Just as we were putting the finishing touches on today's issue, the FDIC voted in favor of a special assessment to recoup the expected $15.8 billion cost to the Deposit Insurance Fund in the aftermath of the Silicon Valley Bank and Signature Bank failures in March. We offer a first take on this vote today and will be looking at this more closely in the weeks to come. 

This week's issue also looks at an important report from the Federal Reserve Board in the U.S. and some important guidance from the Prudential Regulatory Authority in London, along with some very noteworthy enforcement news from the CFTC. 

Are you also looking past the past and, like the FRB and the PRA, focused on what's coming next? I'd love to hear. You can reach out to me here.

Daniel Meade 
Partner and Editor, Cabinet News and Views

By Daniel Meade

Partner | Financial Regulation

The Federal Deposit Insurance Corporation (“FDIC”) Board voted (3-2) to propose a special assessment to recoup the expected $15.8 billion cost to the Deposit Insurance Fund “(DIF”) in the wake of invocation of the special risk exception (“SRE”) to cover all deposits at Silicon Valley Bank and Signature Bank in March. The Notice of Proposed Rulemaking (“NPR”) will be subject to comment for 60 days from publication in the Federal Register.

The NPR would assess a 12.5 basis point assessment on an insured depository institution’s estimated uninsured deposits reported at year-end 2022. This assessment base would be adjusted to exclude the first $5 billion in estimated uninsured deposits reported at year-end 2022. The assessment would be paid over 8 quarters, beginning in 2024. Using this estimated uninsured deposits as the assessment base for the assessment, FDIC Chair Martin Gruenberg stated “[t]he proposal applies the special assessment to the types of banking organizations that benefited most from the protection of uninsured depositors.”

Vice Chair Travis Hill and Director Jonathan McKernan raised concerns with the calibration of the proposal in the Board meeting, noting that many banks that saw large in-flows of deposits in a flight to perceived safety didn’t benefit from the SRE, yet will pay the biggest share of this special assessment. Both Vice Chair Hill and Director McKernan voted no on the proposal. 

The use of the uninsured deposits as the assessment base is a somewhat novel approach by the FDIC. The FDIC’s staff memo regarding the proposal estimates that the proposal would result in 113 institutions paying the special assessment, with the approximately 48 institutions with greater than $50 billion in assets paying a little over 95% of the special assessments.

We will see whether any of the comments result in changes to the proposal. Comments made by Vice Chair Hill and Director McKernan at the Board meeting may show some prescience as to what the very largest institutions may argue given the large inflow of deposits they saw even before the SRE, and that a better calculation of the assessment base may be tied to percentage of uninsured deposits compared to total deposits rather than just an absolute number.     

By Peter Y. Malyshev

Partner | Financial Regulation

By Lary Stromfeld

Partner | Financial Regulation

By Ivan Loncar

Partner | Financial Services

Two settled enforcement actions in April 2023 indicate that the Commodity Futures Trading Commission (“CFTC”) is expecting increased swaps disclosure by swap dealers under the Dodd-Frank Act of 2010 and applicable CFTC regulations.

In the first enforcement action, the CFTC sanctioned a U.S. swap dealer for failing to comply with CFTC Regulation § 23.431, which requires a swap dealer, among other things, to provide pre-trade mid-market marks (“PTMMM”) before each transaction to allow its non-swap dealer counterparties to “make their own informed decisions about the appropriateness of entering into the swap.” Pre-trade mid-market marks are intended to represent an “objective value,” providing counterparties with “a baseline to assess swap valuations.” 

The CFTC found that the swap dealer had transacted dozens of “same-day” equity index swaps with U.S.-based clients and failed to disclose to clients the PTMMM of these swaps. In a “same-day” equity index swap, the equity leg of the swap strikes on the “same day” as the other material terms of the swap are agreed upon, rather than − as is typical − the day after the date of agreement. The CFTC found that the swap dealer often disclosed a PTMMM for a different swap (the analogous “T+1” swap, not the “same-day” swap), thereby obscuring the value of the same-day swap.

Although academic and somewhat arbitrary, PTMMM are clearly important in the CFTC’s view of a swap dealer’s obligation to communicate in “a fair and balanced manner based on principles of fair dealing and good faith” under applicable CFTC rules.

In the second enforcement action, the CFTC sanctioned a U.S. swap dealer for failing to adequately disclose to its non-swap dealer swap counterparties the effects of the swap dealer’s pre-hedging in connection with certain foreign exchange forward transactions. (We note that in the block futures context, which is different from swaps, pre-hedging by intermediaries is actually prohibited in certain circumstances.)

This swap dealer entered into a number of deal-contingent foreign exchange (“DCFX”) forwards for customers who would need foreign currency if an unrelated financing were to close; as such, these transactions were very time-sensitive and typically involved large sums of foreign currency. Upon being instructed to execute the DCFX forward, the swap dealer would pre-hedge in the open market “in the minutes or seconds” before executing the customer transaction. The CFTC found that the swap dealer did not adequately disclose to customers that the swap dealer’s pre-hedging practices may have resulted in less favorable exchange rates.

The CFTC found violations of three of its swap dealer business conduct standards regulations, specifically § 23.431(a)(3)(ii), which requires a swap dealer to disclose to its counterparties all material incentives and conflicts of interest before a swap transaction; § 23.433, which requires communication with a counterparty in a fair and balanced manner; and § 23.602(a), which requires a swap dealer to diligently supervise its business and implement policies and procedures reasonably designed to prevent the violations of the CEA and CFTC regulations. Notably, the CFTC did not find in either of these two enforcement actions that the swap dealers’ failure to disclose caused actual harm to their customers. It follows that to allege the violation of disclosure violations under Part 23 of the CFTC regulations, it is sufficient for the CFTC to merely show a possibility that the disclosures were inadequate, without demonstrating that a swap dealer’s customer actually experienced any negative economic consequences. 

These enforcement actions follow several previous CFTC matters involving primarily pre-trade marks as well as the March 4, 2019 Bogucki decision in U.S. District Court of the Northern District of California. In that case, the court had held that a trader was not involved in “front-running” because the underlying ISDA documentation clearly stated that the counterparties are acting on an arm’s-length basis.

It is likely that in response to these recent CFTC enforcement developments, OTC swaps documentation, such as ISDA’s General Disclosure Statement or the futures- and options-related industry standard disclosures, will need to be updated to provide a more robust set of hedging and pre-hedging disclosures.

By Daniel Meade

Partner | Financial Regulation

Earlier this week, the Federal Reserve Board (“FRB”)  issued its latest semi-annual Financial Stability Report.

As it has in past iterations, the Report notes that the FRB’s monitoring framework “distinguishes between shocks to, and vulnerabilities of, the financial system,” and “focuses primarily on assessing vulnerabilities, with an emphasis on four broad categories and how those categories might interact to amplify stress in the financial system.” The four categories of vulnerabilities are (1) valuation pressures, (2) borrowing by businesses and households, (3) leverage within the financial sector, and (4) funding risks.  

The overview of the Report notes the bank failures that have occurred since the November 2022 report was released, as well as actions taken by the FRB, Federal Deposit Insurance Corporation and the Department of Treasury in response in order “to protect bank depositors and support the continued flow of credit to households and businesses.” The Report went on to note that “banking and financial markets normalized, and deposit flows have stabilized since March, although some banks that experienced large deposit outflows continued to experience stress” and that “[t]hese developments may weigh on credit conditions going forward.”         

The report identified several near-term risks identified by the FRB’s survey respondents that could interact with the four financial vulnerabilities, including “more restrictive policy to address persistent inflation, banking-sector stress, commercial and residential real estate, and geopolitical tensions.”