The recent passage of the Financial CHOICE Act -- “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs” (the “CHOICE Act” or the “Act”) – by the U.S. House of Representatives heralds the long anticipated repeal of certain material parts of the Dodd-Frank Wall Street Reform and Consumer Protection Act. While it is unlikely that the bill survives in its current form, the effect of the final legislation could be significant. Reforming a multitude of areas across the financial sector, from regulations on small community banks to systemic adjustments to the industry framework, the CHOICE Act will be closely watched by all members of the industry as the legislation continues to progress. What follows is a summary of key aspects of the CHOICE Act in its current form.
A Regulatory “Off-Ramp”
A material step in the deregulation of the financial sector would be the creation of a regulatory “off-ramp” from more strenuous regulatory requirements. The CHOICE Act stipulates that a bank that maintains at least a 10 percent leverage ratio will be eligible for this off-ramp. This version of the regulatory off-ramp differs in two significant ways from a prior version of the CHOICE Act. First, the requirement that a bank must maintain a composite CAMELS rating of at least “2” to qualify for the off-ramp has been removed. Second, any bank exercising the off-ramp would be exempt from living will and stress testing requirements (as discussed further below). This would represent an incentive for institutions to raise additional capital if they are close to the 10 percent threshold.
Another proposed benefit for certain qualifying banks is an exemption from federal laws and regulations regarding capital or liquidity standards, and those laws or regulations permitting prudential regulators authority to object to capital distributions. The combination of these regulations would allow qualifying subchapter S banks increased flexibility in making tax distributions, as there would no longer be an expectation that dividends could be made only from current earnings and must be rapidly restricted at the onset of stress. Despite these possible exemptions at the federal level, state-level laws and regulations on these subjects remain unaltered and may limit the utility of the federal exemptions for many community banks.
New Bankruptcy Code Section for Financial Institutions
Another aspect of the proposed legislation would be the repeal of the FDIC’s orderly liquidation authority. In its place, the CHOICE Act would implement a new subchapter of the Bankruptcy Code that is tailored to address the failures of large, complex financial institutions. The shift from an FDIC-run program to a bankruptcy proceeding would result in a modified process administered through the judicial system.
The Consumer Financial Protection Bureau (CFPB) would also see fundamental modifications. It would be renamed the Consumer Law Enforcement Agency (CLEA) and significantly restructured. According to the House Committee on Financial Services’ comprehensive summary of the legislation (the “House Report”), the new agency would be subject to the congressional appropriations process and would be overseen by a director, appointed and removable by the President. Additionally, the CHOICE Act would give Congress the power to review and approve significant agency regulations before they take effect, while granting the courts greater authority to review the agency’s interpretations.
Finally, the new agency would be stripped of the CFPB’s authority to target and sanction unfair, deceptive, or abusive acts or practices (UDAAP).
Regulatory Relief for Community Banks
Qualifying community banks would see significant relief if the CHOICE Act were to pass in its current form. The Act would reduce compliance costs, with the House Report stating the plan “requires regulatory agencies to appropriately tailor regulations to fit an institution’s business model and risk profile.” Similarly, the Act would reduce the reporting requirements of smaller financial institutions by reducing call report requirements and eliminating duplicative data collection demands.
Coupled with these regulatory reductions, the CHOICE Act would provide greater due-process protections for institutions. Specifically, institutions would have increased opportunities to question supervisory and enforcement actions.
Reforms to the Living Will and Stress Test Process
Living wills and stress testing would be overhauled under the CHOICE Act by providing that living wills may only be requested by a banking regulator every two years, requiring the agencies to provide feedback on the living wills to financial institutions within six months of submission, and requiring that agencies publicly disclose their assessment frameworks. These changes to the living will process would introduce increased transparency to the process.
The stress testing regime would also be significantly reformed. First, the House Report indicates the Act would “extend the Federal Reserve’s regulatory relief from CCAR’s qualitative assessment to all banks,” while making internal stress testing an annual requirement and CCAR a biennial process. Second, the Federal Reserve would be required to craft regulations providing for three sets of conditions under which evaluations will be conducted (which would depend on the health of the institution), and models to estimate losses on certain assets. Lastly, the House Report stipulates that the Federal Reserve would be required to publish a summary of all stress test results.
Repeal the Volker Rule
The Act would repeal the Volker rule, which prohibits proprietary trading and the sponsoring of hedge and private equity funds by U.S. bank holding companies and their affiliates. The existing Dodd-Frank framework contains numerous exceptions to this prohibition, but the line between permitted market-making activity and prohibited trading has proven difficult for institutions and regulators to navigate. Repeal of the Volker rule would make it easier for banks to buy or sell securities for their own inventory or in anticipation of client demand.
In addition to the reforms already discussed, the 600-page CHOICE Act would make numerous other changes such as repealing the Financial Stability Oversight Council’s SIFI designation authority and reforming the authority of the Federal Reserve. It would apply the Regulations from the Executive in Need of Scrutiny (REINS) Act to all financial agencies and would repeal the “Chevron doctrine” of agency deference by the courts. Finally, the Act would repeal the Durbin amendment, eliminate the Office of Financial Research, reform the structure and powers of the SEC, and require greater transparency at the National Credit Union Administration.
The changes proposed by the CHOICE Act are significant and would materially alter the business and regulatory landscape of the banking industry. Although the Senate has indicated that it will pursue its own reform of the Dodd-Frank Act and not pass the CHOICE Act, many of the CHOICE Act changes will inform forthcoming debate, and some could soon become law. All industry participants should pay close attention to the Act’s progress, and the course the Senate follows in its own proposals for reform.
About Schiff Hardin’s Financial Institutions Team
Schiff Hardin has a dedicated team of financial institution transactional, regulatory, and litigation attorneys with significant experience handling various aspects of bank and non-bank financial institution matters. Our attorneys regularly advise financial institutions on corporate matters, mergers and acquisitions, regulatory compliance, enforcement matters, and litigation throughout the U.S.