Major Developments In Fintech Regulation: Midyear Report

By Philip Rosenstein
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Law360 (July 29, 2020, 6:44 PM EDT) -- The first half of 2020 saw a former cryptocurrency executive catapult to the top of a federal banking regulator, while state financial agencies reinforced their oversight of fintech and consumer protection as Congress began discussing the significance of digital assets with increased urgency.

The former chief legal officer at cryptocurrency exchange Coinbase, Brian Brooks, was tapped as acting head of the U.S. Office of the Comptroller of the Currency on May 29, having joined the agency earlier this year. In Brooks' time at the helm, the agency has put out a wide-ranging request for comment on existing regulations that govern the use of tech in banking, finalized a rule addressing a critical question in the fintech lending space and expressed the potential for a national payments charter that could ease the entry of nonbank fintech companies into the American market.

As the COVID-19 crisis rages and social distancing remains the norm, Congress has held hearings about the implementation of a digital dollar and the opportunities that digital payments could offer American consumers.

Meanwhile, other federal regulators have directed attention to parties seeking to take advantage of the economic turmoil unleashed by COVID-19, and have reiterated their concerns with digital currency being used as a means of skirting regulatory oversight. Among those regulators is the Financial Crimes Enforcement Network, which has released notices for consumers to be on the lookout.

On the state level, financial regulators in California and New York have moved to implement more robust innovation offices and consumer protection oversight, hoping to pick up slack from what the states see as a lagging Consumer Financial Protection Bureau. And the Department of Financial Services in New York rang in the five-year anniversary of its BitLicense program with a package of proposed updates to further streamline the regulatory process for listing digital currencies.

With significant movement on the fintech regulatory front over the first six months of 2020, Law360 takes a look at some of the most impactful developments.

OCC Signals a Fintech-First Approach to Banking

Brooks has pushed the OCC into top gear to tackle regulatory questions around the use of fintech in banking, with an advance notice of proposed rulemaking published June 4. The notice confirmed the active review of regulations that address digital activities in banking and solicited comments on how existing regulations on such use of digital technology may be out of date.

"He's clearly moving quickly," Clifford Stanford, a bank regulatory partner at Alston & Bird LLP, told Law360. "Clearly from the ANPR and interviews, he's drawing attention to these issues and questions — moving the needle on the policy dialogue and making sure that fintech is part of the conversation and that it's not lost that fintech questions are important."

"The ability for the institutions that he's responsible for to engage in activities that relate to cryptocurrency or fintech will allow for the evolution of financial services and innovation in that space," he said.

The OCC has wrestled with digital innovation in banking since it first issued regulations that governed data processing in 1996, with more guidance released in 2002 and updated in 2008. Other regulations were issued in 1998, with updates in 2001 and 2017, addressing the use of technology by federal savings associations.

As the agency undertakes a review of these regulations, it has asked the industry and other stakeholders to provide input on the efficacy of existing rules, given the quickly changing technological landscape. In addition to seeking thoughts on how banks are using digital assets, blockchain technology, artificial intelligence and machine learning, the agency is also interested in learning about developments in payments innovation and "regtech."

Joshua Ashley Klayman, senior counsel at Linklaters LLP who serves as the firm's U.S. head of fintech and head of blockchain and digital assets, told Law360 that Brooks' appointment to lead the OCC "points to the future of our financial system, and the potential marriage of crypto innovation with mainstream markets."

Earlier this month, the OCC also released an interpretive letter stating that banks can custody crypto assets.

Brooks has also floated the idea of a national payments framework that could help regulate fintechs looking to do business in the payments space on a nationwide basis.

"A federal payments charter is an option that would boost innovation, competition and ultimately benefit customers with lower costs, better speed, better service," Nick Catino, head of policy and campaigns at global payments company TransferWise, told Law360. "That's why you see in the U.K., they have an e-money license, in the European Union there's a payments institution license, and in Canada they're moving forward with a new regulatory regime with this goal."

Catino explained that the payments charter would be a significant boon to the fintech industry, particularly since it could provide access to Federal Reserve Bank services.

"That's a conversation that really hasn't been had here in the U.S. and is now starting to happen," he said.

Fintech-Bank Partnerships Get a Boost

The OCC and the Federal Deposit Insurance Corp. both finalized their rules on the "valid when made" question in the first half of the year, asserting that a legal interest rate on a bank-originated loan remains valid throughout the lifetime of the loan.

The OCC issued its final rule at the end of May stating that interest rates established on bank-originated debt remain valid even after the debt is transferred to a nonbank partner. The FDIC rule covers the permissibility of interest rates charged on loans made by state-chartered banks, and largely mirrors the OCC's.

"As a whole, I would say it is a huge win for the OCC in the canon of banking law tradition at the federal level, because it's another assertion of the OCC's ability to create a national harmonized playing field for banks and bank partners," Pratin Vallabhaneni, a White & Case LLP partner who had a stint at the FDIC, told Law360.

The rules provide clarity across the country for banks and fintech companies, Vallabhaneni said, making it easier to generate a pipeline of loans. When a bank doesn't know whether loans will actually bear the interest rate at which they were underwritten, it makes it more difficult to securitize them, which provides a robust revenue stream for the large vendors, he added.

Legal uncertainty over the validity of interest rates on loans that are transferred to nonbank partners stems from the Second Circuit's 2015 decision in Madden v. Midland Funding , which cast doubt on the enforceability of some interest rates charged on loans that nonbanks acquire from bank originators.

Alston & Bird's Stanford added that the valid-when-made rules were "long needed and long desired, especially in the lending space in fintech, providing clarity in the secondary market for loans generated on [lending] platforms."

A related concern, the true lender question, is being addressed by the OCC as well, with a proposed rule released earlier this month that would clarify that a bank is the "true lender" of a loan if that institution is named on the loan document at the date of origination or if it funds the loan.

States Continue to Delve Into Fintech and Consumer Protection

Large states like New York and California, homes to the headquarters of numerous financial institutions, have seen their regulators enhance cooperation with fintech companies through innovation offices.

Reflecting what New York did in 2019, California Gov. Gavin Newsom's plan to restructure the California Department of Business Oversight and rename it the Department of Financial Protection and Innovation would include the establishment of a Financial Technology Innovation Office to manage the development of new financial products responsibly.

The plan to restructure the DBO would also put an increased focus on financial protection. The governor noted in his budget address in January that it was his administration's aim to fill a gap left by the federal government under President Donald Trump. The budget summary outlined that the CFPB has left Californians vulnerable to predatory businesses and companies without the clarity they need to innovate.

California's proposed reform to its financial regulator would also allow for more powers, including enforcement to better protect consumers. New York Gov. Andrew Cuomo announced a similar proposal in January to reinforce the state's ability to oversee financial protection.

"The political movement in California to create a mini-CFPB and reorganize the DBO looks to be gaining significant political steam. Obviously, the politics of California are much different than the politics of Washington at the moment," White & Case's Vallabhaneni said.

"It is very interesting and potentially very exciting and influential, because either companies are based in California, so they're going to be under the regulation of the California financial services regulator, or if they're not based in California, they certainly do business in California with California residents," he added. "So they will be caught up and in this way, California can synthetically become a national regulator on par with the feds."

New York, for its part, has been moving quickly on the digital asset front, proposing updates to its BitLicense regime as it hit its five-year anniversary. In late June, the New York Department of Financial Services issued a proposal outlining its concept for a conditional version of its BitLicense that would give startups and other early- to mid-stage companies a regulatory on ramp to the New York market.

This conditional license would allow its recipients to engage in cryptocurrency activities in the state while partnered with an existing BitLicense holder for sponsorship and support, providing them with a platform to begin operations until they're ready to shoulder the costs and challenges of getting fully licensed.

COVID-19 Highlights Digital Asset Opportunities and Concerns

As the COVID-19 health and economic crises roil countries around the world, consumers have started to shift toward digital banking. Congress held hearings on the potential for a digital dollar, during which the former chairman of the U.S. Commodities Futures Trading Commission, J. Christopher Giancarlo, urged the adoption of a digitized dollar.

Separately, legislation to create a digital wallet through which Americans eligible for the COVID-19 stimulus relief payments could receive a cash infusion was proposed by Sen. Sherrod Brown, D-Ohio. The Banking for All Act would provide for the creation of "digital dollar wallets," or FedAccounts, to be maintained by any Federal Reserve bank. FedAccounts would be accessible at any post office or local bank and could be opened by any U.S. citizen.

"The COVID-19 crisis and its resulting social distancing arguably has provided an extended proof-of-concept for a wide variety of digital innovations, potentially greatly accelerating their mainstream adoption," Linklaters' Klayman said.

"In my view, this has been true in terms of payments innovations generally, and the crypto space is no exception," she added. "At a time when numerous financial institutions have closed branches, many banks arguably are facing growing pressures to provide broad digital solutions and face competition not just from other banks, but also from digital native companies."

Klayman explained that remote work and virtual learning have been familiar to those in the blockchain and crypto space, and that she sees signs of a "digital dawn" following an extended "crypto winter."

As interest in digital assets waxes, federal agencies have released notices cautioning consumers about potential nefarious activity that may involve cryptocurrency. COVID-19 has led to the emergence of new cyber-focused illicit schemes targeting vulnerable individuals and companies, FinCEN Director Kenneth Blanco said at a conference in May.

That same month, the Financial Action Task Force, a global watchdog that sets international standards for combating money laundering, published a report detailing various risks businesses are facing in light of COVID-19 as a result of widespread business closures and a general policy shift to focus on the health crisis.

Those risks include an increase in the incidence of fraud, including the impersonation of officials and the proliferation of investment scams; increased cybercrime; and an increase in the "misuse of online financial services and virtual assets to move and conceal illicit funds," the FATF report stated.

--Editing by Kelly Duncan and Michael Watanabe.

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