Cryptocurrencies and the Regulatory Landscape
Bitcoin is a digital currency that was created in 2009 by an unknown person using the alias Satoshi Nakamoto.[1] Although it has never clearly been stated why, the Genesis Block (the original block containing the first 50 bitcoins) had a message “The Times 03/Jan/2009 Chancellor on brink of second bailouts for banks.” Many believe that this message is a reference as to the reason Nakamoto wanted to create a pure peer-to-peer version of cash which would enable online payments to be sent directly from one party to another without any involvement of a financial institution. Instead of having a financial institution prevent the double-spend problem, Bitcoin relies on a peer-to-peer network which is now known as the hash. The idea of this network was for the network to verify transactions by hashing them into an ongoing chain of hash-based proof-of-work to form a record that cannot be changed without redoing the proof-of-work. This chain of proof-of-work is now known as the blockchain.
As Bitcoin picked up adoption, many other variations of cryptocurrencies followed. Eventually, other types of cryptocurrencies were created, including stablecoins, and Non-Fungible Tokens (NFTs). Stablecoins were pegged to a fiat currency to fight the volatility of the price of cryptocurrencies, and NFTs were a different type of token that proved authentication rather than be used as a medium for commercial transaction.
Currently, most of the regulations do not apply to traditional banking institutions. Aside from the BSA, many additional regulations apply more so to cryptocurrency exchanges than it does to banks. The offer or sale of cryptocurrency is only regulated if the transaction (1) constitutes the offer or sale of a security under state or Federal law, or (2) is considered money transmission under state law or conduct otherwise making the person a money services business under Federal law. Additionally, the Financial Crimes Enforcement Network (FinCEN) considers exchanges and administrators of cryptocurrencies when they have the authority to both issue and redeem the virtual currency. There are Internal Revenue Services (IRS) regulations and guidance surrounding tax and reporting of virtual currency transactions but as of today, this applies to individuals and cryptocurrency companies in reporting capital gains or losses.
In regard to the other “backend” functions of cryptocurrencies, the OCC has issued a few interpretive letters to clarify what banks are allowed to do:
- Interpretive Letter 1170 clarified that banks can provide custody services for crypto assets.[2]
- Interpretive Letter 1172 clarified that banks can hold stablecoin reserves.[3]
- Interpretive Letter 1174 clarified that banks can participate in independent node verification networks and use stablecoins for payments activities.[4]
- Interpretive Letter 1176 expanded the eligibility for the OCC National Trust Charter by removing the requirement for trust companies to operate in a fiduciary capacity.[5]
Therefore, banks are also able to provide custody services and participate in certain stablecoin transactions. However, it does not appear that many banks have been providing these services yet.
As cryptocurrencies have gained more media attention, and the public adoption of these virtual currencies increased, the regulators have been issuing regulations and guidance on this topic. Not much of the guidance applies to the majority of traditional financial institutions, but we may see regulation increase if and when this sector matures.
[1] See Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, Bitcoin, 1 (2009), https://bitcoin.org/bitcoin.pdf [2] https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2020/int1170.pdf [3] https://occ.gov/topics/charters-and-licensing/interpretations-and-actions/2020/int1172.pdf [4] https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-2a.pdf [5] https://occ.gov/topics/charters-and-licensing/interpretations-and-actions/2021/int1176.pdf
Latest Updates on the LIBOR Transition
Compliance Alliance is committed to bringing you the latest developments in federal banking regulation and the resources to stay compliant. As we get closer and closer to the end of the year more questions keep getting asked about LIBOR, which is scheduled to sunset on the very last day of the year. With the end of the year, and end of LIBOR, now being less than five months away, there has been a remarkable period of silence from regulators on the topic but now there is finally news to report on the anticipated transition. The Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corp. (FDIC) each issued FAQs on the transition in recent weeks and the Federal Reserve’s Alternative Reference Rates Committee (“ARRC”) released its anticipated announcement on a recommended replacement index. Here, I want to share with you the relevant highlights of these releases and what they mean for you and your institution.
On July 29th the ARRC announced, as expected, that it is formally recommending the Secured Overnight Financing Rate (“SOFR”) as LIBOR’s replacement. The decisions confirm what most expected and you can anticipate SOFR becoming the dominant index in the marketplace. With this decision, banks and other market participants can now utilize the recommended best practice materials previously released a week prior by the ARRC when using the SOFR Term Rates in contracts that have adopted ARRC fallback language and new contracts to prepare for LIBOR’s end. Soon, the ARRC will release a factsheet outlining key steps leading to this point, SOFR’s strengths, and upcoming milestones.
The FDIC and OCC, in their separate announcements to their supervised institutions, stated that they do not view replacing or revising a capital instrument with the sole purpose of replacing a reference rate linked to LIBOR with another reference rate as constituting an issuance of a new capital instrument under their capital rules. For purposes of the capital rule, they said, the replacement or amended instrument would retain the maturity of the original instrument. This was an important announcement as banks consider how to adjust current instruments with soon to be outdated reference rates.
The agencies also noted that the replacement or amendment would not create an incentive to redeem, as long as the replacement or amended capital instrument is not substantially different from the original instrument from an economic perspective. “For example, amending the credit spread solely to reflect the difference in basis between Libor and the replacement reference rate and not adjusting for changes in the credit quality of the issuer would not result in creating an incentive to redeem the capital instrument,” according to the FAQs.
Lastly, the agencies said a bank making such adjustments solely to address the move way from LIBOR “should support its determination with an appropriate analysis that demonstrates that the replacement or amended instrument is not substantially different from the original instrument from an economic perspective.” The OCC stated that they may ask banks to provide that analysis.
The above information should help banks plan for their futures in a post-LIBOR world. We anticipate the release of more guidance in the coming weeks.
CFPB Publishes Juneteenth Guidance
On June 17, 2021 the Federal government designated June 19 as the federal holiday of Juneteenth, which was to be observed June 18, 2021, since Juneteenth fell on a Saturday in 2021. Banks nationwide were left wondering how a new federal holiday might affect their loans already in progress. On August 5, the CFPB published guidance answering banks’ questions about what should have been done back in June about their loans already in progress.
Since 1981 there has been a two-tiered definition of “business day” in Regulation Z, with the goal of providing a more definite and uniform definition of the term “business day.” The two tiers include what is referred to as the general definition of business day which means days on which the bank is open for carrying on substantially all of its business functions (meaning that some banks will count Saturdays at business days, and some will not), and the specific definition of business day, which means all calendar days, except Sundays and federal holidays.
The CFPB’s Juneteenth guidance addresses the specific business day definition as it applies to four TRID requirements and clarifies that the effect will be that the four TRID requirements will be viewed in light of the definition of business day that was in effect when the activity occurred. Because the customer is not negatively affected by receiving more time than the regulation requires, there is no penalty for any banks that treated Saturday, June 19 as a holiday and extended the rescission, delivery or receipt periods by an extra day.
Rescission
Regulation Z provides that for loans secured by a consumer’s principal dwelling, each consumer will have a right to rescind the loan until midnight of the third business day following closing. For those transactions for which the rescission period began on or before June 17, 2021 both Friday, June 18 and Saturday, June 19 were considered business days. Conversely, for those transactions for which the rescission period began after June 17, Friday, June 18 was considered a business day, but Saturday, June 19 was not considered a business day, and was considered a federal holiday.
Mailbox Rule
Regulation Z provides that if a loan estimate or closing disclosure is not delivered in person, the disclosure is considered to be received three business days after it is placed in the mail. For those transactions in which disclosures were placed in the mail on or before June 17, 2021, both Friday, June 18 and Saturday, June 19 were considered business days. If, however, the disclosures were placed in the mail after June 17, Friday, June 18 was considered a business day, but Saturday, June 19 was not considered a business day, and was considered a federal holiday.
Initial Loan Estimate Seven Business Days Prior to Closing
Regulation Z requires that the initial loan estimate be delivered or placed in the mail no later than seven business days before loan closing. For transactions for which the initial loan estimate was delivered or placed in the mail on or before June 17, 2021, both Friday, June 18 and Saturday, June 19 were considered business days. However, for transactions for which the initial loan estimate was delivered or placed in the mail after June 17, Friday, June 18 was considered a business day, but Saturday, June 19 was not considered a business day, and was considered a federal holiday.
Receipt of Revised Loan Estimate (LE) and Closing Disclosure (CD)
Regulation Z requires that any revised LE be received no later than four business days prior to closing, and the initial CD be received no later than three business days before closing. For transactions for which the revised LE or initial CD was provided on or before June 17, 2021, both Friday, June 18 and Saturday, June 19 were considered business days. For transactions for which the revised LE or initial CD was provided after June 17, Friday, June 18 was considered a business day, but Saturday, June 19 was not considered a business day, and was considered a federal holiday.
Continuing to Modify Loans for Borrowers Affected By the Pandemic
During the pandemic, many regulations and guidance came out to protect consumer interests and assist in avoiding foreclosures. A lot of these rules are set to expire during this Summer and the Consumer Financial Protection Bureau (CFPB) issued a final rule regarding protections for borrowers affected by the COVID-19 Emergency Under the Real Estate Settlement Procedures Act (RESPA) to ensure a smooth transition to go back to “normal.” Since the CARES Act was passed in Spring 2020, mortgage servicers placed over seven million borrowers into forbearance programs. This final rule which is effective on August 31, 2021 puts forth temporary procedural safeguards to ensure borrowers have an opportunity to be reviewed for loss mitigation before a servicer can make the first notice or filing for foreclosure. The temporary safeguards are set to expire on October 1, 2022.
The temporary safeguards were created to ease borrowers from their COVID foreclosures. Generally, a servicer must provide borrowers with an opportunity before making the first notice or filing required for foreclosure due to delinquency to pursue loss mitigation options. This requirement applies if:
- The borrower’s loan obligation is more than 120 days delinquent on or after March 1, 2020; and
- The statute of limitations for the foreclosure action in their given state or municipality expires on or after January 1, 2022.
A procedural safeguard has been met and the servicer could proceed with foreclosure under any one of these three circumstances:
- The borrower submitted a completed loss mitigation application and permits the servicer to make the first notice or filing;
- The property securing the mortgage is abandoned under state or local law; or
- The servicer has performed outreach and the borrower has been unresponsive.
These safeguards are set to expire on January 1, 2022.
As for loan modifications, the rule continues to allow banks to accept incomplete loss mitigation applications. The modification also cannot increase the borrower’s monthly principal and interest payment. If the modification allows the borrower to delay paying certain amounts until the loan is refinanced, the property is sold, the loan matures, the mortgage insurance terminates for a loan insured by the Federal Housing Administration, those amounts cannot accrue interest. The borrower’s acceptance of the modification ends any preexisting delinquency on the loan or it must at a minimum be designed to end such delinquency. Additionally, the servicer cannot charge any fee in connection with the modification and would have to waive all existing late charges, penalties, stop payment fees, or similar charges incurred on or after March 1, 2020, upon the borrower’s acceptance of the modification. Finally, the servicer isn’t required to exercise reasonable diligence to complete the loss mitigation application and send an acknowledgement notice.
Regarding the reasonable diligence, the servicer must contact the borrower no later than 30 days before the end of the forbearance period if the borrower remains delinquent to determine whether they wish to complete the loss mitigation application and proceed with a full evaluation. Then, if the borrower indicates the need for further assistance, the servicer must exercise diligence to complete the application before the end of the period.
As the forbearance moratoria comes to its expiration, banks should determine which borrowers are experiencing hardships related to the pandemic and implement the procedures to be compliant with this new rule.