €30,000 per non-compliant vehicle.

The Commission’s proposal focuses on three elements.  First, the European Commission proposes to reinforce the credibility of the type-approval assessment of new vehicles by ensuring that the technical services testing the new vehicles are fully independent from car manufacturers.  For this purpose, the proposal would enhance the financial independence of such technical services and require Member States to create a national fee structure to cover the costs of type-approval testing and market surveillance activities for vehicles.  Moreover, in order to prevent the use of ‘defeat devices’, as in the Volkswagen controversy, the proposal would grant approval authorities and technical services access to the software and algorithms of the vehicles tested.

Second, the proposal includes measures to strengthen the market surveillance of vehicles after they are type-approved and in circulation.  Member State authorities and the Commission would be able to conduct tests and inspections on cars available on the market and would be empowered to adopt restrictive measures in case of non-compliance of vehicles.  Among other proposed measures, the Commission would establish and chair a forum to coordinate the network of national authorities responsible for type-approval and market surveillance.  Member States would also be able to inspect and take measures against vehicles type-approved in a different EU Member State.

Third, the Commission proposes measures to ensure that non-compliant manufacturers are penalized in case of non-compliance.  Member States would be required to adopt penalties for non-compliant economic operators, including car manufacturers, importers and distributors, as well as technical services.  This may be complemented by administrative fines, imposed by the Commission, of up to €30,000 per non-compliant vehicle, as referred to above.

Finally, the European Commission hopes to ensure a more uniform application of the legislation in the EU by proposing a Regulation as opposed to the current Framework Directive 2007/46/EC.  If adopted, the Regulation would be directly applicable in national law with no requirement of transposition.

The Commission proposal is available here; it has been sent to the Council and European Parliament for consideration.

The European Commission is expected to propose a revision of the Fertilizers Regulation (EC) 2003/2003 in March 2016.  This revision comes in parallel to the Circular Economy Package announced in December 2015, which aims to create a single market for the reuse of materials and resources.

Under the current EU Regulation 2003/2003, manufacturers and importers of fertilizers may choose to comply with the laws of the Member States where they market their products, or to get their products approved and CE-labeled under the Regulation.  However, Regulation 2003/2003 only regulates a limited number of categories of fertilizer products.

According to Commission officials, the proposal aims to create a level playing field between existing, mostly inorganic categories of fertilizers, and innovative fertilizers, which often contain nutrients or organic matter recovered and recycled from biowaste or other secondary raw materials.  Therefore, the proposal will make the approval process more flexible for new categories of CE-labeled fertilizers.

The draft legislative text is structured in four parts: (i) a list of materials that could be used for the production of CE-marketed fertilizing products under the conditions included in the annexes of the proposal; (ii) a list of product function categories for fertilizers, rules for blends of different product categories, and respective safety and quality requirements for each category included in the annexes; (iii) an annex with the labelling requirements by product function; and (iv) a section with the different conformity assessment procedures.  Fertilizers that follow the harmonized EN standards will be presumed to conform with the requirements of the regulation.

Moreover, the proposal would continue to allow Member States to regulate national fertilizing products.  Products that are not in compliance with the EU Fertilizers Regulation and do not carry the CE label would be able to marketed in a particular Member State if they comply with its national legislation.

Importantly, the revised Fertilizers Regulation is also likely to include an EU-wide limit on the presence of cadmium in fertilizers.  In November 2015, the Scientific Committee on Health and Environmental Risks published an opinion concluding that new scientific information available justifies an update of the 2002 opinion on Member State Assessments of Risk to health and the Environment from Cadmium – see here.

The draft proposal is currently in inter-service consultation among the different Directorates General of the European Commission.  Fertilizer manufacturers wishing to voice their opinion regarding the future Regulation on fertilizers should reach out now to the different services of the Commission.

Internal Market and Financial Services Policies

On January 15, the European Commission launched a public consultation on non-binding guidance for reporting non-financial information by certain large companies, following Article 2 of Directive 2014/95/EU – see here.  Directive 2014/95/EU aims at improving the transparency of certain large companies related to Environmental matters, social and employee matters, human rights, and anticorruption and bribery matters.  The feedback gathered during the consultation will be used to prepare the guidelines and facilitate the disclosure of non-financial information by undertakings.  The public consultation will run until April 15, 2016.

On January 28, the European Commission presented its so-called Anti-tax Avoidance Package – see here.  The initiative includes: (i) a new communication on tax avoidance in the EU; (ii) a proposal for an Anti-Tax Avoidance Directive; (iii) a proposal for a Directive implementing the G20/OECD Country by Country Reporting (CbC Reporting); (iv) a Recommendation to the Member States on Tax Treaties, and (v) a Communication on an External Strategy regarding tax avoidance.

The Anti-Tax Avoidance Directive includes six measures, which aim at limiting the abuse of six well-established practices used to avoid taxes in various jurisdictions in Europe.  These include the mismatch in legal characterisation of financial instruments or legal entities between Member States, excessive inter-group interest charges, and a general anti-abuse rule against arrangements the essential purpose of which is to obtain a tax advantage.

The legislative proposal on CbC Reporting aims to strengthen the existing mandatory and automatic exchange of information between the Member States in the field of taxation.  The proposal also requires the parent entity of a multinational group to report to the competent authorities the aggregated information on the revenue, profit (or loss) before income tax, income tax paid, income tax accrued, stated capital, accumulated earnings, number of employees, and tangible assets other than cash equivalents, in respect of each jurisdiction in which the group operates.

Finally, because tax avoidance has a strong global dimension, the EU will also cooperate better with third countries on tax issues. The Commission therefore proposes to adopt a common EU system to screen, list and put pressure on third countries that refuse to adopt policies to limit tax avoidance. In addition, before the end of 2016, the Commission and Member States will consider whether to put in place sanctions to incentivize third countries to improve their tax systems.

Life Sciences and Healthcare Policies

At the beginning of February 2016, the Dutch presidency will resume trilogues on the legislative proposals regarding the medical devices Regulation (“MD proposal”) and the in vitro diagnostic medical devices Regulation  (“IVD proposal”).  The European Commission presented this pair of proposals in September 2012, and recently called upon the Council of Ministers and the European Parliament to reach an agreement in the first half of 2016.  The Dutch delegation therefore intends to ramp up the number of trilogues between the institutions to five political meetings and 10 to 15 technical meetings during its presidency.  Nonetheless, important differences remain between the negotiators on the reprocessing of single use devices, liability insurance for manufactures, and the classification of devices in the framework of the IVD proposal.  It is understood that the Dutch presidency hopes to achieve an agreement by the Employment, Social Policy, Health and Consumer Affairs Council of June 17, 2016.

Trade Policy and Sanctions

On January 1, the Deep and Comprehensive Free Trade Area (“DCFTA”) between the EU and Ukraine became operational.  According to the Commission, the implementation of the DCFTA will improve the Gross Domestic Product of Ukraine by circa 6% and increase economic welfare for Ukrainians by 12% over the medium term.

On January 13, the European Commission held an initial orientation debate on Market Economy Status for China in anti-dumping proceedings.  Under the current WTO rules, the EU can calculate potential anti-dumping duties on the basis of data from another market economy country rather than the domestic prices used in China, because there is a presumption that market economy conditions do not prevail in China.  However, this provision, included under Article 15(a)(ii) of China’s Protocol of Accession to the WTO, will expire on December 12, 2016.  The Commission is therefore considering its options for changing the methods used to calculate dumping margins in respect of China.  It is important for the Commission to start the process on time, because any change in the anti-dumping rules are likely to require legislation to be adopted by the Council and the European Parliament.  Given the delicate nature of such negotiations, the process is expected to take a year.

January 16, 2016, saw the Implementation Day of the Joint Comprehensive Plan of Action (“JCPOA”) – the historic deal reached among China, France, Germany, Russia, the UK, the U.S., the EU and Iran to ensure the exclusively peaceful nature of Iran’s nuclear program.  As part of that agreement, the Council of the EU lifted all nuclear-related economic and financial EU sanctions on Iran.  It did so by bringing into force the EU legislative package adopted on October 18, 2015, following the verification by the International Atomic Energy Agency (“IAEA”) that Iran had complied with the requirements laid down in the JCPOA.  As of January 16, many sectors and activities have been reactivated, including, among others: financial, banking and insurance measures; oil, gas and petrochemical; shipping and transport; gold and other metals; software; and the un-freezing of the assets of certain persons and entities.  Note that proliferation-related sanctions, including arms and missile technology sanctions, will remain in place until 2023 (subject to various conditions).  For the Council press release, see here.  For more details, see the Council Information Note here.

Article By Sebastian F.A. Vos of Covington & Burling LLP
© 2016 Covington & Burling LLP

Foreign Correspondent Banking – The Good, The Bad and The Ugly

Foreign correspondent accounts have long been used by financial institutions to facilitate cross-border transactions. However, as a result of its susceptibility to money laundering and terrorist financing, this practice is encountering heightened concern among U.S. banking regulators. In this rigorous environment, it is increasingly important for financial institutions to take positive actions designed both to safeguard their operations against illicit transactions and, in the event their correspondent business comes under regulatory scrutiny, to establish a defensible position.

What is a foreign correspondent account?

A “correspondent account” is statutorily defined as “an account established to receive deposits from, make payments on behalf of a foreign financial institution, or handle other financial transactions related to such institution.”1 Laying the foundation for its Anti-Money Laundering (AML) guidance on foreign correspondent accounts, the Federal Financial Institutions Examination Council (FFIEC) adds some detail explaining, “An ‘account’ means any formal banking or business relationship established to provide regular services, dealings, and other financial transactions. It includes a demand deposit, savings deposit, or other transaction or asset account and a credit account or other extension of credit.”2 Moving from that neutral view, the FFIEC later takes a more positive tone, stating, “Foreign financial institutions maintain accounts at U.S. banks to gain access to the U.S. financial system and to take advantage of services and products that may not be available in the foreign financial institution’s jurisdiction. These services may be performed more economically or efficiently by the U.S. bank or may be necessary for other reasons, such as the facilitation of international trade.”3

The Good: Benefits of foreign correspondent banking

The concept of foreign correspondent banking is an accepted practice that can be very beneficial to financial institutions and their customers. Correspondent banks essentially act as a domestic bank’s agent abroad in order to service transactions originating in foreign countries. Championing a positive view, the Bank for International Settlements observes, “Through correspondent banking relationships, banks can access financial services in different jurisdictions and provide cross-border payment services to their customers, supporting international trade and financial inclusion”.4

The Bad: Challenges of foreign correspondent banking

Notwithstanding the benefits related to foreign correspondent banking, this practice also presents significant challenges, with regulatory burden featured prominently. Extensive rules governing foreign correspondent accounts implement the provisions found in USA PATRIOT Act sections 312 (imposing due diligence and enhanced due diligence requirements on U.S. financial institutions maintaining foreign correspondent accounts), 313 (preventing foreign shell banks from having access to the U.S. financial system) and 319(b) (authorizing federal law enforcement to investigate any foreign bank maintaining a U.S. correspondent account). The decline in correspondent banking relationships has much to do with the challenge of regulatory compliance, as recently noted by the American Bankers Association, “[O]ne key factor leading to the decline in correspondent/respondent banking relationships is the heightened regulatory burden on banks related to anti-money laundering and counter terrorism compliance.”5

The Ugly: Foreign correspondent banking as a means to launder money and finance terrorism

The regulatory strictures are not without good reason. There have been instances of foreign correspondent accounts being used to launder money and to potentially finance terrorism. Even in the early rush to implement the USA PATRIOT Act, the OCC, though taking a balanced view, expressed its concern, stating, “Although [correspondent] accounts were developed and are used primarily for legitimate purposes, international correspondent bank accounts may pose increased risk of illicit activities.”6 In recent years, the U.S. government has sent a strong message to financial institutions that fail to create a process to prevent criminal behavior. Financial institutions that disregard their obligations under the Bank Secrecy Act or operate without effective anti-money laundering programs have been the subject of enforcement actions resulting in hefty penalties. In 2012, a Virginia-based bank that allowed itself to be used to launder drug money flowing out of Mexico agreed to pay a record $1.92 billion to U.S. authorities, including hundreds of millions of dollars in civil money penalties to the Office of the Comptroller of the Currency, the Federal Reserve, and the Treasury Department.7 In 2015, a German-based bank and its U.S. branch accused of violating laws barring transactions with Iran, Sudan, Cuba and Myanmar, as well as abetting a multi-billion dollar securities fraud, agreed to pay $1.45 billion in fines.8 In both of these high-profile cases, government authorities cited Bank Secrecy Act violations including: (1) failure to have an effective AML program, (2) failure to conduct adequate due diligence or to obtain “know your customer” information with respect to foreign correspondent bank accounts, and (3) failure to detect and adequately report evidence of money laundering and other illicit activity. Mirroring the U.S. actions, the international Financial Action Task Force has sounded this stern warning in addressing the cross-border financial activities of Iran and North Korea: “Jurisdictions should also protect against correspondent relationships being used to bypass or evade counter-measures and risk mitigation practices … .”9

The Solution: How financial institutions can best protect themselves from a harmful correspondent banking relationship

In order to meet its obligations to measure, monitor and control risks, a financial institution should consider the following actions:

1. Ensure BSA/AML policies and procedures are reviewed at least annually and adjusted to address any new risks related to correspondent banking activities.

2. Perform an annual risk assessment to determine the adequacy of its BSA/AML/OFAC program, especially as it relates to correspondent banking.

3. Conduct due diligence on counterparties to understand the nature and extent of the various aspects of the correspondent’s business, including, but not limited to, ownership, products, services, customers, locations, etc. Due diligence should be ongoing based upon the nature and scope of the correspondent activities and should include periodic validation of the counterparties and their activities by the correspondent bank.

4. Ensure that adequate expertise and resources are available to establish a BSA/AML/OFAC program capable of effectively and timely monitoring the volume and nature of activities processed through the correspondent account.

5. Ensure that the correspondent bank, and not the initiating bank, administers the systems used to process correspondent banking transactions, thus allowing the correspondent bank to independently identify exceptions, generate reports and analyze data to support its BSA/AML/OFAC program.

6. Perform monitoring of processed correspondent banking transactions in a timely manner, preferably through the use of an automated system that can effectively aggregate transactions and create “alerts” in order to identify potentially suspicious transactions.

7. Ensure that the correspondent bank establishes an enhanced due diligence (EDD) protocol that will be followed for investigative purposes when transactions trigger a BSA/AML alert in the monitoring system.

Steven Szaroleta and Walter Donaldson are co-authors of this article.

Article By Frank A Mayer, III, Richard M. Berman, Jonathan L. Levin & Molly K. Lampe of Dinsmore & Shohl LLP
Steven Szaroleta and Walter Donaldson are co-authors of this article.
© 2016 Dinsmore & Shohl LLP. All rights reserved.

1 31 U.S. Code § 5318A(e)(1)(B)
2 https://www.ffiec.gov/bsa_aml_infobase/pages_manual/OLM_027.htm
3 http://www.ffiec.gov/bsa_aml_infobase/pages_manual/olm_047.htm
4 http://www.bis.org/cpmi/publ/d136.pdf
5 http://www.aba.com/Advocacy/commentletters/Documents/cl-BIS-CorrespondentBanking2015Dec.pdf
6 http://www.occ.gov/topics/bank-operations/financial-crime/money-laundering/money-laundering-2002.pdf
7 http://www.reuters.com/article/us-hsbc-probe-idUSBRE8BA05M20121211
8 http://www.justice.gov/opa/pr/commerzbank-ag-admits-sanctions-and-bank-secrecy-violations-agrees-forfeit-563-million-and
9 http://www.fatf-gafi.org/documents/documents/public-statement-october-2015.html#DPRK

In three weeks! Attend the 3rd Annual Bank & Capital Markets Tax Institute West – December 3-4 in San Diego

When: December 3-4, 2015
Where: The Westin San Diego, San Diego, California

Register today!

We are proud to announce that BTI West will be coming back for a third year! For 49 years the annual BTI East in Orlando has provided bank and tax professionals from financial institutions and accounting firms in-depth analysis and practical solutions to the most pressing issues facing the industry, and from now on professionals on the west coast can expect the same benefits on a regular basis.The tax landscape is continually changing; you need to know how these changes affect your organization and identify the most efficient and effective plan of action. At BTI West you will have access to the same exceptional content, networking opportunities and educational value that have made the annual BTI East the benchmark event for this industry.

In an industry that thrives on both coasts, we will continue to offer exceptional educational and networking opportunities to ALL of the hard-working banking and tax professionals across the country. Join us at the 2nd Annual Bank and Capital Markets Tax Institute WEST, where essential updates will be provided on key industry topics such as General Banking, Community Banking, GAAP, Tax and Regulatory Reporting, and much more.

The Bank Tax & Capital Markets Institute Conference – West will feature a full one-day program consisting of keynote presentation, deep-dive technical sessions, and peer exchange and networking time.

In three weeks! Attend the 3rd Annual Bank & Capital Markets Tax Institute West – December 3-4 in San Diego

When: December 3-4, 2015
Where: The Westin San Diego, San Diego, California

Register today!

We are proud to announce that BTI West will be coming back for a third year! For 49 years the annual BTI East in Orlando has provided bank and tax professionals from financial institutions and accounting firms in-depth analysis and practical solutions to the most pressing issues facing the industry, and from now on professionals on the west coast can expect the same benefits on a regular basis.The tax landscape is continually changing; you need to know how these changes affect your organization and identify the most efficient and effective plan of action. At BTI West you will have access to the same exceptional content, networking opportunities and educational value that have made the annual BTI East the benchmark event for this industry.

In an industry that thrives on both coasts, we will continue to offer exceptional educational and networking opportunities to ALL of the hard-working banking and tax professionals across the country. Join us at the 2nd Annual Bank and Capital Markets Tax Institute WEST, where essential updates will be provided on key industry topics such as General Banking, Community Banking, GAAP, Tax and Regulatory Reporting, and much more.

The Bank Tax & Capital Markets Institute Conference – West will feature a full one-day program consisting of keynote presentation, deep-dive technical sessions, and peer exchange and networking time.

Buyer Beware! Despite Tokenization, Mobile Payments are not Bulletproof

Virtual Card Present – A New Breed of Mobile Credit Card Fraud 

As credit card fraud rises, ensuring the security of mobile payments is important for merchants and consumers alike. To combat fraud, the next generation of mobile payment platforms employ tokenization to create more secure mobile payments systems. While tokenization may reduce the susceptibility to mobile payment fraud, it is not bulletproof, leaving room for a new breed of credit card fraud.

Tokenization is a process in which sensitive information, such as a credit card number, is replaced with a randomly generated unique token or symbol. Tokenization helps simplify a consumer’s purchasing experience by eliminating the need to enter and re-enter account numbers when shopping on mobile devices. Tokens benefit merchants too, by eliminating the need for them to store payment card account numbers. Merchants have decreased risk as they are not directly handling sensitive and regulated data. The result is overall increased transaction security and reduction in mobile payment fraud.

For example, Apple Pay uses tokenization to ensure all personal account numbers (PANs) are replaced with randomly generated IDs, or tokens, that are then used to authorize one-time transactions. Although Apple Pay users upload credit card information to their devices, neither Apple nor retailers ever have direct access to this sensitive financial data. The security of the iPhone’s tokenization is further bolstered by the use of a biometric fingerprint that is stored on an isolated chip, separate from the token.

Even with the use of tokenization, there remains a weak link in securing mobile payments: ensuring a mobile payment system provides its app to a legitimate user, rather than a fraudster. And criminals love a weak link.

While Apple Pay’s use of tokenization coupled with the biometric authentication provides strong security, hackers are committing a new type of fraud by exploiting this weakness in user authentication. To circumvent tokenization (and biometrics), hackers have been loading iPhones with stolen card-not-present data to create Apple Pay accounts. This essentially turns the stolen credit card data back into a “virtual” physical card – à la Apple Pay.

The responsibility for this new type of Virtual Card Present (VCP) rests with the card issuers, who have the burden of establishing that Apple Pay cardholders are legitimate customers with valid cards. Some banks have begun addressing the issue of user authentication by requiring customers to call to activate Apple Pay, ensuring their identities are verified.

VCP fraud is sure to increase as additional entrants, such as Samsung and Loop Pay, enter the market with their own mobile payment systems. The largest Apple Pay competitor, CurrentC, backed by the Merchant Customer Exchange (MCX), a consortium of large retailers, is set to be launched later this year. While boasting “Security at Level” including passcode, paycode and cloud protection, how CurrentC intends to combat VCP fraud is yet to be seen.

As cybercriminals grow more sophisticated, mobile payment providers and issuers should react to VCP by focusing on developing innovative and strong user authentication solutions.

This article appeared in the October 2015 issue of The Metropolitan Corporate Counsel. The views and opinions expressed in this article are those of the author and do not necessarily reflect those of Sills Cummis & Gross P.C. Copyright ©2015 Sills Cummis & Gross P.C. All rights reserved

Article By Nicole Joy Leibman of Sills Cummis & Gross P.C.

© Copyright 2015 Sills Cummis & Gross P.C.

Only three weeks away! Register for the 50th Annual Bank and Capital Markets Tax Institute East – November 4-6, 2015

When: November 4-6, 2015

Where: Hilton Orlando Lake Buena Visa, Orlando, FL

Register now!

For the past 49 years Bank and Capital Markets Tax Institute (BTI) has provided bank and tax professionals from financial institutions and accounting firms in-depth analysis and practical solutions to the most pressing issues facing the industry. With cutting-edge sessions, speakers and networking opportunities BTI is the must attend event for all forward-thinking tax professionals.

Now in its 50th year, BTI 2015 will continue to provide attendees with unmatched tools and resources to ensure that you continue to remain current on the ever-changing issues facing the industry. Essential updates will be provided on key industry topics such as General Banking, Community Banking, IRS Developments, GAAP, Tax and Regulatory Reporting, and much more.New to the program this year, we’ve added sessions on Regulatory Banking, Tax Process, Technology & Efficiency, and much more!

Who Should Attend?

Job Function

  • Accountant
  • Attorney (Tax)
  • Business Development
  • Comptroller
  • Consultant
  • Chief Financial Officer (CFO)
  • Internal Auditor
  • Partner/Senior Manager
  • Tax Advisor
  • Tax Officer/Specialist
  • Tax Research/Manager
  • Treasurer
  • Other Corporate Finance Management
  • Administrator (Government)
 Organizations

  • Commercial Bank
  • CPA Firm
  • Government
  • Investment Bank
  • Law Firm
  • Online Bank
  • Retail bank
  • Savings and Loans
  • Technology/Software Industry Provider
  • Consultant: Business/Finance
  • Consultant: Other
  • Academia/Non-Profit

BTI West is coming back for a 3rd year! Register for the Bank and Capital Markets Tax Institute West – December 3-4 in San Diego

When: December 3-4, 2015
Where: The Westin San Diego, San Diego, California

Register today!

We are proud to announce that BTI West will be coming back for a third year! For 49 years the annual BTI East in Orlando has provided bank and tax professionals from financial institutions and accounting firms in-depth analysis and practical solutions to the most pressing issues facing the industry, and from now on professionals on the west coast can expect the same benefits on a regular basis.The tax landscape is continually changing; you need to know how these changes affect your organization and identify the most efficient and effective plan of action. At BTI West you will have access to the same exceptional content, networking opportunities and educational value that have made the annual BTI East the benchmark event for this industry.

In an industry that thrives on both coasts, we will continue to offer exceptional educational and networking opportunities to ALL of the hard-working banking and tax professionals across the country. Join us at the 2nd Annual Bank and Capital Markets Tax Institute WEST, where essential updates will be provided on key industry topics such as General Banking, Community Banking, GAAP, Tax and Regulatory Reporting, and much more.

The Bank Tax & Capital Markets Institute Conference – West will feature a full one-day program consisting of keynote presentation, deep-dive technical sessions, and peer exchange and networking time.