The OCC recently finalized two broad updates to its regulations that increase flexibility for regulatory filings, including for corporate transactions such as business combinations, and update and clarify permissible activities for national banks, federal savings associations, and federal branches of non-US banks. These changes cap a busy year in which the OCC has continued to position the national bank framework as a modern, attractive alternative to other US banking options. US and non-US financial services providers may find that these initiatives make a national bank charter or OCC license the preferred avenue for financial innovation, expansion of US operations, or entry into the US.

For details concerning key US banking agency developments, including proposed and final rules, as well as guidance, visit the White & Case Financial Services Regulatory Dashboard.

What happened?

The OCC finalized broad changes to its regulations concerning procedures for corporate activities (procedures rule) and permissible activities and operations (activities rule). These regulations generally govern what a national bank and federal branch of a non-US bank (generally, national banks or banks) can do, and whether a filing for prior approval or after-the-fact notice is required to engage in activities.

When do these changes take effect?

• The procedures rule is generally effective January 1, 2021.
• The activities rule is generally effective April 1, 2021.

Why make these changes?

The rules finalize proposals from earlier this year and dovetail with recent OCC actions and announcements that seek to position the national bank framework as the preferred avenue for modern financial services providers, as well as traditional financial institutions seeking regulatory flexibility.

The activities rule clarifies and codifies recent OCC interpretations (e.g., custody of cryptocurrencies), adds new authorized activities, and updates or eliminates outdated requirements and terminology (e.g., eliminating certain standalone provisions for "electronic" activities), as well as makes technical changes.

The procedures rule generally simplifies many corporate filings and offers less burdensome notice options and, in some cases, imposes no filing requirement at all. The finalization of these rules also appears to be part of a sprint to the January 20, 2021 finish line when a new US administration takes the reins.

What are the highlights?

Activities Rule

The activities rule generally updates Part 7 of the OCC's regulations to modernize the provisions concerning permissible activities for national banks, consistent with the OCC's overtures in recent years to more modern and innovative financial services providers, products and services—not least of which includes the development of a special purpose national bank charter for fintechs and granting full national bank charters to fintechs. The activities rule also generally aligns national bank powers and federal savings association powers, continuing the integration that began a decade ago.¹

Key takeaways from the activities rule include:

• Part 7 is now technology neutral. As part of a general modernization effort, the regulations no longer maintain a separate list of factors to determine whether "electronic" activities are permissible. Because the OCC uses the same factors to determine whether any activity is permissible when it is not expressly provided by statute, the test is now integrated with more general provisions. The prior illustrative list of permissible electronic activities is retained. This list remains subject to an advance notice of proposed rulemaking on digital activities, and further changes may follow.²
• More flexibility for branchless operations. The activities rule expands the definition of "remote service unit" (RSU), which allows certain operations that are exempt from branch regulations to include automated and unstaffed facilities, among others. The regulations will now allow for more flexible use of RSUs, loan production offices and deposit production offices, and preserve the carve-out for each—as well as locations that engage in all of these activities—from being treated as branches for purposes of the branching and place of business requirements of federal banking law.
• National banks can become payment-system members in private/modern or non-US systems. Such systems are not limited to bank-owned systems. Alternatives include payment systems set up by non-banks, including technology companies. A payment system means any financial market utility, including both retail and wholesale payment systems, but not those payment, settlement, or clearing systems that are not regulated in the US by the SEC or CFTC. Prior notice may be required if the bank's membership would expose it to "open-ended liability," otherwise, after-the-fact notice is available, subject to certain requirements, including a written legal opinion (whether provided by in-house or outside counsel) about the risks involved and a commitment to identify, measure, and control for risk.
• Permissible derivatives activities are now expressly covered by regulation. Part 7 now codifies previous interpretations and includes express provisions for permissible derivatives activities for national banks:

(1)    derivatives referencing underlyings a national bank may purchase directly as an investment;

(2)    derivatives with any underlying to hedge the risks arising from bank-permissible activities (after providing notice to the national bank's Examiner-in-Charge³);

(3)    derivatives within the context of financial intermediation for customers, with any underlying that are:

- customer-driven (i.e., for a customer's valid and independent business purpose; such transactions do not include those entered into by a national bank for the purpose of speculating in derivative, currency, commodity, or security prices);

- cash-settled; and either:

- perfectly matched (i.e., two back-to-back derivative transactions that offset risk with respect to all economic terms (e.g., amount, maturity, duration, and underlying), but a difference in price between two derivatives that reflects a bank's spread is allowed); or

- portfolio-hedged (i.e., hedged based on net unmatched positions or exposures in the portfolio).

Note: Relative to prior OCC interpretations, the final rule makes fewer distinctions based on the particular underlying or how the national bank hedges its derivatives financial intermediation activity. While prior interpretations typically analyzed both the underlying and the bank's method for hedging the customer-driven derivative (i.e., perfectly matched versus portfolio-hedged), the activities rule permits customer-driven, cash-settled derivatives transactions on any underlying, whether perfectly matched or portfolio-hedged.

(4)    derivatives with any underlying that are customer-driven and physically settled by transitory title transfer; and 

(5)    derivatives with any underlying that are customer-driven, physically settled (other than by transitory title transfer), and physically hedged (i.e., holding title to or acquiring ownership of an asset—e.g., by warehouse receipt or book entry—solely to manage the risks arising out of permissible customer-driven derivatives transactions). Physical hedging is only allowed if⁴:

- the national bank holds the underlying solely to hedge risks arising from derivatives transactions originated by customers for the customers' valid and independent business purposes;

- the physical hedging activities offer a cost-effective means to hedge risks arising from permissible banking activities;

- the national bank does not take anticipatory or maintain residual positions in the underlying, except as necessary for the orderly establishment or unwinding of a hedging position; and 

- the national bank does not acquire equity securities for hedging purposes that constitute more than 5% of a class of voting securities of any issuer.

• The new rules may facilitate the elimination of some bank holding companies. New corporate governance provisions permit additional flexibility for choice of domicile, which the OCC notes may make it easier for a national bank to eliminate its parent bank holding company. For instance, a national bank could choose the law of the state of its former parent or controlling bank holding company, or of the bank's main branches, among other options, which removes an impediment to a national bank seeking to eliminate its holding company but wishing to retain longstanding and familiar corporate governance provisions. In addition, the activities rule provides national banks the ability to engage in tax-equity finance,⁵ including through fund structures, subject to certain limitations and with the OCC's prior approval.⁶ As a result, a national bank may conduct such activity directly without, for instance, using a financial holding company's merchant banking authority in an affiliate.
• Some state banks may also benefit. States with wildcard statutes that allow state-chartered banks to enjoy national bank powers will also benefit from these changes.

Procedures Rule

The Procedures Rule makes various substantive and technical changes to Part 5 of the OCC's regulations. These changes generally provide more opportunities for expedited review of applications, notices in lieu of applications, simplified or alternative procedures for filings and, in some cases, no filing at all. The substantive changes are consistent with the OCC's push in recent years to attract more financial services providers to its array of charter options, including banks that seek to invest in (or otherwise do business with) fintechs, as well as fintechs that are considering an OCC charter or license. For more detailed information on key elements of the procedures rule, please refer to Appendix A.

Key takeaways from the procedures rule include:

• More opportunities for expedited review. Eligible banks that meet certain criteria may benefit from many of these opportunities, reducing review periods to 10–45 days. Other opportunities do not require banks to meet the eligible bank standards.

The OCC has also defined and standardized its definition of "well managed" to uniformly include both minimum composite and management-specific examination ratings. Well-managed banks that meet other requirements generally may take advantage of the widest array of reduced procedures. What constitutes well managed, however, remains at the discretion of the OCC and subject to the opaque supervisory process.

• More flexibility for certain non-controlling investments. A national bank may make non-controlling equity investments in entities that have not agreed to OCC supervision, provided the investments pose minimal risk to the bank's safety and soundness. The OCC expects that these changes should facilitate bank investments in fintechs and enhance strategic partnerships and the development of innovative products and services. 

Although prior approval is still required for such investments, previously, such target companies would have to agree to OCC supervision, thus precluding expedited review. In addition, for investments in entities that are subject to OCC supervision and examination, notice procedures or no filing requirement at all may apply.

Under the rule, a "non-controlling investment" is an equity investment made under 12 U.S.C. 24(Seventh) that is not governed by procedures prescribed by another rule.⁷ Non-controlling investments also do not include, for instance, a national bank that holds interests in a trust formed for the purposes of securitizing assets held by the bank as part of its banking business.

• Simplified procedures concerning operating subsidiaries, but no substantive changes for financial subsidiaries. A new procedure allows for notice for an activity that is substantively the same as a previously approved activity, provided the bank meets certain eligibility criteria.

The OCC has clarified that no other person or entity may have the ability to exercise effective control or influence over the management or operations of an operating subsidiary to an extent equal to or greater than that of the bank or an operating subsidiary of the bank. In addition, consistent with general practice, a trust formed to securitize assets held by the bank as part of its banking business is not considered an operating subsidiary, because the bank has limited control over the trust and the beneficial interests in trusts lack many of the indicia of traditional equity (e.g., lack of voting power and operational discretion).

Appendix B includes the operating-subsidiary activities for which the notice procedure may be available, and include certain lending, investment and securities, tax and transactional advice, insurance and other activities.

Annual reports to the OCC describing operating subsidiaries that do business directly with consumers are no longer required.⁸ No substantive changes were made concerning financial subsidiaries.

• More procedural flexibility for certain business combinations. National banks may choose to follow the procedures applicable to state banks where the national bank's main office is located for certain business combinations. The combinations include:

• Other takeaways include:
  • Applicants with novel, complex or unique proposals should seek pre-filing meetings; and
  • The regulations now include explicit exceptions from the residency and citizenship requirements for non-US directors⁹, as well as explicit background requirements for federal branch senior executive officers.

Final thoughts

The finalization of these key regulations, in conjunction with more novel and provocative actions described above, confirms that the OCC continues to actively court traditional and new entrants in the financial services market. US and non-US financial institutions and services providers that seek to operate nationally with uniform rules and without multiple state regulators or without the scrutiny of certain enforcement-focused regulators might carefully consider the revised national bank framework and related license options.

The regulatory and enforcement atmosphere, however, is expected to change in a new US administration, and changes to these rules are possible under a new US administration. Any new OCC leadership would have to follow the requirements under the Administrative Procedures Act to do so. Separately, review under the Congressional Review Act remains a possibility.

Click here to download Appendix A: Key Elements of the Procedures Rule (PDF)

Click here to download Appendix B: Operating Subsidiary Activities Eligible for the New Notice Provisions (Procedures Rule) (PDF)

¹ Under the revised regulations, federal savings association powers are generally consistent with national bank powers, except to the extent federal law provides differences.
²  Finder powers are similarly reorganized, even though the OCC has a separate ANPR on digital services that explores expanding the finder definition.
³  The written notice required includes information that is substantially similar to the information discussed in OCC Interpretive Letter 1160. Specifically, the written notice must include a detailed description of the proposed activity, including the relevant underlying(s); the anticipated start date of activity; and a detailed description of the national bank's risk management system (policies, processes, personnel, and control systems) for identifying, measuring, monitoring, and controlling the risks of the activity. The notice requirement does not impose a prior approval requirement. Rather, the notice is designed to make OCC supervisors aware of a national bank's derivatives activities so that the OCC can scope such activities into its ongoing supervision and oversight of the bank's safety and soundness.
⁴ Physical hedging with commodities is subject to additional requirements that are not detailed in this alert.
⁵ In tax-equity finance transactions, a bank provides equity financing for a project that generates tax credits/benefits and the structure allows for the transfers of such benefits to the bank.
⁶ For instance, the transaction is subject to equity-holding and underwriting restrictions. At a high level, the terms must be loan-equivalent, per the criteria in the regulations, and the arrangement must only last for a "reasonable" amount of time necessary to receive tax benefits or a rate of return based on tax benefits, but not investment or sales revenue. Such investments must be not more than 5% of the bank's capital and surplus in the aggregate and no more than 3% for any single entity, although higher aggregate limits are allowed if OCC approval is received. 
⁷ Non-controlling investments for purposes of revised section 5.36 are distinct from the Federal Reserve's control framework. For information on the Federal Reserve's control framework, please refer to our previous alert.
⁸ The information, however, is still provided elsewhere, including the FFIEC's National information Center and through reports to the Consumer Financial Protection Bureau.
⁹ Banks may request a waiver of the residency requirement for any number of directors by filing a written application. Waivers from the US citizenship requirement may also be granted by written application, but only for a minority of the total number of directors. The OCC notes in the preamble to the procedures rule that "changing geo-political circumstances may in some circumstances warrant the revocation of citizenship waivers, particularly if [non-US] governments are [(in the OCC's estimation)] unduly influencing directors' activities with regard to a national bank."

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