United States: Structured Thoughts: Volume 7, Issue 4 - March 31, 2016

FDIC Proposals Could Alter Recordkeeping Requirements For Issuers And Distributors Of Brokered CDs

In February 2016, the FDIC released proposed rules that were designed to facilitate the payment of insured deposits when large insured banks fail. The proposal would require insured banks with two million or more deposit accounts to maintain complete data on each depositor's ownership interest by right and capacity for all of its deposit accounts. These banks would also be required to develop the capability to calculate the insured and uninsured amounts for each deposit owner; the FDIC would use this data to make deposit insurance determinations in the event of a failure.

In this article, we discuss how these proposed rules would change the current allocation of responsibility for record keeping between issuers and distributors of brokered CDs. The full proposal may be found at the following link:

https://www.fdic.gov/news/board/2016/2016-02-17_notice_dis_b_fr.pdf.

The Proposed Rule, in a Nutshell

The proposed rule, 12 C.F.R. 370, would apply to banks with two million or more deposit accounts ("covered institutions"). Each such bank would be required to:

  • collect the information needed to allow the FDIC to determine promptly the deposit insurance coverage for each owner of funds on deposit at the covered institution; and
  • ensure that its IT system is capable of calculating the deposit insurance available to each owner of funds on deposit in accordance with the FDIC's deposit insurance rules set forth in 12 C.F.R. 330.

The bank's IT systems would need to facilitate the FDIC's deposit insurance determination by calculating deposit insurance coverage for each deposit account and adjusting account balances within 24 hours after the appointment of the FDIC as receiver.

A covered institution could apply for:

  • an extension of the implementation deadlines;
  • an exception from the information collection requirements for certain deposit accounts under certain limited circumstances;
  • an exemption from the proposed rule's requirements if all the deposits it takes are fully insured; or
  • a release from all of the new requirements when it no longer meets the definition of a "covered institution.

(We discuss several of these exceptions, including their potential application to brokered deposits, in more detail below.)

Covered institutions would be required to certify compliance on an annual basis. A failure to satisfy the rules' requirements would result in enforcement action under the FDI Act.

Purpose of the Proposals

The FDIC is concerned that the size and complexity of large banks justify imposing more specific data requirements, so that the FDIC can make prompt deposit insurance determinations in the event of a failure. Larger banks often use multiple deposit systems, which may complicate the FDIC's deposit insurance determination. Obtaining the necessary information could significantly delay the availability of funds when information is incomplete for millions of accounts.

Additionally, the FDIC believes that larger banks rely on credit-sensitive funding more than smaller banks, which makes the larger banks more likely to suffer a liquidity-induced failure. This could increase the risk that the FDIC would have less time to prepare for administering deposit claims as part of a resolution. In addition, to establish a bridge depository institution, which is the likely resolution strategy for large institutions, the FDIC must generally have the ability to determine rapidly the amount of insured and uninsured deposits that are held by the predecessor failed bank.

Current Rules and Practice

In July 2008, the FDIC enacted its Rule 12 C.F.R. 360.9, which applies to certain large banks. These banks must be able to provide the FDIC with standard deposit account information, which can be used if the bank fails. The rule sets forth the structure for the data files that these banks must provide to the FDIC. However, banks are permitted to populate the data fields by using only preexisting data elements. If the bank does not maintain the information to complete a particular data field, then a null value can be used in that field. As a result of this approach, banks' standard data files can be incomplete. Accordingly, the FDIC believes that if a large bank failed, additional measures would be needed to ensure the prompt and accurate payment of deposit insurance to the relevant depositors.

In the area of brokered deposits, current FDIC rules allow the relevant account identification information to be maintained off-site in the records of the applicable deposit broker or other agent. In the event of a failure, these intermediaries would submit the required depositor information to the FDIC in a standard format within a certain time frame. The FDIC's claims agents would then review the depositor information provided and make a deposit insurance determination. (The FDIC views this process as labor-intensive and will generally require depositors' access to these funds to be temporarily restricted.)

Accordingly, under the present legal regime, deposit brokers maintain the necessary information about the identity of the depositors. The relevant agreements between the issuer and the brokers (or the agreements between the brokers and any "sub-distributors") set forth this requirement. In the case of brokered CDs, the issuer will rarely know the identity of the relevant account holders or the amount that they have on deposit.

Potential Impact of the New Rules

If the proposed rules are adopted in their present form, access to account information will change significantly. Issuing banks will need to obtain this information from their brokers, in the format required under the rules. Any sub-distributors used by the brokers will need to furnish this information up the distribution chain, so that it can reach the issuing bank.

Historically, many distributors of brokered CDs have been reluctant to share purchaser information with other brokerdealers and banks. For example, sharing this information could provide valuable competitive information to other market participants. If the new rules become effective as proposed, brokers would be likely to agree to share this information with other brokers and banks only under an agreement that limits its use to the purposes of the rules and restricts access to the information from bank personnel who might use it in order to seek new customers for their own products.

Available Exemptions?

The proposed rules set forth a number of potential exceptions. However, these exceptions may not be viable alternatives for many or most brokered deposits.

Deposits of Less than the Maximum Insured Deposit Amount. Proposed Section 370.4(a) would permit banks to apply for an exemption if they can demonstrate that they will not take deposits from account holders which, when aggregated, would exceed $250,000 (or any future maximum insured deposit limitation). This exemption will likely not be available in the case of brokered deposits, as the relevant brokers cannot necessarily control (or know about) how much a particular investor may have on account with a particular bank through multiple accounts (or multiple deposit brokers). Moreover, in the case of structured CDs, some investors are sufficiently attracted to a particular instrument that they may seek to invest an amount that causes their total deposits to exceed the maximum.

Legal Restriction. Proposed Section 370.4(c)(1)(ii) would permit an exception to be made if the bank provides a reasoned legal opinion that the relevant information is protected from disclosure under applicable law. This provision is not expected to apply to most brokered deposits.

Frequent Changes. Proposed Section 370.4(c)(1)(iii) would permit an exception to be made if the bank can demonstrate that the information required to be disclosed "changes frequently and updating the information on a continual basis is neither cost effective nor technologically practicable." To the extent that most brokered CDs do not change hands frequently, this may not be an appropriate basis for claiming an exception.

Refusal to Provide Information. Proposed Section 370.4(c)(1)(ii) would permit an exception to be made if the bank has requested the information from the account holder and certifies that the account holder has refused to provide the information or has not responded. This exemption seems particularly relevant to brokered CDs, where one dealer refuses to provide information about its customers to other distributors or to the issuing bank. In fact, in the proposal, the FDIC indicated that a community bank might be able to apply for this exception, due to the relevant competitive concerns. That being said, under the proposal, the FDIC's grant of an application for an exception may or may not be granted, and it may be subject to conditions imposed by the FDIC. It remains to be seen whether an exception would be granted in a situation where the bank or a distributor wishes to continue to offer brokered CDs through a broker that refuses to provide this information, whether due to potential competition or other concerns.

Comments

The FDIC is soliciting comments from the industry and the general public about the proposal. Comments are due in May 2016.

Accounting Standards Update 2016-06: Contingent Call And Put Options In Debt Instruments

In March 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update, ASU 2016-06 (the "Update"),1 to provide new guidelines on how to account for certain call and put options that can accelerate the repayment of principal on a debt instrument. In particular, the Update clarifies how companies should make the "clearly and closely related" determination under ASC Topic 815 "Derivatives and Hedging," in an effort to reconcile the current diversity in accounting practice. The Update also helps ease the reporting burden on banks and other companies that hold these types of instruments by decreasing the likelihood that a contingent option will require the complex treatment of bifurcation under generally accepted accounting principles (GAAP).

Divergent Approaches in Practice

Under ASC Topic 815, embedded derivatives are to be accounted for separately from their host contracts if the economic characteristics and risks of the embedded derivative are not clearly and closely related to the economic characteristics and risks of the host contract. For contingent call and put options (the "embedded derivative") in debt instruments (the "host contract"), ASC Topic 815 states that the clearly and closely related criteria is met if the event that triggers the ability to exercise the option is indexed only to interest rates or credit risk. This guidance lent itself to multiple interpretations, and further guidance put forth by the FASB's former Derivatives and Implementation Group (the "DIG") led to the development of two divergent approaches, one which relied solely on the DIG's guidance and another that combined the DIG's guidance in addition to a separate assessment of whether the triggering event is indexed only to interest rates or credit risk. These two approaches permitted different conclusions about whether a contingent call or put option was clearly and closely related to its debt instrument host and, thus, resulted in different conclusions about whether the options should be bifurcated and accounted for separately as derivatives under GAAP.

FASB Solution

In issuing this Update, the FASB endorses the first approach of utilizing only the four-step analysis put forth by the DIG to determine whether a contingent call or put option meets the "clearly and closely related" test. The DIG's four-step analysis requires an entity to consider whether (a) the payoff is adjusted on the basis of changes in an index, (b) the payoff is based on an underlying index that is something other than interest rates or credit risk, (c) the debt involves a substantial premium or discount, and (d) the call or put option is contingently exercisable. An assessment of whether the event that triggers the ability to exercise a call or put option is related to interest rates or credit risk is not required. According to a comment letter by the American Bankers Association and the Clearing House Association2, this approach should decrease the number of contingent options that require bifurcation under ASC Topic 815. The process of bifurcation, or accounting for such options separately from the underlying debt instrument, can be complex. Therefore, by requiring fewer options to be bifurcated, this Update is expected to ease accounting and reporting requirements for holders of these debt instruments.

Scope and Date of Effectiveness

The Update will be effective for public company financial statements with fiscal years beginning after December 15, 2016, as well as interim periods within those fiscal years. For non-public companies, the Update is effective for fiscal years beginning after December 15, 2017, as well as interim periods within fiscal years beginning after December 15, 2018. Early application is permitted, including adoption during an interim period. The Update should be applied on a modified retrospective basis to existing debt instruments; if adoption takes place in an interim period, any adjustment should be reflected as of the beginning of that fiscal year.

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Footnotes

1 ASU 2016-06 is available at: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167971876&acceptedDisclaimer=true.

2 The comment letter is available at: http://www.aba.com/Advocacy/commentletters/Documents/ABA-TCH-Comments-Contingent-Put-Call-102015.pdf.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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Authors
Anna Pinedo
Bradley Berman
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