United States: Financial Services Alert

Interim Rule on Securities Borrowing Transactions Under Market Risk Rules. The OCC, FRB and FDIC issued an interim rule that would amend their market risk capital rules to permit banking organizations subject to them (generally only those organizations with significant trading activities) to exclude from risk-weighted assets receivables recorded when cash collateral is posted in connection with securities borrowing transactions, but only to the extent such receivables are collateralized by the market value of the securities borrowed. These transactions are treated as loans of cash by the bank collateralized by securities and historically generally have been subject to 100% risk weight. Under the interim rule, the new capital treatment is subject to the transaction being (1) based on securities includable in the trading book that are liquid and readily marketable, (2) marked-to- market daily, (3) subject to daily margin maintenance requirements, and (4) one of the following: either a securities contract under the Bankruptcy Code, a qualified financial contract under the Federal Deposit Insurance Act, or a netting contract between or among financial institutions under the Federal Deposit Insurance Corporation Improvement Act of 1991 or the FRB’s Regulation EE. The agencies note that the revised capital treatment under the market risk rules is subject to change pending the outcome of revisions to the Basel Accord. The interim rule is effective January 4, 2001, but U.S. banking organizations may apply its provisions beginning December 5, 2000. Comments must be received by January 19, 2001.

Proposed Rule on Risk Weight for Certain Securities Firms. The OCC, FRB, FDIC and OTS issued a proposed rule that would reduce from 100% to 20% the risk weight applicable to claims by banking organizations on, and claims guaranteed by, qualifying securities firms under the agencies’ risk-based capital rules. Under the proposed rule, qualifying securities firms must be incorporated in an OECD country, subject to the following conditions: (1) if the firm is incorporated in the U.S., it must be a registered broker-dealer and comply with all of the applicable SEC rules; (2) if the firm is incorporated in any other OECD country, it must be subject to consolidated supervision and regulation comparable to that imposed under the Basel Accord; and (3) whether incorporated in the U.S. or not, it (or its parent consolidated group) must have a long-term issuer credit rating, or a rating on at least one issue of long-term unsecured debt (from a nationally recognized statistical rating organization) that is in one of the three highest investment grade categories used by the rating agency. Comments must be received by January 22, 2001.

The FRB voted to issue a proposed rule that is intended to address concerns about "predatory" lending by amending the regulations implementing the Home Ownership and Equity Protection Act of 1994 ("HOEPA"), the part of the Truth In Lending Act ("TILA") that regulates high-cost mortgage loans. HOEPA currently applies to closed-end non-purchase-money mortgages that have: (1) annual percentage rates ("APRs") more than 10% above the interest rate on Treasury securities of comparable maturity; or (2) total associated "points and fees" that exceed the greater of 8% of the total loan amount or $451 (after 1/1/2001, $465). HOEPA requires a lender, among other things, to provide pre-closing disclosures to borrowers and restricts the ability of the lender to make shorter-term balloon loans or to impose prepayment penalties. Violations of HOEPA are subject to significant penalties and HOEPA eliminates most "holder-in-due-course" protections for secondary market purchasers of HOEPA loans. The proposed rule would extend HOEPA coverage to more loans, require additional information in the HOEPA disclosure, and prohibit certain additional practices.

Extends HOEPA Coverage. The proposed rule would lower the interest-rate test to loans with an APR 8% above the interest rate on comparable Treasury securities. It would also expand the definition of "points and fees." Currently, reasonable closing costs paid to nonaffiliated third parties are specifically excluded from the definition. The proposed rule would include amounts paid at closing for optional credit life, accident, health, or loss-of-income insurance and other credit-protection products, including single-premium credit insurance, even if such amounts are paid to nonaffiliated third parties.

Adds Disclosure. The proposed rule would add to the HOEPA disclosure a statement of the total amount borrowed, as reflected in the note. The disclosure is intended to inform consumers in advance of the loan closing that the total amount borrowed may be higher if points, fees and insurance are added to the principal amount of the loan.

Prohibits Certain Acts and Practices. The proposed rule would: (1) prohibit a lender holding a HOEPA loan from refinancing the loan within 12 months of its origination unless the lender can demonstrate that the refinancing is in the borrower’s interest; (2) prohibit a lender from refinancing certain zero-interest-rate and other low-cost loans from mortgage-assistance programs with higher-rate loans within 5 years of origination, unless the lender can demonstrate that the refinancing is in the borrower’s interest; (3) prohibit a lender from treating a mortgage as open-end credit if it does not meet the TILA definition of open-end credit; and (4) prohibit due-on-demand clauses, eliminating the possibility that such clauses can be used to evade HOEPA’s limitation on balloon loans by making nominally non-balloon loans, but declaring them due and payable before their maturity.

The proposed rule would establish a totality-of-the-circumstances test for whether a refinancing is in the borrower’s interest, explicitly importing the standards for such a test established in connection with equal employment opportunity cases. Comments on the proposed rule are expected to be due by March 16, 2001. Other developments on the "predatory" lending front include (1) the FRB’s proposal to revise Regulation C, implementing the Home Mortgage Disclosure Act, to address predatory mortgage lending practices by expanding the scope of information collected, and (2) Massachusetts’ adoption of final amendments to the high-rate mortgage loan regulations, both to be discussed in next week’s Alert.

The FRB proposed to amend Regulation Y to: (1) authorize bank holding companies ("BHCs") to increase the amount of nonfinancial data processing services they may provide in connection with their processing of financial data; and (2) allow financial holding companies ("FHCs") to invest up to an aggregate of 5% of the FHC’s Tier 1 Capital in companies engaged in data storage, Internet and electronic information portal hosting activities, as long as such companies also provide financial data processing or other financial products and services. As to subpart (1) above, in order to enable BHCs and FHCs to make more efficient use of their data processing capacity, the proposed rule would expand from 30% to 49% the amount of revenue that a BHC (or an FHC) may derive from nonfinanical data processing in a data processing subsidiary. As to subpart (2) above, the FRB, in the proposed rule, proposes to find that the cited investments are permissible under the Gramm-Leach-Bliley Act as complementary to a financial activity. The FRB also seeks comments on whether FHCs should be allowed to make noncontrolling investments in companies that (1) engage in new technologies that may support the sale and availability of financial products and services; (2) provide communications links for the delivery of financial products and services; or (3) engage in the electronic sale and delivery of products and services that include, but are not limited to, financial products and services. Comments on the proposed rule are due no later than February 16, 2001.

The SEC proposed amendments to Rule 10f-3 under the Investment Company Act of 1940 that would permit a fund to purchase government securities in a syndicated offering involving an affiliated underwriter. The proposed amendments would also modify the limitation contained within Rule 10f-3 governing a fund’s participation in an offering involving an affiliated underwriter. Currently, Rule 10f-3 limits aggregate purchases in such an offering by a fund and any other fund having the same investment adviser to 25% of the securities issued in the offering. In determining whether this condition had been met, the proposed amendments would also consider purchases by any other account over which a fund adviser has discretionary authority or exercises control. Therefore, in order for a fund to rely on Rule 10f-3 as proposed to be amended, the fund's purchases, aggregated with purchases by any other fund advised by the fund's adviser, and any other account over which the fund's adviser has discretionary authority or otherwise exercises control, could not exceed 25 % of the offering. Comments are due by February 15, 2001.

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